The link between Islamic banking and microfinancing

Abstract

PurposeThe purpose of this paper is to show the link between Islamic banking and microfinancing.Design/methodology/approachThe approach used in this paper is first to describe the basic principles of Islamic banking and microfinancing and then to show the link between the two financial practices. In general, it is believed that the two practices are not compatible since microfinance allows interest payments on loans and Islamic banking prohibits interest payment based on Islamic law, sharia. Both practices, however, promote equality and fairness for all members of the society and encourage entrepreneurship by giving collateral‐free loans to the poor. The two practices, therefore, are ideologically linked. This paper shows that they are also practically linked.FindingsIslamic religious leaders usually dismiss microfinancing because microfinancing requires high‐interest rate which is against Islamic law. This paper finds that it is possible to combine the two practices and to convince Islamic religious leaders that Islamic banking could be applied to microfinancing.Originality/valueSince microfinancing has been proven to help many poor people in different countries, the findings of this paper could be beneficial to the poor in some Islamic countries that do not practice microfinancing based on religious beliefs.