Integrating Zakat and Microfinance: A Proposed Framework

Background

Inequality and poverty have been a global issue for centuries. United Nation Development Program (UNDP) estimates that in 2018, 77% of global population faces a multidimensional poverty. Most of this population reside in Sub-saharan African and South Asian countries. UNDP defines that multi-dimensional poverty is a condition where people have issues with their standard of living which includes sanitation, drinking water, education and health (UNDP, 2018). To address poverty issues, myriad of steps have been proposed and undertaken by the government, which include macroeconomic financial approach such as controlling the interest rate, to microeconomic financial approach such as incentive for business and others alike. As poverty issue persists, there is always avenue for academics and social activists to propose alternative approaches that can potentially help eradicate poverty.

Previous study reports that microfinance programs provided by conventional banks in the United States have failed to develop the business due to the higher rate that lender gave to the business (Petersen and Rajan, 1994). On the other hand, inspired by success story of Grameen Bank in Bangladesh in reducing poverty through Islamic microfinance program, Dusuki (2007) argued that Islamic banks can be a solution (source of fund) for poverty issues in Muslim-majority countries. His study offers some schemes that can be used for the program. However, there have been limited studies analysing the role of Islamic banks in microfinance programs. We note only Possumah et al., (2019) who document the effect of microfinance programs implemented by Islamic banks on the inequality of Indonesian society through the year of 2000 to 2017.

On the other hand, many scholars also propose the use of Islamic social fund such as Zakat and waqf for the Islamic microfinance program (Ahmed, 2002; Kaleem et al., 2010; Ismail and Possumah, 2012; Rahman and Dean, 2013). In practice, many Zakat institutions in Indonesia and Malaysia have started applying Zakat and waqf fund for Islamic microfinance, aptly known as Zakat for productive purpose (Hassan and Noor, 2015 ; Yumna and Clarke, n.d). A more recent example is Akhuwat Islamic Microfinance in Pakistan (Rafay, et al., 2019), a waqf based Islamic microfinance in Turkey (Babacan, 2011).

Zakat is an Islamic medieval income distribution tool that is obligatory upon Muslim whose wealth possession reaches the nisab (minimum threshold). The amount of Zakat fund collected by Zakat institutions around the world is potentially huge. For instance, in Indonesia, Al Parisi (2017) mentioned that the potential of Zakat funds had reached IDR 286 trillion or equal to USD 20,46 billion. However, the actual Zakat fund collection reached only IDR 3.7 trillion in 2015, which is the equivalent of USD 265 million.

Fundamentally, Zakat has been distributed to support consumption purpose among the poor and needy. Following the suggestion from Islamic scholars, a recent innovation in Zakat distribution includes “productive” Zakat. Several Muslim countries like Indonesia and Malaysia have introduced and practiced Zakat for productive purpose, which is a financial aid program to support the poor and other mustahik (deserving categorized) setting up or growing their business until they reach the status of non-eligible for Zakat funds.

Notwithstanding the progress made, Zakat institutions still face some challenges. Notable issues are inefficiency and Shari’ah-compliance problems. Inefficiency is reported in the case of Malaysian Zakat institutions, particularly with respect to the distribution of Zakat funds which failed to reach the “real target group” (poor people in dire need of support). Ab Rahman et al., (2012) opine that this issue is caused by the lack of publicity from the authorities and information about the target group in the community.