islamic financing for smes

Islamic Financing for SMEs Presented By: M.Shoaib MalickUnit Head-SME-Meezan Bank Limited

Islamic Financing for SMEsIntroduction to Islamic BankingSignificance of SME SectorDifference Between Islamic Banking & Conventional BankHow IB, can address business needs (100%)Comparison of Islamic Mode of Finance and ConventionalIslamic Modes of Financing• Short Term Modes of Islamic Financing• Long Term Modes of Islamic Financing• Trade Finance Facilities in Islamic Banking

Challenges in SME FinancingConclusion

Significance of SME Sector

1 Total Population 182Mn 100%2 Financially Included 18.2Mn 10%3 Financially Excluded 163.8Mn 90%4 Financially Excluded-Major Sector SME5 90% of all private enterprises SME6 SMEs access to finance from banking

sector:• Pakistan• India• Bangladesh

04%33%32%

7 SME lending of total credit 06%8 Surveyed Facts• Hard to borrow from banks • Not even have a bank account

51%31%

Contribution of SME Sector to Economy

GDP Exp. Mfgd Goods Mfgd-value

added Non-Agri Labor Force

0%20%40%60%80%

100% 30% 25%35%

75%

Overall Economy SME Sector

Current Status of SME Financing: SME financing witnessed continues decline by banks/DFIs since 2008. Due to consistent decline in this sector, share of SMEs also reduced from 16% to 6% in overall advances of banks in last 4-5 years.

Reasons for downfall: Adverse economic conditions. Law and order situation. Shortage & rising costs of electricity and other utilities.

Reasons for downfall: Growing NPLs.

Natural catastrophes also hamper this sector badly in consecutive years of 2010 & 2011 and created wipeout situation for small sized units.

Banks also took a risk-averse posture from this sector, due to deteriorating business conditions for SMEs.

5 Years trend of SMEs

`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120.00

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

3,500.00

4,000.00

Status of SME Financing (Rs. In Billions)


`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120

1,000

2,000

3,000

4,000

5,000

6,000

SME Borrowers Vs Total Borrowers (In Thousands)


`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120.00

50.00100.00150.00200.00250.00300.00350.00400.00450.00500.00

SME NPLs Vs Total NPLs (Rs. In Billions)

9.4% 16.1% 22.1% 28.9% 32.4% 38.9%

SME Financing For Working Capital Key portion of financing is used for working capital in SMEs, which constitutes 76% of total SME lending. However other is followed by Trade Financing & Long term/Fixed Investment.

Working Capital Fixed Investment Trade Fiance0

20,000

40,000

60,000

80,000

100,000

120,000

140,000Working Capital Requirement for SMEs

SMEs provide a significant portion of jobs world wide

Low Income Middle Income High Income0

10

20

30

40

50

60

70

SME contribution to formal country employment Median values

Source. Ayyagari, Beck and Demigirguc/kunt. 2003

GDP Contribution of the SME sector increases, and informality decreases with income

Low Income Middle Income High Income0

10

20

30

40

50

60

70

80

90

100

Residual, 37%Residual, 31% Residual, 36%

Informal ,47%

Informal , 30%Informal , 13%

SME Sector, 16%

SME Sector, 39%SME Sector, 51%

Definition of Riba

Any increase over and above the price, without due consideration is Riba

We find the differences are on three levels: 1. Conceptual & Socio-religious level

- not money lenders - cannot deal with interest & non permissible industries 2. Business model & Governing framework - IB actively participates in trade and production process - Governing framework in terms of Shariah Advisor &/or SSB

Distinguishing Features

15

3. Product Level Implementation - usually asset backed & involve trading/renting of asset &

participation on profit & loss basis - Implementation is not just a mere change of paper work

and terms but it involves- having the right intention, - the correct sequence of steps and timing of execution

Distinguishing Features

Parties: Bank & ClientLimit : Rs 10.00 MnRate: K+2Tenor : 1 yearPurpose : To buy Cotton

Parties: Bank & ClientLimit: Rs 10.00 MnRate: K+2Tenor: 1 yearPurpose : To buy Cotton

Islamic Banking Conventional Banking

PERCEPTION OF ISLAMIC BANKING

Parties: Bank & ClientLimit : Rs 10.00 MnRate: K+2Tenor : 1 yearPurpose : To buy Cotton

Parties: Bank & ClientLimit: Rs 10.00 MnRate: K+2Tenor: 1 yearPurpose : To buy Cotton

Islamic Banking Conventional Banking

PERCEPTION OF ISLAMIC BANKING

= OWNERSHIP

Goods

Services

Islamic BankingBasic Difference between Islamic and Conventional Modes of Finance

Conventional

Client

Money

money + money (interest)

Bank

Islamic BankingBasic Difference between Islamic and Conventional Modes of Finance

Islamic

Bank ClientGoods & Services

money

Sales xxxCost of Goods Sold

Raw Material xxxDirect Labor xxxOver Head xxx

Gross Profit xxxOperating ExpensesAdmin. & Gen. ExpxxxSalaries xxxUtilities xxxOther xxxNet Profit xxx

Income StatementLiability/Deposit Products

Istisna/Tijarah

Murahaba

Istisna/Tijarah

Deposit Products

Current Assets:Stocks xxxReceivable xxxCash in hand xxxAdvances & Deposit xxx

Fixed Assets:Plant & Machinery xxxLand & Building xxxTotal Assets xxx

Owner’s Equity:Capital xxx

Liabilities:Creditors xxxFinancial Liabilities xxxTotal Liabilities & Equity

Balance Sheet

Murahaba/Import Murahaba/FIM/LC

Deposit ProductsIstisna/Tijarah/Bai-Salam/Usance-Murahaba

Musharka

Murahaba/LGs/Ijarah/Tijarah

Murahaba/Istisna/Tijarah/LG

DM/Ijarah/Murahaba

Conventional Banks Islamic Banks 1. The functions and operating modes of conventional banks are

based on fully manmade principles. 1. The functions and operating modes of Islamic banks are

based on the principles of Islamic Shariah. 2. The investor is assured of a predetermined rate of interest. 2. In contrast, it promotes risk sharing between provider of

capital (investor) and the user of funds (entrepreneur). 3. It aims at maximizing profit without any restriction. 3. It also aims at maximizing profit but subject to Shariah

restrictions. 4. It does not deal with Zakat. 4. In the modern Islamic banking system, it has become

one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks.

5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well.

6. It can charge additional money (penalty and compounded interest) in case of defaulters.

6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are give for early settlement at the Bank's discretion.

Difference Between Islamic Banking & Conventional Bank

Difference Between Islamic Banking & Conventional Bank

Conventional Banks Islamic Banks 7. Very often it results in the bank's own interest becoming

prominent. It makes no effort to ensure growth with equity.

7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

8. For interest-based commercial banks, borrowing from the money market is relatively easier.

8. For the Islamic banks, it must be based on a Shariah approved underlying transaction.

9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.

9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.

10. The conventional banks give greater emphasis on credit-worthiness of the clients.

10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.

11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.

11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.

12. A conventional bank has to guarantee all its deposits. 12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position..

Meezan Bank Limited

Financing Product Comparison Islamic Vs. Conventional BankS.# Islamic Product Conventional Products

Working Capital Finance

1

a) Murabahab) Murabaha - Spotc) Istisna - Export & Locald) Meezan Tijarah - Export & Locale) Murabaha FE-25 Export & Import

Current Finance / Running Finance

2 Murabaha - Pledge Cash Finance

3

a) Ijarah - Plant & Machineryb) Ijarah - Sale & Lease Back for Plant & Machineryc) Diminishing Musharika - Plant & Machineryd) Diminishing Musharika - Premises / Land for Commercial usee) Diminishing Musharika - Sale & Lease Back (Plant & Machinery; Premises Land & Building)f) Musharaka

Demand Finance / Term Finance

Financing Product Comparison Islamic Vs. Conventional Bank

S.# Islamic Product Conventional ProductsExport Related Facilities:

1

a) Bai Salam against Discrepant Export Sight Billsb) Bai Salam against Export sight contractc) Murabaha against Accepted export Usance Bill (Bank Risk Line)d) Murabaha against Un-accepted export Clean Usance LCe) Murabaha against un-Accepted export Discrepant Bills under Usance LCf) Murabaha against export Usance Contract

Finance Against Foreign Bills

2 a) Murabaha against Un-accepted Local Usance LCb) Murabaha against Accepted Local Usance LC (Bank Risk Line) Local Bill Purchases

3

a) Istisna – Exportb) Islamic Export Refinance Facility (IERF) Part I & II - under Murabahac) Islamic Export Refinance Facility (IERF) - under Istisna (Local and Export) and Tijara (Local and Export)

Finance Against Packing Credit Part - I & II

Meezan Bank Limited

S.# Islamic Product Conventional ProductsImport Related Facilities:

1

a) Sight LC under MMFAb) Sight LC under Master Agency Agreement (For Ijarah & Diminishing Musharaka)c) Sight LC wihthout MMFA (Exceptional Cases)d) Usance LC without MMFAf) Usance LC under MMFA (Exceptional cases)g) Usance LC under Master Agency Agreement (for Ijarah and Diminishing Musharaka)

Import Letter of Credit

2a) Local LC(Sight) without MMFAb) Local LC (Sight) under MMFA (Exceptional cases)c) Local Usance LC wihtout MMFAd) Local Usance LC under MMFA (Exceptional cases)

Inland Letter of Credit

3 a) Murabaha - Financing of Imported Merchandise (FIM) Pledgeb) Murabaha - Financing of Imported Merchandise (FIM) Spot

Finance Against Imported Merchandise - FIM

4 Finance Against Trust Receipt Letter of Guarantee

1 Letter of Guarantee / Shipping Guarantee/Standby Letter of Credit Letter of Guarantee / Shipping Guarantee

Financing Product Comparison Islamic Vs. Conventional Bank

Short Term Financing Needs• Raw Material• Overheads / Utilities• Finished Goods• Trade receivable financing• Rental financing

Long Term Financing Needs• Acquisition/replacement/

expansion of fixed assets, plant & machinery

Issues & Challenges of SMEs

Demand Supply

Lack of Collaterals to Meet Bank’s Requirements

Shortage of Marketing Skills-(Bank Side)

Informal Organizational Structures

Informal Accounts & Management System

Lack of Credit & Collateral History

Low Level of Financial Literacy

Reluctance on part of SMEs

External Shocks

SMEs perceived as high risk borrowers

Corporate Finance Mindset

Lack of Infrastructure for SME Business

High Lending Costs

Absence of SME R&D Centers in Banks

•Plain Murabaha•Advance Payment Murabaha•Suppliers Credit Murabaha•SLC under MMFA•Tijarah•Istisna•Diminishing Musharaka•Ijarah•Bai Salam

•Plain Murabaha

Murabaha Agreement

Agency Agreement Order Form Purchase of

Goods by Agent

Payment of Purchase Price*

Intimation of possession of goods by the

agent (Declaration)

Offer & Acceptance (Murabaha Contract)

Payment of Murabaha

Price

*Payment of purchase price is either direct payment to supplier or through customer account

For Detail

•Advance Payment Murabaha

Murabaha Agreement

Agency Agreement Order Form

Payment of Purchase

Price*

Purchase of Goods by

Agent


agent (Declaration)


Payment of Murabaha

Price


•Credit Murabaha

Murabaha Agreement

Agency Agreement Order Form Purchase of

Goods by Agent


agent (Declaration)


Payment of Purchase Price*

Payment of Murabaha

Price


•SLC under MMFA

Murabaha Agreement

Agency Agreement

Order Form & LC Application

Establishment of LC

Receipt of Import

Documents


agent (Declaration)


Retirement of LC Through Murabaha

Payment of Murabaha

Price

•Tijarah

Master Tijarah Agreement

Agency Agreement Written Offer

Payment of Tijarah Price

upon Acceptance

Delivery of Goods &

Acceptance of Delivery by

bank


agent (Declaration)


Retirement of LC Through Murabaha

Payment of Murabaha

Price

For Detail

Thank You