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Updated: Mar 27, 2021

Islamic Microfinance as a Tool for Poverty Reduction

No doubt there has been significant growth in Islamic financial services over the recent years and there are good reasons to expect that this growth will continue at a fast pace. Despite the volatile world political scene, there is expanding demand for Islamic financial products, not just in the Muslim world but also around the world globally.

Islam, unlike other religions and faiths, offers a comprehensive way of life leading to a balanced way of living. Islam offers practical solutions to all aspects of human life including a highly robust economic system. Islamic finance (financial activity consistent with Shari’a or Islamic law) and its underlying principles are as old as the religion of Islam itself. Despite this, only from the mid-1970’s modern banks started to offer Shari’a-compliant products. Since then it has rapidly grown into a global industry. Islamic finance is no longer a passing fad but a global market worth between $1.5 – $2 trillion and growing (Ernest & Young 2013). Major geographical Islamic finance markets today are Kingdom of Saudi Arabia, Kuwait, Malaysia, Iran, Qatar, Turkey, Sudan and the United Arab Emirates (AT Kearney 2012).

The rapid growth and development of Islamic finance across various parts of the world has ensured confidence and provided proof of the practicality of Islamic financial solutions.

Research shows that more than 650 million Muslims live on less than US$2 a day. This clearly indicates the need and growing demand for a range of Sharia-compliant financial services. Despite the large numbers, Islamic finance still represents less than 1% of total global microfinance outreach. Having said that, Islamic Microfinance has been progressively growing in the world, especially in poor countries. Islamic microfinance is viewed as a credible alternative which allows poor populations access to basic financial services at low cost. Islamic Microfinance is deemed as an efficient instrument to encourage entrepreneurship and facilitate the creation of Small to Medium Enterprises (SMEs).

Islamic financial principles and microfinance are two major components in the fast emerging Islamic finance market space. According to Investopedia, ‘Microfinance is a type of banking service that is provided to unemployed or low-income individuals, or groups who otherwise have no other access to financial services.’ Islamic finance and microfinance have a lot in common. Islam emphasises ethical, moral, social and religious factors ultimately promoting equality and fairness for the overall good of society. Islamic finance principles not only relate to the financial needs of the poor but also address the social principles in caring for the less fortunate.

Microfinance in itself is not a panacea to fight poverty but rather facilitates its reduction significantly. Microfinance has been growing rapidly in the last three decades. However, growth of Islamic microfinance is still a long way behind its counterpart. Generally, commercial banks consider microfinance risky and costly hence economically not viable. As a result, microfinance providers are mostly dominated by NGOs (Brugnoni, 2010).

The results of microfinance are more visible in countries where poverty is high, namely developing countries. Muslims are one third of the world’s poor communities (Economist, 2008).

However, conventional microfinance does not cater for the cultural and belief systems of Muslims (e.g. dealing with interest which is prohibited in Islam). Alternatively, Islamic microfinance on the other hand has its own challenges. One of the biggest challenges faced by Islamic microfinance institutions today is the costly issue of having Shari’ah experts on board who can supervise and facilitate product development and compliance.

New approaches are needed here, for instance a suggestion is to encourage the development of a network of Islamic microfinance institutions which could potentially function as quasi Self-Regulatory Organizations or later on a suitable organization could be identified to handle regulatory arrangements. Islamic microfinance is growing rapidly and has great potential to flourish across the world, it is just a matter of time.

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