Sustainable Finance, Social Finance and Islamic Social Finance: Primer on Concept and Differences (Part 2 of 3)

By: Syed Alwi bin Mohamed Sultan

Social Finance as a Viable Alternative Financial System

In the first part of this series of articles, it was explained that sustainable finance refers to the role of financial institutions or investors and other financiers in using finance towards achieving socio-economic and sustainable development goals. In that regard, a robust banking and financial system is essential towards achieving the objectives of sustainable finance. This is because an efficient banking system can use their multifaceted intermediary functions and services involving mobilization of savings and deposits and reallocating them to productive purposes through credit creation and provide low-cost monetary payments to create an impact to the economy and society. But on the other hand, an unstable financial system imposes enormous costs on the real economy and strains the public finances as demonstrated by the Global Financial Crisis of 2007-2009 (GFC).

 The GFC is a vivid illustration of the devastation that banking institutions can wreck to domestic and the global financial markets and economy. Since the GFC, there have been stronger calls for reform and to strengthen the governance of the global financial sector and financial institutions. Meanwhile, the GFC was also a catalyst for the call for alternative financial systems which practice ethical, responsible and sustainable financing methods. One of them is social finance and social banking.  

Social banking has had many decades of history with a predominant focus to resolve social issues within their local communities that they serve. According to Weber and Remer (2011) social banking had existed for more than four decades before the Global Financial Crisis (GFC). Some of the early examples of social banking institution that existed in the 1970s were the Chicago-based Shorebank which was founded in 1973, the Wainwright Bank and Trust Cy and Triodos Bank which were both founded in the early 1980s. Social banking is not a banking system that is founded on any religious or spiritual texts. Instead, it consists of a set of commonly agreed practices based on ethical principles with the objective of solving societal problems that is not addressed by existing financial institutions. Social banking mainly consists of banks with commercial objectives of profits and return on investments but at the same time they attempt to strike an equal balance with goals that are tied to the greater good for society and the environment.

Social banks operate a business model within financial systems that are based on principles of fairness, transparency, social development and sustainable practices. These are banking institutions that clearly state that their purpose is to make an impact directly, by increasing lending and investing to people and organizations that benefit people, the environment and culture. According to Benedikter (2011) and Weber (2014), social banks embrace the triple-bottom line principle in its operations. The triple-bottom line refers to 3Ps which are; firstly people, which refers to the principle of serving communities as a social mission; secondly the planet, which refers to ensuring environmental sustainable practices; and finally profit, which refers to ensuring that the social bank is sustainable and able to afford to be a going concern.

This triple-bottom line principle compels social banks to be transparent regarding their operations by allowing their stakeholders to observe details of their funding flow including sources and allocations of the funding. Accordingly, its customers have knowledge about whether their money is invested in the most appropriate manner, either financially, socially, or environmentally.

The basic assumption of neo-classical economics regarding firms is that firms allocate scarce corporate resources towards achieving profit maximization goals for the benefit of shareholders. Milton Friedman, the eminent proponent of neo-classical economics, is widely credited to have started the intellectual debate on the corporation’s social responsibility when he said that the objective of the firm is to maximize profits. Friedman argues that having corporate officials extend their social responsibilities beyond serving the interests of their stockholders is fundamentally a misconception of the character and nature of business in a free economy.

However, social finance and social banking is motivated by sustainable practices that accrue benefits to the greatest possible amount of people and where the positive effects endure over time to produce a multiplicity of benefits for future generations. Benedikter (2011) states that the main difference between mainstream banks and social banks can simply be drilled down to the fact that mainstream banks are in most cases focused solely on the principle of profit maximization, while social banking espouse the triple bottom line approach of maximization of benefits to people, planet and profit.

Studies show that during the GFC, when the global financial system was going through a meltdown, social banks were experiencing remarkable resilience. According to Benedikter (2011), European social banks grew by more than 20% per year and doubling their assets between 2007 and 2010.

The growing acceptance of the concept of social banking can also be credited to the fact that it is people-centred and focuses on local capacity building by empowering the poor, encouraging local sustainable enterprises, and overcoming financial and social exclusion. By that, these financial institutions help in improving individual lives and enable more individuals to be involved in the dynamics of economic development. In other words, it is humanising financial services, not just as a tagline, but internalised from top leadership right down to actual operational practices. Social banks make decisions on its loans and investments based on social utility and the long term effect to the improvement of the quality of life of individuals, communities, sustainable enterprises and the environment, without ignoring the value of making profits under commercial basis.

One recent initiative to formalize the role of social banks was the establishment of the Global Alliance for Banking on Values (GABV), which is an independent network of banks using finance to deliver sustainable economic, social and environmental development. In a study by Weber (2013) who examined 13 member banks of the GABV analyzing their business and financial indicators, results suggest that these social banks follow the mission of social finance and prefer social impacts over financial returns without neglecting financial sustainability. With respect to financial indicators during the years 2007 to 2009 when the GFC occurred, evidence suggests that social banks were more profitable than conventional banks. As of January 2021, the GABV comprised of 66 financial institutions and 16 strategic partners operating in countries across Asia, Africa, Australia, Latin America, North America and Europe with a collective assets under management exceeding US$200billion.

In a world which is facing multiple challenges across aspects like global population, industrialization, food production, the climate and the planet system, the human society is called upon to impose limits to economic activity and resource utilization to establish a condition of sustainable ecological and economic stability. In that regard, finance has a critical role to play to guide the transition towards a sustainable and inclusive economy that integrates economic, social and environmental aspects. Herein lies the real value proposition of social banking and social finance. While it is still relatively small in size, social banking can be seen as a beacon of hope in the pursuit of a more balanced, sustainable and stable financial system as an intermediary to achieve sustainable development and a better quality of life for society.  

In the next article, we will explore another alternative financial system which also advocates financial practices based on values and principles of fairness and justice and promotes ethical, responsible and sustainable financing methods -  the Islamic banking and finance system. The article will discuss the concept of Islamic banking and finance, including Islamic social finance and the key differences with the concept of social finance as explained in this article.