Unlocking the Transformative Power of Zakah for Financial Inclusion

15 Jan, 2020

Institutional development in the Islamic financial services industry has taken place at different levels where the Islamic banking sector continues to predominate in shaping the direction towards which the industry is heading. The Islamic financial industry, composed of four primary sectors, namely Islamic banking, Islamic capital market, takaful and re-takaful, and Islamic social finance, has achieved considerable growth. However, one sector that is often overlooked, but which carries immense potential, is Islamic social finance. This sector has proven to be more resilient than the first three mentioned sectors, and it can also help in achieving greater financial inclusion.

The Islamic social finance sector, which broadly comprises traditional Islamic institutions based on philanthropy such as zakah, sadaqah and awqaf, as well as contemporary Islamic not-for-profit microfinance institutions, has the potential to serve clients that are not ‘bankable.’ Since these institutions use forms inherited from the Islamic tradition, the way they operate is also subject to a set of Shariah principles that must be adhered to at all times. Effective management and utilization of zakah and awqaf are crucial to ensure that their benefits and impact are enjoyed optimally across the next generations.

Using the appropriate technological advances to administer the Islamic social finance sector can improve efficiency and optimize the potential of the zakah management system. Every Muslim country, particularly the Islamic Development Bank (IsDB) member countries, have a different way of managing the zakah, and to adopt a method of zakah management system is not simple. There is therefore the need to find ways of instituting a uniform, efficient and effective zakah system. Hence, the Islamic Development Bank Institute (IsDBI) of IsDB teamed up with Bank Indonesia in 2014 to establish a unified framework for zakah management. This partnership resulted in the production of Zakah Core Principles (ZCPs). The core principles of zakah management help existing regulatory bodies in different jurisdictions to improve governance. For the countries that do not have a zakah system in operation, ZCPs will provide the basis for making zakah laws and regulations.

The ZCPs are a formulation of a set of minimum regulatory requirements that govern the operations of zakah collection, disbursement and mobilization. ZCPs are comprised of 18 principles, divided into two main categories, namely (a) essential criteria and (b) additional criteria. The essential criteria set out in ZCPs is any element that should be in place in zakah management in order to function both efficiently and effectively, such as the presence of legal foundations and robust governance. Whereas the additional criteria refer to ‘add-on’ elements, such as risk management, that may be relevant to those who are more advanced in managing their zakah.

Although Islamic social finance has grown and attracted a range of new key stakeholders, it remains engulfed with a number of challenges at the macro-, meso- and micro-levels of organization. These include:

1. How much regulation is right for the Islamic social finance sector?
2. Do stringent laws and overregulation stifle the sector?
3. How should the key stakeholders harmonize different regulatory frameworks governing institutions that include religious and secular philanthropy, cooperation, and not-for-profit and for-profit finance?
4. How should they develop a unified and integrated framework for the Islamic social finance sector?

More specifically, questions relevant to sub-sectors that may have major policy implications are:

1. How do we ensure standardization in defining assets subject to zakah and estimating zakah liability in the presence of diversity in legal opinions?
2. Is zakah a dependable source of funds for institutions?
3. Does the state perform better than private institutions in the domain of zakah management?
4. Should zakah payment to state authorities be made compulsory?
5. Should a zakah payer be allowed to choose between public and private zakah collectors?
6. Should zakah payments be allowed as a deduction to income tax payable or to taxable income?
7. Is corporatization good for zakah management?
8. Should zakah be allocated for other types of beneficiaries only after the needs of the ultra-poor are addressed?
9. Does the requirement of ownership (tamleek) imply unconditional cash transfer?
10. Should zakah be used for giving loans? Will the answer be different if zakah funds are used to create a revolving fund (credit pool) to leverage the relatively scarce zakah funds for meeting the needs of a much larger number of the poor? Will the answer be different if the revolving fund is owned by the poor?

Answers to the above questions surely required careful analysis and careful observation, backed up by robust data and sensitivity to the uniqueness of each jurisdiction. The search of such answers motivated IsDBI to initiative developing the Zakah Core Principles (ZCPs). The project was launched at the World Humanitarian Summit (WHS) 2016 in Istanbul.

To develop the draft of the core principles, IsDBI and Bank of Indonesia formed a partnership with various key stakeholders in the field. These include MORA Bangladesh, Kuwait Zakah House, South African National Zakah Fund, Zakah Foundation in India, and zakah authorities from Malaysia. Some of the principles have already been adopted by BAZNAS, the national authority of zakah in Indonesia, such as ZCP#8 (Good amil governance), ZCP #9 (Collection management), and ZCP#10 (Disbursement management).

Dr. Hylmun Izhar, Senior Economist at IsDBI, was involved in the project to develop the ZCPs. He explains: “The concept of zakah regulations and regulatory frameworks differ across countries. These differences reflect the unique circumstances and priorities of each jurisdiction depending on the history and customs of their societies. Hence, it was not easy to spread the concept of zakah. However, the coming of the core principles and guidelines is expected to unleash the potential of zakah and strengthen a sound supervisory zakah management especially for the benefit of the IsDB member countries.”