Islamic Finance Innovations for Social Progress

 Nurul Aini Muhamed and Muhammad Iqmal Hisham Kamaruddin

 

Introduction

Islam promotes private ownership and acknowledges property gained by individual efforts. At the same time, its teachings also promote the attainment of social objectives such as reducing poverty and public rights (basic needs, health, education, etc.). Islamic finance nowadays is criticized for not realizing its full potential in balancing private and social objectives. Islamic finance today tends to be more focused on profits rather than easing the plight of the poor and reducing poverty. However, Islamic financial institutions can help and serve both, public as well as private sector objectives.

Waqf, zakah, sadaqah, hibah and qard are all charitable schemes to support the needs of the needy. These have nowadays been extended to benefit large numbers of people, Waqf, for example, has been innovatively developed into several types of waqf such as cash waqf and share waqf, instead of only immovable assets. In addition, zakah as an obligatory almsgiving has also been innovated with the inclusion of the zakatable portion to support the business activities of the poor, rather than only to cover their basic needs. These two charitable contracts have some restrictions compared to others such as hibah and sadaqah, which are more flexible in terms of their usage. The development of the third economic sector is however shadowed by profit-based Islamic financial institutions. Hence, some of the innovations initiated by Islamic financial institutions should be learned and adopted.

Innovative approaches in the usage of charitable contracts are significantly important to support third economic sector citizens. Islamic social enterprise (ISE) is one form of third economic sector institution, besides zakah and awqaf based institutions. The uniqueness of ISE lies in its flexibility to generate income from business activities to cover long-term societal contributions and their sustainability. The sustainability of the ISE itself is important to ensure that it can contribute more to recipients and serve stakeholders in the long run. Here we propose that the ISE should be financially supported using suitable charitable contracts with the help of innovations in Islamic finance.

 

Islamic Social Enterprise

ISE refers to an institution that gains monetary and non-monetary funding from Islamic charitable sources to be channeled to business activities. The income generated from its businesses are then used for charitable contributions and sustainability (to cover for expenses). Its offering is not limited to trading products as it can also offer services. Nowadays, there are several sectors that are involved by ISE. These include retail services (new and used goods), education, hospitality, and health. The institution provides services at different ranges of prices, ranges from the affordable to lowest prices or free of charge for the poor.

ISE serves society in several ways. ISE’s contribution to society members include; (1) to deliver opportunities to the richer to contribute monetarily and non-monetarily to the poor via ISE, (2) enable the poor and lower-middle-income people to get product and services at cheaper prices, or in certain situations at no cost, (3) provide jobs to the local community. While these institutions can provide a direct impact on society (such as education and health), they also need financial support to grow and reach more recipients.

 

Supporting ISE’s using Islamic Finance Innovations

ISE needs sufficient funding before it can sustain itself. It can be financially supported using traditional ways of charitable contracts as currently practiced. These include accepting funds from more affluent people under the following categories:

  • Sadaqah or hibah are the most flexible source of funding as they do not restrict types of recipients and responsibility of the intermediary to keep the principal funding. These two sources, however, cannot secure continuous funding since they also depend on the willingness of the donor to donate.
  • Qard is another source that can be used as it is a benevolent loan that only obligates the borrower to pay the principal. ISEs can apply qard from the public to fund their activities. One of the limitations of this contract is the liability of the ISE to pay back the loan, which may become a burden, especially when it is in the phase of stabilizing financial positions.
  • Waqf or endowment is now promoted widely to fund third economic sector activities. In some cases, the immovable assets are developed as housing or business property using funding from Islamic financial institutions and rented out. The rental then will be used to pay the funding and the balance will go back to cover management expenses or giving out to recipients. The assets (such as buildings) from the waqf initiatives can be used as the main premise of the ISE such as to build hospitals, hostels, schools or universities at different ranges of prices- premium, middle, lower and at free cost. The principal of the capital remains as it is, and the ISE will benefit from its usage. One of the limitations of this initiative is that it will not cater to potential more advanced investors who consider some benefits of their investments and at the same time want to do good.

 

Sukuk for Social Impact

Social impact Sukuk (SIS) is one of the sophisticated instruments that can cater to the needs of ISEs as well as profit investors. SIS can be structured using Islamic commercial and charitable contracts and linked with societal obligations. The selection of activities that are funded by SIS differentiates it from ordinary sovereign and corporate Sukuk. SIS also works when government funding is insufficient to support public facilities. Under this type of Sukuk structure, Sukuk is issued to investors to fund societal and environmental based projects and initiatives. The method of payment depends on the success of the project based on certain key performance indicators (KPI). Under the ‘pay for success method’ for example, the investors will let go a certain portion of a nominal amount of yield as part of the commitment to support social obligations. Such instruments can be adapted to fund the ISE.

Another is combining waqf and other Islamic commercial contracts such as wakalah, mudarabah etc. to finance commercial projects as practiced in the industry. Different from standard Sukuk instruments, under this structure, the investors are given some options to contribute some or all parts of their return to fund ISE initiatives under the waqf scheme. The ISE can later use the fund to support its activities by buying immovable and movable assets that can eventually benefit the recipients.

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