Great potential for Islamic microfinancing


Malaysia is currently the world’s second-largest Islamic banking marketMalaysia is currently the world’s second-largest Islamic banking market.

Islamic microfinancing products enjoy great demand and acceptance worldwide but it faces one stumbling block – a lack of funding.

This has weakened its growth and stymied its potential as an effective tool of financial inclusion for Muslims who avoid conventional microfinance because of the Islamic ban on interest.

As at 2014, the Islamic finance industry stood at around US$2 trillion, with Islamic banking making up 78% of the total. The global volume of the Islamic microfinance industry is, however, under 1% of this amount, totaling just around US$1 billion.

There are currently more than 300 Islamic microfinance institutions in 32 countries.

The lack of funding is partly due to the reluctance of Western donors to provide funding in this area. There is, thus, an immense need to develop alternative sources of funding.

At present, many Islamic microfinance institutions are based on an NGO or charitable model but this is clearly inadequate to serve the 44% who live in poverty around the globe.

There is a need to develop commercial Islamic microfinance institutions or banks with handsome funding sources.

We discuss here some of the models of funding which was may be viable.

Sukuk or social sukuk

Sukuk refers to the financing certificate that is similar to a bond but without interest or non-Syariah elements in its structure and mechanism. Generally, sukuk is used in the corporate sector to raise funds for long-term financing, often for mega projects.

Sukuk now makes up 16% of the global volume of Islamic financing, with the total sukuk papers issued currently around US$115 billion.

However, sukuk has never been used to raise funds for the Islamic microfinance industry although it can be effective as it is a Syariah-compliant source of funding. A new term, ‘Social Sukuk’, can be devised for sukuk papers issued for social development and poverty alleviation projects.

Crowd funding

Another possible means of raising funds for Islamic microfinance is through crowd funding platforms to link microfinance institutions to potential donors around the world.

There are many donors who are willing to lend or donate funds for charitable purposes including microfinancing, and especially to Islamic microfinance institutions.

However, the transmission of funds is often difficult. This can be addressed through better IT integration to connect donors or fund providers with Islamic microfinancing institutions, through trustworthy payment gateways.

The use of crowd funding is becoming popular, with some institutions now using this concept to secure funds. The AlHuda Centre of Islamic Banking and Economics (CIBE) has also established a crowd funding system which can integrate with any Islamic microfinance institution.

For Islamic microfinance, crowd funding can work in different ways including tapping venture capital and equity financing.

Venture capital refers to surplus funds set aside by developed financial institutions for investment. It is often used by start-ups. Islamic microfinance institutions can also be developed with the use of Syariah-compliant venture capital funds to create products. Profits are shared between the institution and capital provider.

From an Islamic point of view, Islamic microfinance institutions can raise funds through equity financing or venture capital by utilising the Mudaraba or Musharaka mechanism.


The institutionalised zakat system can also play an important role to supplement Islamic microfinance institutions although it cannot be utilised purely for microfinance activities.

It can, however, supplement its other components such as Micro Takaful, health, education and capacity building programmes.

Charity funds and penalties

The amount of charity funds collected by Islamic banks and financial institutions worldwide come up to a huge amount but is never used for Islamic microfinance.

Further, there are also funds raised through penalties imposed to discourage the malpractices of delay in payments or wilful default by the clients. Similarly, there are penalties imposed on Islamic financial institutions for violation of Syariah rules in its products.

These funds can be a source of funding for Islamic microfinance or as Qarz-e-Hassan (soft loan), as a means to alleviate poverty.

Islamic banks and financial institutions also have the option to raise funds through Syariah-compliant financing modes to grow the microfinance industry.

Mudaraba and Musharaka model

For instance, an Islamic microfinance institution can take funds on Mudaraba basis from an Islamic bank or financial institution which will then become the financier or investor (Rabul Mal). The microfinance institution acts as investment manager (Mudarib), and makes loans according to Syariah principles and shares the profit with the investor as per the agreed ratio.

Under the Musharaka model, both the parties (the Islamic microfinance institution, and Islamic bank/ Islamic financial institution) provide funds for the microfinancing scheme. They share the profit or loss, as per the agreed ratio of their investment.

Currently, this model is being used by several Islamic financial institutions.

Revitalising Concept of Waqf

The term Waqf literally means ‘confinement and prohibition’, or causing something to stop or stand still. The legal meaning of Waqf, according to Imam Abu Hanifa, is the detention of specific things in the ownership of waqf, and devoting its profit or products “in charity of poor or other good objects” (Source: Wikipedia).

The concept of waqf can also be utilised to develop Islamic microfinance institutions. A particular property or asset, wealth or income can be designated as endowment for socioeconomic development programmes such as Islamic microfinance. It is not mandatory in Waqf that the income generated shall be used for the charitable purposes only.

These options show the various ways to grow the industry through trade-based, partnership-based and rental-based Islamic microfinance products to generate income for institutional sustainability and social development.

Muhammad Zubair Mughal is Chief Executive Officer of AlHuda Centre of Islamic Banking and Economics (CIBE), and has been working consistently for the last 10 years on poverty alleviation through Islamic microfinance. He can be reached at . Written in good faith and views expressed are his own.

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