Time for profit-making Islamic finance to step up efforts for social services

Islamic social funds, especially zakah and awqaf, can potentially meet resource shortfalls to alleviate widespread poverty in South and Southeast Asia, says a new report from Thomson Reuters and IRTI. However, the potential remains unrealised as actual zakah mobilised and returns of awqaf assets fall far short of their potential in most countries. Islamic financial institutions and the Islamic capital markets must step in as both a donor and a financing partner and should be involved in bolstering the existing activity of Islamic social finance organizations.

The Islamic Social Finance Report 2014 focuses on zakah, awqaf, cooperatives and not-for profit microfinance in the countries of South and Southeast Asia with sizeable Muslim populations – Indonesia, India, Pakistan, Bangladesh, Malaysia, Singapore and Brunei Darussalam. One of the interesting areas covered in the report is the resource gap, as well as an estimate of the potential zakah resources available to bridge that gap

The report presents case studies of success stories and good practices, including institutions funded partially with zakah such as the Shaukat Khanum Memorial Cancer Hospital and Research Centre (SKMCHRC) in Lahore, Pakistan, which receives zakah and donations that account for about half of its total sources of income. It tracks the uses of the funds to ensure that it maximizes ability to pay among those patients who can afford it, and ensures that zakah are used to pay for care for eligible zakah recipients and the donations are used to cover those who are needy but not eligible to receive zakah.

The most interesting insight—and the one with the greatest implications for the design of policy that incorporates a role for zakah—is the significant shortfall between potential zakah donations (from the amount needed to bridge the resource gap and alleviate the most significant instances of poverty in these countries which are home to 718 million Muslims.

Several countries listed in Table 1 have the resources needed to fill the resource gap at the $1.25 per person per day level that defines extreme poverty, but the resources are significantly lacking to make up the gap at the $2 per person per day level, which is a level that still brings significant hardship. More importantly, the use of zakah resources for income support alone does not directly affect the health, education and other social services needed to avoid a return to poverty if the zakah collection levels dropped.

If there is a structural source of the shortage of zakah funds needed just to cover immediate needs, then the types of projects that will provide education and healthcare services, including services for which the cost can be covered in part with zakah funds, will never come to pass because of the high capital cost of these services.

For projects like the SKMCHRC, the conventional debt markets or bank financing might be an option except that zakah donors might be uncomfortable directing their zakah to a project that uses interest based financing, even if funds were segregated.One way to cover the shortfall is through sukuk, which are not commonly employed outside of the for-profit sector, but have been developed for use with waqf assets where long-term leases keep ownership with the waqf, but allow for private capital to be accessed to increase the value and income from the waqf assets. This type of structure would be useful for projects like hospitals and schools where the up-front capital cost to improve or build a property is substantial and where there are sources of revenue and non-zakah donations that could support the (sharia-compliant) financing cost for a facility where zakah funds are used to provide services (like healthcare) to those eligible to receive it.

Building on the idea of a sukuk to incorporate private capital in important social infrastructure projects that would reduce dependence on zakah, there could be ways to attract for-profit capital in countries with income taxes by offering tax deductibility of the profits paid on social sukuk projects in a similar way to how municipal bonds are taxed in the United States where the interest is exempt from federal taxes and state taxes for residents of the state issuing the bond. This would build on the substantial work to expand zakah collection to help the needy by bringing zakah, waqf assets and private capital to bear on the poverty reduction fight.

However, it should not entirely be left up to the capital markets and most Muslim majority countries do not have sizeable capital markets, whether sukuk or conventional bonds. Islamic banks can and should be involved by stepping in to provide financing in a similar way that was described above for sukuk. Most private sector financing in these economies is provided through (for-profit) banks so the scale involved for Islamic banks is much greater than for sukuk.

Beyond these for-profit financing sources, Islamic financial institutions should be involved in their communities, including through corporate social responsibility programs where they provide donations to charitable organizations. One place that would particularly benefit is if they provided funding to support charitable activities by institutions like SKMCHRC that is not able to be covered by zakah. The Islamic financial institution can also provide funds as part of purifying its non sharia-compliant income.

Regardless of the source, these funds will help to build the capacity within the organizations needed to make best use of the available zakah by reducing the overhead costs attributable to the zakah activities (one of the eligible recipients of zakah are zakah administrators, but it is a lower benefit usage of zakah where other non-zakah funds are available). There is no single source that can fill all the needs not met by existing zakah funds, and Islamic financial institutions and the Islamic capital markets should be viewed as both a donor and a financing partner and should be involved in bolstering the existing activity of zakah organizations.

Download the report http://www.zawya.com/islamic-finance/isfr/