Waqf-based Microfinance: Realizing the Social Role of Islamic Finance

This paper builds a case for introducing a waqf (religious endowment)-based Islamic MFI that can provide microfinance and facilitate wealth creation for the poor.

Eradication of poverty is considered an important objective of an Islamic economic system. The Islamic financial sector can fulfil this objective by providing microfinance to poor entrepreneurs. Islamic institutions providing microfinance should:

• Adopt conventional MFI features of group-lending and weekly repayments to mitigate credit risk in financing the poor;
• Retain Islamic modes of financing that involve transfer of real assets/goods to reduce the problem of diversion of funds to non-productive uses;
• Use waqf to finance MFI operations in order to reduce financing costs and improve institutional viability.

Some risks may arise in a waqf-based MFI. In order to mitigate them, the MFI should:

• Create reserves to cover risks arising due to nature of its assets and liabilities;
• Use takaful (Islamic insurance) and profit-equalization reserves to give depositors competitive returns and mitigate withdrawal risks;
• Allocate proportion of waqf into microfinance depending on the takaful and economic capital reserves;
• Use zakah (welfare contribution to the poor) and sadaqat (voluntary charity) as additional resources.