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Islamic Social Finance Tools for Development


As stated in World Investment Report 2014 by United Nations Conference on Trade and Development (UNCTAD)1, developing countries need US$3.3 to US$4.5 trillion per year in financing for basic infrastructure, food security, climate change mitigation and adaptation, health, and education; resulting in financing shortfall of US$2.5 trillion. Similarly, requirements for global investment across sectors and industries are estimated to be in the vicinity of US$5 to US$7 trillion annually. The Decade of Action calls for accelerating feasible solutions to all the world’s biggest challenges on three levels of action: global, local, and people. With just 10 years away, by calling on all people to make the goals their own, an ambitious global effort is occurring to deliver the promise.

Joint partnership among stakeholders, combining traditional and non-traditional funding to achieve the SDGs, are most evident in countries where issues raised in the global goals become the main development objectives. Likewise, policymakers have recently shown considerable interest in pooling public and private resources, which allows governments to share risks and returns. This is also in part due to a realization that state budget, tax revenue, and official development assistance are inadequate to meet the aims.

In a break from the past, attempts on developing new and innovative financing mechanisms aimed at supporting socially geared projects to close the financing gap are beginning to show promising results. These attempts are blended finance, crowdfunding, and impact investment, as well as different forms and instruments of Islamic finance. The Islamic finance shares commonalities with SDGs, with their pivotal roles on alleviating poverty and hunger as well as reducing inequality by redistributing wealth. Islamic finance and SDGs overlap in terms of the five foundational objectives of Shari’a (see Table 5.1).


Table 5.1


1.  No PovertyYYYYY
2.  Zero HungerYYYYY
3.Good Health and Well-beingYYYYY
4.  Quality EducationYYYYY
5.  Gender EqualityYYYNN
6.Clean Water and SanitationYYYNN
7.Affordable and Clean EnergyNYYNY
8.Decent Work and Economic GrowthYYYYY
  9.Industry, Innovation and Infrastructure  Y  Y  Y  Y  Y
10.Reduced InequalitiesYYYNY
11.Sustainable Cities and CommunitiesNYNNY
  12.Responsible Consumption and Production  Y  Y  Y  N  Y
13.  Climate ActionYYYNY
14.  Life Below WaterYYYNY
15.  Life on LandYYYNY
  16.Peace, Justice and Strong Institutions  Y  Y  Y  Y  Y
17.Partnerships for the GoalsYYNNY

Bridging the Social-Commercial Gap

Through a just system in society, fair financial dealings, and socially responsible practices, Islamic finance offers an important key to support the achievement of SDGs. The core principles of Islamic finance, such as avoiding speculations or ambiguity, limiting debt to the value of assets, prohibiting exploitative activities, and risk-sharing are highly aligned with the spirit of SDGs. Besides generating financial gain, Islamic finance also yields social and environmental returns. It complements the tenets of investment with the existence of moral and social criteria, emphasizing real economic activities, and promoting inclusion and stability. Thus, by definition, Islamic finance is value-based initiatives of doing good and avoiding harm.

Unlike conventional finance which made no effort to integrate both the commercial and social aspects of financing, Islamic finance is embedded equally in the commercial and social elements with the same aim to achieve prosperity. Within the Islamic finance universe, commercial finance covers a wide spectrum of the banking sector with its own products, services, and contracts that range from mudaraba (profit sharing), musharaka (joint venture), murabaha (cost-plus finance), ijara (leasing), wadi’a (safekeeping), and sukuk (bonds). Social finances such as zakat (almsgiving), sadaqa (charity), waqf (endowment), qard hasan (interest-free loan) have just started to get attention at global level.

To further distinguish Islamic social finance ecosystem from conventional one, institutions and instruments can be elaborated. Islamic Social Finance includes the traditional Islamic institutions based on philanthropy (zakat, sadaqa, waqf); those based on cooperation (qard hasan and kafala); and the contemporary Islamic not-for-profit microfinance institutions using for-profit modes to cover costs and sustain their operations. Innovation and collaboration between Islamic social and commercial instruments and institution has also supported the ecosystem.

Islamic social finance has been instrumental as a social safety net for more than 1,400 years. On the other hand, there is also a part of commercial finance that relates to social investment, such as Islamic microfinance, takaful (insurance), and sukuk which not only lead to programmatic improvement, but also long-term resilience and adaptive communities. As a whole, Islamic social finance has a significant potential to address the problems of marginalization and vulnerability. In consequence of its ability to help countries achieve inclusive growth, Islamic social finance is widely adopted even outside the Islamic world.

Among the key legacies of the Shari’a in addressing socio-economic problems are the promotion of social values and principles such as cooperation, public interest, the removal of hardship, and the virtue as well as the development of Islamic social finance instruments such as zakat, sadaqa, waqf, and qard hasan. Islamic social finance is frequently used to contribute to the world in the forms of emergency response, one-off living allowance, and refugee aid. However, it has not been given the same attention as the commercial sector.

The recognition of Islamic finance ability to bridge the gap between funding needs and SDGs is attributable to the global adoption of 2030 Agenda, for which universal pledge to leave no one behind’ aims to end poverty, reduce inequalities, and fully incorporate not only social goals but also the goals of environmental and economic sustainability. However, despite being a rising source of funds, Islamic finance remains an under-utilized mix of financial mechanism. The majority of the contributions for SDGs are made through informal giving, while the effectiveness of formal Islamic organizations in terms of charitable giving or other social purposes remain unacknowledged.

Shifting the Paradigm of Zakat

Moral, ethical, and philosophical aspects are important consideration in understanding poverty. Poverty is not only about inequality in capabilities; it is also about how limited choices and lack of access can have an impact on how a person behave, and how it can diminish social cohesiveness and solidarity, both of which are pertinent in Islamic teaching. This is where moral economy plays its part. Given that poverty is a multidimensional economic phenomenon, reducing it must be ethically correct and must take a holistic approach.

Ending poverty and inequality are two of the most difficult goals within the SDGs objectives, mainly because of the complexity of channeling funds from the givers to be used in ways that can alleviate the challenges. Given the commonalities and convergences between Islamic finance, which favors socially inclusive development, and the SDGs, leveraging zakat to alleviate poverty and reduce inequality is a solution worth tapping into.

As the third pillar of Islam, zakat is a mandatory form of giving for Muslims whose earnings have exceeded certain threshold. Muslims that are eligible for paying zakat should allocate at least 2.5 percent of their income or wealth to a group of those entitled to receive it (asnaf). To put it simply, zakat helps reduce poverty by ensuring wealth redistribution in society. In addition to zakat, there are two other forms of charity in Islam named infaq and sadaqa. Infaq is spending or disbursement that can be paid anytime by those who are willing to without expecting any reward or return, while sadaqa means a good deed. Zakat and infaq are always in the form of wealth, while sadaqa can be behavioral actions such as smiling and delivering a pleasant speech.

Body of knowledge and researches demonstrated how zakat and the SDGs overlap in terms of the Higher Objectives of Shari’a (HOSs). The SDGs are important for the world community including the Muslims, because aside from being good, they are not in direct conflict with Islamic precepts, and have been agreed by world societies in general. The elaboration on such commonalities resulted in a zakat step change that focuses on two aspects: productive approach and zakat institutionalization.

Continuous annual growth of zakat, infaq, and sadaqa indicates high public awareness to pay zakat through formal organizations or agents. However, a considerable gap between the actual and the potential amount collected remains, influenced by various factors. The ability to have a direct contact with zakat recipient (mustahik) could be one of the reasons why zakat payers (muzakki) choose to channel their zakat informally, as it enables them to know where the funds will be distributed.

According to a survey conducted by Pew Research Centre in 20124, a median of 77 percent of Muslims in 39 countries say they regularly pay zakat. Based on the report, the number is higher in Indonesia with nearly all Muslims (98 percent) reporting observance of zakat, yet the country’s actual collection is only 3 percent of its potential. Rates of paying zakat are also high with nine-in-ten in Malaysia, Thailand, Morocco, and Afghanistan.


The yearly global value of zakat is estimated at $550 billion to $600 billion. Yet, the total collection rate never reaches the actual size of zakat, which is due to some unaddressed challenges. To begin with, the collection of other types of zakat, including from trade, agriculture, livestock, gold, silver, and income, are overlooked due to low awareness and limited Islamic social finance literacy. Another challenge comes in the form of lack of public trust to channel funds through formal zakat institutions. Most prefer short-term, decentralized, and interpersonal exchanges between muzakki and mustahik. Tax may also be an issue for muzakki, who in certain circumstances may be subject to double payment.

Most countries treat zakat at par with charity contributions made to voluntary organizations and provide tax relief in the form of deduction to taxable income. Indonesia provides tax relief to muzakki who pays zakat through certified organizations in the form of deduction to taxable income. Pakistan also provides similar tax relief to the muzakki. Malaysia is the only country that applies reduction of income tax liabilities of an individual in the full amount of zakat paid, a very strong incentive indeed. Similar tax benefits mechanism is also applied to charitable giving in Europe.

At the institutional level, the performance of zakat institutions seems to be stagnated. Low quality and quantity of human resources in zakat area, discrepancy among zakat institutions, and data integration are among the many reasons behind the performance issues. One way to address the problems is by convincing people that paying zakat through a formal zakat institution is better than through informal networks. The lack of public trust to non-certified zakat institutions and the muzakki’s preference for interpersonal zakat paying can worsen the condition. Greater public trust, transparent and effective governance, and openness towards the formal zakat institution’s performance are critical for zakat to achieve its full potential.

While zakat can contribute to the SDGs, a further paradigm shift is needed in understanding zakat as a positive measure rather than a corrective measure. Positive means the wealth gets redistributed in order to prevent poverty. Muslims pay zakat hoping to help reduce poverty. Having said that, zakat is only assigned to those who are capable. When there are more poor people, more needs to be spent on their welfare, so the amount of zakat collected will not be sufficient. While growing number of muzakki is seen as an impact, the number of mustahik have expanded as well. Thus, there is no inherent, countercyclical buffer in expenditures, and this is the limitation of zakat when used as the sole measure to prevent poverty.

To optimize the role of zakat in preventing poverty, zakat management needs to shift its disbursement model to include not only giving on consumption for basic needs, but also expanding the rights of the recipients through productive activities to encourage a healthier economic environment. With regard to the impact, meeting both material and spiritual needs are important measures for zakat. Material needs are measured as the minimum living standards, while spiritual needs include how family, environment and government policies can support spiritual activities. Such impacts seem likely, although there are yet existing studies to document the ripple effect of zakat on improved access to basic needs, such as health and education.

To explore zakat collection strategy, the United Kingdom can be an example. The UK National Zakat Foundation has also urged Muslims to pay their zakat locally. To do away with debates over formal and informal mechanisms, the term “local” is seen as the most persuasive. Public service messages calling Muslims to “Pay your zakat locally” reflects a more enforcing meaning to reassure the payers of a competent authority and of how impactful their contribution to their as well as other communities. This is a sharp difference from merely inviting people to “give”, as is commonly done by charitable organizations.

Zakat can also complement government’s social assistance. The possibility of overlapped targeting between government and zakat authority can be addressed through data integration among governmental bodies. One of the wrong assumptions about zakat is that government cannot be involved in zakat arrangements. On the contrary, Islam recognizes the involvement of the state in zakat collection and distribution. A verse in the Quran refers to Prophet Muhammad in his capacity as a state leader:

“Take alms from some of their possessions, by charity ye clean and purify them and pray for them.”

Surah Al-Taubah (3)

During the lifetime of Prophet Muhammad, zakat management was done by assigning zakat officers. This mechanism lasted until the era of Abu Bakr Al-Siddique (632-634) and by the era of Umar Bin Khattab (634-644). Zakat had a remarkable impact on the population, resulting in a zero-poverty rate. The zero-poverty rate meant the absence of mustahiq, as every person became muzakki. It was also supported by cutting bureaucracy, fostering business and entrepreneurial spirit, restructuring organization, saving state budget, and simplifying the administration system, which affected productivity to push the ability to pay zakat. This is the ultimate goal of zakat: to transform mustahiq into muzakki.

This illustrates what society can achieve if zakat as a mustahik’s right over muzakki’s wealth is facilitated by the government. On that account, zakat is not a mere individual obligation, but public interest that encourages human interaction. The practice of zakat may create some society imbalance if not well managed and regulated. Also, state-administered zakat can potentially increase the collection. As pioneered in Malaysia, the tax credit treatment requires inter-government coordination and management of aggregate resource.

It is important to note that while government can be involved in zakat arrangements, there are restrictions in terms of its usage. Zakat cannot be used to finance public finance infrastructural projects, public utilities, or services which can benefit the rich as well, including for administrative expenditure. It must be clearly distinguished from other funds pooled through taxes and state revenues.

Experimental Case: Blended Financing Using Zakat for Renewable Energy and Disaster Recovery

There have been several attempts by Islamic institutions to use zakat for productive activities. However, the initiative is rarely involving multiple stakeholders that epitomizes the complexity of realizing SDGs objectives. An outlier in strategy of enhancing zakat’s productivity is the Indonesian National Board of Zakat (BAZNAS) which collaborated with various stakeholders, including the Regional Development Bank of Jambi (Bank Jambi) and United Nations Development Programme (UNDP) in 2017 on utilizing zakat funds for a renewable energy project in Jambi (see Chapter 8 for further details on BAZNAS).

The initiative was initially intended to raise the proportion of people benefiting from electrification and to bolster rural livelihoods. In harnessing the potential of zakat for SDG- related practices, an important consideration is the willingness to institutionalize zakat management stakeholders, including the government and the private sector.

Since then, BAZNAS has promoted a programmatic and professionally managed approach that goes beyond the predominant zakat model of one-time, individual consumptive donations for short-term need. Now, the emphasis is on more sustainable approaches, such as student capacity building, training, and the provision of initial capital for small and medium enterprises. This principle of productive zakat seeks to empower the mustahik so that they can sustain source of income in the long term.

BAZNAS’ programmes are adapted to the needs of the community and may be productive, consumptive, or both. For example, the economic sector aims at productive programmes such as procurement of fishing boats and support to marine product SMEs, whereas the health sector is fundamentally consumptive such as medicine and clinics. The proportion of zakat distributed by BAZNAS has shifted from 2015 to 2016, moving to longer-term purposes of education and the economy, with short-term humanitarian assistance decreasing6, which was then followed by the renewable energy initiative in 2017. The benchmark is not simply the number of beneficiaries who have received assistance, but, rather, the number of beneficiaries who have increased their standard of living after receiving zakat.

The collaboration between BAZNAS, Bank Jambi, and UNDP on the micro hydro initiative is not limited to providing renewable energy. The scope of work also covers poverty alleviation programme in Merangin and Sarolangun, Jambi Province, two of Indonesia’s least-developed regencies in which one in every seven people have no access to electricity. With zakat and Bank Jambi’s funding offered as part of corporate social responsibility, the partners support the establishment of four micro hydro power plants to raise the proportions of people benefitting from electrification and to bolster rural livelihoods.

BAZNAS and UNDP have also partnered to stimulate economic development in the quake- hit areas in Lombok and Central Sulawesi in 2018. A 7.0 magnitude tremor shook Lombok, which damaged among others key infrastructure for agricultural activities. A catastrophic earthquake followed by a tsunami and the rare phenomenon of soil liquefaction also struck Central Sulawesi. Under this collaboration, villagers learn innovative skills to improve crop production, maintain their farms, and create finished products to build economic enterprises in local commodities. It also enhances the capacity of local government and community in recovery through assistance to develop resilient villages, safer schools, and livelihoods. An integrated disaster preparedness programme is included as part of inter-sectoral linkages mechanism.

A Forward-Looking Perspective of Waqf

An endowment under the Islamic law, waqf, is typically understood as donating fixed assets (such as a building or a plot of land) for religious or charitable purposes with no intention of reclaiming the assets. There is, however, a more liquid form of waqf named cash waqf, which has strong potentials to contribute to the achievement of SDGs. Other movable financial assets, such as rights or ownership, stocks, securities, can also be donated as waqf. Waqf is governed by the fundamental principles of voluntary, perpetuity, inalienability, and irrevocability, hence, it is expected to create a sustainable entity. In many societies, waqf is not only intended for humans, it can also be aimed for the welfare of animals.

The Quran Surah Ali-Imran: 92 explains the guidelines in making use of waqf:

“You will not attain virtuous conduct until you give of what you cherish. Whatever you give away, God is aware of it.”

In addition to the Quranic verse, a Hadith narrated by Muslim amplifies waqf as a form of sadaqa jariyah (perpetual charity):

“When a man dies, all his deeds come to an end except for three things: sadaqa jariyah (continuous charity), knowledge which is beneficial, or a virtuous descendant who prays for him (the deceased).”

The benefits flowing from waqf are by definition sustainable. Unlike zakat, infaq and

sadaqa, which are usually in the nature of specific financial flows, a waqf provides for flow of benefits on a sustained basis, which distinguish it from ordinary sadaqa. Waqf is, thus, a mechanism for institutionalization of charity.

With regard to poverty alleviation, zakat is supposedly a short-term social safety net, whereas waqf is logically means long-lasting with its income-generation abilities. Waqf is superlative in several aspects as a supporting system to zakat. By being more flexible and long-term in utilization, waqf can exceed what zakat can do for economic growth.

Flexibility means waqf beneficiaries need not be restricted to Muslims, with the nature of the expected benefit being clearly stated. The asset donated can be permanent or temporary, though once declared, it is irrevocable.

The traditional form waqf for development generally involves donating for religious or social purposes such as hospitals, schools, and farms. In addition, waqf can also be used for economic growth and income generation. Cash waqf has a relatively broad appeal. It has the ability to support small and medium-sized enterprises and generates revenue through revolving investment mechanisms.

As most of waqf assets remain idle and even lost, the preservation of waqf and the status of waqf institution should be prioritized as it is largely untapped. Worldwide waqf assets are projected to have a value of US$100 billion to US$1 trillion and more than one-third of the total cultivable lands of Muslim countries are waqf lands. Therefore, legal and regulatory framework at a macro level are crucial to see the position of waqf in the economy. The framework should include a universal and generally accepted guidelines that provide a set of global standard, management and governance principles, institutionalization, and direct socio-economic benefits related to the SDGs. In 2018 a Waqf Core Principle was launched following Zakat Core Principle that was formalized two year earlier. Encouraging studies are pushing the frontiers of knowledge on waqf and bring positive results. Islamic social finance sector has also stimulated innovation for the development of waqf assets by linking them to alternative structures.

It remains an undecided and unresolved issue to choose by way of preference between preservation and development of waqf, as the main objective. In line with the principle of irrevocability, the legal and regulatory frameworks must articulate the meaning of perpetuality and the importance of sustaining and enhancing the benefits of waqf. An undue emphasis on either element would dilute and violate the concept of waqf and limit its optimum advantage to the society.

Furthermore, it is important to increase awareness around benefits of formal giving through formal recognized channels in terms of sustainability, professional management, and greater impact. Greater trust, transparent governance, and ability to demonstrate impact are critical for such social funds to reaching their full potential. Equally critical is the overarching need for enhanced performance of the Islamic social finance institutions. Addressing all these issues can build a more sustainable national Islamic social financial system or an integrated platform for zakat, waqf, and other Islamic charity forms.

In seeking the solution, an ingenious technology like blockchain may offer accountability and transparency more than just online transactions, which share compatibility with IsBF in terms of championing public trust. Multibillion-dollar zakat and waqf collection can benefit from and be harnessed using blockchain.

The disruptive innovation of zakat and waqf blockchain is consistent with the SDGs. In delivering a more effective and transparent platform and benefits to the million, such a novel approach to zakat and waqf business model, using blockchain is useful. The way blockchain eliminates central authority and middleman as well as distributes immutable data in secure, accurate, incorruptible, and transparent manner must help improve accountability and efficiency. By protecting and distributing money transparently as it should be – hence gaining greater public trust – blockchain can be a valuable tool for financing, governance, identification and recording services using open-decentralized system and digital ledgers.

Experimental Case: Linking Waqf and Sukuk for Social  Investment

The mainstream (commercial) Islamic finance may now be extended into social domain by innovatively linking waqf and sukuk. An investment instrument using waqf as part of the assets to issue sukuk has been introduced as sukuk linked waqf (SLW). It is simply an investment into a waqf land. Sukuk represents undivided shares in the ownership of tangible assets related to particular projects or special investment activity that could potentially be used as an interest- free instrument for mobilizing funds, whereas waqf has the capacity to generate income and finance productive activities where the returns could be retained for future funding.

Another innovative combination is cash waqf-linked sukuk (CWLS). Essentially, CWLS is a blend of waqf and sukuk for financing certain projects with low cost and without interest rate in order to increase social welfare. The concept of a CWLS instrument was introduced by Bank Indonesia and Indonesian Waqf Board (BWI) back in 2015. CWLS is an investment instrument which has social nature whereby cash waqf funds are collected, which are then managed and placed as sukuk instruments. The instrument was first launched in December 2018 to coincide with the 2018 IMF-World Bank Annual Meeting.

In Indonesia, BWI recorded 4,200 sq. kilometers of waqf lands scattered in more than 42,000 locations around the country at an asset valuation of US$27 billion.9 Assuming 141 million middle-class Indonesian in 202010, 87 percent of Indonesian population are Muslims11, the potential of cash waqf is estimated to reach a minimum of $12 billion. With modern approach of waqf management and innovative financing scheme such as merging waqf and sukuk, it is possible to optimize the potential of the waqf land and cash waqf to increase social welfare.

As an alternative source of funds, the issuance of CWLS does not burden the state budget. Instead, it will reduce foreign debt dependence, which in turn must help stabilize the economy. From market perspective, in which security is one of the push factors, such an innovative instrument can be interesting as long as it is guaranteed by the government. In addition, the community can also ensure that the development objectives of this fund are in accordance with community needs.

Recognizing the potential of CWLS for supporting development of social investment and productive waqf, the Indonesian Government experimented by way of issuing a Rp50 billion (approximately US$3.7 million) worth of CWLS SW001 through private placement on March 10, 2020.

The issued CWLS is SBSN SW001 series, with tenure of five years and is non-tradable, with returns in the form of discount and coupon. Discount is paid once at the beginning of SW001 issuance transaction and will is used for development of new waqf assets (for example, renovation and purchase of medical equipment to support the development of Retina Center at Achmad Wardi Waqf Hospital in Serang, Banten Province). Meanwhile, the coupon is paid every month and will is used for free cataract surgery service for the less fortunate people in the same hospital (targeting 2,513 poor patients in five years), as well as the procurement of ambulance to reach long distance patients. Furthermore, CWLS funds will be returned 100 percent to the waaqif once the SBSN SW001 series is due.

Diversifying Approaches to Achieve the Goals

Globally, Islamic finance assets have reached US$2.733 trillion, which is slightly less than the size of the SDGs financing gap. Enthusiasm to enhance the impact of IsSF is increasingly reflected in key milestones achieved during past few years. A next generation of innovation has to embrace new technologies to unlock the huge potential, to improve outreach, and to capitalize on the innate strength of the Islamic finance for sustainable development.

Concurrently, there is also a scope to support accountability, efficiency, governance, and transparency amongst institutions in managing and utilizing the potential of IsSF, which in turn must improve trust and generate increased contribution. SDGs alignment can also help IsSF better immerse in the global development community with international partnerships, to expand its contributions as part of a common global cause.



The spirit of charity as one of the Islamic pillars of faith embraces all the Muslim communities around the world. Indeed, the revival of Islamic social finance institutions is the result of the reawakening of Islamic religious observance in the past half-century. Zakat and waqf can support each other in eradicating poverty and promoting inclusive and sustainable economic growth. With major changes in approach, zakat and waqf can be integrated with other sources, including commercial instruments. While zakat and waqf are largely charitable forms of funding, sukuk is an investment mechanism that may attract financing from philanthropy to responsible development with a social purpose.

Islamic social and commercial financing can complement each other when used holistically, in spite of the different rules governing their uses. Zakat as an initial lift can be accompanied by revolving instruments such as waqf to move beyond survival in productive economic activities and by sukuk to encourage investment for more inclusive economic growth. In this way, the diversity of Islamic finance instruments should play an important role in poverty elimination and achievement of the SDGs through programmatic and portfolio approach.

In seeking collaborative spirit, international development agencies can help through inclusive interventions in a sustainable manner. Partnership with international development agencies is a good strategy for IsSF organizations to overcome challenges in areas of common interest as outlined in both the HOSs and the SDGs.


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