What businesses should Islamic banks finance?

I wrote this page after thinking about a question which the magazine Islamic Finance News in its edition of 1 August 2012 posed to its forum of experts:

In my view, the question is based upon a common misunderstanding about the role of Islamic banks and their mission. Very simply, Islamic banks can only fund businesses which they are allowed to (namely those conducting a Shariah compliant activity) and from those, they should select businesses which will maximise the long-run profitability of the bank.

The full responses are only available to readers of the magazine. However I have reproduced my full answer below.

Some companies operating in the global Halal sector will be sensible investment propositions. Islamic financial services firms can be expected to invest in such companies out of financial self-interest. Accordingly I assume the question is directed towards laying out money where there is not a good business proposition.

Islamic financial services providers, whether they are banks, Takaful operators, asset managers or real estate fund providers, are normally companies with shareholders. Accordingly their prime responsibility is to maximize shareholder value while conducting their operations in accordance with the requirements of their Shariah supervisory board.

Consequently any expenditure by the Islamic financial services firms must be directed towards building their businesses either directly or indirectly. For example, if a university is a good source of graduates, there can be business benefits in sponsoring a scholarship at that university which bears the name of the Islamic financial services firm.

The only funds firms should expend for non-business purposes should be funds which the firms are required to pay to charity either because they are part of their Zakat liability or because they are being given to charity as part of income purification.

However, even in the case of such charitable funds, the Islamic financial services provider needs to consider whether the global Halal sector is an appropriate recipient. In most cases companies in the global Halal sector will be businesses seeking to make a profit, even if their limited financial track record or weak business plan does not make them good investment propositions. In such cases I can see no reason why charitable funds should be directed towards them as there are many more worthy causes than giving money to weak profit-seeking companies.