The rational choice theory, the rational choice theory of religion and behavioral finance theory
Rational Choice Theory suggests that individuals make decisions by systematically evaluating the available options to maximize their utility, based on preferences that are stable, coherent, and transitive (Handfield, 2014). This theory assumes that individuals have full information, can process this information effectively, and are motivated purely by self-interest to achieve the most favorable outcomes (Becker, 1976). It embodies the classical economic view of humans as rational actors, consistently making choices that maximize their utility. In the context of Islamic financial literacy, Rational Choice Theory suggests that Muslims equipped with knowledge about Islamic finance principles would make rational decisions to engage with financial products and services that not only comply with Shariah law but also offer competitive returns or benefits, thereby maximizing their economic utility. The decision to acquire Islamic financial literacy and apply it in financial management behavior is viewed as a rational pursuit to align financial actions with religious values while seeking the best possible economic outcomes. Rational Choice Theory has been applied in relation to financial literacy and its influence on financial decision-making, including biases (Loerwald and Stemmann, 2016). Within the realm of Islamic financial literacy, it implies that Muslims with knowledge of Islamic finance or sufficient Islamic financial literacy are likely to make informed decisions favoring financial products and services that adhere to Shariah law while offering competitive returns, thus maximizing their economic utility.
The Rational Choice Theory of Religion posits that individuals approach religious practices and beliefs through a cost–benefit analysis, aiming to maximize personal spiritual and social rewards (Jerolmack and Porpora, 2004). Stark and Finke (2000) argue that this theory helps explain why people are drawn to certain religious practices over others, suggesting that individuals make rational choices based on the perceived benefits of their religious engagement. Iannaccone (2016) further explores how this theory can account for various religious phenomena, including conversion and the level of commitment to religious observances, by examining the costs and benefits associated with these actions. This framework challenges older perspectives of religion as merely a societal or cultural phenomenon, instead proposing that religious behaviors can be understood through the same rational processes that govern economic decisions, highlighting the strategic and often economically driven choices individuals make within their religious lives.
Behavioral Finance Theory challenges the classical assumption of Rational Choice Theory, asserting that financial decision-making is influenced by psychological factors and cognitive biases (Kahneman and Tversky, 1982). Quackenbush (2004) notes that Rational Choice Theory often overlooks how decision-makers’ rationality is constrained by institutional, cultural, and psychological factors, suggesting that the premise of rational behavior may be overly optimistic. Mansour and Jlassi (2014) found that religious beliefs can sometimes clash with the principles of financial theory when it comes to decisions related to finance and investment. Behavioral Finance acknowledges that financial decisions are often influenced by psychological biases and emotions rather than purely rational calculations (Kahneman and Tversky, 1982). Relating this to Islamic financial literacy and financial well-being, it can be argued that psychological factors such as identity, trust, and the desire for social cohesion play significant roles in Muslims’ financial decisions. For instance, even if conventional financial products offer higher returns, psychological biases towards conformity with Islamic principles and the emotional comfort of engaging in religiously permissible transactions might lead individuals to opt for Islamic financial products.
In sum, Rational Choice Theory and the Rational Choice Theory of Religion provide frameworks for understanding the deliberate, utility-maximizing choices behind the acquisition and application of Islamic financial literacy and engagement in Shariah-compliant financial behaviors. Behavioral Finance adds depth by highlighting the psychological and emotional dimensions that influence these decisions. Together, these theories offer a comprehensive view of how Islamic financial literacy, influenced by rational calculations and psychological factors, shapes financial management behavior and contributes to the financial well-being of Muslims, balancing economic objectives with religious adherence. Behavioral finance introduces the concept that psychological influences and cognitive biases can affect financial decision-making, acknowledging that emotional and psychological factors derived from religious beliefs significantly influence financial decisions beyond rational calculations. This approach is particularly relevant when examining the impact of religiosity and Islamic financial literacy on financial behavior and well-being, helping to explain how sociodemographic variables might affect financial behavior and well-being by influencing individuals’ perceptions, risk tolerance, and decision-making processes.
Centrality of religiosity
Beliefs and experiences of divine existence are universal components of human life (Luckmann, 1990). This belief is manifested in the concept what so-called religion. A belief system that relates humanity to spirituality gives meaning and purpose to human life. It reinforces social unity and stability; serves as an agent of social control; promotes psychological and physical well-being; motivates people to work for positive social change and other social behavior (Barkan, 2021; Renneboog and Spaenjers, 2012).
Theoretically, religion’s central position in one person’s life has been measured using the concept of the Centrality of Religiosity (Huber and Huber, 2012). The idea integrates the perspective of sociology and psychology in viewing the Centrality of Religiosity through five dimensions: intellectual, ideology, public practice, private practice, and religious experience (Esperandio et al., 2019; Huber and Huber, 2012; Łowicki et al., 2022). First, the intellectual dimension refers to the religious reflexivity and social expectation that religious people understand and can articulate their beliefs about religion, transcendence, and religiosity, as exhibited in how frequently one considers religious issues in life (Huber and Huber, 2012; Zarzycka et al., 2020). The second is the ideology dimension. It is defined as the social presumption that religious people hold ideas about the presence and nature of a transcendent reality (Fear of God) and the connection between that reality and humanity (Huber and Huber, 2012; Zarzycka et al., 2020). The third is a public practice which refers to the social expectation that members of religious communities be active in their communities, as seen by the public’s engagement in religious ceremonies and social gatherings (Huber & Huber, 2012). Fourth is a private practice that reflects the devotion of the religious people in spending their time to the transcendence in private rites and activities (Huber & Huber, 2012). Last is a religious experience. The dimension resembles the assumption that religious people have some close relationship (contentment) with a higher reality (Huber & Huber, 2012; Zarzycka et al., 2020).
Islam, in particular, places religion in a central position in Muslim life (Haneef, 1997). In line with the first intellectual dimension, Muslims are encouraged to remember Allah often and glorify him morning and evening (Surah Al-Ahzab—41-42, 2022). Regarding the ideology dimensions, Islam obliges its adherence to the belief of transcendence or what is called Iman (al-Faruqi, 1992). Islam declares that everyone should care for God’s transcendence. It claims that God created all people with the ability to know Him in His transcendence. This is a natural blessing that all people forbid discrimination as believing in transcendence reality is something innate to humanity (al-Faruqi, 1992).
According to Kuran (1995), Islam has clearly outlined the norms and guidelines on how Muslims should manage their economic behavior by avoiding waste, excess, and ostentation. This fact shows that Islam as a religion holds the way it behaves economically. Islam forbids Muslims from engaging in extravagance and being spendthrift (Musadik and Azmi, 2019). For Muslims, Islam has a central position in their life and guides how they behave in any dimension of life, including their financial management behavior. Given this, it is hypothesized that:
The effect of religion in influencing individuals’ well-being has been a topic of discussion in the academic literature for a long time (St. George and McNamara, 1984). Previous studies have shown that religiosity has a positive impact on individual well-being (Green and Elliott, 2010), as evidenced by lower anxiety scores and a stronger sense of life direction (Phillips et al., 2022). A study conducted by Green and Elliott (2010) found that individuals who identify as being religious tend to express higher levels of health and happiness, more participation in religious activities, and better financial situation regardless of their specific religious denomination. A significant relationship between religiosity and well-being was also supported in the pandemic context (Hu and Cheng, 2022). In the context of finance, Renneboog and Spaenjers (2012) found that people’s perceptions of the importance of saving, risk, financial responsibility, and other critical economic concepts are influenced by their religious beliefs. Krause and Hayward (2015) found that individuals who faced financial hardship but had greater trust in god were reported to have higher self-rated health, lower depressed affect scores, and higher life satisfaction.
According to Abdellatef (2021), rationality, as central dogma in mainstream economics, has faced harsh criticism throughout the history of economic thought and the rise of modern economics due to the “homo-economicus” primary axiom’s inability to reflect reality. In contrast, Islamic economics views an Islamist rationalist as the utility and morality maximizer who balances his well-being to maximize utility in life here and hereafter (Abdellatef, 2021). Therefore, it is hypothesized that:
Islamic financial literacy
Financial literacy can be defined as the knowledge of fundamental economic and financial concepts and the ability to utilize that knowledge, along with other financial skills, to manage financial resources effectively for a lifetime of financial well-being (Stolper and Walter, 2017). Financial literacy is critical for individuals to make sound financial decisions (Dinc et al., 2021; Hamid and Loke, 2021). Numerous studies have found evidence that higher financial literacy leads to greater economic resilience (Lusardi et al., 2021), a higher probability of having emergency savings (Babiarz and Robb, 2014), better credit score (Huston, 2012), more responsible credit card usage (Kurowski, 2021; Robb, 2011) and prevents individuals from holding risky credit portfolios such as home-collected credit, mail order catalog debt, and payday loans (Disney and Gathergood, 2013; Kurowski, 2021).
Generally, Islamic financial literacy is discussed in the context of Islamic economics. It refers to a person’s ability to manage financial resources according to Islamic principles, using financial knowledge, skill, and attitude (Rahim et al., 2016). Islamic financial literacy has been driven by both the internal and external factors of the Muslim community. Internally, Muslims are required to obey Islamic teachings; externally, the presence of complex financial products leads the Muslim community to respond by making financial decisions based on Islamic financial literacy (Setiawati et al., 2018).
Islamic financial literacy also provides an understanding of the distinctions between Islamic and conventional financial products (Albaity and Rahman, 2019). It is crucial in appreciating the positive impact of Islamic financial literacy on financial management behavior. Islamic financial products are designed based on Shariah principles, which prohibit interest (riba), uncertainty (gharar), and investment in haram (forbidden) activities (Hassan and Lewis, 2009). This fundamental difference influences the structure of products, such as Islamic loans, which are based on profit-sharing (Mudarabah) or lease (Ijarah) principles, rather than interest payments, and Islamic investments that ensure compliance with ethical standards (Hassan and Lewis, 2009; Mansour et al., 2015). Consequently, Muslims equipped with Islamic financial literacy are more capable of making informed decisions that align with their religious beliefs and ethical considerations (Biplob and Abdullah, 2019; Muhamad et al., 2016). This knowledge empowers them to choose financial products that not only meet their economic needs but also adhere to Islamic teachings, contributing to responsible financial management and avoidance of prohibited transactions (I. Osman et al., 2023).
The increasing attention to the significant role of financial literacy is attributed to the rising level of indebtedness among young people. According to Zainudin et al. (2019), preferences for lavish lifestyles have led them to spend beyond their limits to the point that they are willing to incur debt. This is contrary to Islam’s teachings, which promote moderation in spending and limit the use of debt only for genuine needs. A hadith narrated by Imam Ahmad, where the Prophet Muhammad (Peace Be Upon Him) was reported to have said:
“Be wary of debts. Indeed, it is sadness at night and a disgrace during the day,” stresses that being in debt not only leads to an increase in financial burden but can also cause emotional burden. This explains why the concept of moderation in spending is highly encouraged in the Quran, as stated in chapter Al-Furqan verse 67, which means: “Those who, when they spend, are not extravagant and not niggardly, but hold a just (balance) between those (extremes).”
Based on the above discussion, the following hypothesis is developed:
Many studies have shown the significant effect of financial literacy on individuals’ well-being (Z. Osman et al., 2018; Younas et al., 2019). It is important to note that the success of a financial education program should not only be assessed by financial outcomes such as obtaining a bank account, buying a home, or maintaining saving habits. It should also be evaluated in terms of the enhancement of life satisfaction, happiness, and a sense of financial security (Kozup and Hogarth, 2008). In the Islamic research context, Islamic financial literacy is also proven to significantly influence Muslim customers’ well-being (Abdullah et al., 2019). Therefore:
Based on the above hypotheses, the following research model is developed (see Fig. 1).
