Role of Islamic microfinance in alleviating poverty in Islamic world By: Monowar Hussain Badrudduza

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Role of Islamic microfinance in alleviating poverty in Islamic world
By: Monowar Hussain Badrudduza
Introduction:
In the contemporary world, financial institutions may play pivotal role in alleviating poverty by
extending loans but they need collaterals to fulfil this obligation. Therefore, nearly 75% the world’s
poor are financially excluded from institutional finance for different reasons (World Bank, 2013) and,
consequently, poor are kept unbanked. Lack of capital did not allow the poor to utilize economic
opportunities and shelter themselves from financial crisis (Obaidullah & Khan, 2008). In this regard,
various efforts have been initiated from international development organizations. Microfinance is
one of those efforts initiated by Grameen Bank in Bangladesh, in 1976. Since its inception, the
Grameen Model has been replicated in many countries where MFIs provide financial services under
the umbrella of social collateral. Although global microfinance industry is expanding, rapidly, and it is
playing significant role in alleviating poverty (World Bank, 2013; Aghion and Morduch, 2005;
Khandker, 2003; Mosley, 1999), its success has been questioned due to its interest based feature
which is normally very high (Fernando, 2006) and discourages poor to opt this route. Abdul Mannan
(2007) argued that Grameen Bank charges 54.95 percent interest rate if the hidden costs are also
included. In an
Independent study, Sadeq (2007) concluded that Bangladeshi NGOs charge 25-30% interest which
Ignites unrest in the population. As interest is strictly forbidden in Islam therefore most of the
practicing
Muslims try to avoid conventional microfinance. It has been observed that 72 percent of Muslims 86
Islamic Microfinance and Poverty Alleviation: An Empirical Ascertainment... in majority countries
avoid financial services (CGAP, 2008). According to a study undertaken by ADB (2009), 80% of the
respondents interviewed claimed to avoid interest. Similar kinds of results were observed by
different international organizations during the surveys to know the preferences of the people of
different Islamic countries. In this regard, 20-40%, 60%, 40%, 43-46% and 49% respondents of
Jordan, Gaza, Yemen,
Syria and Indonesia respectively, prefer Islamic Microfinance (ADB, 2009).
Poverty in Islamic world:
The Islamic world is enormous with over 1.2 billion people, stretching from Senegal to the
Philippines
– comprising six regions: North Africa, Sub-Saharan Africa, the Middle East, Central Asia, South Asia,
and Southeast Asia. Except for a handful of countries in Southeast Asia and the Middle East, there
are
high and rising poverty levels in both urban and rural parts of most Muslim countries. Poverty levels
have also been associated with high inequality alongside low productivity. In Indonesia alone with
world’s largest Muslim population, over half of the population - about 129 million are poor or

2. vulnerable to poverty with incomes less than US$2 a day. Bangladesh and Pakistan account for 122
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million each followed by India at approximately 100 million Muslims below poverty line. Indonesia,
Bangladesh, Pakistan, Nigeria and Egypt account for over half a billion (528 million) of the world’s
poor with incomes below $2 a day or national poverty line. With another five countries -
Afghanistan,
Sudan, Mozambique, Turkey and Niger, they account for over 600 million of the poor of the world. If
one considers another comprehensive measure of poverty – the Human Development Index
compiled
for 120 developing countries by UNDP, it is observed that a large number of IDB member countries
rank extremely low in the 1-120 rank. Mali, Burkina Faso and Chad have ranks below 100 at 102, 101
and 100 respectively, closely followed by Niger and Guinea at 99 and 96.
Micro finance and Islamic micro finance:
Micro finance:
Microfinance (MF) is a powerful poverty alleviation tool. It implies provision of financial services to
poor and low-income people whose low economic standing excludes them from formal financial
systems. Access to services such as, credit, venture capital, savings, insurance, remittance is
provided
on a micro-scale enabling participation of those with severely limited financial means. The provision
of financial services to the poor helps to increase household income and economic security, build
assets
and reduce vulnerability; creates demand for other goods and services (especially nutrition,
education,
and health care); and stimulates local economies. A large number of studies on poverty however,
indicate that exclusion of the poor from the financial system is a major factor contributing to their
inability to participate in the development process. In a typical developing economy the formal
financial
system serves no more than twenty to thirty percent of the population. These concerns are reflected
in
the Millennium Development Goals (MDGs) set by the United Nations in the year 2000 and the
international initiatives that have followed.
Similarities and differences between conventional and Islamic micro finance:
While conventional micro-finance institutions exist in Muslim countries, they barely conform to
Islamic
values on finance. Therefore, Islamic microfinance paves the way for the religious Muslims to

3. participate in financial services industry through Islamic microfinance programs. We also need to
look
at the similarities and differences of conventional and Islamic micro finance.
It is also worth mentioning that Islamic microfinance is a combination of both microfinance and
Islamic
finance. It is also argued that microfinance and Islamic finance are quite similar in several ways.
Firstly,
they focus on promoting the welfare of the entire society. Secondly, both encourage the poor to
participate in entrepreneurship activities in order to improve their welfare. Thirdly, these two
financial
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systems advocate for financial inclusion and participation of the poor in financial services. Finally,
both
are based on principles of ethics, morality and equality (Obaidullah, 2008).
On the other hand, there are however, some points of difference, discomfort and discontentment.
Unlike
conventional microfinance, Islamic microfinance products are shariah compliant. It means that it
avoids
all kinds of Riba, Gharar( Uncertainty, deception etc) and Mysir( Gamble) which are the basic tenets
of
Islamic finance. Conventional microfinance is not for the poorest of the poor. There is a sizeable
substratum within the rural poor whose lives are unlikely to be touched, let alone improved by
financial
services. They are not "bankable" in their own or their neighbour’s eyes, even when the bank is
exclusively for poor people. On the other hand, in theory Islamic micro finance programs should
target
the poorest of the poor. An Islamic microfinance system, on the other hand, identifies being the
poorest
of the poor as the primary criterion of eligibility for receiving zakah. It is geared towards eliminating
abject poverty through its institutions based on zakah and sadaqah.
Sources of funds of Islamic micro finance:
Sources of funds of Islamic Micro finance institutions (IMFI) may be broadly divided into (1) charity
that includes zakah, sadaqah, awqaf; gifts that include hiba and tabarru; (2) deposits that may take
the
form of wadiah, qard al-hasan and mudarabah and (3) equity that may take the form of classical
musharakah or the modern stocks.
While sadaqah, hiba and tabarru have parallels in conventional microfinance, such as, donations or

4. contributions, zakah and awqaf have a special place in the Islamic system and are governed by
elaborate
fiqhi rules. Prohibition of riba, gharar, jahl, darar and other constraining norms in Islamic finance
does
not constitute an obstacle in building sound microfinance products. On the contrary, the need for
Shariah
compliance has led to considerable research into product development. While the conventional
system
provides for simple interest-based deposits, donations and loans, the Islamic financial system
comprises
an array of instruments for mobilization of funds, financing and for risk management.
Islamic microfinance models
IMFIs consist of several models tailored to meet the needs of various sections of the poor in the
society.
Onakoya and Onakoya (2013) list the major ones as Mudaraba, Musharaka, Mubaraha and Wakalah.
Apart from these, there are also Qard e Hassan, Salam, Istisna, Micro leasing and takaful for Islamic
micro finance projects. These are discussed below:
1. Mudaraba: The Mudaraba principle requires that the Islamic micro finance Institutions(IMFIs)
provide the funds while the borrower (who in this case is an entrepreneur) acts as the manager
of the project. The losses in this kind of a venture are bone by the financer (who in this case is
the IMFI).
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2. Musharaka: When it comes to the Musharaka model, the IMFI and the entrepreneur enter into
a joint venture arrangement in which they equally share in profits and losses . In most cases the
entrepreneur will provide skills for the project while the IMFI will avail the funds to be used
by the project. The profits and losses are shared in equal proportion.
3. Murabaha: The Murabaha model envisions a situation where the IMFI will purchase
particular goods or assets and sell it to a customer at mark-up price (Onakoya and Onakoya,
2013). The payment can be made at future date or instalments.
4. Wakalah:In Wakalah model, the IMFIs act as agents Although Islamic principles prohibit
default on loans but it is not a sufficient deterrent to delinquency on the part of the borrower.
Therefore, IMFIs need not risk their institutions’ funds by providing credit where there are clear
signs of potential default. If they do this, they risk running into bankruptcy, a situation that will
deny credit to others who are in dire need of it. This is the reason why there was devised another
model of IMF. The funds would be provided from a Zakat fund or a Non Governmental donor.

5. 5. Salam: It is an advance payment in exchange of a future delivery. It is often used in agricultural
settings, allowing farmers to finance production in exchange for future delivery cultures. To
respect the sharia, the quantity, the quality of future goods and effective date of delivery must
be specified explicitly
6. Istisna: In istisna, the Sellers can either produce goods themselves or buy them from a third
party. The end customer can pay the sale price is at once the contract is signed, or subsequently
at other stages of the manufacturing process.
7. Micro-leasing: The MFI allows the customer to use an asset that belongs to him. Risks
remain within the MFI, unlike a conventional leasing (all damages caused by involuntary
means or in case of force majeure are supported by the MFI, to avoid leasing as a disguised
sale with interest). Cash flows are adjusted so that costs and risks of MFIs are covered. The
terms of the lease are set in advance to avoid speculation.
8. Takaful : Mutual insurance is needed in Micro finance project. Each person participates in a
fund that is used to help the group in case of need, for example, death, agricultural losses,
accidents etc... Premiums paid are reinvested to avoid the mechanism of interest.
The needs of the Poor and alleviation of poverty through Islamic
microfinance:
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The needs of the poor in Islamic countries are no different from the poor in other societies except
that
these are conditioned and influenced by their faith and culture in a significant way. They need
financial
services because they are often faced with events that call for spending more money than might be
available around the house or in the pocket. To come up with the financial outlays required by life-
cycle
events, emergencies, and opportunities, micro-credit is needed. However, the poor need more than
credit. They need a range of options, from credit (beyond enterprise finance), to savings, to money
transfer facilities, and insurance in many forms. Provision of these financial services to the poor is
expected to lead to poverty alleviation. We need to review how Islamic micro finance meets these
financial service services and alleviate poverty:
1. Micro-credit: Micro-credit as offered by conventional MFIs in Muslim countries violates the
fundamental prohibition of riba that the Islamic Shariah mandates. While some poor Muslims,
devoid of options and hard-pressed for cash avail of interest-bearing credit, many prefer to stay
away. The Islamic MFIs offer micro-credit using a variety of Shariah compliant mechanisms,

6. such as, qard alhasan (with recovery of actual costs of service), murabahah with baybithamanajil,
ijarah, bay-salam etc. Less popular are partnership-based financing based on
mudarabah and musharakah.
2. Micro-savings: Poor people want to save, and many of them do save. But they are constrained
by the multiple demands on their low incomes and a lack of available deposit services that
match their needs and expectations. Poor people in Islamic countries like their counterparts
elsewhere, prefer high returns. They also want their deposits to score high on safety, security
and liquidity. However, there is an additional dimension to their needs and expectations in the
matter of deposits. They want the returns to be halal even while they may be using interest rates
as a benchmark for comparison. A hotly debated issue relates to expected behaviour of savers
when faced with a trade-off between returns and Shariah compliance. Indeed, many Islamic FIs
seek to artificially smoothen returns on their deposits on the basis of a fear of losing clients if
“realized” volatile returns are passed on to savers. Arguably, there is not enough understanding
of savings behaviour in Islamic societies.
3. Micro-transfers: Money transfers encompass more than just remittances, which are defined as
the portion of migrant-worker earnings sent to family members or other individuals in their
place of origin. Some mainstream Islamic Financial Institutions, with emphasis on technology
and strategic partnerships have been quite successful in offering this service that is efficient,
economical and also Shariah-compliant. A case in point is the Al-Rajhi Banking and Investment
Corporation catering to migrant workers in the Gulf. However, few Islamic MFIs offer such
services to their clients.
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4. Micro-Insurance: Few poor households have access to formal insurance against such risks as
the death of a family breadwinner, severe illness, or loss of an asset including livestock and
housing. This is recognised as micro-takaful in the Islamic micro finance framework.
Fundamental conditions of Islamic microfinance for alleviating poverty:
The components of two hadith1
can be seen to emphasize the following fundamental conditions of a
successful Islamic microfinance program:
1. Access of the poorest of the poor to the program
2. Careful assessment of the financial health of the poor; enquiry blended with empathy; insistence
on
contribution and beneficiary stake;

7. 3. Transformation of unproductive assets of the beneficiary into income generating ones through
rigorous valuation (on the basis of price discovery through auction method); Involvement of the
larger
community in the process;
4. Meeting of basic needs on a priority basis and investment of the surplus in a productive asset;
5. Direct involvement of the program in capacity building in the run-up to income generation and
technical assistance to the beneficiary; Commitment of top management of the program;
1
(1) Narrated Ubaydullah ibn Adl ibn al-Khiyar: Two men informed me that they went to the Prophet
(peace
be upon him) when he was at the Farewell Pilgrimage while he was distributing the sadaqah and
asked him for
some of it. He looked us up and down, and seeing that we were robust, he said: If you wish, I shall
give you
something, but there is nothing spare in it for a rich man or for one who is strong and able to earn a
living.
(Sunan Abu Dawood, Kitab alZakah, Book 9, Number 1629).
(2) Narrated Anas ibn Malik: A man of the Ansar came to the Prophet (peace be upon him) and
begged from
him. (#1) He (the Prophet) asked: Have you nothing in your house? He replied: Yes, a piece of cloth,
a part of
which we wear and a part of which we spread (on the ground), and a wooden bowl from which we
drink
water. (#2) He said: Bring them to me. He then brought these articles to him and he (the Prophet)
took them in
his hands and asked: Who will buy these? A man said: I shall buy them for one dirham. He said twice
or thrice:
Who will offer more than one dirham? A man said: I shall buy them for two dirhams. (#3) He gave
these to him
and took the two dirhams and, giving them to the Ansari, he said: Buy food with one of them and
hand it to
your family, and buy an axe and bring it to me. (#4) He then brought it to him. The Apostle of Allah
(peace be
upon him) fixed a handle on it with his own hands (#5) and said: Go, gather firewood and sell it, and
do not let
me see you for a fortnight. (#6) The man went away and gathered firewood and sold it. When he had
earned

8. ten dirhams, he came to him and bought a garment with some of them and food with the others.
(#7) The
Apostle of Allah (peace be upon him) then said: This is better for you than that begging should come
as a spot
on your face on the Day of Judgment. Begging is right only for three people: one who is in grinding
poverty,
one who is seriously in debt, or one who is responsible for compensation and finds it difficult to pay.
(Sunan
Abu Dawood, Kitab al-Zakah, Book 9, Number 1637).
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6. Technical assistance in the form of imparting requisite training to the beneficiary for carrying out
the business plan/ income-generating project; monitoring through a time-bound schedule and
impact
assessment through a feed-back mechanism; and
7. Transparent accounting of operational results and liberty to use part of income to meet higher
needs.
In short, the Islamic approach to poverty alleviation is more inclusive than the conventional one. It
provides for the basic conditions of sustainable and successful microfinance, blending wealth
creation
with empathy for the poorest of the poor. There are certain aspects of the Islamic approach that
need
added emphasis. One, transparency through meticulous accounting and proper documentation is a
fundamental requirement of financial transactions in the Islamic framework. As the holy Quran
asserts:
“O ye who believe! When you deal with each other, in transactions involving future obligations in a
fixed period of time, reduce them to writing” and “Let a scribe write down faithfully as between the
parties” (2:282)
The import and significance of this verse is often not fully understood. Indeed, lack of proper
documentation and accounting by beneficiaries is a major challenge confronting microfinance. Two,
as
discussed earlier, a common feature of successful microfinance experiments is group-based
financing
and mutual guarantee within the group. This is a highly desirable feature of Islamic societies. Mutual
cooperation and solidarity is a norm central to Islamic ethics. The second verse of Surah Al Maida in
the holy Quran says:
"Assist one another in the doing of good and righteousness. Assist not one another in sin and

9. transgression, but keep your duty to Allah" (5:2)
The following hadith by the Prophet (pbuh) reinforces this principle of cooperation and mutual
assistance.
“Believers are to other believers like parts of a structure that tighten and reinforce each other."
(AlBukhari
and Muslim)
The Islamic approach to poverty alleviation needless to say, must also be free from riba, gharar, jahl
and darar.
Additionally, IMFIs do not deduct any amount from the principle unlike conventional MFIs which
deduct a small amount from the principle as service charge. IMFIs guard against default by engaging
the in which the lender belongs
Further, the loan can be guaranteed by the spouse of the borrower. Furthermore, Islamic ethics
demand
that no one should default on his creditors and therefore this principle acts as a deterrent against
any
urge to default. The final and most unique distinction between IMFIs and conventional MFIs is that
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their products are targeted towards religious groups and social groups (UNDP, 2010). The meaning
of
this is that despite the absence of discrimination in IMFIs products, it is only Muslims who would feel
comfortable borrowing from IMFIs since their products are created in accordance with Islamic
practices
and values. IMFIs consist of several models tailored to meet the needs of various sections of the
poor
in the society.
.
Implementation of Islamic microfinance in Muslim countries and its impact
on poverty alleviation:
Here implementation of Islamic microfinance projects in some Islamic countries have been
discussed to explore the issues of poverty alleviation through Islamic micro finance:
Bangladesh:
Bangladesh has leading microcredit programs. A large number of NGOs (Grameen Bank, Brac, ASA
etc), state-owned commercial banks, private commercial banks, and specialized programs of some
ministries of the Bangladeshi government are involved in providing collateral-free credit and have
been

10. able to alleviate poverty of millions of poor households through generations of self-employment
over
the last few decades. The absence of a distinct regulatory framework for Islamic microfinance is
working as an impediment to their growth and development. This is powerfully reflected in the list
of
licensed microfinance institutions in Bangladesh, with only two Islamic microfinance institutions
(observed by name) out of 689 as of December 27, 2016. Most academic literature on Islamic
microfinance progress in Bangladesh address the Rural Development Scheme (RDS), the
microfinance
program of Islamic Bank Bangladesh Limited (IBBL). The main objective of this scheme is to alleviate
rural poverty by providing shari’ah based small capital micro investment nance to the agricultural
and
rural sector for generating employment and raising income of the rural poor. The scheme also
provides
welfare, moral and ethical services to the rural people of the country. In 2010, the scheme was
implemented through 129 branches covering 10,023 villages in 60 districts. Some 0.52 million group
members are covered: 94% are females.
In Bangladesh, The progress of Islamic microfinance is not satisfactory as, despite having a good
potential considering its sources and funding uses, the cumulative disbursement of Islamic Bank
Bangladesh Limited (IBBL) up to December 2016 under its Rural Development Scheme (RDS) was
only US$ 20,492.57 million which was the maximum among all private commercial banks in
Bangladesh registering the highest recovery rate of 99.54%. Institutionally the development of
Islamic
microfinance is confined to IBBL’s RDS programs, and accordingly, most of the studies conducted to
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evaluate the growth and development of Islamic microfinance in Bangladesh employ the data of the
IBBL’s RDS programs. In view of the limited access of conventional microfinance to certain low
income communities, those lacking collateral and specifically in Muslim communities those in search
of Islamic-compliant microfinance, undoubtedly Islamic microfinance in Bangladesh is operating far
below its potential.
A number of researches conducted in Bangladesh have reflected that the positive impact of Islamic
MFIs, most notably the RDS was significant in achieving the Millennium Development Goals of
poverty alleviation, Gender equality and women empowerment, Access to healthcare services, safe
drinking water and sanitary latrines. (UNDP, 2012). The changes in income can be shown in a chart
(Rahman, 2010) –

11. Household Income per year (In
Taka)
Change in Income (In Taka)
Source of
Income
Before Joining After Joining Amount Percent (%)
Agriculture 17,470 22,595 5,125 29.3
Business 46,513 60,505 13,992 30.1
Total 63,983 83,100 19,117 29.9
Impact of RDS in income of rural people
Two different studies from Habib (2003) and Badiuzzaman (2006) clearly portrayed the positive
impact
of RDS in poverty alleviation mechanism. What makes this scheme different from any other
mechanism
is that it offers the clients, who successfully graduated the RDS, to commercial products of the Bank.
This partnership between the Bank and the beneficiaries has been proved to be a win-win
partnership,
and it helped the bank to make this program a self-reliant sustainable one across the country.
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Pakistan:
Islamic finance and Islamic microfinance are emerging industries in Pakistan. The State Bank of
Pakistan devised guidelines for Islamic microfinance in 2007 (Karim et al., 2008). These guidelines lay
down different types of arrangements for institutions to offer Islamic microfinance services and set
forth
the requisites concerning appointing Shariah advisors, licensing and separating the funds for Islamic
and conventional products if the bank or institution is providing both conventional and Shariah
based
products. In Pakistan, some institutions like Akhuwat, Farz Foundation, Wasil Foundation, Naymat,
and Islamic Relief are disbursing Islamic MF products.
Akuwat foundation is the largest that disbursed Qarzd Hassan to 0.355 million households with 175
branches in 116 cities of Pakistan (Akhuwat 2013). In a research, it was found ( Rehanuddin 2010)
that
critical financial analysis of Akhuwat indicated that it iwas providing its services for all living below
the poverty line including the “extreme poor” and Interest free loans could be used as a powerful
tool

12. against poverty. Yet Loan portfolio growth of Akhuwat declined with the sharp decline of equity
growth
over the last 5 years that might pose some constraints on its financial stability in future. This
challenge
could be overcome by integrating Islamic microfinance with NGOs, NPOs (non-profit organizations),
Zakah, Awqaf and with Takaful well as with professional training and capacity building institutions in
Pakistan to provide Islamic microfinance to the poorest of the poor under one roof. It will help to
uplift the living standard of people and ultimately contribute towards the economic development
and
enriched prosperity of the country.
Indonesia:
Indonesia’s first formal microfinance began in the late 19 century with the establishment of the
People’s
Credit Bank and Lumbung Desa by the Government. There are several types of MFIs in Indonesia.
But
most of the Micro finance projects are based on conventional microfinance. The MFIs that operate
based on the Islamic system (Shari’ah) include BPR Shari’ah (BPRS) and BMT (Baitul Mal Wat
Tamwil) (Ismawan and Budiantoro, 2005; Widiyanto, 2007). In an empirical research ( using the
sample of 150 borrowers from 20 Islamic micro finance institutions) conducted in central Java ,it was
found that Islamic microfinance had a significant role on improving income level, children’s
education, and business progress. However, the study did not find any significant role of
microfinance in access to health care ( Wahibur Rokhman, 2013).
Malaysia:
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Due to the high number of Islamic Finance educational institutions, notable scholars, product
development potential and certification programs, Kuala Lumpur is considered Asia’s Islamic Finance
capital. Malaysia, as a whole, takes the lead in the global Sukuk market, standing at US$ 14 billion in
2014 and Malaysia’s Islamic Finance institutions are experiencing dynamic growth each year. A
handful of Islamic microfinance programs have been created to alleviate poverty.Malaysia has
strived
hard towards sustaining economic growth and reducing poverty as indicated by the reduction in
country’s poverty rate to 1.7% in 2012 compared to 16.5% in 1990. The mechanism used for poverty
alleviation in Malaysia is the establishment of three main Islamic Microfinance Institutions (IMFIs)
which are Amanah Ikhtiar Malaysia (AIM), The Economic Fund for National Entrepreneurs Group
(TEKUN) and Yayasan Usaha Maju (YUM)(Mokhtar, Nartea, and Gan, n.d.; Mokhtar, Nartea, Zealand,

13. and Gan, 2012). Few researchesjustified that poverty alleviation can be achieved by fulfilling the
Social
Performance: the ability of extending loan to the more potential loan recipients that are poorer in
more
geographically hard-to-reach areas; and the financial performance: the performance of IMFIs’
Accounting Information System (AIS) in loan disbursement and loan repayment section (Kauffman
and
Riggins, 2012; Weber, 2012). In achieving the aforementioned performances, an innovation
recommended by Bank Negara Malaysia (BNM) called Mobile Banking (MB) has the capability to be
accessible by all in widening the access of financial services (BNM, 2010).
Challenges:
Challenges that confront efforts for Islamic microfinance have been analysed here:
1. Shariah Supervisory boards: Mainstream Islamic financial institutions provide comfort to their
stakeholders that they conform to Islamic finance principles by setting up Shariah supervisory
board (SSB)s. The members of SSBs are usually distinguished scholars and experts of fiqh who
confirm the compliance of financial products and consistency of operations with Shariah. A
review of Islamic microfinance institutions reveals that none of them have instituted SSBs. A
simple reason may be that this approach is costly.
2. Plurality of juristic opinion: Divergence of views among Shariah scholars on many issues
needs no elaboration and continues to be a major challenge to development of Islamic finance.
The problem becomes particularly acute in the context of Islamic microfinance. The local
nature of the practices in microfinance allows for many variations from the standardized set of
contracts discussed in fiqh literature and can open up rooms for debate.
3. Divergent perceptions of the clients: Client perceptions towards mudarabah, murabahah, qard
al-hasan which are predominant forms of Islamic microfinance in the Islamic world show wide
variations and this can pose a major challenge for the Islamic microfinance sector. At times,
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such perceptions are rooted in the ignorance of the clients about fiqhi rules governing the
various riba-free mechanisms.
4. Lack of product diversification: Islamic microfinance in spite of the richness of fiqh literature
remains highly murabahah-centric. Even ijarah has not witnessed many takers unlike
mainstream Islamic finance. Profit-loss-sharing, though highly acclaimed as “ideal” is hardly
used .
5. Linkages with Banks and Capital Market: If microfinance is to help build inclusive financial

14. systems, it must develop strong linkages with the formal banking sector and the capital markets.
The absence of such linkages except in certain economies like Malaysia and Indonesia is
another challenge for the development of Islamic microfinance projects.
Apart from above-mentioned challenges, other issues in Islamic microfinance include the need for
coordinating policy and direction, weakness in regulatory and supervisory environments, lack of
awareness and education about Islamic finance, and a severe shortage of qualified and trained
human capital.
Conclusion:
Microfinance is a well-developed strategy to alleviate poverty around the world. IDB is also working
to develop Islamic finance in its member countries including our African member States. Access of
the
poor to financial services is indeed important for the success of market based and sustainable
poverty
alleviation programs. In this regard, microfinance has been recognized worldwide as an important
policy instrument. However, the Islamic financial services industry although has progressed
significantly during the last 3 decades, but has yet to develop Islamic microfinance services to a
satisfactory level. But it has also been noted to be growing at an annual rate of 15%. International
development experts have been urging investors and international development agencies to turn to
Islamic Micro-finance Institutions as way of poverty eradication.