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Poverty is one of the greatest problems affecting developing countries. Socio-economic imbalances, created by both natural and artificial resource scarcity, restrict impoverished people’s access to economic opportunities, limiting their purchasing power and empowerment. Environmental degradation is thus both a cause and effect of resource scarcity, as the poor are forced to seek increasingly environmentally and economically unsustainable methods of income generation, further marginalizing them. Microfinance is known to be one of the best tools to combat poverty, as it allows the poor to empower both themselves and their communities through the creation and sustainment of their own businesses. Moreover, green microfinance, which combines the core concepts of microfinance with environmental awareness and preservation, aims to allow empowerment to occur without compromising the environment. Microfinance institutions (MFIs) use simple administrative procedures and the general abolishment of collateral to allow inhabitants of remote areas to access microfinance, whilst maintaining relationships with them and assisting with their financial and personal problems, educating them, and providing aid in the event of environmental disasters. Hence, microfinance is believed to have a positive effect on both poverty alleviation and environmental awareness. In Indonesia, the country with the largest Muslim population in the world, Islamic finance, which was established in 1991 and saw rapid development during the politically volatile years of 1997 and 1998 (Seibel 2008), comprises commercial banks and banking units, Islamic rural banks, and Islamic financial cooperatives. Commercial Islamic banks focus on providing savings, financing, and insurance to medium and large businesses. People running small or micro businesses are thus restricted from receiving their services. Islamic microfinance, in the form of banking units, rural banks, and financial cooperatives, fills the void left by the commercial banks, enabling Indonesia’s disadvantaged entrepreneurs to generate income on their own terms. Most people in Pasuruan Regency, East Java, earn their incomes in the processing industry, agriculture, and trading. In this region, these sectors contribute more than any other to the total Gross Regional Domestic Product (BPS Pasuruan). However, most of them generally negatively affect the environment, through pollutive and chemically harmful practices, as well as a lack of skill and knowledge required to mitigate the negative impacts of these practices. These effects could be influenced by the microfinance institutions that finance their business activities and have a say in how their businesses are run. This is particularly the case with the Islamic MFIs in the region, in whom clients put a great deal of trust, and whose growth has been stimulated by Islamic finance’s own growth in Indonesia as a whole. Although MFIs have seen significant development since the 1970s, not enough is known about them. While they have been shown to contribute to poverty alleviation, little is known about their simultaneous roles as facilitators of poverty alleviation and environmental development. Understanding this dynamic was of particular concern in Pasuruan Regency, as the peoples of our research sites appeared to show little regard for their environment whilst relying on MFIs to support their businesses. With their institutions failing to intervene in their destructive behaviors, there is an opening for environmental degradation to be countered with the use of MFIs as promoters of environmentally-friendly business practices. This study aimed to investigate the effect of Islamic microfinance institutions on the welfare of their clients, and whether they positively contribute to their environmental awareness. We examined the role of Islamic microfinance institutions in poverty alleviation and environmental awareness in three different areas of Pasuruan Regency, namely lowland, coastal, and upland. We further compared the impact of Islamic MFIs with that of conventional MFIs, to understand whether Islamic microfinance is consistent with other microfinance types or is able to stand out in its influence on clients’ welfare, awareness, and behavior Field work data was collected using qualitative and quantitative approaches. The qualitative approach comprised in-depth interviews, direct observations, and focus group discussions, while the quantitative approach comprised standardized and semi-structured questionnaires. Additionally, secondary data was obtained from banks and a number governmental organizations and officials and statistics offices. Triangulation and a logic model were used to evaluate and validate data before conducting both qualitative and quantitative data analyses. The qualitative analysis was used to describe the behavior of the people in our research area, particularly towards changes in their economic welfare and awareness of specific environmental issues after joining a microfinance institution. Quantitative data analyses consisted of frequency distributions and numerical summaries. Our results revealed that both Islamic and conventional MFIs’ primary concerns were self-sustainability, as they attempted to maintain financial performances and increase client bases within a regional context. Pondok pesantren, through their prevalence and their teachers and students’ social programs, contributed to the development of Islamic MFIs in the lowland area by improving the public’s perceptions of Islamic microfinance. In the coastal area, Islamic MFIs managed to mitigate the challenges and poor perceptions created by their failed predecessors. Meanwhile, Islamic MFIs in the upland area employed specific strategies to overcome challenges to their sustainability during periods of mass withdrawals. Conventional MFIs largely tailored their services to the needs of their clients, helping farmers acquire seeds and fertilizer in the lowland area, for example, or assisting fisheries and small entrepreneurs in the coastal area and helping clients grow, harvest, and process agroforestry products in the upland area. The microfinance institutions in all three areas positively contributed to poverty alleviation, with a significant majority of MFI clients being able to develop their businesses after receiving financing or loans—more so those in the lowland and coastal areas than the upland area. In terms of business re-investment, the lowland area was found to have the lowest percentage of clients spending their surplus incomes on increasing business size or employee numbers; a factor that requires attention from the local government and MFIs if they are to contribute to self-empowerment. Contrasting their impacts on poverty alleviation, both conventional and Islamic MFIs had negligible impacts on increasing the environmental awareness of their clients. Our analyses revealed that the MFIs in all three areas had problems with providing environmental training to their clients, failing to combat the already existent lack in awareness, and consequent accumulative degradation that occurred as a result. In all three research sites, more respondents reported that they did not receive training from their MFI than those who did. MFIs found it costly to dedicate a part of their net profits to environmental matters, but we found one cost-effective way to contribute to environmental awareness was through informing them of the existence of the few training programs that were available. There are still a limited number of empirical studies on Islamic microfinance’s contributions to the poverty reduction of both the poor and the poorest. Our comparisons of the roles of Islamic and conventional MFIs in alleviating poverty revealed that both Islamic and conventional MFIs had a positive effect on poverty alleviation—Islamic MFIs slightly more than conventional ones. The screening system used by the Islamic MFIs, in particular their targeting of clients who were less inclined to use their funds for unrelated purposes, had a significant impact on their ability to avoid the lending risks encountered by the conventional MFIs, as well as the development of their clients’ businesses. This was supported by key informants’ observations that Islamic microfinance reduces the poverty level of clients, with their interest-free financing options and more flexible repayment plans being major factors. Islamic MFIs’ redistributions of public donations to the poorest in the form of qard al hasan (credit without interest) also fortified their roles as important contributors to poverty reduction. Nevertheless, considering how integral the environment is to their clients’ livelihoods, their environmental initiatives were merely enablers in their clients’ destructive behaviors, and will only contribute to increased resource scarcity and more arduous poverty alleviation efforts. Islamic MFIs should therefore look at targeting environmentally-friendly businesses, in spite of their unfairly negative associations with cost and risk, whether through the use social funds or collaboration with the government. Green microfinance, which was unsuccessful in our study, should continue to be studied as a viable method of providing financial services to poor communities. Green Islamic microfinance, further, may be considered the next step in Islamic finance’s development, as institutions attempt to empower individuals and communities in increasingly vulnerable environments.

The role of Islamic microfinance in poverty alleviation and environmental awareness in Pasuruan, East Java, Indonesia