WP# 1435-07

Ethics in Relation to Islamic Finance Activities

Abdul Ghafar Ismail, Nor Azmidah Zali

3 Jumada’2 1435H | April 3, 2014

Islam2c Economics and Finance Research Division

IRTI Working Paper Series

IRTI Working Paper 1434-07

Title: Ethics in Relation to Islamic Finance Activities

Author(s): Abdul Ghafar Ismail, Nor Azmidah Zali

Abstract

Ethics has been fundamental in organizations and in specific, Islamic financial

institutions have selected ethics as their core competencies. Islam accepts ethics as a

good value in enhancing company performance since ethics is grounded by Shariah

rules. The ethical issues have been raised steadily in business and they do not seem to

settle as a lot of companies have not been aware of its importance. There are a lot of

theories of ethics that have been introduced but the number of unethical business

activities does not seem to be reduced. This paper seeks to explain the conventional

ethical theory and how Islamic ethical philosophy generates the ethical business

activities. Later on, the study will produce an ethical model which is in accordance to

the Islamic intellectual discourse , that will explain the relationship between ethics and

Islamic finance activities and also discuss the screening criteria of financial activities .

This study has the intention to contribute to the current knowledge of the business

ethic’s field and to contribute its findings for further research in business ethics. This

study will also bridge the gaps about how ethics can be a corporate identity to the

Islamic financial institutions.

Keywords: Ethics, Philosophy of Ethics, Ethical Theory, Business Ethics, Islamic

Ethics

JEL Classifications: A13, D21, D46, M14, P40

Islamic Research and Training Institute

P.O. Box 9201, Jeddah 21413, Kingdom of Saudi Arabia

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share ideas on the issues related to theoretical and practical development of Islamic economics and finance

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Institute or the Islamic Development Bank or those of the members of its Board of Executive Directors or

its member countries.

Ethics in Relation to Islamic Finance Activities

Abdul Ghafar Ismail1

Islamic Research and Training Institute

Islamic Development Bank

P.O. Box 9201, Jeddah 21413 Kingdom of Saudi Arabia

e-mail:AgIsmail@isdb.org

Nor Azmidah Zali2

Institut Islam Hadhari

Universiti Kebangsaan Malaysia

Bangi, 43600 Selangor Darul Ehsan, Malaysia

Fax: +603-8921 5789

e-mail:norazmidahzali@gmail.com

ABSTRACT

Ethics has been fundamental in organizations and in specific, Islamic financial

institutions have selected ethics as their core competencies. Islam accepts ethics as a

good value in enhancing company performance since ethics is grounded by Shariah

rules. The ethical issues have been raised steadily in business and they do not seem to

settle as a lot of companies have not been aware of its importance. There are a lot of

theories of ethics that have been introduced but the number of unethical business

activities does not seem to be reduced. This paper seeks to explain the conventional

ethical theory and how Islamic ethical philosophy generates the ethical business

activities. Later on, the study will produce an ethical model which is in accordance to

the Islamic intellectual discourse , that will explain the relationship between ethics and

Islamic finance activities and also discuss the screening criteria of financial activities .

This study has the intention to contribute to the current knowledge of the business

ethic’s field and to contribute its findings for further research in business ethics. This

study will also bridge the gaps about how ethics can be a corporate identity to the

Islamic financial institutions.

Keywords: Ethics, Philosophy of Ethics, Ethical Theory, Business Ethics, Islamic

Ethics

JEL Clasifications: A13, D21, D46, M14, P40

1He is head of research division, Islamic Research and Training Institute and Professor of Banking and

Financial Economics. He is currently on leave from School of Economics, Universiti Kebangsaan

Malaysia. An earlier version has been presented at the Presented at Seminar on Ethics and Religions for

a Fair Economy, Singer-Polignac Foundation, Paris 23-24 January 2014 2 Phd Candidate in Islamic economics, Institut Islam Hadhari, Universiti Kebangsaan Malaysia

2

1. Introduction

Business entities showed a rapid development in 1960s. It brings the opportunity

for them to participate in the development and make a significant impact on the

economy and to solve the social problems like providing jobs and clean water, and

reducing crime rates. One of the main attentions to this development is business ethics.

Most people learn ethical norms at home, at school, in mosque, or in societal setting,

but researchers as mentioned by De George (1987) learn about the business ethics from

the theory of justice.3 The theory and application on this subject had flourished in 1980s

with the publication of a special journal (i.e., Journal of Business Ethics) dedicated

towards this area.4 Since, then, there are literally hundreds of researches that have been

done on business ethics. The written papers on this subject are also many. Aspects

involved are theological and religious aspects, business environment, business

legislation, and business corporate responsibility. The development of this area has also

been recognised through the publication of a special journal dedicated to this area.5

.Business ethics has also been classified as an academic field in management,

marketing, governance, economics, finance, human resources, engineering, and other

related study fields and recently, ethics has been institutionalized in an organization to

address the significance of human moral and ethics.

In 2000s, the collapse of many companies (Sims and Brinkmann, 2003), and

business scandals has inspired the academician to “re-visit” the subject. They discuss

on the wide ranging issues such as theological and religious aspect, business

environment, business legislation, and business corporate responsibility.6 While the

companies are trying to distance themselves from unethical behaviour by disclosing in

their financial statements their ethics codes and their social responsibility. In addition,

the commitment into ethical behaviour is an important way of sustaining an ethical

organizational culture (Weaver et al, 1999), business performance (Oz7, 2001; Haniffa

and Hudaib, 2007 and Kulshreshtha, 2007), company value (Guy, 1990; Saeed et al.

2001 and Vogel, 1991), and strategic leadership (Thomas, et al. 20048; Key and Popkin,

1998 and Minja, 2009). Thus, the sustainability of ethical behaviour in management

showed it is one of the contributors to the stability of financial institutions.

The establishment of Islamic financial institutions and Shariah-compliant

companies also attracts an interest among researchers. For example, Shariah committee

at Securities Commission of Malaysia and Bank Negara Malaysia are given the task to

3 Please read further in Rawls, John, A Theory of Justice (Cambridge, Mass., Belknap Press of Harvard

University Press, 1971). 4 Also the formation of European Business Ethics Network (EBEN) 5Journal of Business Ethics was published in 1982 whereby the only original articles from a wide variety

of methodological and disciplinary perspectives concerning ethical issues related to business that brings

something new or unique to the discourse in their field. 6 See Vann Center for Ethics (http://www.pinterest.com/vanncenterethic/pins/)- Ethics Forum: “Business

Ethics in Today’s Global Economy” by Richard De George. University Distinguished Professor of

Philosophy, of Russian and East European Studies, and of Business Administration, and Co-Director of

the International Center for Ethics in Business at the University of Kansas. Wednesday, December 5,

2012 at Davidson College. 7 See further in Oz, E. (2001). Organizational Commitment and Ethical Behavior: An Empirical Study

of Information System Professionals. Journal of Business Ethics, 34(2): 137-142. 8 Further reading on Thomas, T., Schermerhorn, J. R. & Dienhart, J. W. (2004). Strategic Leadership Of

Ethical Behavior In Business. Academy of Management Executive, 18(2): 56-66.

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screen out the financial activities so that these activities are in line with Shariah. The

unethical activities need to be filtered out to ensure the financial activities are

permissible under Shariah rulings. The screening of financial activities is done under

the qualitative9 and qualitative10 criteria. Qualitative screening will look out into two

perspectives which are the structure of business transaction and the nature of business

itself whereas the quantitative screening consists of three aspects; the indebtedness of

the company; interest income and other incomes of the company; and the extent of cash

and receivables. The purpose of doing this to ensure financial activities and business

operation is operating ethically.

It is not enough to say that the company complies Shariah, but the business

behaviour does not have the ethical values. Furthermore, it is similarly to say that they

are two contrasting views: first, the business behaviour is attacked for disregarding the

freedom of business owner and, second critics are saying that business owner is

supporting the capitalist. It shows that philosophy is part and crucial elements in

understanding the business ethics. However, the current explanation is lacking in terms

of linking the two. Furthermore, in discussing the ethical finance activities, the

understanding of Islamic business philosophy should be extended to a wider scope.

This paper wants to explain the conventional ethical theory and how Islamic

ethical philosophy will come up with ethical axioms and characteristics. Later, it will

be used to produce the ethical business principles that can be utilised to derive the

parameters of business ethics for Islamic finance activities.

The remaining discussion of this paper will be divided into four sections.

Section 2 will highlight the insight into the ethical theory in business ethics. Section 3

will discuss the ethical theory in Islam. The proposed model of ethics for Islamic

finance activities will be explained in section 4. Section 5 will present the conclusion.

2. An Insight into the Ethical Theory in Business Ethics

There is consensus among researchers (see Derry and Green (1989)) that ethical theory

is important in explaining the field of business ethics. They seem to believe that an

understanding of ethical theories is important for three reasons: explaining the on-going

debate about issues in business ethics; engaging in personal and social analysis of moral

issues; and arriving for business decision making (see Section 2.2). Each one will be

discussed in following discussion. Given this consensus, we will first discuss the ethical

theory in the light of understanding the frontier knowledge of business ethics.

2.1 What does the theory say?

9 The screening process of qualitative criteria involves two parts; (1) the structure of the transaction in

terms of whether there is any elements that is prohibited in Islam such as interest (riba), uncertainty

(gharar), etc; and (2) the nature of the counter-party’s (company’s) business. 10 Generally, the quantitative screen involves the three main financial ratios, namely, liquidity ratio,

interest ratio and debt ratio. Some index providers also examine non-permissible income ratio.

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Each sub-field of knowledge has its own philosophy, such as philosophy of legal,

religious, culture and personal approaches. The same also goes to business, as

mentioned by Cavanagh et al. (1981) there are also ethical philosophy of business.

Initially, they find out three types of ethical philosophy in business, i.e., utilitarian,

rights, and justice. However, recently, the researchers have expanded the philosophy to

include common good and virtue approach. This ethical philosophy may influence the

individual decision in managing business organizations.

The utilitarian view was introduced by Jeremy Bentham (1748-1832) (1907).

This is one of the ethical philosophies that evolve from teleology or so called

consequentiality ethics. It is called consequentiality because the understanding of the

valuation of a good or bad action depending on the purpose or result of the action. It

shows that the approach only looks at the beginning and the end (i.e., they do not look

at the process). The ethical actions would only provide the greatest balance of good and

evil. This view was further strengthened by Frankena (1963) who stated that utilitarian

is a basic premise in teleological that argues people should choose the alternative that

has the greatest good for the greatest number of people.

Therefore, utilitarian is known as moral principle to business organization that

hold the moral rights in any circumstances that produce the “greatest balance of benefit

over harm” for everyone. It shows that utilitarian does not care whether the benefits are

produced by (via a process) lies, coercion or manipulation as long as it gives maximum

benefits for everyone. Many of the business organization are “take for granted” the

wrong action because they believe they have the moral duty to perform the action and

the good will come from the action. For business that wants to maximize their self-

interest, utilitarian is the powerful moral principle to remind them to spread the

"interest" to the good of all. However, Williams (1985) argued that utilitarian is a type

of benevolence aspect and Burton and Don (1996) refuted this statement and explain

utilitarian give the nature of vague for benevolence concept for individual in giving

benefit to the society. This carries the means that, the individual only takes the action

based on obligation purposes. Kant (1724-1804) said if action is only taken based on

obligation, the action consider as an ethical.11

The theory of right was pioneered by Kant (1724-1804). The concept has

evolved from the philosophy deontology. It is called deontology or non-

consequentiality ethics because in every action, it must be based on the assessment of

good or bad of the action. According to Kantian or right view, they assume that in a

universal moral principle, every person has certain basic rights. In doing the business

activities, business organization has a right to not do something if it violates the moral

principles they hold as long as it is not against the public trust. For example, company

has the rights to refuse in engaging the selling the non-halal activities for mere profit.

This has been constituted in Robert Nozick’s theory of moral rights that every

individual has the basic of moral right such as the right to life, the right to choose, and

right to information (Shaw, 1999). However, Cavanagh et al (1981) suggested these

rights also include the right to free consent, the right to privacy, the right to freedom of

11 See further in Guyer, P. (1998, 2004).

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conscience, the right to free speech, and the right to due process. The theory of rights

provides a guide on how to respect the rights of individuals.

Theory of Justice was pioneered by John Rawls (1971) who argues that justice

must be based on equity, fairness and impartially (Shaw, 1999). Principles of justice

are designed to protect the interest of all participants in a business operation. The justice

approach to ethics has its roots in the teachings of the ancient Greek philosopher

Aristotle, who said that “equals should be treated equally and unequals unequally.”

The basic moral question in this approach is: How fair is an action? Business

organizations have to think that whether that decision taken is fair to all parties within

and outside of organization. The theory of justice further holds that rules should be

administered fairly and impartially enforced and individuals must not be held

responsible for matters over which they have no control and injured individuals should

be compensated for their injuries by those responsible (Premeaux and Mondy, 1993).

Then, other scholar like Shaw (1996) who has argues that justice must be related to

equality and individual moral equation.

From the discussion of these three ethical theories, this will represent the ethical

normative structures for individual (Boal and Perry, 1985). However, the decision

making of individual is likely related with the virtue of the individual internally. The

virtue approach is different from other views because it seems like a spiritual essence

of the person. It focuses to human as a moral actor and more to an internal value

(Whetstone, 2001). Then, other scholars like Satyanugraha (2003) stated that a virtue

ethics looks into moral characteristic or a person12. García-Rosell and Moisander

(2008) mentioned that virtue ethics are referred to the person’s act as a decision maker

and promote internal quality for the whole of life. However, he also says that virtue

ethics is related to the personal traits that contributing personal effort to the quality of

business operations. Based on this, in managing business operation, the virtuous act is

purposeful assessment of the factual situation according to the moral duty (Whetstone,

2001). According to Aristotle who is Father of Philosophy, he said that moral virtue is

a practice of allowing people to act in accordance with the specific purpose and use

wisdom of mind in each action. So, for business people, they have to manipulate their

mind to think of good of all because by using their intellectual mind, they can think

rationally and consider all the priorities in the organization’s decision making process.

Hence, according to Whetstone (2001), Aristotle's approach is more psychological than

philosophically abstract and analytical, being meant to discover how a good person is

to act.

The discussion about the common good approach have lately appeared in the

discussions of business’ social responsibility, discussions of environmental pollution

and discussions of the problems of poverty. What is exactly “the common good”? The

common good is a concept that originated over two thousand years ago in the writings

of Plato, Aristotle and Cicero. More recently, Velasquez et. al (1992) and Argandona

(2009) try to promote the common values and moral or ethical principles found in a

12 For further reading, Satyanugraha, Heru (2003). Etika Bisnis, prinsip dan aplikasi. Jakarta, LPFE

Universitas Trisaksti.

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society. For example, the moral principles foind in China will often be different than

those in India. Business owners and managers often implement these principles to

ensure their company’s overall vision is in syncronization with society as a whole.

2.2 What are the Issues in Business Ethics?

The failure of a company might spotlight corporate moral failings. The cases of Enron

(in December 2001) and Lloyds Banking Group (was fined PS28 million by the U.K.

Financial Conduct Authority for “serious failings” in the bonus and pay structure for its

sales staff in December 2013) are a few example. It is a reminder to company’s leader

who sought excess (such as be greedy (looking for more profits) or disobey the rules at

the expenses of their communities and their employees. The end result would be a

“died” or “problem” company and bring “injuries” all of those who has gone along for

many years with the company.

The examples show that company faces a multitude of ethical issues.

Fundamental ethical business issues include integrity and trust, and other complex

issues such as accommodating diversity, decision-making, compliance and governance.

Fundamental Ethical Issues

The most fundamental or essential ethical issues that businesses shall face are integrity

and trust. The basic understanding of integrity includes the idea of conducting business

activities with honesty and a commitment to treating every stakeholder fairly. When

customers observe that a company is revealing a steadfast commitment to ethical

business practices, a high level of trust can develop between the business and the

customer it seeks to serve. A relationship of trust between business and stakeholder

may be a key determinant to company’s performance.13

Accommodating diversity

There are several examples of diversity issues at workplace. For example, fairness and

opportunity for every employee is the law and the world is a rich and diverse place full

of interesting cultures (based on religion or races) and people, who should be treated

with respect and from whom there is a great deal to learn. Furthermore, in Al-Quran,

Allah said: “Human beings, We created you all from a male and female, and made you

into nations and tribes so that you may know one another. Verily the noblest of you in

the sight of Allah is the most God-fearing of you. Surely Allah is All-Knowing, All-

Aware.14 .A diverse workplace is made up of employees of different races, genders,

abilities, ages and cultural. An ethical response to diversity begins with recruiting a

diverse workforce, enforces equal opportunity in all training programs. The results

would be that every employee is able to enjoy a respectful workplace environment that

13 See among others Kulshreshtha (2007), Guy (1990); Vogel (1991) and Gellerman (1986) 14 Refer to Chapter Al-Hujuraat (49:13)

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value their contributions and could maximize the value of each employee’s

contribution. Both are key elements in business performance.

Decision-Making Issues

In their review of ethical decision making, Tenbruensel and Smith-Crowe (2008)

present a distinction between moral decision making and amoral decision making.

Within each category of decisions, one can make ethical decision or unethical decisions.

They further argue that we should be in the business of telling people what they should

do, that is define what is ethical and what is not, but they should acknowledge the

necessary to define the criteria by which decisions are placed into their typology for

analytical purposed. Hence, the framework for ethical decision making is needed to be

created as a method for exploring ethical dilemmas and identifying ethical courses of

action: recognizes an ethical issue, gets the information and facts, evaluate alternative

actions, make a decision, and tests it and reflects on the outcome. Therefore, ethical

decision-making process should focus on protecting employee and customer rights,

making sure all business operations are fair and just, protecting the common good and

making sure individual values and beliefs of employees are protected.

Compliance and Governance Issue

A sad story of corporate ethics that happened in the last two decades plus falling

stock markets, corporate failure, dubious accounting practices, abuse of corporate

power and criminal investigations indicate that the economic system upon which

investment returns have depended is growing signs of strain that have undermined

public’s confidence. Hence, the public becomes more interested on the subject of

corporate governance and compliant, because both apparently have an important

implication for the economic health of corporations and society in general. It seems that

that the checks and balances should be there to protect the shareholder interest (such as

conflict of interest, scandals and malpractices, see Anderson and Orsagh, 2004) and

public confidence (due to such as inexperienced directors, overly lucrative

compensation or unequal voting rights).

By having the list of issues in business ethics is not enough. It tells us what are

the issues? In addition, to getting the facts, resolving an ethical issue also requires an

appeal to analyze the personal and social of business ethics, particularly the personal

and social values in dealing with ethical issues.

2.3 Personal and Social Analysis of Business Ethics

A company is established by individual via legal form. At the same time, it is also run

by individual. Each has its own behaviour or known as human behaviour. Hence,

personal relationship exists between stakeholders in a company, such as owner and

creditor, owner and employee, employee and customers. The behaviour of the

interacting agents related business transactions show that personal analysis of business

ethics should be there. It shows that the presence of human flourishing should be

recognized in the ethical theories.

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The interacting agents are related and governed by contractual theory and

property theory. This theory is called normative theories as they are prescriptive ethical

principle for the contracting party to adhere to what have been agreed under a particular

principle. While the property theory should look into social aspect of property which is

not owned by owner (owner as a trust) then the right of others should not be ignored.

3. Ethical Theory in Islamic Business Ethics

In a company, it also involves in managing resources, like people and money. While

the ethical perspective for workers has been discussed in Possumah et al (2013), the

discussion on the ethics for financial activities is not many. In this section, we will

discuss the ethical theory in explaining the Islamic financial activities. Therefore, in

this section we will discuss the ethical theory in Islam and followed by ethics in Islamic

financial transactions and ethics in shariah compliant companies.

3.1 Ethical Theory in Islam

The summary in section 2 shows that conventional ethical theory can be applied for

specific circumstances due to the specific of decision making and purposes and any

action from ethical theory has to be supported by moral principle because ethics and

morality have mutual connections. These principles are different in Islam. However,

the theoretical foundation of business ethics from religious perspectives is not known

by many. Therefore, to gain a greater understanding towards the ethical theory, Islam

has its own view. Following is the discussion of business ethics from Islamic

perspective which is derived from original sources and Islamic intellectual discourse.15

For example, Al-Qaradawi (2011) refuted the statement of Kantian that is all

actions are considered as ethical but must be based on the intention and haram action

(forbidden). It is still considered as haram even though the action gives benefits to the

society. Islamic law does not allow the principle of the so-called al-ghayah tubarrirul

wasilah (to achieve the purpose, anything is allowed), or a principle that says al-

wushulu ilal haq bil khaudhi fil katsiri minal bathil (to be able to acquire a good thing,

can be done to wander in falsehood).

Furthermore, Muslims regard Islam as a way of life and not merely a religion.

The term of ethics in business or business ethics is not an issue. Since in Islam, business

ethics cannot be separated from ethics because it deals with all aspects of a Muslim’s

daily life (Carney, 1983; Hasanuzzaman, 2003; Beekun and Badawi, 2005). It is further

stressed by Muhammad, et al. (2008) that business ethics is referred to moral principles,

15 Islam ecognize ethics as akhlaq (attitude) and the origin sources of ethics in Islam is from the teachings

of the Quran and the Sunnah (i.e. recorded saying and behavior of Prophet Muhammad, peace be upon

him (pbuh)). Ethics is also widely used as a term of morality (Hanafy and Sallam, 2001) and the word

of adab is also represent the words of ethics (Al-Attas, 1979). In his writings, he also reveals that ethic

is not only akhlaq but also adab which the most fundamental concept in Islamic teaching of being good

manners.

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standards of code of conduct and the guidance in the business environment. A company,

as suggested by Haniffa and Hudaib (2007), should maintain in good behaviour,

involving in social responsibility with promoting justice and welfare (al-‘adl wa al-

iḥsan)16 in society and seeking God’s pleasure and blessing (al-barakah). It also means,

as suggested by Rice (1999), Islam also promotes human harmony in daily life, strong

element of brotherhood and establish justice in the socioeconomic and also try in

balancing the material aspects and spiritual aspects of humankind.

Naqvi (1981) also agreed on what has been proposed by Rice (1999) that a

harmony in human life can be achieved since ethics dominate the business and not vice

versa. Then Al-Qaradawi (1995) stated that to being involved in Islamic business, there

are some business practices like ethical behaviour, the nature of piety, strong

compassionate nature and fair or balanced in any action that should be there. The

tawhidi elements that bring the meaning of oneness, monotheism, unity or singularity

of God, have been claimed as the core or basic of Islamic ethics (Faruqi, 1992; Naqvi,

1981; Rice, 1999; Beekun, 1997; Haneef, 2005) along with the other ethical axioms

like balanced, free will and responsibility (Naqvi, 1981). Therefore, Muslim is

encourage to have ethical manners that is recognized as an ethical code of conduct like

forgiveness, create positive relationship to public, do not suppress, hoarding and have

a sense of responsibility to God to do business as been ordered by God (Abeng, 1997).

Therefore, the Islamic business should be linked with three branches of

philisophy that are meta-physical philosophy, ethical philosophy and logical

philosophy. Firstly, in metaphysics, even though Islam encourages his followers to do

business, but Islam at the same time provide guidance to people so that business is done

in line with the main objective is to attain al-falah.17 To achieve al-falah, the continued

profitability of the business world and the hereafter, company has to follow the rules of

ethical code of business ethics. In Islamic business, the activities must be base on the

rabbani or divine principles.18 It is means that all the activities must be done in

accordance to the God’s command and cannot escape from God’s judgments. The

ethical command in business that has already been stated in Islamic intellectual

discourse is the akhlaq (ethics) element in business transaction. This element is actually

a direct command of God to man. The God’s command also ask us to do justice in

business.

Secondly, ethics is a branch of philosophy that deals with the human behavior

or act in relation to a good or bad. All the ethical action must obey to the Islamic law

or Shariah as a main guidance in all aspect of life (Beekun and Badawi, 2005).

According to Rashid and Ibrahim (2005), Islam considers ethics as an offshoot of iman

(a Muslim belief system), and it emerges from the Islamic worldview of human life.

Ethics are also known as akhlaq. Akhlaq is seen as a set of moral and Islamic value

16 The term of al-‘adl wa al-ihsan is refer to the Islamic ethical system that offered the balanced, fair, just

and benevolent, and seeks to respect the rights of both primary and derivative stakeholders without

allowing for exploitation, nepotism and other human ills (Muhammad et al 2008). 17 Al-Falah means the success in the world and in hereafter 18 See Yusuf al-Qaradawi (1995), Dawr al-Qiyam wa al-Akhlaq fi al-Iqtisad al-Islami, Kaherah:

Maktabah Wahbah, pp. 29-31

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system which is essentially contained and rooted in the Holy Quran and all acts of the

ethical behavior was implemented by Prophet Muhammad (p.b.u.h) during his life.

Principally, akhlaq is classified in two types; good or so called mahmudah and bad or

mazmumah. Islam emphasizes the important of practicing good akhlaq (mahmudah) in

all aspect of human life and recognizes it as one of the purpose of sending His

messengers. Muslim is also encouraged to have good akhlak (mahmudah) in all aspects

which will bring the business operates ethically. Sholars like Miskawayh or known as

father of ethics tells that it is important to have a good values to create civil society and

holistic.19 In other words, the values cannot be selfish because simply we want our own

safety regardless of hereafter society. Classical scholars such as Al-Ghazali (2005) in

his encyclopedia Iḥya’ ‘Ulum al-Din (Revival of Islamic Sciences) for instance,

dedicated a chapter on the ethics of earning and living (Kitab al-Adab al-Kasb wa al-

Ma‘ash), which precedes the chapter on lawful and unlawful matters (Kitāb al-Ḥalāl

wa al-Ḥaram), indicating the importance of ethical behavior in earning a livelihood in

promoting human well being. Scrutinizing this chapter of Iḥya’, al- Ghazali observes

and recognizes that there are three main ethical values that must be internalized; justice

, truth and charity in engaging in the Islamic business transactions. This point of view

showed general explanation of business ethics and ethics of relation.

The last part is logical philosophy. It tries to investigate human thought and a

fundamental to the thinking straight, accurate and healthy. Learning about the rules of

logic is expected to lay the foundation so that it can make accurate conclusions. Any

ethical action must have reasons and be able to defend our actions if it is called upon to

do so (Minja, 2009). In Islam, logic in business activities can be determined by ijtihad

that must obey to the Shariah rules. In the logic behind it, the Muslim will be classified

as a man who disobeys Allah. In this perspective, we can refer to Al-Ghazali’s major

works like (Mizaan al-'Amal (The Criterion or Logic of Action), one of the early works

on ethics.20 Al-Qaradawi (1995) also noted that the study of Islamic business was

emphasized by Islamic scholars and researchers in recent years. He described Islam as

God's business, ethical, humanitarian and concerned with the socio-cultural and

economic equilibrium, and is of the opinion that it is the responsibility of the state to

ensure that the theories of Islamic economics are implemented through the legislation

of laws to uphold righteousness and ethics.

Therefore, the discussion of the philosophy of business ethics in Islamic

perspective is try to create an ethical business organization. Muslims are not only need

to have a good behavior internally but also externally and the external behavior is

translated into the compliance of ethical principle of Islamic business.

From the above discussion, the theory is constructed based on the axioms. These

axioms need to be implemented internally, as a guidance that is intrinsically to ensure

Islamic business rules exist in the management of business activities and to comply

with shariah requirements. The ethical axioms are unity, equilibrium, free will and

19 See Umaruddin (2003). Umaruddin, M. (2003). The Ethical Philosophy of Al-Ghazali. Kuala Lumpur:

A.S Nordeen. 20 See Ghazanfar and Islahi (1997) in Islamic Economics Research Series, King Abdulaziz University.

11

responsibility that bringing company in promoting business behavior from Islamic

point of view and enhancing company performance.

Unity or in Islamic term called Tawheed is the vertical dimension of Islam. The

vertical carries the means of all the human aspects like political, social and religious

must be vertical according to the command of Allah. In the perspective of business, the

command of Allah includes the behavior in doing finance activities must be parallel

what in Islam needs and give usufruct (manfaah) to the people without scarifying the

rights of others (Badroen et al 2006). The concept of unity will create the balancing of

human life.

Equilibrium or wasatiyah is basic needs in balancing between this world and

here after. Muslim is encouraged to not create harm (mudarat) and damage

(mafasadhatan) that can cause imbalance in human life.21 The equilibrium of

consolidation of various element (Hussain and Ahmad, 2006) such financial activity

will give human life satisfaction and lastly will create the positive connections between

human.

Free will is a freedom in choosing their own way of life either to follow

Muhammad (pbuh) teaching or set their own way of life. However, the best way is to

combine all the Islamic setting in any action and have freely to think whether to follow

or not (Hussain and Ahmad, 2006). According to this, Naqvi (1981) has express “His

theomorphic character, combined with Free Will, sanctifies in the clearest possible term

the principle of human freedom, which is innate in human nature”. Towards to the

business perspective, people have free will in any actions either no involves in

permitted trading or making haram activities.

The last axiom of ethical principle is responsibility that closely to the free will.

Free will that is tied to the rules and ethical norms will teach people to responsible in

any action have done (Hussain and Ahmad, 2006). Within the Islamic context, Saeed

et al. (2001) said that there are four type of responsibility that can be apply in business

perspective. There are responsible towards God, responsible towards society,

responsible towards himself and responsible towards environment (Muhammad 2009).

From these point of view, the ethical axioms are able to create the happiness of

financial activities regarding the responsibilities that Muslims should do. The

discussion of these responsibility include towards God, human and environment. We

suggest that, the creation of happiness can be achieved for organization who want to

get Allah's blessings by applying all these responsibility. We agree that the achievement

of happiness will create the characteristics of ethical financial activities that will be

discussed in section 3.2.

3.2 Ethics in Islamic Financial Transactions

Islam is a dynamic religion that encompasses the aspects of faith (belief), shariah and

akhlaq (ethics). In the practice of a company, compliance with these three aspects

should be adhered because it is the cornerstone of the elements of Islam. According to

21 Further reading on Badroden et. al (2006), Alhabshi and Ghazali (1994) and Chapra (1992).

12

Beekun and Badawi (2005), Islamic business is not only seen as a system based on mere

belief system, but covers legal and Shariah compliance and has it own ethics. Based on

the ethical axioms that have been discussed in section 3.1, to legitimize the ideal Islamic

business behavior, the criterion of adl (justice), amanah (trust) and ihsan (benevolene)

should be included in the characteristic of Islamic ethics.

In Islam, man is as a trustee of the earth and the Gods as the trust owner that

obligate man to care all that is on this earth. Based on the Qur’an in chapter Al-Mulk

verse 2, “[He] who created death and life to test you [as to] which of you is best in

deed - and He is the Exalted in Might, the Forgiving, the God has expressed the human

act as a khalifah (trustee) of God on earth and this world as a ‘test’ for mankind. As a

trustee of the owner in this world, man must act in accordance with what in obligations

of that trust and have to responsible on it. For example, under the mudarabah financial

trasaction, the shareholder is obliged to contribute capital in a company and the

entrepreneur should share the profit with the shareholder. In another chapter of Al-

Quran, Al-Muddhathir in verse 38, “Every soul will be (held) in pledge for its deeds”.

This verse shows, all in this world is own by God and man just owe just for a while.

and the finance activities is also including in this means. By implication, behaving

ethically is one of the man’s trusteeships and man has to responsible to fulfill the

requirement stated. It shows that the contracting party in financial trasaction acts as

trustee for the business organization in ensuring any financial activities meet the

responsibilities entrusted.

Ihsan or virtue (benevolent) is do the right things that beneficial to others

without any obligation to do those things (Beekun, 1997) or the simple meaning is do

ibadah as if you see God or feel God sees us. In the Quran chapter of Al-Qasas in verse

77, “But seek, through that which Allah has given you, the home of the Hereafter; and

[yet], do not forget your share of the world. And do good as Allah has done good to

you….” The concept of Ihsan is very good grace to be applied in the work culture and

must adhere in involving in any financial activities. For example financial activities like

hoarding, and corruption. The concept of ihsan will produce the concept of trust when

performing the business dealings that tied with a spiritual relationship with God.

In al-Quran chapter Al-Maidah in verse 8 tells that “O you who have believed,

be persistently standing firm for Allah , witnesses in justice, and do not let the hatred

of a people prevent you from being just. Be just; that is nearer to righteousness. And

fear Allah; indeed, Allah is acquainted with what you do”. This verse mentioned

Muslim is encouraged to behave justly towards all. Allah has force people to respect

each other and not hatred another party. When making any finance activities, the

concept of ‘adl is implemented to achieve al-falah. The concept of al-falah is very

subjective in Al-Quran that covers all aspects including spirituals, and intrinsic

motivations to get happiness world and blessings in the Hereafter. Thus, Islam

encourage a person to have all these aspects. We found that these aspects are closely

linked with ethical behavior. Therefore, the ethical behavior of individual should be

controlled by a modified code of ethics. This will be discussed in in section 4.

13

4. A Modified Model of Ethics for Islamic Finance Activities

Conventionally, the code of ethics is created as a tool to communicate the company’s

philosophy to stakeholder including employee, customers and the public. However, a

modified model of ethics that is suggested in this paper will try to link not only to

philosophy, but also the ethical theories, principles and ethical elements. The purposes

of this model are: to promote the code of ethics in promoting ethical behavior in Islamic

finance activities and to ensure higher standards behavior.

The model can be explained in Figure 1. It can be represented by five boxes.

Box A shows the philosophy of business ethics. From this box, the root of Islamic

business ethics is grounded by Islamic philosophy. In Islamic philosophy, the meta-

physical philosophy and ethical philosophy are actually grounded from Al-Quran and

Hadith which guide the all aspects in life. The logical philosophy comes from

experiences and empirical studies. These philosophies are expected to encourage the

business owner that is not only look at the monetary and non-monetary rewards in this

world but also non-monetary reward in the hereafter. The results would be shown in

Box B, that are: (i) the creation of unity among the business owners because they follow

the God’s command; (ii) the balancing of human life; and (iii) they are free to choose

the rules but at the same time, they are also needed to be responsible towards society,

themeselves and environment.

In creating the moral awareness in business, the discussion of ethical axioms is

able to create intrinsic or internal guidance for an individual who covers the concept of

unity (tawheed), equilibrium (wasatiyah), free will and responsibility. In conjunction

with this ethical axiom, the characteristic of individuals ethics i.e. adl (justice), amanah

(trust) and ihsan (benevolence) can be disclosed in legitimize the behavior of an ideal

Islamic business. The combination of ethical axioms and individual characteristics are

able to create ethical manners in organization. These ethical manners is has been

recognized as Islamic codes of ethics that able to transform the ethical behaviour in the

organization. Islamic code of ethics is one of the management tools of control to guide

people in organization to behave ethically.

From (i), it means that all the activities must be done in accordance to the God’s

command and cannot escape from God’s judgments. These will result in the three

important ethical characteristics, i.e., trust (amanah), justice (adl) and benevolence

(ihsan), as shown in Box C.

The combination of ethical axioms and individual characteristics are able to

create ethical principles for a business organization (see Box D). These ethical business

principles are expected to transform the ethical behaviour in the business organization.

These principles are one of the management tools of control to guide people in

organization to behave ethically.

These principles will be translated into ethical elements for Islamic finance

activities as presented in Box E, that covers all the good behaviour i.e. do not involve

14

in haram activities like riba (interest),22 maysir (gambling)23, gharar (uncertainty)24,

have good character and behavior25 like forgiveness, good relation among people and

care for the environment, and generosity in doing business26 (i.e. do not supress, and

hoarding the goods and hide the information). The end result would be to achieve the

Maqasid Shariah.

The above discussion would lead us to: first, broaden the scope of research on

the ethical business; second, suggest new parameters for business ethics that would

influence the ethical behaviour in organization and both employees and employers

aware about the unethical or illegal activity in organizations that adopted formal codes

of ethics. This will lead us to produce the highest level of compliance to established

ethical standards as proposed by several studies such as Stead et al (1990), Jamal and

Bowie (1995), Somers (2001), Tsalikis and Fritzche (1989); Murphy et al., (1992).

22 “O you who have attained faith! Remain conscious of God, and give up all outstanding gains from

Usury, if you are (truly) believers” (Al Quran, 2: 278, 2: 275, 3: 140, 4: 161 and 30: 39). 23 “O you who believe! Intoxicants and gambling, (dedication of) stones and (divination by) arrows, are

an abomination of Satans handwork: Abstain from such (abomination), that you may prosper. Satans

plan is (but) to excite enmity and hatred between you with intoxicants and gambling, and hinder you

from the remembrance of Allah, and from prayer: Will you not then abstain?” (Al Quran, 5: 90-91). 24 Hadith narrated by Muslim, Ahmad, 'Abu Dawud, Al Tirmidhi, Al Nasa'i, Al Darami and Ibn Majah

on the authority of Abu Hurayra where the Prophet prohibited the pebble sale and the gharar sale. 25 Islam insists on obligation to observe good character and behavior as the Prophet himself is sent to us

for purpose of perfecting the best of character. Abd Allah ibn 'Amr said, the Prophet used to say: "The

best of you are those who have the most excellent morals” (Bukhari, 61: 23). Hadith narrated by Abu

Hurairah, the Messenger of Allah said: "The most perfect of the believers in faith is the best of them in

moral excellence, and the best of you are the kindest of you to their wives" (Al Tirmidzi, 10: 11). Muadh

Ibn Jabal reported that the Prophet said: Fear Allah wheresoever you may be, follow up an evil deed by

a good one which will wipe (the former) out and behave good-naturedly to people” (Al Nawawi, 2001:

35). 26 Generosity in doing business refers to willingness and kindness in giving away either rights or property

or times for the benefit of others. Uthman bin Affan reported that the Prophet said: “Allah will admit to

the Paradise a man who is lenient as a seller and a buyer.” (Ibn Majah, 3: 2202) Jabir bin Abdullah

reported that Allah‟s Messenger said: “May Allah have mercy on the bondsman who is kind when he

sells, kind when he buys and lenient when he demands (his debt)” (Ibn Majah, 3: 2202)

15

Figure 1: Islamic model of ethical financial activities

The reason of companies to being ethical in managing activities is good for

business. Due to this, ethics has strong relationship with finance activities that brings

the stand of the company. It means the good ethics is the good business. The good

business carries the means that all the financial activities were undertaken in accordance

with business ethics rules. For the company that applies all the business ethics

accordance in Islam, the business will brings the good image to the company. From this

point of view, we suggest that, the ethical of finance activies of the firm will bring the

good image to the company since the company has applying of all good manners in

business practicess. This has been proven by Balmer (2002) and he support that image

is the expression of the company identity. We found that, the organization identity is

rooted form ethics best practicess or organizational behavior and Ashfort and Mael

(1996) agree that the these ethics is derived form social identity, social constructed

through the thoughts, feelings and behaviors of individual and group members

embedded within the organizational context.

5. Conclusion

From time to time, the theory of ethics was introduced in parallel with changes in ethical

behavior in certain circumstances. Ethical theory is to use to determine the action to be

done practically. However, over time, many of ethical theories were born but still could

not solve the ethical issues experienced. This is because the conventional ethical theory

is rooted based on the thought and assumption. In Islamic perspective, ethical

philosophy is based on two main intellectual discourses that are Qur'an and Hadith.

Ethical Islamic framework has showed the linkages between ethics and Islamic finance

activities. Islam offers an ethical system which is unique. In Islam, ethics and religion

Box A

Philosophy of

business

ethics

Al falah

Obey to

Shariah

reasoning

Box B

Ethical axioms

Unity

Equilibrium

Free will

responsibility

Box C

Ethical

characteristics

Justice

Trust

benevolence

Box E

Islamic ethical

in finance

activities

Permitted/har

am activities

Usufruct

Responsible

to

stakeholders

Good

behaviour

Box D

Ethical

Business

principles

Balancing

life

Less harm

Human

freedom

responsible

16

are rooted to primordial human nature which is innocent and good unless is corrupted.

Similarly, ethics, religion and law (fiqh) are complementary and do not contradict to

each other. In this case, what is morally wrong is also illegal, and the law permits only

what is moral. Similarly, in Islam both morality and law are derived from religious

sources and religious teachings are practiced through morality and law. Second, Islamic

ethical system is unique, because its value-judgements transcend all worldly gains and

relativism interpretations. Transcendentalism, universalism and normative character

are among building blocks of Islamic ethics.

17

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