Responsible innovation in the financial sector: an Islamic perspective

ABSTRACT

In today’s dynamic economic environment, innovation is commonly perceived as one of the critical mechanisms for businesses in attaining sustained competitive advantage. Moving alongside other sectors, banks and financial institutions also produce innovative products and services. However, the recent major financial crisis has been attributed to irresponsible innovation in the financial sector. Consequently, there is a need to emphasize responsible innovation practices that not only focus on monetary outcomes but also on the welfare and safety of society. This perspective briefly explores responsible innovation practices in the financial sector from an Islamic perspective.

KEYWORDS:

• Financial innovation
• responsible innovation
• Islamic banking and financial institution

Introduction

Innovation is commonly perceived as a key component in improving the efficiency, productivity and profitability of businesses. Yet, while many studies on innovation focus on manufacturing and product-based business, the financial sector is often left out of mainstream research on innovation. Given that the major financial crisis of 2008 has been attributed to irresponsible innovation in the financial sector (Clement, James, and Van der Wee 2014), there is a clear need to emphasize responsible innovation practices that not only focus on monetary outcomes but also on the welfare and safety of society.

Financial innovation is a significant yet often overlooked form of innovation (Su and Si 2015). Past studies on financial innovation have focused on the behavioral determinants of financial innovation (Su and Si 2015), the process and governance of financial innovation (Asante, Owen, and Williamson 2014), the implications of differential awareness for financial innovation (Quiggin and Hammad 2014), the effects of micro-financial innovation on the financial performance of institutions (Muriungi 2014), financial innovation in social service delivery to the poor (Masino and Niño-Zarazúa 2014), financial innovation development in national contexts such as Indonesia (Iman 2014), the determinants of financial innovation (Arnaboldi and Rossignoli 2014) and theoretical aspects of financial innovation (Wan Kamarudin and Ismail 2013).

Financial innovation is defined here as the adoption of new or improved products and/or processes that lower the cost of producing existing financial services (Heffernan, Fu, and Fu 2013). Like other types of innovation, financial innovation is an ongoing process responding to changes in the economy (Wan Kamarudin and Ismail 2013) as well as to other societal and technological changes. Financial innovations are associated with economic growth and development, are thought to make economic development possible (Ülgen 2013), allow cost or risk reduction for banks (Arnaboldi and Rossignoli 2014) and have transformed the business of banking (Al-Salem 2009). However, there has been serious risk associated with excessive financial innovation, especially in the absence of adequate regulation. In fact, both public opinion and academic literature blame the Asian financial crisis of 1997–1998 (Buckley, Arner, and Panton 2014) and the global financial crisis of 2008 (Clement, James, and Van der Wee 2014) on financial innovation.

Both the risks and the perception of risks associated with it point to a need for more responsible governance of financial innovation. Asante, Owen, and Williamson (2014) define governance of financial innovation as relating to the processes and mechanisms used by stakeholders to manage and oversee the creation, development and commercialization of financial products and services.

Innovation in financial product development in particular has received a great deal of criticism in the wake of the recent financial crisis that affected the developed economies around the world (South Asian Media Net 2012). These criticisms may be due to the focus on monetary reward or on financial outcomes as the sole objective of conventional financial innovation. By contrast, other approaches include ethical, cultural, and religious considerations. For instance, in addition to monetary reward, an Islamic approach to financial innovation also focuses on the safety and welfare of the community by complying with Sharia’ah law. Therefore, it can serve as a promising basis for responding to the need to develop a more responsible way to handle financial innovation.

The purpose of this paper is to briefly explore responsible innovation practices in the financial sector from an Islamic perspective. This paper locates and engages responsible financial innovation in contexts, cultures and practices of Islam. It briefly explains the concept of responsible innovation and then goes on to discuss the concept of Shari’ah-compliant responsible innovation. It concludes by providing suggestions and a recommendation to Islamic banking and financial institutions regarding Shari’ah-compliant responsible innovation.

Responsible innovation in finance

Responsible innovation is emerging as an important discourse (Macnaghten et al. 2014) in various disciplines, including finance and banking (Armstrong et al. 2012; Asante, Owen, and Williamson 2014). Responsible innovation ‘ … seeks to imbue in the actors of the innovation system a more robust sense of individual and collective responsibility’ (Valdivia and Guston 2015). For some, such as Halme and Korpela (2014), responsible innovation involves new or significantly improved products, services or business models whose implementation in the market solves or alleviates environmental or social problems. Others go further: Responsible innovation must not only alleviate problems, it must allow stakeholders to effectively evaluate outcomes based on societal needs and moral values (European Commission 2013).

According to Armstrong et al. (2012), responsible innovation in finance can be variously defined in terms of whether a particular financial innovation: (1) respects the functions of finance in the economy, (2) is authorized with regards to superior moral principles, (3) is carried out by agents with intrinsic moral values, (4) considers the effects of its own diffusion, (5) allows responsibility tracing for which an agent is ready to acknowledge liability, (6) is developed within a safety net, or (7) is rendered discussable by all concerned parties.

An Islamic perspective on responsible innovation in finance

Existing literature provides focal points to examine new products from the perspectives of function, moral rules, internalized values, aggregate consequences, accountability, precaution and democracy (Armstrong et al. 2012). In addition to the conventional approach of meeting the economic needs of society, Islamic banking and financial institutions are required to develop products to achieve the goals of Shari’ah (Al-Salem 2009) while maintaining the ability to achieve similar profitability as compared to conventional financial products (Dar 2003).

Briefly defined, Shari’ah is ‘a set of recommendations and principles contained in the Quran and the prophetic tradition’ (Diaw 2015). Although financial instruments offered by Islamic banks should also be directed towards achieving the purpose of Shari’ah (Wan Kamarudin and Ismail 2013), in the existing economic system it is a major challenge to develop products in compliance with Shari’ah (Al-Salem 2009). Examples of Shari’ah-compliant requirements include matters pertaining to forms of Riba (interest), Gharar (uncertainty on the terms of the contracts) and Maysir (gambling) (Mohamad and Furqani 2013).

Future directions for Islamic banking and financial institution

Arguably, responsible financial institutions must keep abreast of new and emerging technologies such as wearable devices, the Internet of things, next-gen biometrics, virtual assistants and natural language question answering and new currency (Jacobs 2014). To continue to thrive, Islamic banking and financial institutions may wish to consider developing and deploying a common responsible financial innovation framework. One promising step in this direction would be for Islamic banking and financial institutions to assimilate the framework of responsible innovation that consists of anticipatory, reflective, deliberative/inclusive and responsive dimensions (Owen et al. 2013; Stilgoe, Owen, and Macnaghten 2013) with Shari’ah perspectives and aims of serving public interests. Table 1 briefly explains the application of each dimension within the responsible financial innovation framework incorporating an Islamic perspectives.

Table 1. Mapping responsible innovation to responsible financial innovation.

Dimension	Meaning	Islamic Perspectives of Responsible Financial Innovation
Anticipation	Describe and analyze both intended and unintended impacts.	Consequences of today’s action on the state of the world tomorrow. Respect the function of finance in the economy and regarding the safety and welfare of the community.
Reflexivity	Reflecting on underlying purposes, motivations and potential impacts, known and unknown	Superior moral principles and social objectives. Lesson from narration of important events in the Quran can underwrite knowledge and innovation.
Deliberation	Deliberate through dialogue, public engagement and debate	Inclusive debate and empowerment of stakeholders. Quranic verses advise engaging in contemplation in finding the truth.
Responsiveness	Set the direction and influence	Compliance with Shari’ah while seeking the economic effects of conventional products. Availability of safety nets and rescue paths.

Developed based on Dar (2003), Adham et al. (2012), Armstrong et al. (2012), Barom (2013), Stilgoe, Owen, and Macnaghten (2013), Owen (2014) and Valdivia and Guston (2015)

Anticipation is intended build adaptive capacity regarding future consequences of current innovations. Reflexivity increases awareness of and about moral principle and social objectives. The third dimension, deliberation, ensures that all stakeholders are involved in the innovation process. Finally, responsiveness includes mechanisms to influence the design and use of an innovation as well as necessary backups in case the innovation fails.

In short, Islamic banking and financial institutions should pay attention to a broader range of considerations that can influence innovation in banks including factors related to competitors, markets, internal management, customers and technological advancement (Iman 2014).

Conclusion

Responsible financial innovation is critical for ensuring the survival and profitability of financial institutions as well as promoting financial development and broadening financial inclusion (Masino and Niño-Zarazúa 2014). It is important to incorporate public values in responsible innovation (Taebi et al. 2014) as it requires both a high level of personal commitment and collective responsibility (Asante, Owen, and Williamson 2014). Islamic countries must be part of the mainstream discourse as well and not just ‘as an after-thought, or just as another comparative case study’ (Macnaghten et al. 2014).

This paper recommends that Islamic banking and financial institutions develop, commit to and adopt a common responsible financial innovation framework. As a long term solution, responsible innovation in finance needs to internalize responsibility in order to develop effective practices (Armstrong et al. 2012).

Notes on contributor

Mohd Faiz Hilmi is a senior lecturer at the School of Distance Education, Universiti Sains Malaysia. He holds a BA in Business Administration from Washington State University and an MBA from Universiti Utara Malaysia. He received a DBA from Universiti Sains Malaysia in 2008. His research focuses on innovation and technology management.

Disclosure statement

No potential conflict of interest was reported by the author.

ORCID

Mohd Faiz Hilmi http://orcid.org/0000-0003-4548-0565