the quran and poverty alleviation: a theoretical model for charity-based islamic microfinance...

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Ahmad Kaleem and Saima AhmedIslamic Microfinance Institutions (MFIs)

The Quran and Poverty Alleviation: A Theoretical Model for Charity-Based

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Authors’ Note: The authors are thankful to Dr. Amjad Saqib, executive director of Akhuwat, for explain-ing in detail the philosophy of philanthropy and brotherhood. Dr. Amjad Saqib is a philanthropist who lends interest-free loans to the poor from the money he raises through charity and donations.

Nonprofit and Voluntary Sector Quarterly

Volume 39 Number 3June 2010 409-428

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The Quran and Poverty AlleviationA Theoretical Model for Charity-Based Islamic Microfinance Institutions (MFIs)Ahmad KaleemLahore School of EconomicsSaima AhmedUniversity of Management and Technology

The Quran prohibits interest and encourages trade and charity as alternates. This article seeks guidance from the verses of the Quran and develops a theoretical model of charity-based Islamic microfinance institutions (MFIs), which can be used as an alter-native approach to reduce poverty. The article argues that charity-based Islamic MFIs will be financially and socially sustainable as these are to be based on the concepts of brotherhood, local philanthropy, and volunteer services. Charity-based Islamic MFIs will provide money for consumption as well as production purposes and, thus, can broadly target the economic and social needs of the poorest of the poor. They can help minimize indebtedness and reduce unequal distribution of wealth in society.

Keywords: Islamic; poverty alleviation; microfinance; charity; Pakistan

Microfinance has emerged as an important tool toward eliminating poverty dur-ing the past two decades. The idea gained momentum in the 1970s when

Nobel laureate Dr. Yunus of Grameen Bank of Bangladesh introduced collateral-free small loans to poor households. He brought in the concept of group lending and peer pressure. Today, there are more than 7,000 microfinance institutions (MFIs) provid-ing loans to more than 25 million poor around the world, of which a majority are women (Polakow-Suransky, 2003). The United Nations Capital Development Fund declared 2005 as the year of microcredit.

Despite the rapid global growth of MFIs and numerous success stories of poverty elimination, a closer look raises doubts about its effectiveness. Researchers like Nuruzzaman (1997), Chowdhury (1999), and Karanshawy (2007) raise issues such as the high interest rates on loans, regular arrest of defaulters by the police, large

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410 Nonprofit and Voluntary Sector Quarterly

rural debts, social unrest through women empowerment programs, Islamic view of interest-based loans being against religion, and so on.

The above-mentioned researchers also raised questions like, Does microfinance really help the deserving and does it really reach the poorest of the poor? These stud-ies emphasize the need to redefine the existing MFI setup such as new types of own-ers, new roles for donors, new ways to raise funds, new regulatory frameworks, and new governance structures. In the words of Dr. Yunus and Jolis (1998),

It is not micro-credit alone which will end poverty. Credit is one door through which people can escape poverty. Many more doors and windows can be created to facilitate an easy exit. It involves conceptualizing about people differently; it involves designing a new institutional framework consistent with this new conceptualization. (p. 124)

This article argues the need for institutionalizing the concept of charity to elimi-nate poverty. It thus develops the framework of charity-based Islamic MFIs after seeking guidelines from the Holy Quran, which declares, “and there is nothing hid-den in the heaven and in the earth, but it is recorded in a clear Book” (Ch 27:75) and “Allah will blot out interest and will cause charity to increase” (Ch 2:276).

The article at the first stage reviews the existing literature on MFIs. At the second stage, it explains the Islamic philosophy toward poverty alleviation and compares Islamic teachings with the current MFI philosophy. At the third stage, it suggests a theoretical model for charity-based Islamic MFIs and also explains its salient features. At the end, it presents some recommendation for the successful operation of charity-based Islamic MFIs in the case of Pakistan.

Objectives

Following are the main objectives of this article:

1. to review the existing available literature on the performances of MFIs2. to explain the Islamic philosophy toward poverty alleviation in the light of the Holy

Quran3. to compare the current practices of MFIs with Islamic concepts of poverty alleviation4. to come up with a charity-based Islamic MFI model as an alternate to interest-

based MFIs5. to provide suggestions for converting interest-based MFIs into charity-based

Islamic MFIs in the light of the teachings of the Holy Quran

Literature Review

Microfinance can be defined as provision of financial services such as deposits, loans, payment services, and so on to low-income people and to underprivileged




Kaleem, Ahmed / The Quran and Poverty Alleviation 411

sections of the society such as artisans, farmers, and small proprietors and entrepreneurs. These people are generally left out by the traditional banks and other financial institutions as they are considered less credit worthy and risky. Financial institutions are also reluctant to advance small loans due to the high processing and monitoring cost involved.

The performance of small businesses (in terms of their ability to contribute to job and wealth creation through business start-up, survival, and growth) has become an important area of recent policy and academic debate (Smallbone & Wyer, 2000). The greatest barriers to business formation and success are access to capital and mobilizing start-up resources, which may have severe restrictions on any future growth potential (Cosh & Hughes, 2000; Hisrich & Brush, 1986).

Microfinance has proved to be a very effective development tool in two vital areas of national uplift: alleviation of poverty and women’s empowerment. Earlier studies showed that traditional banks are gender biased and do not want to lend money to women. Banks assumed that the guarantees required for external financing are beyond the scope of most women’s personal assets and credit track record (Riding & Swift, 1990). Olm, Carsrud, and Alvey (1988) concluded that finances for ongoing businesses are less available for female-owned firms than for male enterprises, largely due to women’s inability to penetrate informal financial networks.

MFIs function under the theory of group lending and peer pressure. Besley and Coate (1995) believed that group loans are a powerful device to yield higher repayment rates than individual loans. The self-selected group shares the common interest of gaining access to credit at low information cost and applying sanctions to those who do not comply with the rules. However, MacIsaac (1997) noted that microcredit programs in Pakistan such as Kashf are designed for immediate repayment from any source of income. Borrowers, in practice, repay loans from general family income rather than the activity for which the loan is granted. He recommended that repayment may be good if linked with the economic status of the borrowers or their business performances.

Another study conducted by Hussein and Hussain (2003) in Pakistan found that the actual loan received in a group is much larger if it goes to fewer borrowers than intended and because the nonpoor are also interested in loans regardless of the loan size. These factors potentially exclude the poor from the program.

Microfinance is generally considered as a tool to eliminate poverty. Even in Bangladesh where microfinance practices are considered the best, contradictory results were observed. Economists like Syed Sirajul Islam (1998), Chaudhary (1999), Hassan and Alamgir (2000) raised questions about the effectiveness of the microfinance programs (MFPs) in Bangladesh. They claimed that as MFIs are generally dependent on local subsidies or foreign support, a majority may not survive if the lending agencies collapse or if subsidies are terminated. They further claimed that MFPs normally reach the better-off section of the society and not the poorest of the poor, which represents 20% to 25% of the rural population. The





majority of the loans demanded in rural areas are agriculture related where private moneylenders or middlemen play dominant roles. Overall, these poverty reduction programs have brought no significant change in the socioeconomic conditions of the poor in Bangladesh (Hulme, 2002).

Gonzalez-Vega (1998) argued that lack of loans is not the constraint that limits the expansion of a household income. Schools, hospitals, roads, access to markets, and institutions would typically be more important than mere loans in contributing to their income and welfare. Morduch (1998) cross surveyed 1,800 families in Bangladesh during the period 1991-1992 served by three MFPs: Grameen Bank, the Bangladesh Rural Advancement Committee (BRAC), and the Bangladesh Rural Development Board (BRDB). He also included, for comparison, a control group of a rural population that was not served by any of the programs. It is surprising that he did not find any significant difference in the results in terms of per capita consumption, female children school enrollment, and so on.

MFPs generally encourage women to take loans. There is no doubt that this increases women’s participation rate among the labor force. However, some authors question the wisdom of preferring women when the unemployment rate among men is already high in a country. In most cases, women are used to obtain the loans, which are actually spent by men (Nuruzzaman, 1997). Furthermore, women are generally engaged in the businesses where the rates of returns are generally low (R. I. Rahman & Khandker, 1994).

Sadeq (2007) argued that if nongovernmental organizations (NGOs) are sincere in increasing the income of the women, then they should create an environment where both male and female members of the family can work together. In some cases, women empowerment programs create socioeconomic problems in the society such as increase tension and violence within the family and high divorce rate (Nuruzzaman, 1997; A. Rahman, 1999).

Hassan and Alamgir (2000), in the case of Bangladesh, pointed out that nearly 70% of the total funds of NGOs goes into paying the salary of the foreign staff, leaving as little as 5% to 10% for the poor after meeting the expenses of the local staff. Sadeq (2007) found that a majority of the rural microfinance NGOs in Bangladesh charge 25% to 30% interest rates on loans. This creates social unrest as interest is prohibited in Islam. Mannan (2007) pointed out that even Grameen Bank, which is considered the flagship in microfinance, charges an interest rate of 54.95% on its loans if all hidden charges are included. He commented that there is hardly any business in the banking sector, which yields such a high profit as microfinance.

Islamic MFIs

MFIs, in practice, concentrate on the urban poor or those who are already above vulnerable level. The extremely poor cannot be regarded as microcredit clients as





“they will only be pushed further into debt and poverty due to the loans they cannot repay” (Burney, 2008, p. 18). Islamic Shariah (religious laws) consider profit rather than interest more close to its sense of morality and equity because earning profits inherently involves sharing risks and rewards. Following the philosophy, even international donor agencies like UNDP and DFID in Muslim countries now recommend and offer financial services under the concept of Mudarabah (partnership) and Murabaha (cost plus financing) where rate of return is more related to the transaction than to time (Dhumale & Sapcanin, 2006; Houtman, 2006).

Obaidullah and Salma (2008) reviewed various microfinance models and their acceptability among Muslim countries. They concluded that already established microfinance models are successfully copied in providing noninterest-based financing, such as Islami Bank Bangladesh Limited follows the Grameen Bank Model, FINCA in Afghanistan and UNDP in Syria follow the Village Bank Model, Muslim Community Cooperative (Australia) Ltd. uses the Credit Union Model, and the Self Help Group Model is quite famous among Islamic NGOs in Indonesia.

Islam identifies the poorest of the poor as the primary criterion of eligibility for receiving charity. Muhtada (2007) analyzed the efforts of zakat (charity) organizations empowering peasants in Indonesia by financing nonfarm activities. He concluded that their performances are less than satisfactory as most of the financial assistance is used for consumption purposes. Another interesting study done by Wahyuni (2007) concluded that charity-based organizations in Indonesia do not fall under any regulatory mechanism, lacking any incentives for the managers to have their financial statements audited.

Zarka (2007) suggested a monetary waqf (benevolent fund) to overcome the problem of poverty as he divided the poor into two groups—economically active and economically inactive. He proposed trade-based financial instruments for the former group, whereas interest-free loans along with training for improving technical skills were recommended for the latter group. Zarka’s model is successfully adopted and implemented by the Institute of Microfinance Development, India.

Gharzul-Hasaneh Fund in Iran is also a prominent example of interest-free loans. The fund operates on a mutual help basis and all loans are secured through legislation. Anyone who borrows from another has to return the full amount of the loan whenever the lender calls for it unless conditions are specifically stated (Sadr, 2007).

Concluding the debate, Islamic MFIs at the most offer financing under the concept of trade and partnership. Numerous examples are also available in the Muslim world when charity-based funds are also created to help the poorest of the poor through interest-free loans and monetary aid for consumption purposes. The need is to institutionalize the Islamic concept of charity as per modern day’s requirements.





The Quranic Philosophy Toward Poverty Alleviation

Islamic point of view in regard to natural sources of wealth. Islam begins from the supremacy of one God Who is the only ultimate authority in this universe: “He it is Who created for you all that is in the earth” (Ch 2:29). The Quran further describes the rationale for all creation and for life on earth:

And the earth have We spread out and set therein firm mountains and caused everything to grow therein in proper proportion. And We have made for you therein means of livelihood and also for all those for whom you do not provide. (Ch 15:19-20)

The Quran rejects the idea of the exclusive right of any single human being, or any particular class of humans, to the available natural resources, as God alone has sovereignty over all and everything. People may ask, then, Why do some have more wealth than others? The Holy Book explains that it is only a favor, a blessing, and even a test from God, Who has ordered that it be spent in an equitable and just man-ner, with due share for those less fortunate.

God provides for all His creatures, and none are neglected.1 The Holy Book defines God’s blessings in the following words:

The similitude of those who spend their wealth in the way of Allah is like the similitude of a grain of corn which grows seven ears, in each ear a hundred grains. And Allah multiplies it further for whomsoever He pleases and Allah is bountiful, All Knowing. (Ch 2:261)

Concept of brotherhood. Islam, like all revealed religions, advocates the concept of brotherhood among believers. The aim is to reduce the social and economic inequali-ties in society. The Quran says that “surely all believers are brothers. So make peace between your brothers and fear Allah that mercy may be shown to you” (Ch 49:10). The concept of brotherhood is further defined in verse 2 of chapter 5: “and cooperate in righteousness and piety, but do not cooperate in sin and aggression.” The Quran does not confine the concept of brotherhood to male members of the society but declares both men and women as friends of one another and one family.

And the believers, men and women, are friends of one of another. They enjoin good and forbid evil and observe prayer and pay the Zakat and obey Allah and His Messenger. (Ch 9:70)

Concept of family empowerment. The God declares in the Quran that all human beings are created in pair and Says, “and everything have We created in pairs that you may reflect” (Ch 51:49). The Quran promotes the concept of family empower-ment as against the conventional idea of women empowerment. It declares both men and women as equal in terms of work and financial rewards.





And covet not that whereby Allah has made some of you excel others. Men shall have a share of that which they have earned, and women a share of that which they have earned. And ask Allah of his bounty. Surely Allah has the perfect knowledge of all things. (Ch 4:32)

Management selection criteria. Trustworthiness and Justice are two essential characters describe in the Quran for the selection of the management or appointing person. It instructs people to select the best suited personality whenever they are asked. “Surely Allah commands you to make over the trusts to those worthy of them and that when you judge between people, you judge with justice” (Ch 4:58). Even in management it is encouraged to seek the opinions of others whenever important decisions are required. The Quran encourages Muslims to adopt a democratic culture based on mutual consultation in their daily lives.

And those who hearken to their Lord, and observe prayers, and whose affairs are decided by mutual consultation, and who spend out of what We have provided to them. (Ch 42:38)

Encourage to spend money. Hoarding of money in terms of gold and silver2 are discouraged in Islam. Instead, Muslims are encouraged to work hard to meet their daily needs. The Quran says, “and whatever you spend, He will replace it; and He is the best of the providers” (Ch 34:39). The Quran also enjoins the share of the poor and needy in one’s wealth and advises the Muslims to spend for the welfare of the general public. It defines the rules to spend money, such as forbidding hoarding as well as extravagance and wastefulness.

And give to the kinsman his due, and to the poor and the wayfarer, and squander not thy wealth extravagantly . . . and keep not thy hand chained to thy neck out of miserli-ness, nor stretch it forth to its utmost limit out of extravagance, lest thou sit down blamed, exhausted. (Ch 17:26-29)

Prohibition of interest. Interest is prohibited in Islam. The ideas of trade and char-ity are promoted as alternates to help the fellowmen. The rationale is to encourage positive economic activities and discourage earnings through interest and without taking risks. The Quran asks lenders to give up whatever remains outstanding in interest or else it will be deemed a war against God (Ch 2:279-280).

So give to the kinsman his due, and to the needy and to the wayfarer. That is best for those who seek the favor of Allah, and it is they who will prosper. Whatever you lay out as interest that it may increase the wealth of the people, it does not increase, in the sight of Allah; but whatever you give in Zakat, seeking the pleasure of Allah—it is these who will increase their wealth manifold. (Ch 30:38-39)





Islam, as an alternate to income generated from interest, asks believers to pay charity if they really seek the blessings of God. The next verse further clarifies the message of God with regard to increasing one’s wealth manifold if the poor-due is paid. “Allah will blot out interest and will cause charity to increase. And Allah loves not anyone who is a confirmed disbeliever and an arch sinner” (Ch 2:276). Charity reduces the level of inequality in society, as money is transferred from the rich to the poor, who borrow mainly for subsistence purposes. It is argued that charity is more beneficial than economic inefficiency resulting from a reduction in availability of funds to supply to the poor.

The Quran also encourages believers to adopt legitimate trading practices as an alternate to interest-related earnings: “Allah has permitted trade and forbidden usury” (Ch 2:275). The Prophet Muhammad (pbuh) was asked, “Which are the best forms of income generation?” He (pbuh) replied, “A man’s labor and every legitimate sale” (El Gamal, 2000).

Islamic jurists sometimes confuse the idea of trade as the only alternate to interest without keeping in mind the economic condition of the borrowers and the purpose of the amount borrowed. Loans are generally divided into two broader categories—consumption loans and productive loans. People take loans either for consumption purposes or for productive purposes. The article argues that the concept of trade (Ch 2:275) only applies in the case of productive loans. One can raise the question of whether it is justifiable to share profits with the poor who are barely able to meet their economic needs. The Quran also provides the solution to this problem. It promotes the idea of Qard Hasan (interest-free loans), which is discussed in detail in the next section.

Concept of charity and voluntary services. Numerous verses of the Quran urge Muslims to give charity (such as Ch 2:43, 110, and 263). These verses encourage the rich to contribute toward the welfare of the poor segments of society to seek the blessings of God without taunting those less fortunate.3 The Holy Book at the same time defines the recipients of the charity:

And worship Allah and associate naught with Him, and show kindness to parents, and the kindred, and orphans, and to needy, and to the neighbor who is a kinsman and the neighbor who is a stranger, and the companion by your side, and the wayfarer, and those whom your right hands possess. Surely Allah loves not the arrogant and the boastful. (Ch 4:36)

The concept of charity is not limited to donations in cash or kind. Muslims are also encouraged to voluntarily participate in welfare projects.4 The rationale is to share and transfer knowledge and expertise to the needy/poor people to improve their economic condition caused by unequal distribution of wealth in society.





And it is not your wealth nor your children that will bring you near Us in rank but those who believe and do good works, will have a double reward for what they did. (Ch 34:37)

Distribution of inheritance. Islam clearly defines rights and ways to divide the property of a deceased relative among the legal heirs. The logic is to discourage the concentration of wealth in a few hands. At the same time, Islam encourages all Muslims to work and earn a living instead of merely enjoying their forefathers’ wealth.

For men is a share of that which parents and near relations leave; and for women is a share of that which parents and near relations leave, whether it be little or much—a determined share. (Ch 4:7)

Furthermore, the concept of inheritance is not confined to legal successors only. Islam motivates the Muslims to consider other needy people at the time of distribu-tion. The Holy Quran says, “and when other relations and orphans and the poor are present at the division of the heritage, give them something therefrom and speak to them words of kindness” (Ch 4:8).

Sources of Funds

The above section explains the basic approach of Islam toward the reduction of poverty5 in society. This section elaborates on the major sources of financial charity in Islam.

Concept of Zakat/Sadaqat (charity). Islam was probably the first religion to intro-duce the concept of Zakat (compulsory charity) to reduce the socioeconomic gap between the rich and the poor, “and in their wealth was a share for one who asked for help and for one who could not” (Ch 51:19). Islam considers it the collective duty of Muslim society to take care of the poor. Zakat is imposed as a penalty on idle money not used for any productive purposes. It is not a kind of tax levied on one’s income, but it is imposed on one’s savings to diminish the monopoly of a few hands on the available wealth.

Surely, men who give alms and women who give alms and those who lend to Allah a goodly loan—it will be increased manifold for them, and theirs will also be a honorable reward. (Ch 57:18)

The alms are only for the poor and the needy and for those employed in collection therein, and for those whose hearts are to be reconciled and for the freeing of slaves,6 and for those in debt and for the cause of Allah, and for the wayfarer—an ordinance from Allah and Allah is all knowing, wise. (Ch 9:59)





It is commonly believed among the Muslims that Zakat increases the productivity of wealth. It improves the purchasing power of the poor who otherwise suffer due to nonavailability of funds. That’s why God Himself takes the responsibility of the reward.

He grants wisdom to whom He pleases and whoever is granted wisdom has indeed been granted abundant good; and none would take heed except those endowed with under-standing. (Ch 2:269)

And when he (Joseph) attained his age of full strength, We granted him judgment and knowledge. And thus do We reward those who do good. (Ch 12:22)

Concept of Waqf (endowment). The word Waqf is used in Islam to mean confining property to certain philanthropic causes. Muslim jurists hold the view that the first ever Waqf in Islam is the sacred building of Kaaba. The Quran says, “Surely, the first House founded for all mankind is that at Becca, abounding in blessings and guidance for all people” (Ch 3:96). Waqf is also a kind of Sadaq-e-Jaria (endowment fund). Once a property is dedicated as a Waqf, it remains so until the Day of Judgment. It is perpetual in nature and prohibits the use of the reserved property outside its stated objectives.

It is prescribed for you, when death comes to anyone of you, if he leaves much wealth, that he makes a will to parents and near relatives to act with fairness. This is an obliga-tion on those who fear God. (Ch 2:180)

Kahf (2003) defines five different types of Waqf: (a) Religious Waqf—spread of religion, (b) Philanthropic Waqf—welfare of the general public, (c) Family Waqf—welfare of the family members, (d) Waqf of Usufruct—only usufruct of the property is used as Waqf, and (e) Financial Waqf—only the income generated can be used for Waqf purposes.

Numerous examples of Waqf properties or funds are available in the Muslim world, such as the University of Al-Azhar in Egypt. It is among the oldest universities in the world, providing free education from primary until postgraduation under the concept of Waqf.

Usage of Funds

The above discussion concluded that Islam promotes the concept of charity to promote brotherhood and reduce inequalities in society. There is no doubt that a reduction in social and economical gaps between various segments has greater benefits than the economic inefficiencies created through limited availability of funds for the poor. Islam also defines in detail the usage of the available charity money.





Food, clothing, and shelter. Islam considers it the primary responsibility of the government to look after the needs of the people and ensure necessary facilities for a decent life for all its citizens. In the Quran, God promised the Prophet Adam the four basic essentials of life (food, clothing, water, and shelter) in the following words:

Surely it is ordained for you that you shall not be hungry therein, nor bare of clothing: and that you shall not be thirsty therein, nor shall you feel the heat of the sun. (Ch 20:118-119)

Education and training. The Quran calls on mankind to use intellect, to reflect, and to think, with the objective to seek knowledge and discover truth, “Proclaim! And thy Lord is the Most Bounteous; Who taught by the pen, taught man what he knew not” (Ch 96:4-6). Arfaa and Sadeq (2007) pointed out that knowledge (ilm) and its derivatives are mentioned 811 times in the Quran, the same number as faith (iman) and its derivatives. The authors noted that the Quran considers the quest for new knowledge as equal to faith in any Muslim:

. . . but only says; Lord, bestow on me increase of knowledge. (Ch 20:114)

Qard Hasan (benevolent loan). Islam does not limit charity to giving money to meet the consumption requirements of the poor; it also introduces the unique idea of donating charity money for productive purposes. The Prophet Muhammad (pbuh) said, “Sadaqat do not reduce property” (Kayed, 2007).

Qard Hasan is probably the only type of loan recognized in Islam. It is an interest-free loan with no predefined time period for the return. Interest-free loans may encourage talented people to start their own businesses. Qard Hasan maintains the dignity of the poor while minimizing the chances of laziness that may develop among the recipients of charity. The Quran declares Qard Hasan as a loan to God Who Himself takes the responsibility of the reward.

Who is it that will lend Allah a good loan that he may multiply it for him manifold? And Allah receives and enlarges, and to Him shall you be made to return. (Ch 2:245)

If you lend to Allah a goodly loan, He will multiply it for you and will forgive you; and Allah is Most Appreciating, Forbearing. (Ch 64:17)

Comparison Between Charity-Based Islamic and Interest-Based MFIs

The Quran promotes the idea of brotherhood and social welfare to reduce inequalities and poverty. It directs all Muslims to become the participants either as





donors or as beneficiaries of the charity money (Zakat/Sadaqat). Thus, the scope of charity-based Islamic MFIs is much broader in nature than interest-based MFIs where only a selected portion of society participates. Charity-based Islamic MFIs are based on and promote local philanthropy and voluntary services. Compulsory and optional charity money is their essential feature.

Charity-based Islamic MFIs may be said to be based on the slogan, “Reduce poverty through mutual cooperation.” They are absolutely different from interest-based MFIs, which depend on either foreign donors or loans on subsidized rates. The idea of charity-based Islamic MFIs is driven entirely by spiritual motivation and satisfaction rather than any commercial objectives. It emphasizes family empowerment rather than only women empowerment, as Islam declares men and women equal partners in terms of financial income and its usage.

Table 1 compares the salient features of interest-based MFIs with charity-based MFIs. From the table, one can conclude that charity-based Islamic MFIs are supposed to be as financially and economically sustainable7 as the present day’s interest-based MFIs to effectively meet the social and economic needs of the poorest of the poor.

Proposed Model for Charity-Based Islamic MFIs

This article promotes charity-based Islamic MFIs with the aim to reduce poverty and to ensure economic uplift of the poor. The framework of the proposed charity-based Islamic MFIs is mentioned in Table 1. Charity-based Islamic MFIs are to be

Table 1Salient Features of Charity Based Islamic MFIs and Interest-Based MFIs

Charity-Based Islamic MFIs Interest-Based MFIs

Sources of funds local philanthropy international donorsUsage of funds socioeconomic development profit earningType of charges interest free interest basedNature of funds charity debtNature of recovery only community pressure forced recovery through peer group pressureType of contributors voluntary nonvoluntaryType of empowerment family or individual womenType of motivation concept of brotherhood commercial motivationLevel of participation compulsory participation by selected members of the society every individual of the take part society

Note: MFI = microfinance institution.





set up under Waqf (endowment) Certificates to replace ordinary capital-based Share Certificates. The income generated from these Waqf Certificates would be used to meet operational expenses, as certificate holders are not supposed to receive the income/dividend.

The proposed Islamic MFIs will raise funds from the Zakat (compulsory charity) and Sadaqat (optional charity) plus Qard Hasan (interest-free deposits).8 Charity and interest-free money would reduce the cost of raising capital to a minimum (assume almost zero). The money raised will then be used for two broader types of loans—consumption and production. Charity-based Islamic MFIs will either directly or indirectly with the help of reputed NGOs provide emergency aid to the poor to meet their consumption requirements (food, shelter, clothing, etc.). Suggested MFIs will also ensure funds for the education and vocational training of the poor.

The major contribution of charity-based Islamic MFIs will be to provide interest-free loans to talented, honest, and hard-working people to start their own businesses. Interest-free loans will not only resolve the problem of funds shortage of the recipients, these will also provide them with the incentive to work diligently to return the principal amount, without having to pay any additional charges.9

In addition, it will reduce the stress of risk in business for the recipients and create an enabling environment for productive work and, thus, increased economic opportunities in society. Although the Holy Quran does not set a time limit for returning the interest-free loans, the charity-based Islamic MFIs can set timeframes for returning loans, in mutual consultation with the borrowers.10 At the same time, various steps should also be taken to minimize the issues of moral hazards such as willful defaults on loans.

Proposed Model

Inclusion of volunteers11 as part of the management will be another important feature of the proposed Islamic MFIs. Volunteers can help provide the basic wherewithal of life, education, technical training, and so on to the needy and can even motivate them to work as volunteers for the Islamic MFIs to develop their own community (see Figure 1).

Through charity money and interest-free loans, the suggested MFIs can build human resources and convert the beneficiaries of charity into charity donors. Once the needy achieve a certain level of financial stability, they should be encouraged to first pay off the interest-free loan, then to pay Sadaqat (optional charity), and then to pay Zakat (compulsory charity). Thus, charity-based Islamic MFIs can convert the poor into respectable members of society who may set examples for others to follow.





Recommendations for Charity-Based Islamic MFIs in Pakistan in Light of the Holy Quran

Pakistan is the second largest country of South Asia with a population of 160 million and an average growth rate of 6% per annum (since 2000). It is believed that South Asia holds one of the largest concentrations of poor in the world. Statistics about Pakistan show that almost 25% of Pakistan’s population (nearly 38 million

Figure 1 Model Proposed for Charity Based Islamic MFIs

Note: The idea of Waqf Certificates is taken from the Cash Waqf Scheme of Social Investment Bank, Bangladesh (see http://www.siblbd.com/html/cash_waqf_scheme.html).





people) lives in absolute poverty.12 The country is also facing a high level of inequality in income distribution. The share of the highest 20% of households was 49.7% in the national income in 1999, whereas the bottom 20% of households received 6.2% of the national income (Government of Pakistan, 2005-2006).

To reduce poverty in the country, the government has come up with a strategy to invest in social development sectors, rural development, creating job opportunities, and providing easy access to financial services. And within this, microfinance is recognized as a significant poverty alleviation tool.

Pakistan Interim Poverty Reduction Paper (Government of Pakistan, 2001b) asserted that “access to credit is the surest way of empowering the poor and improving their income generating opportunities” and that “international experience has shown that micro-credit can be an important instrument in improving the income generating capabilities of the poor” (p. 38). Similarly, the Asian Development Bank’s (2000) assessment of the microfinance sector in Pakistan was that the “poverty reduction potential of micro-finance is widely recognized at the policy level and among the development community.”

The MFP sector in Pakistan presently includes 20 to 25 NGOs, 6 microfinance banks (MFBs), 4 to 5 commercial financial institutions (CFIs), and 6 rural support programs (RSPs) (Pakistan Microfinance Network, 2005). Recent data published by Pakistan Microfinance Network (PMN) and ShoreBank International show the total outreach of various MFPs in 2008/Q1 to be 1.59 million active borrowers and 1.715 million active savers.13 Therefore, Pakistan is considered a huge potential market for microfinance.

Mutual Help and Cooperation

The Quran clearly states that “surely Allah changes not the condition of a people until they change that what is in their hearts” (Ch 13:11). Charity-based Islamic MFIs generate funds entirely on the concept of local philanthropy rather than any foreign aid and donations. It is widely believed that in developing countries, demand for credit and credit-related services far exceeds the supply side among the poor. The issue of reducing poverty without any foreign assistance would be a question for Pakistan.

A survey conducted by the Asian Development Bank (2000) revealed that there were 6.3 million poor households in Pakistan and all of them were potential clients for financial services. Another report estimated that at least 10 million households in Pakistan need microfinance services.14 The average size of the loan is Rs 12,000 (US$200/-). Thus, the total estimated amount required in microfinance is Rs 120 billion (US$2 billion) in Pakistan.

In the Quran, God says, “and We burden not any soul beyond its capacity, and with Us is a Book that speaks the truth and they will not be wronged” (Ch 23:62).





The Pakistan Center for Philanthropy estimates that Rs 70 billion (US$1.2 billion) was distributed as charity money in 1998.15 This figure does not include charity money received from expatriate Pakistanis (the country receives US$250 million or Rs 15 billion as charity money only from America; Pakistan Center for Philanthropy, 2005). These figures indicate the potential size of available local philanthropy, which can easily fulfill the requirements of the needy in Pakistan.

Recommendations for the Borrowers

And when you are greeted with a greeting, greet ye with a better greeting or at least return it. Surely, Allah takes account of all things. (Ch 4:86)

This article concludes that it is almost a religious duty of every affluent Muslim to come forward and help his or her needy brethren and expect a reward and blessing from God alone. However, this does not mean that God has relieved the needy from all social and economic responsibilities. The Quran also expects the recipients of charity money to greet their benefactors in a better way or at least in a similar fash-ion. They are not supposed to consider the charity they receive as their birthright, but to honor their benefactors and keep their promise of returning the money, if made.

Recommendations for Interest-Based MFIs

MFIs in Pakistan mostly seek technical and financial assistance from foreign donor agencies. In general, they borrow at low interest rates from different interna-tional agencies and then disburse to the poor at a higher interest rate. Local MFIs are legally bound to return the borrowed amount after a specified time period. The Holy Quran also teaches the believers to fulfill their promises:

And fulfill the covenant of Allah when you have made one, and break not your oaths after making them firm, while you have Allah your surety. Certainly, Allah knows what you do. (Ch 16:91)

This article recommends a gradual shift in the existing MFIs’ operations from interest based toward charity based. MFIs in Pakistan may initially start collecting charity money and offering interest-free loans, parallel to their interest-based opera-tion. Once these MFIs achieve a certain level of donations through charity money, they may waive off the remaining interest income on outstanding loans and thus convert all loans to interest-free (Qard Hasan) service.

MFIs are to be allowed to recover their principal amount to reduce losses. However, the Holy Book recommends granting more time if the debtors are in dif-ficulty, or entirely waiving off the outstanding amount if the situation is completely beyond the control of the borrower.





O ye who believe! Fear Allah and give up what remains of interest, if you are truly believer. But if you do it not, then beware of war from Allah and His Messenger; and if you repent then you shall have your principal; thus you shall not wrong nor shall you be wronged. And if the debtor is in difficulty, grant him time till it is easy for him to repay. But if you remit it by the way of charity, that is best for you if you only knew. (Ch 2:278-280)

Notes

1. “And Allah has favored some of you above others in worldly gifts. But those more favored will not restore any part of their worldly gifts to those whom their right hands possess, so that they may be equal sharers in them. Knowing this, will they still deny the favor of Allah?” (Ch 16:71).

2. “. . . and those who hoard up gold and silver and do not spend in the way of Allah, announce to them a painful punishment, on the day when it shall be heated in the fire of hell, and their foreheads and their sides and their backs shall be branded with it. This is what hoarded for yourselves, so now taste what you hoarded” (Ch 9:33-34).

3. “A kind word and forgiveness are better than charity followed by injury. And Allah is self sufficient, forbearing” (Ch 2:263).

4. “O ye who believe! Shall I point out to you a commerce which will deliver you from the painful punishment? That you believe in Allah and His Messenger, and strive in the cause of Allah with your wealth and your person. That is better for you, if you did but know” (Ch 61:10-11).

5. World Bank defines poverty as “Poverty is hunger. Poverty is lack of shelter. Poverty is being sick and not being able to see a doctor. Poverty is not having access to school and not knowing how to read. Poverty is not having a job, is fear for the future, living one day at a time. Poverty is losing a child to illness brought about by unclean water. Poverty is powerlessness, lack of representation and freedom.”(see http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPOVERTY/0,,contentMDK:20153855~menuPK:373757~pagePK:148956~piPK:216618~theSitePK:336992,00.html).

6. Islamic jurists believe that prisoners of war are also included within the definition of slaves. The Quran does not allow the taking of prisoners except after a regular war (see Ch 8:68), and Zakat money can be used to free them (see Ch 24:33 and Ch 47:4).

7. Akhuwat, a charity-based NGO in Pakistan, provided its first interest-free loan of Rs 10,000 (US$150) in 2001. Today, beneficiaries of Akhuwat number to 30,760 with a total disbursement of Rs 323,745,842 (US$5.396 million) and a recovery rate of 99.3% (see www.akhuwat.org.pk).

8. Habib (2002) pointed out that Zakat and Sadaqat will reduce the need to diversify funds meant for investment to unproductive use, thus improving the overall returns on investment and decreasing the prob-ability of defaults on loans.

9. Zarka (2007) viewed that a beneficiary, if unable to repay his or her loan, also becomes ghaarim (one burdened with debt) according to Zakat rules in the Holy Quran (9:60). The beneficiary thus becomes a legitimate recipient of Zakat to pay back what he or she owes.

10. For example, the U.S. Personal Responsibility and Work Opportunity Reconciliation Act (1996) limits the recipients of the welfare money maximum up to 5 years.

11. The Pakistan Center for Philanthropy estimates that individual volunteers contributed Rs 30 billion in terms of time value of money in 1998. Detailed statistics are given at www.pcp.org.pk/fact_sheet.html.

12. According to the Pakistan Microfinance Ordinance (Government of Pakistan, 2001a), a person is considered poor if his or her per month income is less than Rs 15,000 (US$250/-).

13. For details visit, www.pmn.org.pk.14. Microfinance Performance in Pakistan (1999-2005), USAID-WHAM project.15. The country’s per capita income has doubled since 1998.





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Ahmad Kaleem, PhD, is an associate professor at Lahore School of Economics, Lahore, Pakistan. His areas of interest include Islamic finance, philanthropy, and financial institutions.

Saima Ahmed is a PhD scholar at the University of Management and Technology, Lahore, Pakistan. Her research and teaching are focused on banking and quality management.




the quran and poverty alleviation: a theoretical model for charity-based islamic microfinance...

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