Humanomics

Islamic banking contribution in sustainable socioeconomic development in

Indonesia: An epistemological approach
Ari Pratiwi,
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Ari Pratiwi, (2016) "Islamic banking contribution in sustainable socioeconomic development in
Indonesia: An epistemological approach", Humanomics, Vol. 32 Issue: 2, pp.98-120, https://
doi.org/10.1108/H-12-2015-0085
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H
32,2
Islamic banking contribution in
sustainable socioeconomic
development in Indonesia
98 An epistemological approach
Ari Pratiwi
Paramadina University, Jakarta, Indonesia

Abstract
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Purpose – As a prominent actor in terms of achieving sustainable socioeconomic development,

especially in rural areas, Islamic banks are urged to pursue their main objective. It is required to set the
objective accordingly from time-to-time to continuously make a positive contribution to the sustainable
socioeconomic development. Hence, the integration of the external factors such as government’s
economic target (macro) into Islamic banking’s objectives (micro) is needed.
Design/methodology/approach – This research attempts to identify factors that might prevent the
sustainable economic development activities within the micro–macro circular causal model established
by Tawhidi String Relation (TSR) methodology.
Findings – The research clearly found that the existing Islamic banking’s business and directions had
an uncorrelated connection with Indonesia’s economic objective. Nevertheless, the Islamic banking’s
Musharakah and Mudharabah contract for Usaha Mikro Kecil Menengah [(UMKM) (Micro, Small
Medium Enterprises)] was showing the positive correlation to their financial performance indicator.
Hence, Islamic banking is strongly suggested to be more focused on these two types of partnership
financing contract to UMKM. Furthermore, its value and volume is needed to be expanded to build
Indonesia’s sustainable socioeconomic foundation. Then the positive gross domestic product (GDP)
growth will be achieved.
Originality/value – The existing research covering the sustainability index is mainly only based on
the macro perspective, while in this research, the integration between the micro and macro perspectives
between government objectives and Islamic banking objectives is needed. This interaction and
integration between the two are in line with the concept of the TSR methodology.
Keywords Islamic banking, Sustainable development, Micro small medium enterprises,
Tawhidi string relation, UMKM
Paper type Research paper

1. Introduction
In Indonesia, Islamic financial institutions consist of banks, with their diverse scopes
and areas, including Islamic commercial banks (BUS), Islamic banks as the business
units of conventional banks (UUS) and Islamic rural banks (BPRS); and non-banks, such
as multi-finance companies, Baitul Maal wa Tamlik (BMT) and Takaful. Ismal (2013)
stated that Islamic banking in Indonesia, as part of Indonesia’s financial institutions,
Humanomics
Vol. 32 No. 2, 2016
pp. 98-120 The author gives special sincere gratitude to Prof Masudul Alam Choudhury and Dr Rifki Ismal
© Emerald Group Publishing Limited
0828-8666
for all the endless supports and advice that led the author to this point of the author’s Islamic
DOI 10.1108/H-12-2015-0085 economy learning journey.
 has already provided its own lending or financing services, and of course by complying Sustainable
with its Islamic principles and values. Although it is strongly attached to the Islamic socioeconomic
rules that restrict some common practices of the conventional banking, the contribution
of Islamic banking, as the financial intermediary, toward Indonesia’s economic
development
development has been positive so far. However, Indonesia’s financial inclusion index
was only recorded at less than 20 per cent (World Bank, 2011). It means that 80 per cent
of Indonesian people (age ⬎ 17 years old) are yet to have access to financial institutions, 99
both for saving and financing. Overall, Indonesia’s Islamic banking has only covered 4.6
per cent of the national market shares (Ernst & Young, May 2013), which only equals to
serving less than 1 per cent of Indonesia’s population.
Bank Indonesia acknowledged this condition by issuing Bank Indonesia Regulation
Number 14/22/PBI/2012. The regulation is concerning Credit Allocation or Financing by
Bank and Supporting Instruments in terms of developing micro, small and medium
enterprises (UMKM). It was a clear direction from Bank Indonesia that all banks,
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including Islamic banks, are obliged to provide credit or financing services to UMKM at
minimum 20 per cent from the banks’ total credit or financing. It is in line with Bank
Indonesia’s vision to establish and develop the competences of Islamic banking to
support activities in the real sectors and, ultimately, to realize the national development
implementation that drives justice, unity and equitable development.
To accomplish the vision, Bank Indonesia set the mission to be translated into some
actions in strengthening and driving the positioning of Islamic banking as a credible,
efficient and prudent financial institution, which is also more than capable to support
the sustainable national development, to drive the stable financial system and to bank
the un-bankable community. Therefore, to accelerate the development of Islamic
banking in Indonesia, Bank Indonesia has been focusing on some areas of strategic
implementation, including increasing the Shariah compliance, increasing the quality of
prudential banking operations, increasing the operational efficiency and competitiveness,
increasing the stability of the banking system, increasing the expertise and quality of human
resources and optimizing the social roles of Islamic banking in developing micro, small and
medium enterprises (UMKM) (Bank Indonesia, 2007).
To support Indonesia’s economic development, one of the key highlights is building
the unique-shared pattern of sustainable development on the selected areas that is
applicable in targeted areas. The successful criteria of this pattern are the base to
generate the index. The existing index was generated typically based only on macro
indicators. Only taking a macro view eliminated the household or organization
preferences, which led to unmatched objectives between the household and government.
Contrary to the existing index, the Islamic sustainability index is generated to ensure the
sustainable pattern is focusing on the mashlahah which means focusing on the
sustainable human’s well-being. Hence, identifying key factors (including the micro
preferences) is deemed imperative to build the sustainability index. Furthermore, the
macro and micro index will be used during the learning process to provide the
performance result for all of the actors of the Sustainable Development program, and
also to notify them about actions required to achieve their objective of realizing the
well-being.
The other identified issue on the sustainable development is the inequitable economic
development. This inequitable economic development especially in the rural areas turns
to be the biggest challenge for Islamic banking to enter the local market. Indonesia with
 H its lack of infrastructure supports and such circumstance will surely cost Islamic
32,2 banking much in terms of the investment costs to enable it to access the areas. In fact,
this is actually one of the reasons behind Indonesia’s low financial inclusion index. Bank
Indonesia has set the objective of Islamic banking in supporting the real economy on the
grassroots, but, unfortunately, it seems that Islamic banking has covered the urban
areas only.
100 Furthermore, the usage of Mudharabah and Musharakah financing was low. These
two financing types are considered as the effective way to drive a more active
participation of Islamic banking for the further development of real economy. The
partnership principles provide the ability to enable the transfer of knowledge and
technology supports to small medium enterprises (SMEs) or micros, especially for those
living in the rural areas. Thereby, such supports for the SMEs and micros are expected
to be able to reinforce all of the efforts to achieve the community well-being, and at the
end will also contribute significantly in increasing our national economic performance.
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However, the total values of both Mudharabah and Musharakah were only around 30-35
per cent (OJK, 2015), compared to the Murabaha financing contract (2008-2014) that
reached over 55 per cent of the total financing values. The Mudharabah and
Musharakah actually offer more benefits for real economy, but unfortunately the
Islamic banking has not optimized them the most. Therefore, there should be attempts to
identify the causes and cope with them, and one of the feasible attempts is to build a new
model.

1.1 Islamic banking in the sustainable socioeconomic development

A story of Umar bin Khatab about how his policies[1] run the economy during his tenure
(Ahmad, 2003) can be an important lesson. Umar set a good example that managing
sustainable economic development requires the inclusion of social considerations and
Tawhid. His policies proved that the realization of Islamic ecosystem successfully made
people and the Government take actions properly with respect to the future. And, as a
result, the human well-being during his tenure was also improving. This macro point of
view by Umar is important to be included into the micro view of the Islamic banking in
the present time. By this approach, the Islamic banking is believed to might be able to
contribute actively toward the sustainable socioeconomic development.
Other cases, like Bank Rakyat Indonesia and Grameen Bank in Bangladesh, also
assert the comparable insight, wherein the equitable and integrated development on
numerous areas is indeed one of the main cores in efforts to realize the sustainable
national economic development. Hadinoto and Retnadi (2007) shared his experiences as
the CEO of Bank Rakyat Indonesia. In his opinion, the rural communities actually need
more than the capital distribution. They also do need market enablement, advisory
services regarding product packaging and managerial issues and also the realization of
information technology. The business management and accounting skills are deemed
vital for any business for further growth, or else it would not sustain in the long term.
Not least important, the foregoing expertise should also be supported by a good
understanding on the social characters. Blending with local people does help Islamic
banking to obtain the acceptance and adoption from local communities regarding its
financial products for micro enterprises. Also, better product quality, better product
packaging, better management and higher market awareness will inevitably boost the
micro enterprises’ bargaining power in front of the larger corporations.
 Yunus (2003), as the founder of Grameen Bank and Nobel award winner, also Sustainable
acknowledged that understanding the social conditions and needs (referring to poor socioeconomic
women in this case) helped him to identify and propose a new mechanism to distribute
and maintain the capital readiness to cope with the poverty reduction as the main
development
objective. During the process, the team provided the education program about
technology utilization for the product quality improvement. Besides, they also
succeeded in being appealing to consumers by establishing product display. 101
Stimulating the real sector, especially the micro enterprise financing, as the part of
Islamic banking’s main agenda of the sustainable development should cover social,
ethical and economic factors. Including these factors into the sustainable development
agenda is believed to be useful to generate the capabilities to achieve the long-term goal.
Hence, the sustainable development will eventually assist in creating a pathway to
realize the sustainable socioeconomic development. For that reason, the reliable human
resources as the agents of change on the field are definitely crucial. The agents should be
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the ones to understand the business landscape within the coverage areas. Deep
understanding on the local circumstances will help Islamic bank’s available resources to
support the micro enterprises and become their preferred business partner.
In addition, ethical factors are also unquestionably important when interacting with
the Islamic banking and its agents of change. Ethics are derived from Tawhid,
comprising the Qur’an and the Sunnah. Therefore, the participation of local government
and local Ulamas is really required to maintain the knowledge development and
implementation of Tawhid for close people and other economic actors who support the
sustainable socioeconomic development. Technology is used to help the day-to-day
operation by providing transparent information to the community and public.
Supported with the right SME (subject to the business industries owned in the
respective area), technology will be able to optimize the natural resources efficiently,
while maintaining the continuation of the resources for the future usage as well.
In summary, to realize Indonesia’s sustainable economic development, it is
imperative to achieve and maintain the sustainable well-being of each individual; better
and more equal distribution of wealth will be realized through the combination of good
political wills, social attitudes, ethics and well-defined economic goals. The Islamic
banking should contribute more on real economy development especially in the rural
area, not only because it is the main objective of Islamic banking itself, but for it also
brings more opportunities for Islamic banking to grow better in the future. The
socioeconomic contribution for the real economy has to be the soul that underlies how
the Islamic banking is running its business, and it should be included as the top measure
in evaluating the bank performance, on top of the conventional measures, such as return
on assets (ROA) and non performing loan (NPL).

1.2 The epistemological model of Unity of Knowledge applied to community (C) and
micro enterprise (E) unifying linkages (participation, complementarities)
This model was constructed by Choudhury (2009a) and described the correlation
between communities and micro enterprises and how the communities helped micro
enterprises to grow and the other way round. This complementariness between
community and micro enterprises is modeled in the diagram below (see Figure 1).
Some researchers have taken the Indonesian Islamic banking case in relation to micro
enterprises and identified how Islamic banks with Islamic principles positively
 H
32,2

102
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Figure 1.
Communities and
micro enterprise
complementary
model

contribute to the performance of micro enterprises. Taken into account the Tawhidi
String Relation (TSR) concept and previous researches on the roles of Indonesian
Islamic banking in micro enterprises, this research uses some variables, which are:
• Total financing (V1) ⫽ Mudarabah (M1) ⫹ Musharakah (M2) ⫹ Murabahah (M3)
⫹ Istisna (Ist).
Mudarabah, Musharakah and Murabahah are combined as MMM to denote an
integrated financing scheme with diversification on it as desired by shareholders and
in the social context.
• Debt/asset ratio (V2). Values are represented by debt which is an inter-bank liability
and asset is the total investments.
• Deposit/financing ratio (V3).

Those variables are to be reviewed to investigate whether poverty alleviation is

prioritized in Islamic financing among some choices in Islamic banks to manage and
distribute their assets. The MMM is selected to see how Islamic banking deeply
focuses on developing the micro enterprises and actively participating in the
community development. Ideally, Islamic banking should gain more benefits if it
runs Islamic investment rather than inter banks placement. Hence, the financing
choices are more favorable to sustain the Islamic banking business leading to the
selection of MMM to do Islamic investment including the ethical and social aspects
during the decision process.
However, variables used in this research will be used and needed to be enhanced by
field survey or taking more secondary macro variables data to give more views on how
Islamic banking incorporates its micro and macro view in addressing the sustainability
 of socioeconomic development with the aspect from outside of Islamic banking such as Sustainable
people who have directly interacted with Islamic banks. socioeconomic
development
1.3 Research objective and significances
This research attempts to identify factors that might prevent the sustainable economic
development activities within the micro-macro circular causal model established by
TSR. In this regard, the main objective is to achieve the socioeconomic development as 103
the micro-macro interfaced sustainability index. It is not only identifying the factors, but
more on how the socioeconomic development supports both current and future goals.
The conceptual and quantitative sustainability index will help the actors of
sustainability system to act and set the goals of each socioeconomic development
activity in reference to the main objective, which is social well-being (Mashlahah).
Islamic banking as one of the vital actors in achieving the sustainable socioeconomic
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development, especially in rural areas, has to be in line with this main objective and set
its own objective accordingly from time-to-time to contribute positively to the main
objectives. The objectives have to be drilled down to operational level activities to
support the Islamic banking’s objectives. Identifying the obstacles on the operational
activities and mitigating those with the right action plans will keep the Islamic banking
running on its right trail.

2. Methodology
The methodology used in this research is TSR (see Figure 2 above). TSR examines the
overall view of the system, how the agents or actors within the system always influence
one another through interaction and integration process. These interaction and
integration then lead the system to evolve to be a new system that is based on the
learning process taking place during the previous (dynamic) interaction and integration.
TSR believes that each part of the learning process is already induced with ethics and
morals derived from the Qur’an and the Sunnah. Based on the Islamic point of view, the
social well-being is the objective of the interaction and integration process. For that
reason, the TSR interaction, integration and evolution processes have the main objective
to achieve the social well-being, and it is translated into the well-being function.

Figure 2.
Tawhidi String
Relation
 H This research defines the inclusion of environmental treatment in the sustainable
32,2 development that results in the inter-systemic ideas. The inter-systemic ideas are the
complementarities between efficiency and equity, and also the complementarities
between economic, social, ethical and institutional interactions (Choudhury, 2007b).
With this interaction and integration among economic, social, ethical and institutional
aspects as complementary, actors or variables will then evolve the universe in the Unity
104 of Knowledge induced into the world system (Choudhury, 2014). This interaction and
integration among variables will be simulated and analyzed as the quantitative analysis
using VAR/VECM.
Furthermore, the secondary data (see Table I) were collected from Indonesia
statistical center (BPS), Financial Services Authority (OJK) and Indonesia Central Bank
(BI). The data used are time-series quarterly data from 2005 to 2014 as a collection of
data from multiple sources above.
There are some critical terms used in this research related to the TSR methodology.
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The terms were applied into the case of Islamic banking and sustainable socioeconomic
development as elaborated below:

2.1 Sustainability
Sustainable development is the circumstance wherein the development succeeds in
meeting the needs of present time without risking the ability of future generations to
meet their own needs (Brundtland, 1987). Orientation on production and marginal
consumption, environment consciousness and also capital consciousness lead to the
issues of depreciation. A number of ethical aspects derived from Tawhid are invoked in
the decision-making process, regarding every activity related to the sustainable
development. The ethical aspects themselves include (but not limited to) environment,
justice, equality and moral consideration. Hence, the sustainability requires both
interaction and integration among social, economic and ethical aspects, and this balance
acts as the complementarities of the well-being to ensure its sustainability.

2.2 Well-being
Sustainable development focuses on the continuity to support all generations, both for
present and future needs as well, which is commonly called as the human or social
well-being. Well-being is the measure of complementarities existing between ethical
choices and social choices represented by their variables and relations according to the
TSRs objectives, namely the unity of knowledge and the unity of choices. The continuity
in addressing social well-being from time to time will generate a well-being function to
guarantee that it will be always in line with the goal of accomplishing a sustainable
socioeconomic development.

Group of data Variables identified

Table I.
Secondary data Macro data Real GDP growth
collected for this Islamic banking micro data ROA, OER, Mudharabah and Musharakah (MM) financing contract
research value for UMKM in percentage of total MM financing values
 2.3 Circular causation Sustainable
The decision-making process involving interaction and multi-aspects consideration socioeconomic
mentioned above creates a circular causation among the social, economic and Tawhid
aspects of the unity of knowledge and the unification between variables. In nature, it is
development
considered more as the multi-causal relationship instead of the mono-causal one.
Therefore, there should be a two-way interaction among variables to enable them to
establish the integration among the variables. 105
2.4 Unity of knowledge
Every decision-making process retrieves knowledge from the knowledge pool as the
basis to help people in making decision about particular issues. People will learn the
impact of any decision they just made, and this learning process will subsequently drive
the emergence of a new knowledge. Thereby, the knowledge found during the learning
process will be stored back into the knowledge pool that is, based on Tawhid, called as
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the Unity of Knowledge. The learning process itself will always continue until the end of
the world because of its epistemology of oneness mentioned in the Qur’an as “pairing”
between the good things of life for well-being.

3. Result and analysis

3.1 Islamic social and economy structure view in the case of Islamic banking
In the TSR methodology, the learning process, naturally, might result in either negative
or positive outputs, which is as per the knowledge. Each of the knowledge is collected
and kept in the knowledge pool. And later, the whole knowledge pool will be used as the
base of any following interaction and integration, or the decision-making process as
well. The pool of knowledge itself is known as the Unity of Knowledge (Choudhury,
2014). Furthermore, the comprehensive Islamic Socioeconomic Structure View (Pratiwi,
2015) which derived from the TSRs concept is believed as the only way to maintain the
sustainability of socioeconomic development (see Figure 3). The sustainability focuses
on the capability to sustain the social well-being. Each of the learning process is the form
of circular causation of “good” outputs from macro and micro views. Hence, the
sustainability is shaped by outputs of the learning process, and the sustainability itself
is known as the well-being function (Choudhury, 2014).
In the socioeconomic development case, the Islamic banking as the financial
intermediary will definitely play crucial roles. Islamic banking ought to consider the

Figure 3.
Islamic banking’s
Islamic social and
economic structure
view
 H micro-macro point of view. It is necessary for the Islamic banking to adopt the Islamic
32,2 Socioeconomic Structure View in the decision-making process. Thereby, both the
objective of sustainability (social well-being) and the business objective of Islamic
banking itself will always stay on track. Hence, it is clear that the thoughts derived from
complementarities and ethics always become the basis for the Islamic banking thinking
process.
106 Adopting the view also means there should be some interaction and integration
occurring between the Islamic banking and other sub systems (actors) within the
system. The process of accumulating and shaping the knowledge during the learning
process itself occurs simultaneously with the interaction and integration among the
actors. Meanwhile, the knowledge formed beforehand will be used as the basis for the
subsequent learning process. For comparison, in the TSR, the initial knowledge is
derived from the Qur’an and the Sunnah (Choudhury, 2014), as the only set of knowledge
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revealed by Allah for human being, and the knowledge pool explained above acts the
similar function like that set of divine knowledge. Hence, the knowledge derived from
the Qur’an and the Sunnah also becomes the thinking process basis in the Islamic
banking.
Based on the foregoing details, this research adopts the TSR methodology. TSR
examines the overall view of the system, how the agents or actors within the system
always influence one another through interaction and integration process. The process
of interaction and integration drives the system to evolve to be a new system based on
the learning process taking place during the process.
The sustainability of the system required an integration and interaction among the
variables from macro views (surrounding the system) and micro views (within the
system). Adopting such a holistic view into Islamic banking system is believed to bring
about sustainability development for Islamic banking as well as the other surrounding
systems, such as SMEs/micros, people and the government. It will then, bring a bigger
impact if the same view is also adopted by the other systems surrounding Islamic
banking. Along with integrated view on the daily operational decisions and business
plans of economic players (Islamic banking, SMEs/micros), it will lead into more solid
socioeconomic foundation. Furthermore, in the case of Indonesia, sustainable
socioeconomic development of Indonesia can be achieved.
The Islamic social and economic structure view for Islamic banking (see Figure 3) has
the well-being as their sole objective. Specifically, the human well-being [W(␪)] is the
main goal of the Maqasid as Shariah of the whole integrated systems. In the TSR view,
the well-being objectives of the Islamic banking are derived from all variables of macro
and micro views as formulated in equation (1) below.

W( ␪ ) ⫽ f ( macro-variablei, micro-variablesj ) ( ␪ ), where i ⫽ 1, 2, …, n;

(1)
j ⫽ 1, 2, …, n;

Therefore, only focusing on one aspect may not produce the best objective result of the
well-being itself (Figure 4).
Besides well-being, the interaction and integration of all variables referred to [Xi (␪)] will
also produce ␪ (knowledge) to be pulled in into the pot of knowledge [X(␪) 僆 ⍀; {␪} 僆 ⍀].
The knowledge taken from the previous iteration is then taken into the consideration in the
 Sustainable
socioeconomic
development

107

Figure 4.
Variables reviewed
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for the empirical

analysis

next iteration. As part of the transformation, each of the iteration will generate a positive and
negative learning. Both of them will enrich system in its tenure to achieve the well-being.
The choices both bad-s and good-s are available for human to choose. Further, the
available choices consciously were selected and reviewed during the thinking and
decision-making processes with the guide of Qur’an and Sunnah. It should leave the
bad-s behind and take the good-s accordingly. Consciously expanding the choices to
address broader human well-being target was the key. One example in the case of
Islamic banking explained further the correlation between government and Islamic
banking.
One of the examples is zakah. Zakah collection and distribution are government
responsibilities. The more zakah funds collected by government show the wealth of the
community was increased. The more effective zakah fund distributed by government
shows the increment on the number muzakki and/or reducing the number of mustahiq.
Islamic banking who consciously selected and reviewed zakah as one of its performance
indicators, was tend to have more preference and thoughts to any choices that related to
the success of zakah programs in its operation decisions. Hence, Islamic banking as the
financial intermediary will put its preferences to finance on SMEs/micros rather than
corporate to generate more muzakki. It shows that Islamic banking consciously took
necessary actions to make this zakah program run successfully.
At the other side, government as regulator then creates necessary policies and
incentives to support Islamic banking to run its zakah-related programs. Policies were
made by the government as a result of government’s preferences to ensure the Islamic
banking business remains and grow together with the growing of community’s wealth.
The government and Islamic banking then monitored the success of the program and
gained the experiences as knowledge and pulled it back to the knowledge pool.
Necessary actions to put aside the bad-s choices found during the learning will be
defined as part of the learning process. Hence, the interaction and integration of Islamic
banking from and to government is established. Both consciously work as a “team” to
achieve the same objectives which is the increasing of community’s wealth.
Furthermore, community’s wealth is translated into the better human well-being.
 H Zakah in the example above is considered as the macro variable. This variable is
32,2 needed to be included into the Islamic banking objectives together with its micro
variables (namely ROA and OER). This interaction and integration between selected
choices (represented by variables) by Islamic banking was represented as the
Islamic Social Economic Structure view (see Figure 3). Furthermore, in this research,
the following choices (marked as black-box in Figure 4) were analyzed in empirical
108 way.

3.2 Empirical data analysis

Quantitative analysis was used in this research to analyze the secondary data
representing the above variables (see Table I). TSR methodology focuses on the learning
process by doing the integration and interaction among reviewed variables. The
learning process was presented by the changes of the dependent variables from
the changes of independent variables which is the same pattern with the linear model as
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the well-being function below:

␪ ⫽ ␣ ⫹ ␤t1xt1 ⫹ ␤t2xt2 ⫹ ␤t3xt3 ⫹ ␤t4xt4 ⫹ ␧ (2)

Where:
␪ ⫽ AVERAGE_THETA denotes sustainability Index, which is a monotonic
transformation of the Social Wellbeing Function as indicated by TSR
methodology;
x1 ⫽ GDPg which denotes growth of the real GDP (in percentage);
x2 ⫽ POBO which denotes PO/BO: PO/BO ⫽ 1/(BO/PO) ⫽ 1/OER; operating expense
ratio (OER) is percentage value of the operating expense value against gross
operating income value (Ismail, 2010). Hence, 1/OER is the income value generated
from the each amount expenses spend;
x3 ⫽ ROA which is a percentage value of profit value against asset value (Bank
Indonesia, 2007). This indicator is another way to measure the business
healthiness; and
x4 ⫽ MMUMKM which denotes percentage of Mudharabah and Musharakah (MM)
for UMKM financing contract value of total MM financing values (in
percentage).
The circular causations for x1 to x4 are estimated in the regression equations. These
equations are obtained as follows:

x1 ⫽ ␣1 ⫹ ␤t2xt2 ⫹ ␤t3xt3 ⫹ ␤t4xt4 ⫹ ␤t5␪ ⫹ ␧ (3)

x2 ⫽ ␣2 ⫹ ␤t1xt1 ⫹ ␤t3xt3 ⫹ ␤t4xt4 ⫹ ␤t5␪ ⫹ ␧ (4)

x3 ⫽ ␣3 ⫹ ␤t1xt1 ⫹ ␤t2xt2 ⫹ ␤t4xt4 ⫹ ␤t5␪ ⫹ ␧ (5)

x4 ⫽ ␣4 ⫹ ␤t1xt1 ⫹ ␤t2xt2 ⫹ ␤t3xt3 ⫹ ␤t5␪ ⫹ ␧ (6)

The expected correlation of each variable (␪, x1 to x4) to the well-being function was
noted in Table II. Furthermore, the ␪ was constructed by the explanatory equation in the
other variables (␪ value data set). Firstly, the variable (xi) will be represented and
 Correlation between x values
and W values
x1 positive
x2 to x4 positive
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Sustainable
␪ values socioeconomic
development
Based on the historical data, the best real GDP growth was selected
based on the highest GDP growth and lowest inflation rate (see
Figure 5)
␪ ⫽ 10 for the selected x’s value (xt) based on Shura’s decision,
which is 0.0388
109
␪ ⬇ 0 the highest difference between x’s value to selected x’s value
(|xi ⫺ xt|)
The x’s value within the highest |xi ⫺ xt| to xt, the ␪ value will be
prorated accordingly between 0 to 10
␪ ⫽ 10 for the highest x’s value
␪ ⬇ 0 for the lowest x’s value in the range of observation Table II.
The x’s value within the highest to the lowest, the ␪ value will be ␪ values and each

prorated accordingly between 10 to 0 variable correlations

␪ positive ␪ is calculated as the average value of all ␪ values from each x1 to x4 to well-being values

Figure 5.
Best ␪ values

measured as ␪I (see Table II). ␪ is the index value of each variable (Choudhury, 2014).
Second, the ␪ (AVERAGE_THETA) value was calculated from the average of all ␪i
values (see Figure 6 below).
In this research, linear modeling using VAR/VECM was generated for all circular
causations and well-being functions that represent the above equations [equations
(2)-(6)]. With the equation (2), the first form of ␪ values (sustainability index) were
generated based on the linear model generated by VAR/VECM. VECM represents the
shorter period of learning that consciously induces other independent variables during
the model creation and consists of 40 learning periods (Y2005-Y2014).
3.2.1 Estimated ␪ values as the sustainable index. The ␪ equation generated from
VAR/VECM estimation process is stated in equation (8) below. Furthermore, the first
form of estimated ␪ values (␪E1) was generated from this equation and pictured out in
Figure 7 as the black-dashed line.
3.2.2 Estimation of vector error correction model for circular causation. Summary of
the coefficient value and correlation independent variables with its dependent variable
in the circular causation together is summarized in Table III below.
Each of the variables (x1 to x4) and the average theta were tested on the unit root.
Based on the results, the data were not stationary (level 0). Subsequently, the variables’
group was also tested for co-integration. The results showed that co-integration among
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H
32,2

110

Figure 6.
Average theta
 Sustainable
socioeconomic
development

111

Figure 7.
Estimated ␪ and
Original ␪
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Well-being
functions Average theta POBO GDP growth MMUMKM ROA Constant

Average theta Negative Positive Negative Negative

⫺3.299199 52.20038 ⫺4.327884 ⫺1.475509 3.131529
POBO Negative Negative Positive Positive
⫺0.303104 ⫺15.82214 1.311799 0.447232 ⫺0.949178
GDP growth Positive Negative Negative Negative
0.019157 ⫺0.063203 ⫺0.082909 ⫺0.028266 0.059991
MMUMKM Negative Positive Negative Positive
⫺0.23106 0.762312 ⫺12.06141 0.340931 ⫺0.72357
Table III.
ROA Negative Positive Negative Positive VECM result
⫺0.677732 2.235974 ⫺35.37789 2.933148 ⫺2.122339 summary

variables did exist. Therefore, the VECM was used to estimate both short-run and
long-run associations among variables. The VECM estimation of each variable was
reviewed (x1 to x4) to simulate the circular causation and the well-being function that
represent the empirical model of long-run and short-run associations. The long-run
model is expressed in equations (7)-(11). A summary of the coefficient values and
association independent variables with the dependent variables are presented in
Table III.
During the shock test of each variable, it shows that the shock on MMUMKM,
ROA and POBO has a positive impact on the other variables. Hence, MMUKM and
POBO should be changed in a positive way to have the same wave as the other
variables. Furthermore, the average theta shock had a positive impact on other
variables in the long run. Even though some of the variables responded negatively,
they rebounded to positive values. Hence, the more the system worked as a
complementary, the more the system responded in a positive way. A GDP shock
created system stability in MMUKM in the long run. A GDP shock showed positive
stability at POBO and is very relevant with economic theory that an increase of GDP
will increase the income generated from each rupiah spent by Islamic banks. On the
contrary, it shows negative feedback to ROA and average theta. Hence, the GDP
 H increment does not come from ROA but might be the result when the ROA of Islamic
32,2 banks is smaller than overall GDP.
3.2.2.1 AVERAGE_THETA (␪) estimation. Overall, it shows that all variables
significantly impact average theta in the long run. There is also a significant stability
adoption (␭ negative) of the average theta in the long run (Table IV):

112 52.200 * GDPg(⫺1) ⫺ 3.299 * POBO (⫺1)

AVERAGE⫺THETA(⫺1) ⫽ [53.8711]
[23.8273]
⫺1.476 * ROA(⫺1)⫺4.328 * MMUMKM(⫺1)
[⫺29.2288] [⫺14.093]
⫹ 3.132 ⫹ e (7)
(R 2 ⫽ 0.886, F-Stat ⫽ 17.576)
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GDPg estimation
Overall, it shows that all variables significantly impact GDPg both in the short run and
long run. There is significant stability adoption (␭ negative) in the long run (Table V):

Association with Findings

GDPg Changes in GDPg/changes in Average theta ⫽ 52.200 per cent in GDPg. This
shows that any positive changes in GDPg will drive the average theta to
move positively. Both average theta and GDP were on the same learning
path. This means economic performance (represented by GDP) determines
socioeconomic development despite the roles of other variables. In fact,
Islamic banks contribute to GDP (even though it still very small compared to
conventional banks) and, hence, are participating in socioeconomic
development
POBO Changes in POBO/changes in average theta ⫽ ⫺3.299% in POBO. This
shows POBO negatively contributes to the well-being indicator by way of the
knowledge variable, theta. From the micro view of Islamic banking
operations, inefficient operations may trigger a downturn in terms of
socioeconomic development. With limited real sector contributions (mostly
SMEs), Islamic banks should strongly maintain efficiency to positively
impact socioeconomic development
MMUMKM MM contract value to MSMEs was negatively correlated with average theta
with a value of ⫺4.328%. This shows MM contracts to MSMEs by Islamic
banks negatively contribute to average theta, implying that the quality of
Islamic bank MSME financing (such as the quality of monitoring, evaluating,
supervising and mentoring) is less than expected causing a less optimal
impact to socioeconomic development in the community
ROA Changes in ROA/changes in average theta ⫽ ⫺1.476% in ROA. This shows
a change in ROA contributes negatively to the rate of average theta. This
implies Islamic banking operations leading to receivable profit may not
improve the quality of society (higher socioeconomic development). The
Table IV. earnings of Islamic banks come from activities less associated with
Average theta socioeconomic development as also identified in the economic and banking
estimation analysis interpretation of other variables above
 ⫺0.0283 * ROA (⫺1) ⫺ 0.083 * MMUMKM(⫺1) ⫺ 0.063 * POBO(⫺1) Sustainable
GDPg(⫺1) ⫽
[⫺14.8196] [⫺10.1314] [18.6117] socioeconomic
⫹ 0.019 * AVERAGE⫺THETA(⫺1) ⫹ 0.060 ⫹ e development
[⫺19.7240] (8)
(R 2 ⫽ 0.991, F-Stat ⫽ 262.536)
3.2.2.2 POBO estimation. Overall, it shows that all variables significantly impact POBO
113
in the long run (Table VI).

⫺15.822 * GDPg(⫺1) ⫹ 0.447 * ROA(⫺1) ⫹1.312 * MMUMKM(⫺1)

POBO(⫺1) ⫽
[⫺21.9644] [22.4931] [13.6500]
⫺0.303 * AVERAGE⫺THETA(⫺1) ⫺ 0.949 ⫹ e
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[⫺52.6270] (9)
(R ⫽ 0.156, F-Stat ⫽ 0.421)
2

3.2.2.3 ROA estimation. Overall, it shows that all variables significantly impact ROA in
the long run. There is stability adoption (␭ negative) for ROA in the long run (Table VII).

2.933 * MMUMKM(⫺1) ⫺ 0.678 * AVERAGE⫺THETA(⫺1)

ROA(⫺1) ⫽
[13.0561] [⫺30.5519]
⫹ 2.236 * POBO(⫺1) ⫺ 35.378 * GDPg(⫺1) ⫺2.122 ⫹ e
[⫺24.0671] [⫺18.7131] (10)
(R ⫽ 0.563, F-Stat ⫽ 2.922)
2

3.2.2.4 MMUMKM estimation. Overall, it shows that all variables significantly impact
micro, small and medium enterprises (MSME) finance in the long run. There is stability
adoption (␭ negative) for MMUMKM in the long run (Table VIII).

Association with Findings

Average theta Changes in average theta were positively associated with real GDP growth with
a value of 0.019%, showing that average theta is in line with real GDP growth.
Hence, increasing the contribution of Islamic banks to GDP would boost social
well-being presented by average theta
POBO Changes in GDPg/change in POBO ⫽ ⫺0.063% in GDPg. This shows that any
positive changes in GDPg will negatively affect the revenue generated by
spending by Islamic banks. This might mean that Islamic banks do not put
enough resources into supporting revenue generation that impacts GDP
MMUMKM A change in MM contracts for MSMEs was negatively associated with GDP
growth with a value of ⫺0.083%, showing that MM contracts to MSMEs do not
really support real GDP growth
ROA Changes in GDPg/change in ROA ⫽ ⫺0.0283% in GDPg. Again, this shows Table V.
that Islamic banks do not contribute much to the macroeconomic objective of Real GDP growth
increasing real GDP growth analysis
 H Association with Findings
32,2
Average theta Average theta was negatively associated with POBO with a value of ⫺0.303%.
This shows that Islamic banks do not spend in areas that positively contribute
to average theta. From the micro view of Islamic banking operations,
inefficient operations may cause a downturn in socioeconomic development.
114 With its limited contribution to the real sector (mostly SMEs), Islamic banks
should strongly maintain efficiency to positively impact socioeconomic
development
GDPg Growth of real GDP was not positively associated with POBO with a value of
⫺15.822%. This shows that Islamic banks might not spend in areas that create
positive GDP growth. This might mean that Islamic banks do not spend
enough to support revenue generation that impacts GDP
MMUMKM Changes in POBO/changes in MMUKM ⫽ 1.312% in POBO. This shows MM
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contracts to MSME by Islamic banks positively contribute to POBO

ROA ROA was positively associated with POBO with a value of 0.447%. It shows
that ROA and POBO are on the same learning path. Islamic bank revenue is
supported by expenses spent to operate the business. Furthermore, the
Table VI. spending objective needs to be reviewed further to sustain the business by
POBO analysis focusing on the MM contracts

Association with Findings

Average theta Average theta was negatively associated with ROA with a value of ⫺0.678%.
This shows Islamic banks need to manage asset returns. One possible way is
by focusing more on MSMEs with MM contracts
GDPg Changes in ROA/changes in real GDP growth⫽ ⫺35.378% in ROA. This
shows that Islamic banks do not contribute much to the macroeconomic
objective of increasing real GDP growth
POBO Every 1% change in revenue generated from expenses spent positively
impacted ROA with a value of 2.236%. This shows that Islamic bank revenue
is supported by the expenses spent to operate the business. Furthermore, the
spending objective needs to be reviewed further to sustain the business by
focusing on the MM contracts
MMUMKM Changes in ROA/changes in MMUMKM ⫽ 2.933% in ROA. This shows MM
contracts to MSMEs by Islamic banks positively contribute to ROA. Hence,
Table VII. the focus on MSME using MM contracts will generate a positive improvement
ROA analysis to ROA

⫺0.231 * AVERAGE⫺THETA(⫺1) ⫹ 0.762 * POBO(⫺1)

MMUMKM(⫺1) ⫽
[⫺16.2391] [16.2560]
⫺12.061 * GDPg(⫺1) ⫹ 0.341 * ROA(⫺1) ⫺ 0.724 ⫹ e
[⫺14.2391] [14.5317] (11)
(R ⫽ 0.388, F-Stat ⫽ 1.439)
2

3.2.3 Well-being function analysis. ␪ denotes the sustainability index, which is a

monotonic transformation of the Social Well-being Function as indicated in TSR
 Association with Findings
Sustainable
socioeconomic
Average theta Changes in MMUMKM/changes in average theta ⫽ - 0.231% in MMUMKM development
This shows that there are no integrated activities in MMUMKM that have
contributed to positive learning. It might mean that Islamic banks should
go back to the earlier years when the focus was more on MSME financing
GDPg Every 1% change of GDPg was negatively associated with MM contracts to
MSME with a value of ⫺12.061. This might mean both MSMEs and Islamic
115
Banks should perform better as economic players to be in-line with the
learning path of real GDP growth
POBO Changes in MMUMKM/changes in POBO ⫽ 0.762% in MMUMM. This
shows MM financing contracts used for MSMEs positively generate more
revenue from each Islamic bank expense spent. Hence, it proves that
applying MM financing contracts does not lead to inefficiencies.
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Furthermore, with this finding, Islamic banks should prioritize MM

financing contracts to MSMEs to generate more revenue
ROA Every 1% change of ROA was positively associated with financing
distribution for MSMEs by MM contracts with a value of 0.341%. This Table VIII.
shows that Islamic banks are on the right track focusing on MSMEs, even Musharakah and
though the existing size is not significant yet. Furthermore, Islamic banks Mudharabah
should allocate more financing in this area while preparing necessary financing to UMKM
supporting resources analysis

methodology. In general, the real ␪ value of Islamic banking is described as an

open-down parabola (negative quadratic equation) trend line (refer to Figure 8). The
equation of ␪ is as follows:

␪ ⫽ a ⫹ b.t ⫹ c.t2
⫽ 5.2913 ⫹ 0.0135x ⫺ 0.00035x2 (12)
(R2 ⫽ 5.2913 ⫹ 0.0135x ⫺ 0.00035x2 )

The changes of ␪ are constructed as the first differential of the quadratic equation of
equation (12), as follows:

Figure 8.
Average ␪
 H g ⫽ d( ␪ ) /dt
32,2 ⫽ b ⫹ 2.c.t (13)
⫽ 0.0135 ⫺ 0.0007x

This shows that the changes of ␪ (g) follow the negative slope (d␪/dt ⫽ ⫺0.0007) of the
linear equation (13), which means the changes of ␪ run negatively from time to time.
116 The estimated ␪ value is illustrated as a black dotted line (␪E1) in Figure 7. ␪E1 represents
the estimated ␪ value of the long-run pattern. The trend line for this estimated ␪ (refer to
Figure 9) is constructed in the following equation:

␪E1 ⫽ a ⫹ b.t ⫹ c.t2

⫽ 14.011 ⫺ 2.0755x ⫹ 0.0626x2 (14)
(R2 ⫽ 0.5136)
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The changes of ␪E1 (g1) are constructed as the first differential of equation (14) as
follows:

g1 ⫽ d( ␪E1 ) /dt
⫽ b ⫹ 2.c.t (15)
⫽⫺2.0755 ⫹ 0.1252x

According to the concept of VECM, there are adaptive processes of estimation

calculation. This means the previous coefficient of the variables will impact the next
coefficient of the same variables. Hence, the impact of the previous policy will then
impact the future condition in the estimation process.

3.3 Propose actions to improve Islamic banking contribution to real economy

Based on the results of the Well-Being Function analysis, the integrated Islamic
Socioeconomic View is strongly suggested for Islamic banks to apply. This new view

Figure 9.
Estimated ␪ (␪E1)
 will give Islamic banks an option to measure their contribution to economic Sustainable
development. The sustainability index (␪) was generated from Islamic banks as the socioeconomic
micro view and the government objective as the macro view. Hence, the government (in
this case BI and OJK, 2014) should also apply the same view to construct new policies
development
that are aligned with the preferences of Islamic banks. Furthermore, this strong
interaction and integration along with the view of complementarities of all reviewed
variables will provide Indonesia a sustainable socioeconomic foundation for current and 117
future needs.
The foregoing cases verify one fundamental lesson for further development of
Islamic banks, namely, that Islamic banking is definitely the best practice for
sustainable socioeconomic development of the real economy in terms of financing and
loans, even compared to conventional banks. With partnership financing contracts,
such as Mudharabah and Musharakah (MM), Islamic banks serve as partners of their
customers, either through active or semi-active participation, and therefore Islamic
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banks are expected to understand the customers’ businesses well and become an
intrinsic part of business growth. These two types of contract, as the first Islamic
banking product, are the fundamental rules for Islamic economic transactions (Fiqh
al-Muamalah). The empirical analysis in the previous section proved that MM financing
contracts to MSMEs grow both Islamic banks and the MSMEs.
Although the association of MMUMKM to average theta and GDPg was negative, it
is believed that if Islamic banks increase the value and volume of MM financing
contracts to MSMEs, then the association will return to positive. A positive slope of MM
financing contracts to MSME actually occurred from 2005 to 2010, but Islamic banks
gradually reduced financing composition away from MSMEs in favor of non-MSMEs in
2010. In short, the change in direction will bring long-term impacts.
In addition, considering the effectiveness of MM financing contract to social and
economic contributions especially rural areas, in its capacity as the financial
intermediary, the Islamic banking is strongly encouraged to penetrate and expand a
larger market in the rural areas. The MM financing contracts are conducted based on the
equity sharing or profit sharing, involving the capital owner or investor (shahib al-mal)
and the user of the investor’s capital (mudharib) as one single entity. Subsequently,
mudharib will not only invest the capital flows to rural communities, but also bring
along the skilled labors, technology and Government’s policies to increase the success
rate of the investment. Hence, the more transparent the flow of information in this
investment contract is carried out, the smoother the Islamic banking operations in both
maintaining the implementation of Islamic principles and reducing the investment risks
will be.

4. Summary
The integrated Islamic Socioeconomic view was the alternative way to look Islamic
banking contribution in the real economy. The non-financial performance indicator is
generated by the index from this view. This indicator was called as the sustainability
index which combines the macro and micro view of the Islamic banking. The MM
financing for UMKM was proven to have a positive correlation for both ROA and POBO.
Furthermore, the change of direction, from UMKM to non-UMKM was identified as one
of the cause to negative learning process in the sustainability index. Hence, Islamic
banking has consciously gone to UMKM (with MM financing), as it has a positive
 H impact on financial performance indicator (ROA, POBO), as well as the sustainability
32,2 index.
In addition, considering the effectiveness of MM financing contract to social and
economic contributions especially rural areas, in its capacity as the financial
intermediary, the Islamic banking is strongly encouraged to penetrate and expand a
larger market in the rural areas. Applying the MM financing contracts in the
118 partnership investment especially for rural people, as the form of current or new micro
enterprises, requires a significant number of Islamic banking’s frontline agents.
Furthermore, the following research is required to understand the working model of
Islamic banking in addressing this.
The other suggested researches as the continuation of this paper are: (1)identifying
factors (including ethics) and ways on how wealth disparities could be reduced; (2) what
will be environmental/climate change could be impacted through preferences/choices
especially during the recursive knowledge pooling (learning process).
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Note
1. Umar bin Khatab focused on four major areas: managing the production site by only
producing primary products and services to support daily life, managing the consumption by
utilizing the products until the end of its lifetime, equal economic distribution to avoid poverty
which would lead to humans utilizing the natural resources without thinking about the future
and mashlahah is the main objective to define any government economic rules (i.e. taxes,
products embargo).

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Corresponding author
Ari Pratiwi can be contacted at: ari.pratiwi@yahoo.com
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