Islamic Microfinance in Somalia: A Path to Poverty Alleviation

Understanding Poverty in Somalia

Somalia, having gained independence in 1960, grapples with persistent challenges including prolonged conflicts, poor governance, and economic stagnation, rendering it one of the world’s most impoverished nations (Warsame et al., 2021). The country’s socio-economic landscape is further complicated by frequent natural disasters, such as droughts and floods, which exacerbate food insecurity and displacement. Traditional financial institutions often fail to reach the most vulnerable populations, leaving a significant portion of Somalis unbanked and excluded from formal financial services.

In light of these challenges, innovative approaches to poverty alleviation and financial inclusion are urgently needed. Microfinance, particularly when structured according to Islamic principles, presents a promising avenue for addressing these issues by providing access to capital, promoting entrepreneurship, and fostering sustainable economic growth among low-income communities. Islamic microfinance, with its emphasis on ethical finance and social responsibility, aligns well with the cultural and religious values of Somali society, potentially enhancing its effectiveness and acceptance (Rohman et al., 2021)

The Role of Islamic Microfinance in Poverty Alleviation

Islamic microfinance operates on the principles of Sharia law, which prohibits interest-based transactions (riba) and encourages risk-sharing and asset-backed financing. This framework provides financial services to low-income individuals and small businesses, fostering entrepreneurship and economic empowerment (Rahayu, 2020).

Unlike conventional microfinance, Islamic microfinance utilizes various Sharia-compliant financing models such as Murabaha (cost-plus financing), Mudaraba (profit-sharing), and Ijara (leasing), which are structured to avoid interest (riba) and promote ethical investmen; Murabaha involves a cost-plus financing arrangement where the Islamic microfinance institution purchases an asset on behalf of the client and sells it at a predetermined markup. Mudaraba is a profit-sharing partnership where the microfinance institution provides capital and the client provides labor, with profits shared according to an agreed-upon ratio, while losses are borne by the financier (Alkhan & Hassan, 2020).

Ijara is a leasing agreement where the microfinance institution leases an asset to the client for a specified period. The implementation of Islamic principles through concepts like Qardul Hassan, which involves lending money with no interest, exemplifies the alignment of Islamic finance with the goals of reducing social inequality and supporting community development (Syamlan, 2021; Thahir, 2023). Notably, Zakat, Infaq, Sadaqah, and Qardhulhasan can create financial inclusion within communities (Rohman et al., 2021). Islamic microfinance institutions play a crucial role in disbursing business funds to eligible micro-entrepreneurs, contributing to the sustainable management of business strategies (Isa et al., 2021). This Sharia-compliant approach not only provides access to finance but also ensures that financial activities are conducted in a socially responsible manner, promoting trust and acceptance within the community.

Financial Inclusion for the Unbanked in Somalia

Financial inclusion is a critical driver of poverty reduction and economic development, particularly in a country like Somalia where a significant portion of the population lacks access to formal banking services. Islamic microfinance institutions can play a pivotal role in extending financial services to the unbanked by offering Sharia-compliant products and services that cater to the specific needs and preferences of the local population.

By providing access to savings accounts, micro-loans, and other financial products, Islamic microfinance empowers individuals to start and expand their businesses, manage their finances effectively, and build assets. Islamic microfinance fosters a more inclusive financial ecosystem by offering cost-effective, ethical, and transparent financial products tailored to diverse populations that can significantly contribute to financial inclusion, especially in Muslim-majority countries (Mohamed & Otake, 2025).

For instance, innovative approaches can make formal financial services more accessible to the poor, while collaborations with local organizations can help overcome cultural and logistical barriers (Hassan, 2020). In Somalia, where trust in formal institutions is often low, Islamic microfinance institutions can leverage their adherence to Sharia principles to build trust and credibility, thereby encouraging greater participation in the formal financial system.

Challenges and Opportunities

Despite its potential, Islamic microfinance in Somalia faces several challenges, including a fragile security environment, weak regulatory framework, and limited institutional capacity. The ongoing conflicts and political instability in Somalia hinder the operations of microfinance institutions and increase the risks associated with lending to vulnerable populations. A weak regulatory framework can lead to a lack of transparency and accountability, undermining the credibility of Islamic microfinance institutions. Additionally, the nascent stage of development of Islamic microfinance institutions in Somalia results in limited capacity in terms of skilled staff, infrastructure, and access to funding. Addressing these challenges requires a multi-faceted approach involving government support, capacity building initiatives, and collaboration with international organizations.

However, there are also significant opportunities for growth and expansion. The high demand for Sharia-compliant financial products and services in Somalia presents a large untapped market for Islamic microfinance. There is also an opportunity to integrate mobile money and microfinance (Aboagye & Anong, 2020). Moreover, the growing awareness of the benefits of Islamic finance and the increasing support from international donors and development agencies can provide the necessary impetus for the development of a vibrant Islamic microfinance sector in Somalia. For example, integrating digital technologies and partnering with fintech platforms can enhance efficiency, reduce costs, and expand the reach of Islamic microfinance institutions.

Microfinance institutions play a critical role in offering financial services to those excluded from traditional banking systems, thus promoting economic empowerment (Kayembe et al., 2021). Microfinance institutions aim to provide legal certainty and fulfill financial service needs for the poor and/or low-income people (Firdaus et al., 2020). Also, microfinance institutions assist in enhancing financial inclusion through micro insurance (Wahab et al., 2023). The growth of SMEs can be greatly fostered by relaxing the cost and conditions of savings and lending by MFIs (Ngimanang, 2020).

Sustainability and Future Potential

Sustaining the operations and administration of microfinance institutions over the long term is a significant challenge, particularly in developing nations (Kayembe et al., 2021). The long-term sustainability of Islamic microfinance in Somalia hinges on several factors, including effective governance, sound risk management practices, and diversified funding sources. Islamic financial institutions need to effectively ensure that the economy strongly supports financial sustainability in the long term (Budiman et al., 2021). By adopting best practices in governance and risk management, Islamic microfinance institutions can enhance their operational efficiency, reduce the risk of loan defaults, and attract more investment. Furthermore, diversifying funding sources through partnerships with international donors, zakat funds, and socially responsible investors can ensure the long-term financial viability of Islamic microfinance institutions. Looking ahead, Islamic microfinance has the potential to play an even greater role in poverty alleviation and economic development in Somalia.

Also, Islamic microfinance can serve as a catalyst for promoting entrepreneurship, creating employment opportunities, and fostering sustainable economic growth. This is possible through empowering marginalized communities, promoting financial inclusion, and supporting the development of micro and small enterprises (AL-Maamari et al., 2022) (Harahap et al., 2023). Microfinance institutions in West Africa fill the void left by commercial banks by providing small loans at low interest rates, proving to be a viable solution for poverty alleviation and empowerment. Islamic microfinance is uniquely positioned to promote social sustainability through instruments like Zakat and Waqf. Zakat, as a mandatory form of charity in Islam, can be used to provide social safety nets and support vulnerable populations, while Waqf, as a form of Islamic endowment, can be used to finance long-term development projects. Overall, realizing the full potential of Islamic microfinance in Somalia requires a concerted effort from all stakeholders, including the government, the private sector, civil society organizations, and the international community.

Policy Recommendations for Enhancing Islamic Microfinance in Somalia

To harness the full potential of Islamic microfinance for poverty alleviation in Somalia, several policy recommendations can be considered and implemented, including strengthening the regulatory framework. The government can formulate a comprehensive regulatory framework for Islamic microfinance, including licensing requirements, prudential regulations, and Sharia compliance standards. Also, it can promote financial literacy and awareness.

Also, governments can launch targeted financial literacy programs to educate the public about Islamic finance principles, products, and services. This can improve access to finance and increase financial inclusion, especially among women and youth. Moreover, supporting capacity building and training programs is also important.

Governments can partner with training institutions and universities to offer specialized training programs on Islamic microfinance for professionals and practitioners. This can enhance the capacity of Islamic microfinance institutions and improve the quality of their services. For instance, integrating Islamic social finance, such as zakat and waqf, with microfinance initiatives can maximize the utility of Islamic social funds (Widiastuti et al., 2022). In addition, there is need to facilitate access to funding and investment. Governments can create a conducive environment for investment in Islamic microfinance by offering tax incentives, subsidies, and other forms of financial support.

Furthermore, governments can promote partnerships and collaborations among Islamic microfinance institutions, commercial banks, and other financial institutions to leverage their respective strengths and resources. To improve the success of monetary policy in Muslim countries, there are some steps that need to be taken such as, Islamization of commercial banking, making Islamic banking guidelines and regulations, and starting the uses of Islamic monetary policy instruments (Hossain, 2020). Islamic monetary policy can support the real sector, and money and banking institutions are vital in achieving Shariah monetary policy (Soemitra et al., 2021). Moreover, with the rise of financial technology, Islamic microfinance institutions can explore innovative ways to deliver financial services, reduce operational costs, and reach underserved populations.

Conclusion: The Future of Islamic Microfinance and Poverty Alleviation in Somalia

In conclusion, Islamic microfinance presents a promising pathway to alleviate poverty, promote financial inclusion, and foster sustainable economic development in Somalia, which is in line with the objectives of Islamic countries to eradicate poverty and equalize income (Trimulato et al., 2022). The values in Islam are in line to achieve the SDGs, but innovative and creative thoughts are needed to develop Islamic financial instruments. . By adhering to Sharia principles, Islamic microfinance offers a unique value proposition that resonates with the cultural and religious values of the Somali people, thus enhancing its acceptance and effectiveness (Hasan, 2020). Also, Islamic microfinance emphasizes ethical and responsible financing practices, promoting social justice and equitable distribution of wealth.

Islamic finance supports the SDGs with the most significant contribution to humanity. That is, by ensuring that the implementation of these objectives is carried out by upholding the values of justice and avoiding activities that are detrimental to society. The flexibility and adaptability of Islamic microfinance models, such as Mudarabah, Murabahah, and Qard Hassan, allow for customization to meet the specific needs and circumstances of different communities and individuals (Raimi et al., 2024). To realize the full potential of Islamic microfinance, it is essential to address the challenges and constraints that hinder its growth and development.

Also, strengthening the regulatory framework, promoting financial literacy, enhancing capacity building, and fostering partnerships are crucial steps towards creating an enabling environment for Islamic microfinance to thrive and make a significant impact on poverty alleviation in Somalia.