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Islamic Microfinance

An Inclusive Approach with Special Reference to Pakistan

Prepared by:

Muhammad Khaleeu!!aman "Principal Author#

Associate Professor

School of Islamic $ankin% and &inanceInternational Islamic 'niversity Islamabad Pakistan

And

(r) *asim Shah Shira!i "+o,Author#

Professor of -conomics

International Islamic 'niversity Malaysia

&or

Second -uropean Research +onference on Microfinance

.une /0 /12 3ronin%en2 the *etherlands

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Islamic Microfinance An Inclusive Approach with Special Reference to Pakistan

This paper reviews demand and experience of Islamic microfinance, as well as,limitations of mainstreaming. An effort has been made to integrate Islamicmicrofinance with prime objective of enhancing inclusion. The paper suggests

extending scope of Islamic microfinance in Pakistan through productdiversification, innovation and linking microfinance institutions with Islamicbanks, particularly for fund sourcing, sharia advisory, and technology transfer.ata set of Pakistan Poverty Alleviation !und has been used to assess impact ofconventional microfinance, which suggests that poverty status of poorest of thepoor has marginally been changed, rather the change was even smaller than theone achieved without microfinance. The "uestion of inclusion therefore needs tobe addressed through tools of Islamic poverty alleviation process.

Introduction:

Although various reports stipulate different magnitudes of population characteri#ed aspoor, there is firm understanding that si#able proportion lives in poverty in Pakistan$. It isalso recogni#ed that magnitude of poverty is much greater in rural than urban areas.%icrofinancial services have been recogni#ed vital to enhance capacity of the poor toutili#e human effort for income generation and empowerment. &owever, access tofinancial services is as low as $$' while ()' are financially excluded, the rest havingresort to informal sector. The women have even lower access *+' than men *$-'$. uchstate calls for to carryout situational analysis of poverty alleviation effort in Pakistan tosee the impact of microfinance programs, if any, and to make a case for Islamicmicrofinance in view of inclusion and just effort to develop poor.

/ver +0 institutions *microfinance institutions, rural support programs, microfinancebanks, and microfinance units of commercial banks and leasing corporations representedthrough Pakistan %icrofinance 1etwork *P%1 provide bulk of microfinance in thecountry. The Pakistan Poverty Alleviation !und *PPA!2is entrusted to provide whole salefunds to microfinance institutions *%!Is and multi3sectoral organi#ations for a variety ofdevelopment interventions including microfinance. According to 4conomic urvey*20056, microfinance institutions were estimated to have provided 7s. ).) billion to $.0million active borrowers by 200(30) which worked out to less than 6' of total population

$According to Poverty 7eduction trategy Paper *8oP, 4conomic urvey 200)305, 62.$' of total population was

living below poverty line in 200$. %ore recently, the 4conomic urvey 200930- reports incidence of poverty as 2+.('estimated by Planning :ommission and 6).$ ' by Task !orce on !ood ecurity. These estimates, however, exclude the

transitory vulnerable poor. /n the other hand, ;1P measures &PI3$ value of 6).2' for Pakistan, ranking 55thamong$09 developing countries.

2une 200-, PPA! has disbursed funds worth7s. )$.$) billion on account of various programs. To assess the efficiency of PPA! programs

68oP, ?4conomic urvey 200)305@, !inance division, 8overnment of Pakistan, Islamabad, 2005

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living under poverty line. /n the other hand, P%1 records microfinance outreach to $9'+

of the estimated potential 9.6 million households in Pakistan. %icrowatch( indicatescoverage to the extent of $6'. isregarding difference in estimates, it can safely beconcluded that substantial efforts are re"uired to extend the current achievement in termsof funds, outreach, scale and commerciali#ation P%1 has forwarded an estimate re"uiring

; )00 B 500 million i.e. 7s. +- B (5 billion to be invested in debt, deposit, and e"uity toreach 6.0 million target.

Appreciating short age of microfinance sector in Pakistan, some issues need attention.Although sustainability is crucial for the success of microfinance programs and theirability to alleviate poverty, evidence depicts that many programs do not fulfill thiscriterion, and cannot reveal operational and financial self sufficiency *P%1 2005).%anyinstitutions remain un3regulated, not allowed to collect and recycle savings, hence rely ondonorsC funds. A recent study5 based on survey findings of 5+ countries, includingPakistan, highlights factors adversely influencing effectiveness of microfinance programslike mission drift, poor management "uality D governance, and lack of transparency.

The paper, with specific reference to Pakistan, attempts to bring out some issues ofconventional microfinance leading to exclusion and suggests alternative mechanism ofIslamic microfinance to serve the cause of poverty alleviation in sustainable manner.

Issues of Microfinance

Typically, social collateral of microfinance groups is considered much strongercommitment than collaterali#ed transactions where the local groups provide cost effectivepeer monitoring and screening to ensure repayment and overcome enforcement problems.=ut, it is failing to deliver in many cases. The trust is breaking and microfinanceinstitutions are experiencing multiple borrowing by their clients. These conclusions aretrue in both national and international context. 4ven the loans have been diverted to thepeople not targeted by the programs9 and the very sense of such collateral has been

violated by the lenders themselves-. The conclusion is further strengthened by a recentstudy which discusses the dynamics of microfinance in Eahore *Pakistan and concludesthat commission agents arranged applicantCs access to loan at a fee ranging from 23$0' ofthe loan amount, possibly with connivance of the field staff of the %!Is, later being

+Pakistan %icrofinance 7eview 2005, Pakistan %icrofinance 1etwork, Islamabad

(MicroWatch (October-December 2008), Pakistan Microfinance Netork, !s"amaba#

)ibid

5:entre for the tudy of !inancial Innovation, ?%icrofinance =anana kins 2009F 7isk in a =looming Industry@,

ponsored by :8AP and :iti %icrofinance. Gthe study is based on a survey of 5+ countries including PakistanH

9=aker, >. E, 2000. p.$063$0+ 3 An impact study of flagship programs *8rameen =ank, =7A:, and =7= in

=angladesh concludes loan mis3targeting where the program officers bent the rules in an unobservable way and leavingconflicting conclusions about reducing income and consumption variation between program participants and non3

participants. 7ather the impact on education was reverse after correcting for selection bias.

- =astelaer, T. ., ?oes ocial :apital !acilitate the PoorCs Access to :reditJ A 7eview of the %icroeconomic

Eiterature@, ocial :apital Initiative


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interested to increase their market share$0. The rent seekers were responsible to raiseeffective cost of loan to the customers. Therefore, there is need to evaluate the jointliability bond and formation of social collateral keeping in view these limitations. !urther,the general practice of microfinance does not include the poorest and destitute ratherenterprising clients. A significant proportion of poor in %uslim communities, otherwise

too, demonstrate self exclusion owing to hariah prohibition of interest based transactionsof conventional microfinance.

-ffectiveness of conventional microfinance:

/ne of the most interesting generali#ations emerges that poorest of the poor *the hardcorepoor borrow essentially for protection purposes, given lower and irregular nature of theirincome. This group, it is suggested, will also be risk averse to borrow for promotionalpurposes *that is, for investment in future and will, therefore, be only a very limitedbeneficiary of microfinance schemes *&ulme and %osley $--)$$.


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4uantification of the impact of microfinance on poverty alleviation: To "uantify theimpact of microfinance on poverty alleviation in Pakistan, hira#i and Amanullah$5haveused counter3factual combined approach to study the impact of PPA! micro credit onpoverty status of the households. This method combines 5with3without@ and the ?before3after@ approaches. The former provides information on the poverty status of borrowers

*target group and compares it with the poverty status of nonBborrowers *control groupwhile the later compares the change in the poverty level of both groups ex3antae and ex3post for the time period in which the borrowers benefited. The methodology used for thestudy enabled to capture the net impact of micro credit and to isolate the influence of otherfactors on the income level and thus on the poverty status of the households whoborrowed. The net impact was assessed using following formulaF

PMN *Pbt$3 Pbt0 B *Pnbt$3 Pnbtoan 200+ to >an 200( and Ot0C stands for theduration from >an 2006 to >an 200+.

The authors have used the official poverty line of 7s.959.)+ per adult e"uivalent permonth for the year 200+30( and the same poverty line has been deflated by consumerprice index *:PI, published by the !ederal =ureau of tatistics Pakistan to get thepoverty line of 7s.969.22 for the year 200630+. The data collected by 8allup Pakistan*200( of a sample of more than 6000 households *including $(00 borrowers who hadtaken at least one loan from PPA! has been used. The other half of the sample comprisedof non3borrowers, having more or less the same socio3economic profile as that of theborrowers. The poverty levels have been estimated in respect of both borrowers and non3borrowers for the years under consideration. The overall poverty level was furtherdecomposed in different poverty bands and groups vi#. extremely poor, ultra poor, poor,vulnerable, "uasi non3poor and non3poor$9.The results are given in Annexure $.

The extremely poor households showed improvement in both groups but the improvementin respect of non3borrowers was more *$.9(' as compared to borrowers *$.22'.imilarly, non3borrowing vulnerable poor could improve their status by 2.-2' as

compared to the borrowers *$.$('. The ultra poor among borrowers, however, improvedthe maximum *+.)0' as compared to non3borrowers *6.$('. The most impact couldtherefore be observed in case of poor band while the least in case of extremely poor andvulnerable poor.

$5hira#i, 1asim . and Khan Amanullah, ?7ole of Pakistan Pover ty Alleviat ion !undCs %icro :redit In Poverty

AlleviationF A :ase of Pakistan@, 3333333333333333333333333333333$9

:ategori#ations of the households into different poverty bands is based on the definitions given in The 4conomic

urvey *200)32005.

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The net impact has been computed by taking difference of the change in poverty status ofthe borrowers and non3borrowers. The results reveal that PPA! micro credit enabled toreduce the overall poverty level by 6.05' and the household shifted to higher incomegroups during the reported period. The status of the extremely poor and ultra poorborrowers was marginally improved by 0.)6 and $.+(' respectively. There was marginal

net impact on extremely poor households. The results are consistent with thegenerali#ation that emerged from the literature that poorest of the poor households borrowessentially for protection purposes. The aforementioned studies clearly indicate thatmicrofinance is benefiting more the better off poor while the destitute are neglected owingnot to be credit worthy and entrepreneurial.

Inclusive Role of Islamic Microfinance: The characteristics of Islamic modes of financeare common to the best practices of microfinance$-. &owever, the microfinanceinstitutions could not diversify into Islamic financial instruments and those %uslimpopulations remained self excluded which rejected interest based financial services. Thefollowing will help understand more the inclusive role of Islamic microfinanceF

The "uestion of inclusion becomes more significant when demand for Islamic finance isconsidered. Although no such estimates have yet been arrived at in Pakistan, :8AP 20citedthat varying proportions of population *203)0' in various %uslim countriesdemonstrated potential demand to access Islamic finance. The respondents were evenready to pay higher price for Islamic products than conventional counterparts. Preferenceof Islamic microfinance vide various studies has been summari#ed at Annexure 2. Asurvey with limited scope of product development in A#ad Kashmir, territory annexed toPakistan *200-, indicated this demand to the extent of -9'. =P trategic Plan forIslamic =anking Industry in Pakistan *2009 expects that +3(' of the microfinanceclientele would prefer Islamic products by 20$02$.

7ehabilitation of the poorest can be achieved by providing social safety net through akat

where capacity can be developed to undertake business and sustain livelihood by thedestitute. It is evident that inclusion is emphasi#ed more in Islamic framework as the poorwho do not possess re"uired entrepreneurial skills are generally excluded fromconventional microfinance. A systematic approach, meeting consumption re"uirementsfirst and production re"uirements thereafter, through grant and finance respectively, canenhance inclusion of this segment. akat and sada"at, the divine tools of povertyalleviation, can be used to achieve the objective. %icrofinance institutions, followingbusiness model, can arrange such grants enabling clients to become bankable.

$-=oth conventional and Islamic microfinance target poverty alleviation, do not re"uire physical collateral, and promote

self3esteem and entrepreneurship.

20Karim 1, Tara#i %. and 7eille Q., ?Islamic %icrofinanceF An 4merging %arket 1iche@, !ocus 1ote 1o. +-, :8AP,


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ebt is not preferred by Islam as usual practice to finance growing needs of clients 22. Inpresent day practice, the possibility cannot be ruled out that amount of loan finds its wayin a purpose other than targeted one or clients manage to pay previous loan with a freshissue from same or other sources. uch state turns harmful to the economic goals ofsociety. That is why Islamic finance favours asset creation and promotes entrepreneurship.

7isk sharing principle helps improving efficiency and sustainability of micro enterpri#es./therwise, too, partnership modes of Islamic finance prove advantageous for institutionover conventional finance in economies with high rates of inflation where real worth ofcapital is maintained.

Islamic social capital26, establishing trust between Institution and clients, can becomeinstrumental in organi#ing coherent actions of all social and economic agents. ;nity andsolidarity can be cultivated among members and institution to understand better theprinciple of risk sharing instead of binding the clients only into a joint liability bond incase of conventional microfinance. uch a confidence building measure would helpdisclosing full information, respecting transparency, and excluding agency problem andasymmetric information. :ooperation would be the binding force among these agents, at

the same time, the clients watch necessity of re3payment as a sacred duty while institutionextends respite in genuine cases.Fard al kafaya, falah andIhsanbecome the motivatingforces for all those *donors, institutions, clients, etc. providing resources which may ormay not entail return. /nce these values are properly instituted, the negative social capital*deceit, selection bias, inefficiency, willful default, mistrust, etc takes exit.

Review of Islamic Microfinance -7perience

The experience of Islamic microfinance ranges from 18/ operation to speciali#eddevelopment finance institutions, cooperatives and formal banking. The first formallyknown effort in this direction was %it 8hamar savings project of 4gypt established in latesixties. Islamic microfinance remained underdeveloped in Arab


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experiences include Amanah Ikhtiar %alaysia *AI% and Islamic Pawn =roking *AlRahnu. Islamic rural banks and Islamic financial cooperatives *known as =aitul %aal walTamwil B =%T are the major players in Indonesia 2(. Islamic 7elief ;K has launchedIslamic microfinance programs in various countries ie. ?!irst Islamic@ of =osnia D&er#egovina, TA7T of Kosovo and mall cale 4nterprise evelopment *4

Program of Pakistan. =angladesh is considered first country to formally introduce Islamicmicrofinance by usingMuraahaand bai %uajjal while leading microfinance institutionsinclude Islami =ank =angladesh, ocial Investment =ank Etd. *I=E and 18/s like Al!alah and 7escue. In the non3formal non3corporate sector, I=E2)also uses cash wa"fcertificates as source of donated capital. At least seven banks were practicingMuraaha,Mudaraa, andMusharakato finance micro enterprises in udan25. The udanese Islamic=ank *I= has successfully implemented Musharaka and Mudaraa29 providingreasonable return on investment to both parties *the bank and the client. The main reasonfor I=Cs success has been to work with productive families *defined as householdsCreadiness to apply means of production to raise their standard of subsistence. I=Csexperience in financing productive families illustrates to achieve dual benefit of reali#ing

social objectives and profit. The bank disburses finance in a location from where thedeposits are collected. A summary of such experiences is shown in Annexure 6.

In Pakistan, very few initiatives have been undertaken with very little coverage. /nly afew 18/s suffering from insufficientRpiecemeal and inefficient operations are makingefforts to operate on Islamic principles. The visible examples of Islamic microfinance inPakistan can be counted as Islamic 7elief Pakistan *I7P, Akhuat, Karakoram :ooperative=ank *K:=, 1ational 7ural upport Program and %uslim Aid. Information on use ofproducts and scope of financing is given in Annexure +.

Eimitations of Islamic %icrofinance in PakistanF

Islamic microfinance is mainly affected by resource and policy constraint, product

concentration, and absence of re"uisite capacity, especially the !har"a# advisory. Eikeconventional banks, Islamic banks too have not perceived microfinance as viableopportunity. 1either, they have assumed social responsibility entrusted to them by thosewho provide funds to these institutions2-. The key principle of Islam that redistributivejustice is achieved through support and empowerment of week has been grossly ignored.This problem intensifies in case of Islamic banks as they have not expanded theirnetworks in rural areas. At the same time, inability of 18/s to recycle savings of their

2(Obai#""ah M an# *han, +ari""ah, !s"amicMicrofinance #e.e"o/ment ha""enges an# !nitiati.es, Po"ic

#ia"oge Pa/er No 2, !4+!, !sD5, 6e##ah, 2008

2) Mannan, M7 Ne rontiers of !s"amic Microfinance an# 9o"ntar :ector 5anking an# inance; 7

com/arati.e ase :t# 7//roach, Pa/er /resente# at the Nationa" onference on !s"amic inance, *a"a+erenggan, Ma"asia, No.ember 2'-28, 200'

25Ibrahim, =adr34l3in A, ?udan 4conomy 7esearch 8roup iscussion Papers@, iscussion Paper 1o. 6(, Institute

for uly 2005.

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http://www.iwim.uni-bremen.de/publikationen/pdf/SERG35.pdfhttp://www.iwim.uni-bremen.de/publikationen/pdf/SERG35.pdfhttp://www.iwim.uni-bremen.de/publikationen/pdf/SERG35.pdfhttp://www.iwim.uni-bremen.de/publikationen/pdf/SERG35.pdf


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clients adds to the problem of sustainability. 18/s need to be linked to financial sector,mainly banks, to leverage their resources as well as make use of savings. Product base isnot sufficient and concentration inMuraahare"uires diversifying into other modes likeI$arah and iminishing Musharaka to support asset building and use of technology.ariants ofMuraahahlike Istijrar are re"uired to be developed due to high fre"uency of

supplies in small businesses.The usual si#e of finance is not sufficient, hence micro enterprises operate onlymarginally. The demand for installation of irrigation system, purchase of rickshawRtaxi,etc. though exist but rarely met. Instances are there where businesses failed due toinsufficient amount of finance. %icro entrepreneurs are risk averse due to many reasonssuch as illiteracy, insecurity, lack of assets, natural ha#ards, poor economic management,and cultural barriers to use better technology. These risks can be reduced once theirconfidence is enhanced, especially when institutions undertake to share bad days if theyclaim right to reali#e the results of prospering business. The volume of financialintermediation envisaged to fulfill these re"uirements is "uite large and it seemsimpossible unless mainstream banking is not involved. The PoorCs capacity to save has

already been established. They are forced to save in kind and encounter fungibility andli"uidity problems given no or low access to the saving services. /n the other hand,market return on savings could further enhance their capacity to save. East, but not least,microfinance clients also face life and other risks which need insurance cover*microtakaful, benefiting both institution and clients.

Applicability of Islamic %odes in %icrofinanceF

%ost of the Islamic products modes being used by Islamic banks can be adopted inmicrofinance with necessary changes to adjust informal environment. The %!Is arealready familiar with fixed rate credit modes and can administer Muraaha and !alamwith little effort and training. It is important to note that partnership modes like Mudaraa

and Musharakamay be practiced only in selected cases and where client has alreadycompleted certain number of graduating cycles with Muraaha. In respect of partnershipmodes, it would be more appropriate to practice iminishingMusharaka in tangible assetsas the institution need not to rely on business results declared by client. The installmentbased % can easily be operated to finance purchase of assets *machinery, e"uipment,transport vehicles, constructionR improvement of houses, small touristhutsRcafRrestaurants, etc. =anks are fre"uently using this instrument and are in position totransfer this technology for microfinance.

Product (evelopment for Microfinance:1ot all products being used by Islamic banksare feasible for microfinance as such. ometimes, the structure re"uires changes while atother the institutions are concerned with meeting full credit needs and proper utili#ation of

finance. ome examples can be considered.Muraaha and !alam can be combined whereinstitution and client may enter two or more contracts, of course under master agreement,especially in agriculturalRcrop production activity. /f different maturity Muraaha and!alam contracts *depending on the length and type of financing can be entered.InputsRraw material can be sold throughMuraaha while !alamcan provide li"uidity tomeet financial re"uirements like hiring of tractorRlabor, purchase of water, marketing andtransportation, etc. :ombining two contracts can effectively save from chance of misuseof finance while serving full credit re"uirements. The instrument like supplierCs credit can

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also be developed.%a" Ist"$rar60, a variant ofMuraaha, is a supply side sale whereby thesupplier agrees to supply the goods on an ongoing basis at an agreed price to be paid inadvance or at a future date when repeated purchases are completed. 4ach time, there is nodocumentary offer or acceptance *as in case of %urabaha or bargain. ettlement of pricecan be decided in any of the permitted ways.

(ownscalin% 8perations of Islamic $anks

4xistence and operation of Islamic banks in urban areas reflects that underlyingphilosophy of distributive justice has been ignored. The use of instruments and servicesand financing criteria has been skewed towards corporate and commercial sector. uchpreference has set standards for clients having high rating, si#able turnover andcreditworthiness. As such, Islamic banking has not been able to tap microfinance neitheras business opportunity nor social obligation despite enabling framework provided by=P. It does not seem possible to mainstream unless Islamic banks extend operation inthis direction.

In view of above, there is need to devise strategy for Islamic microfinance. The concern of

sustainability of %!Is is crucial. Particularly in this context, a mechanism is re"uiredwherefrom the %!Is can benefit from savings of their clients *not contradictory to =Pregulations and raise their e"uity. The savings of microfinance clients can be channeled tofinancing bank having %udarabah arrangement with %!I, as described above. A higherprofit sharing ratio can be decided in favor of %!I than the one followed generally in caseof such arrangement. The profit sharing ratio will compensate %!I for not directlybenefiting from savings. till, another approach of financing e"uity through %usharakahcan help raising funds of %!Is.

The haria advisory is rare and expensive resource but is mandatory for operation ofIslamic finance. %!Is may not be in a position to engage full time haria advisors owingto smaller scale of their business. /ptions can be considered to undertake this task.

Islamic banks providing finance to %!Is can also provide haria advisory and internalharia audit with or without cost. Alternatively, a group of %!Is can engage fulltimeharia advisor to supervise the operation. The banks can assist in product developmentprocess, too. The products already used and tested by Islamic banks can be modified toadjust the microfinance sector. The Islamic banks can help structuring new products andservices compatible to the sector characteristics.

There is real need to establish Islamic microfinance banks providing microfinancialservices in entirety, saving, credit, insurance, payments, remittances, etc. /nce Islamicmicrofinance banks are established, the financial discipline, corporate norms and access tofinancial market would be achieved.

Some Recommendations

60Istijrar is an agreement between a buyer and seller that the buyer will take from the seller the goods he needs withoutbargaining *%usawamah and without explicit offer and acceptance each time. In such case, either the price is paid aftera determined period or the seller leaves some money with the buyer out of which the buyer takes whenever he needs to

purchase the goods.

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/) (ownscalin% 8perations of Islamic $anks +ase of +orporate Social

Responsibility and $usiness 8pportunity:

i. It may not be possible to expand scale without participation of Islamic banks. Thelinkage can result, not only providing re"uired funds *either through &ar' hassanor Mudaraa credit line but also facilitate technology transfer for capacity

building. As first step, Islamic banks, currently present in urban centers, may use%!Is as outlets for Islamic microfinance. %!Is possessing necessary knowledgeand experience of working with communities can become low risk intermediaryfor bank funds, besides undertaking usual job of social mobili#ation, appraisal offinance re"uests and recovery enforcing social collateral in Islamic framework.(ar' hassan or soft Mudaraa placement by Islamic banks will allow %!Is toextend cheaper financing to clients and build own resources. At the same time,%!I can benefit from haria advisory, capacity development, and technologytransfer under some contractual arrangement. In return, %!Is may direct savingsof their clients to Islamic banks.

ii. %!I should direct savings of its clients to Islamic banks. Islamic banks shouldinvest these savings in usual way and share profit with clientsRdeposit holders.ince these savings would be collected without incurring any cost on account ofmarketing, a separate pool can be formed or larger than usual weight can beallocated to appropriate larger share of profit in favor of such customers.

iii. Islamic banks can also participate in e"uity of %!I augmenting the laterCsresource. =esides, this relationship would help %!Is to better govern and observefinancial discipline.

iv. imilarly, (ar' hassan or softMudaraa *allocating higher than normal share inprofits would compensate %!I for directing savings to the bank affording anycost by the latter and building own resources to ensure sustainability.

9) Role of S$P: =P in association with Islamic banks may establish Islamicmicrofinance entity to provide following servicesF

i. %aintain fund to be used as grant for capacity building of Islamic %!Is and%!=s maintaining Islamic microfinance divisions

ii. Provide haria advisory and product development services to %!Is and %!=s

iii. %aintain risk mitigation fund to be contributed by =P and Islamic banks

iv. /nce sufficient tangible assets of microfinance are accumulated, the entity mayhelp arranging Islamic securiti#ation. =esides providing li"uidity to diversifyoperations in microfinance, the process would enable microfinance sector to accessfinancial market and diversify risk as well as expand operation.

) Inclusion of the Poorest:There is clear understanding that microfinance efforts caneffectively be supplemented by incorporating 'akat into the system provideddevelopmental goals are focused instead of mere handout distribution. It can enhanceinclusion of non3enterprising poor by transforming them to self3sustaining active partof society. ince livelihood needs of poor are of recurring nature, therefore, a part of'akatfund should be allocated for empowerment. =y providing safety net in first

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place, business capacity can be developed by spending these funds for training andbusiness supportRstart up capital. !inancing for working capital however can beprovided through Muraaha. arying time frames can be set for different clients,depending on respective capacity to develop entrepreneurial skills. %!Is can,individually or collectively, establish'akattrust as separate entity and out of their own

sphere where'akatcan be collected and spent for both safety net and development ofenterprise. The funds accumulated in)akatcan be invested in profit earning assets forinterim period.

;) Product development for microfinance: /f course, developing micro enterprisespecific products and services is the urgent need.

i. %urabahahF To meet working capital re"uirementRpurchase of supplies for microenterprises and farm D non3farm activities, %urabahah shall be the mostfre"uently used instrument. 8iven the process flow of %urabahah and haria

compliance, the instrument used by Islamic banks can easily be adopted formicrofinance. The procedure and documentation can be simplified and conditionsrationali#ed in view of social mobili#ation process and close monitoring ofmicrofinance clients. upplies of items in recurring demand could be maintainedby %!Is or bulk purchases can be arranged for groups of clients. In case, Islamicbanks intermediate through %!Is, the later would be in a position to physicallyac"uire %urabaha goods and sell them to clients.

ii. In case, the client re"uires supplies "uiet fre"uently in many bits, it would bedifficult to accommodate such re"uests by concluding a number of %urabahaswith the same client, besides increasing transaction costs and price risk faced byboth the parties. The feasibility of Istijrar6$like instrument need consideration62.haria advisors have also suggested that Islamic banks can enter Istijrararrangement with supplier where the bank would pay the full or discounted marketprice and sell these goods to the client on the basis of %urabahah. They also

6$!sti=rar is an agreement beteen a ber an# se""er that the ber i"" take from the se""er the goo#s he

nee#s ithot bargaining an# ithot e>/"icit offer an# acce/tance each time !n sch case, either the /riceis /ai# after a #etermine# /erio# or the se""er "ea.es some mone ith the ber ot of hich the ber takeshene.er he nee#s to /rchase the goo#s62

+he conce/t an# ot"ine of !sti=rar has been #iscsse# n#er :ection 2 .i#e Mrabahah

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Zakat and SadaqaatIslamicfinance(Murabaha)

Basic needfulfillment

Development ofentrepreneurship

Capitalinvestment

Workingcapital

Transformation of hard core poor


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suggest another alternative through which the bank can enter into Istijraragreement with supplier for a certain time period wherein the agent of bank *ie.client may take delivery of goods from time to time within that time period.ifferent clients can also be served through this arrangement. %!Is, however, canmaintain inventory and sell goods directly to their clients as third alternative.

There is therefore needed to make further consultations with Islamic banks andharia advisors to draw the structure of Istijrar to be used in microfinanceoperations. The consultations would focus on haria position of transaction in casethe client takes possession of goods from time to time on behalf of =ankR%!I andthrough certain arrangement the price is paid later, at the same time reali#ingcertain amount of profit in the transaction or the feasibility of Istijrar with advancepayment be looked into where certain amount is kept with supplier and the client*or clients take possession of goods as and when re"uired within specific timeperiod.

iii. alamF It is ideal instrument for agricultural production activity and standardi#edmanufacturing where client can be financed for both purchase of raw

materialRinputs and li"uidity re"uirement. =anks and %!Is can arrange to collectcommodityR manufactured items. Alternatively, the client or managing committeeof the group can be appointed as agent to sell on behalf of the bankR%!I onceownership of subject matter is ac"uired by %!I. =anksR%!Is can also enterparallel salam contract with third parties to dispose off the supplies. :lose peermonitoring and surveillance by the credit officers is re"uired to save from misuseof finance disbursed in cash.

iv. alam cum %urabahah !inancingF In case above products are used alternativelythe risk of %isutili#ation remains. !inancing through %urabahah only may notcater li"uidity re"uirement of farmers. /n the other hand, providing salam capitalmay find way towards unproductive uses. %ore appropriate would be to suggestthat bankR%!I may enter two or more separate contracts, of course under masteragreement, with client especially in agriculturalRcrop production activity. /fdifferent maturity murabaha and salam contracts *depending on the length of timeperiod for which respective financing is re"uired, not contingent to each other,can be entered. InputsRraw material can be sold through %urabahah while salamcan provide li"uidity to meet financial re"uirements like hiring of tractorRlabour,purchase of water, marketing and transportation, etc.

Page 13 of 23


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:ombination of %urabaha with two different maturity alam contracts

v. iminishing %usharakah *%F


15/23

=ibliography

$. =aker, >. E, ?4valuating the Impact of evelopment Projects on Poverty3A &andbookof Practitioners@, The


16/23

$(. Khandker, ., ?!ighting poverty with microcreditF experience from =angladesh@, 1ewLorkF /xford ;niversity Press for the


17/23

Anne7ure /

Table $F Poverty tatus of the =orrower &ouseholds

1oteF *i The poverty bands have been determined being recipient of income more or less thanpoverty line *ii A negative sign indicates a decline and a positive sign stands for an increase.

Table 2F Poverty tatus of the 1on3=orrower &ouseholds

Table 6F 1et Impact of PPA! %icro credit on Poverty Alleviation

Page 1' of 23

20063200+ ' of &&

200+3200( ' of &&

'ifference

Poverty Eine *PE

7s.F 969.62 per month

60.(9 Poverty Eine *PE

7s.F 959.)+ per month

26.-- *3 ).)$

4xtremely poorU(0'i.e *below 7s.+$-.$$

2.924xtremely poorU(0' i.e.*below 7s.+6-.62

$.)

*3 $.22

;ltra PoorV(0' U5('i.e * 7s. +$-.$$3 7s )29.))

$0.+2;ltra PoorV(0'U5('i.e. * 7s. +6-.623 7s )(9.-9

(.92 *3 +.) 0

PoorV5('U$00 'i.e * 7s.)29.)) B 7s969.62

$5.6+PoorV5('U$00'i.e * 7s.)(9.-9 B 7s959.)+

$).(5 *3 0.55

ulnerable PoorV$00'U$2('i.e. * 7s. 969.62B 7s. $0+5.95

$).96ulnerable PoorV$00'U$2('i.e.*7s.959.)+B 7s$0-9.60

$(.)9

*3 $.$(

Wuasi 1on BPoorV $2(' U 200 'i.e. * 7s. $0+5.95B 7s.$)5).)+

65.$5Wuasi 1on BPoorV$2('U 200 'i.e. *7s.$0-9.6B 7s.$5(5.29

+0.+2 *X6.2(

1on3PoorV200'i.e. *7s.$)5).)+ and above

$(.+21on3PoorV200'i.e. *7s.$5(5.29 above

$-.5$ *X+.2-

20063200+ ' of &&

200+3200( ' of &&

'ifference

Poverty Eine *PE7s.F 969.62 per month

2-.62 Poverty Eine *PE7s.F 959.)+ per month

2(.59 *3 6.(+

4xtremely poorU(0'i.e *below 7s.+$-.$$

+.064xtremely poorU(0'i.e. *below 7s.+6-.62

2.$9

*3$.9(

;ltra PoorV(0' U5('i.e * 7s. +$-.$$3 7s )29.))

-.06;ltra PoorV(0'U5('i.e. * 7s. +6-.623 7s )(9.-9

(.99 *3 6.$(

PoorV5('U$00 'i.e * 7s.)29.)) B 7s969.62

$).2)PoorV5('U$00'i.e * 7s.)(9.-9 B 7s959.)+

$5.52 *X$.+)

ulnerableV$00'U$2('i.e. * 7s. 969.62B 7s. $0+5.95

$9.(0PoorV$00'U$2('i.e. *7s.959.)+B 7s$0-9.60

$(.(9

*3 2.-2

Wuasi 1on BPoorV $2(' U 200 'i.e. * 7s. $0+5.95B 7s.$)5).)+

65.05Wuasi 1on BPoorV$2('U 200 'i.e. *7s.$0-9.6B 7s.$5(5.29

+$.+- *X +.+2

1on3PoorV200'i.e. *7s.$)5).)+ and above

$(.$$1on3PoorV200'i.e. *7s.$5(5.29 above

$5.$( *X 2.0+


18/23

Page 18 of 23

?ast o"mn+ab"e 1 (+1)

?ast o"mn+ab"e 2 (+2)

Difference(+1-+2)

O.era""(-)&&1 *33%$ *330'

4xtremely poor *3122 *318% *X0&3

;ltra Poor *3$&0 *331% *31$%

Poor *30'' *X1$& *3223ulnerable *311% *32


19/23

Anne7ure 9

Potential emand for Islamic %icrofinance

ourceF :8AP, ordan, Algeria, andyria

20 to +0'

Pla1et !inance 2005 ordan 2+.-'

I!:R!I1:A 200) >ordan 62'

!rankfurt chool of!inance D%anagement 200)

Algeria 20.5'

I!: sponsored tudy Lemen +0'

I!: 2005 yria +63+)'

=ank Indonesia 2000 Indonesia *4ast >ava +-'


20/23

Anne7ure

/perations of Islamic =anks in udan

1ame of =ank Percent oftotal finance

%ode*s in use Target group %ethodology and *conditions

The udaneseIslamic =ank*I=

5+' %urabaha,mudaraba,musharaka, andsaving deposit

Productivefamilies,

small enterprises,

crafts andinformal sectoractivities.

!amily affairs sections to prepare clients underproductive family concept and deal withinvestment, feasibility studies and project followup in micro enterprises of farmers and smallmanufacturers *63+ percent monthly Muraahamargin. ;p to ) monthsMuraahaperiod

!aisal Islamic=ank of udan*!I=

$00' %urabaha :raftsmenRwomenF Project evaluation and financingF %icro projects of purchasing machinery, spare parts, means oftransport, raw material, agricultural implementsand installation of electric bakeries *63+ percentmonthly Muraaha ;p to one year MuraahaPeriod

Islamic :o3operativeevelopment=ank *I:=

$00' %urabaha mall producers

And craftsmen

;rban 3 ?:raftsmen upport !und@ to financeblacksmiths, carpentry, fishing boats and oilmills.7ural 3 :lients financed through productivefamily concept for poultry, cows and manuallooms. mall3scale projects 3 oil mills, tailoring,needlework, soap making, grain3mills and sweetmaking *63+ percent monthly Muraaha ;p tooneyearMuraaha Period

1eleinIndustrialevelopment=ank 8roup

*1I=8

$00' %urabaha andmudaraba

mall enterprises

And productivefamilies

!easibility of projects against cost of client.Projects food processing *cheese, yoghurt,

*"sra *flat brad, biscuits, sweets and rural oilmillsS tailoring and needlework, leatherwork,

soap3making, building materials andengineering workshops, building and packingservices, tire repair workshops. *$( '

Muraaha margin for

amount up to $(00 thousands. 2('Muraaha margin for

amount more than $(00, but less than 2000

Agricultural=ank of udan*A=

1A %urabaha mallenterprises,

Productivefamilies andcrafts

Productive families in agriculture andlivestock, as well as small industrial andservice enterprises

!armers =ank*!=

1A %urabaha :raftsmenRwomen Productivefamilies,

Professionalsand small

mall enterprises of farmers including cropproduction

Page 20 of 23


21/23

industries.

aving andocialevelopment=ank *=

2-' %urabaha andmusharaka

mall industries,

Productivefamilies,

and retail trade

*$('Muraaha margin, with grace period upto

five months.

ourceF Ibrahim, =adr34l3in A, ?udan 4conomy 7esearch 8roup iscussion Papers@,iscussion Paper 1o. 6(, Institute for


22/23

Anne7ure ;Islamic %icrofinance Programs in Pakistan

1ame ofInstitution

%ode of !inance Target :lientele 7ange of financing*7s.

Purpose of financing

Islamic7elief*4

%urabaha ;rbanmicroentreprises

9,000 B 2(,000


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$

13.khaleequzzaman shahshirazi.format

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