Microfinance

Islamic Microfinance

Dr. Turkhan Ali Abdul ManapIslamic Research and Training InstituteIslamic Development Bank Groupturkhanali@isdb.org

May 18, 2014

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Background

In the last 50 years, different development strategies have been used to resolve the problem of poverty

Most of these programs failed “Microfinance” initiated in the mid-1970s

appears to be the ‘new paradigm’ to eradicate poverty

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Introduction (2)

Limited access to finance is key constraint to private sector growth

The poor do not qualify to get funds from institutional sources (banks) lack of collateral too much risk too costly

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Basic Principle of Shariah Based Microfinance

Prohibition of Interest Care for the poor is a religious obligation in

Islam Asset Based Financing Risk Sharing Sanctity of contracts Financing in Halal/Shariah Compliant Activities. Micro Takaful ( Islamic Micro Insurance) Beneficial for both Muslim and non-Muslim

“Assisting the poor is a pillar of Islam”

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Sources of Islamic Microfinance

• Quran• Sunnah• Ijma’a

(jurist consensus)

• Ijtihad & Qiyas (analogy)

Sources of Islamic

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Islamic Microfinance Products Mechanism

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Factors to be considered while doing IMF

Trainings & Quality HR

Shariah Compliant Funds

Free from Gharar

Micro Takaful

Free from Interest

Financing

Shariah Vetted Products

Shariah Compliant

Investments

Moral Ethical SocialPoverty Alleviation Element

IslamicMicro

Finance

Ensure Shariah Compliance

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Islamic Microfinance Institution Worldwide

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Global - Islamic Microfinance Industry 300+ Islamic Microfinance Institutions operating

in 32 Countries USD 1 billion Market Size. Indonesia, Bangladesh, Pakistan and

Afghanistan have 80% share of Global Islamic Microfinance industry (CGAP)

2 Million Active financing Clients Murabahah & Qarz-e-Hasan are the Major

Products. Share of Islamic Microfinance in Islamic Finance

industry & Microfinance Industry is less than 1%

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Microfinance Models

Group lending

Solidarity Group Community-Based

Organization

Grameen Bank Latin American Solidarity Group

Community Managed Loan

Fund S & L Association

Village Banking Revolving Loan Funds

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“Flavors” of Microfinance Models

Grameen Model: Pioneered by Grameen Bank in Bangladesh in the late 1970s,

now extends world-wide through grameen replicators.

Village Banking: Developed by John Hatch in Latin America in the mid-80s,

focus is on forming independent village banks.

Self-Help Groups (SHGs): Savings-led approach pioneered by Myrada and

PRADAN in India in the mid-80s. Similar to Village Banking, focus is on

developing community-run Self-Help Groups.

ASCAs, ROSCAs, small Credit Unions, etc.: Similar groups have been

operating formally and informally around the world for hundreds of years.

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The Grameen Model

Solidarity Group of potential clients form groups (5 members).

Undergo training for a few days.

Joint responsibility: if a member defaults all members have to pay for her or else

the entire group excluded from future loans

Center meets every week, elects Center Leader

Regular savings by all members .

Loan appraised & approved first by peers in solidarity group and finally approved

by the Centre Leader.

Loan disbursed directly to individuals

All loans repaid in 50 equal installments

A five-member group is in turn part of a larger “center” composed of eight groups

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The Self Help Group (SHG) A homogeneous group of about 15 to 20 who live in the same

neighborhood Every member to save a small amount regularly. Pooled savings

kept in a savings bank account in SHG’s nameTransaction costs of both the poor and bank reduced !

SHG to use pooled thrift to give interest bearing loans to members – decisions taken in group meetings

Every member learns prioritization and financial discipline. Their capacities to think and handle larger resources improves!

Depending on the SHG’s maturity, bank gives loan to the SHG as a multiple of the pooled savings. Bank loan added to the SHG kitty.

Adequate & sustained access to financial services!

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Sources of Group Fund

Membership Fees

Thrift Collections

NGO/Go Contribution

Loan Repayments

Fines & Penalties

Bank Loans

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Village Bank works with groups of 30-60 members, usually all women. As soon as the village bank is inaugurated, it receives its first loan from the

implementing agency for on-lending to the individual members of the village bank.

The sponsoring agency spends one to three months in setting up each bank, organizing the election of a management committee and training its members, as well as developing the rules and regulations to govern the village bank.

The first individual loan (usually US$ 50) is repaid on a weekly basis in equal installments of principal and interest over a four-month period.

The village bank collects these payments at regular meetings At the end of the 16th week; it repays the entire loan principal plus interest to

the implementing agency. The funds circulating back and forth between the implementing agency and the

village bank for loans to members constitute the external account. If the village bank repays in full, it is eligible for a second loan. If the village

bank is unable to pay the amount due, the implementing agency stops further credit until reimbursement is made.

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Modes of IMF

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Modes for Islamic Microfinance

Murabaha Financing Ijarah Financing Bai Salam Financing Qard-e-Hasana Zakah Mirco Takaful Working thru linkages – Wakalah /

Musharakah and Mudarabah New & Innovative Concepts

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Modes for Islamic Microfinance

Murabaha Financing: Murabaha is the sale of goods on cost plus profit

basis. Islamic Microfinance Bank (IsMFB) can purchase

the required goods from market then sells the goods on credit to the client for a known profit.

Application: Purchase of raw material, live stocks, goods for

cottage industry, agricultural products, PCOs etc

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Modes for Islamic Microfinance Ijarah Financing:

Ijarah is an Islamic alternative for leasing As per the concept of Islamic Micro Leasing, an IsMFB can

lease certain fixed assets to individual microfinance customers. The assets would be purchased by IsMFB either directly or

through the agency agreements with the customer The asset would remain in the ownership and risk of IsMFB

through out the lease period Application

Include agri machinery,farming tools, small shops, carts, transport & other related equipments.

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Modes for Islamic Microfinance Bai Salam Financing: A type of Sale with spot payment and delivery at a

deferred date Mainly used for agriculture outputs.

Application: Islamic bank could purchase agricultural products like

rice, wheat, pulses, etc from small farmers to be delivered after a specified period on a future date against full payment of the selling price at spot.

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Modes for Islamic Microfinance Qard e Hasana

Islamic banks/MFIs can utilize charity funds for providing Qard-e-Hasana to MF clients

A special trust or fund could be established

Applications: Small cash loan at zero percent could be given as Qard to

eligible microfinance customers. Could also be used as an additional incentive loan for timely

payment history.

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Modes for Islamic Microfinance Zakah Funds

Zakah from individual and government can be an ideal & helpful source used for poverty alleviation.

Zakah or special Waqf Fund could be established Applications:

The fund can be used to provide training, providing health care, education to the needy.

Could be given in kind eg: Tools, equipments, raw material, trading goods etc.

Provision of basic food items.

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Modes for Islamic Microfinance Micro Takaful:

An ideal alternative to Conventional insurance, based on a concept of ‘mutual insurance’. Unlike premium, clients pay donations to the Waqf.

From the pool of funds, the needs of the affected are fulfilled. Waqf invests funds in profitable avenues but only that are

permissible in Shariah like Murabaha, Tijarah, Salam, Istisna, Ijarah, Musharakah, Mudarabah, Sukuk etc.

Applications: It can be applied to provide credit cover in case of death,

permanent disability, insolvency. Can be done for live stock, crop, theft, fire etc.

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Modes for Islamic Microfinance Developing linkages with MFIs/NGOs:

Rather than getting into the operational side of managing the microfinance assets Islamic Bank can develop special linkages with other active MFIs & NGOs.

Islamic Microfinance Product menu could be shared

It could Result in efficiencies for Islamic bank’s Microfinance program in form of lower costs, better outreach, low default rate, efficient recovery, etc

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Modes for Islamic Microfinance These linkages can be developed along the

following lines: Wakalah

Islamic bank (IB) can appoint a specialized MFB/MFI as Wakeel to manage the Special Musharkah Pool (SMP) for a fixed fee.

The Wakeel using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc.

Profits of the Pool after deducting the related costs (including agency fee) shall be distributed as per the Musharkah or Mudarbah agreement between MBL and depositors.

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Modes for Islamic Microfinance Mudarabah/Musharakah

IB will enter into a Mudarabah or a Musharakah agreement with a specialized MFB/MFI.

The MFB/MFI will work as Mudarib/working partner while IB would be the Raab ul Maal/Sleeping partner.

The MFB/MFI using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc.

Profits earned by the Mudarbah/Musharkah would be distributed between MBL and the MFB/MFI according to the pre agreed ratio at the gross profit level.

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Customer

Islamic MF

Banks

&

MFIs

Zakah & Charity Waqf

Edu. Inst.

Skill training

Health

Character building

Goods

Profit

Partnership

Profit/loss

Qard

Monitoring System

Models for Islamic MF

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MFIs-Main Features

Interested individuals must form a group Several Groups form a Center Center has weekly meetings An official from the MFI attends the meetings

and all transactions take place in these meetings (bank goes to the people)

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Islamic Alternatives to Microfinancing

Different alternatives: Islamic MFIs Islamic Banks Specialized Institutions

Group-based microfinancing can be used (as it mitigates the CR)

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Islamic MFIs-Features (1)

Islamic MFI retains the basic operational format of MFIs Going to the Clients Weekly/Monthly Repayments A Social/Development Program (to fulfill the social role of

Islamic finance) IMFIs have some distinguishing features:

Sources of Funds Other than external sources, can also use funds from

zakah, awqaf, and other forms of charities Use of funds (Mode of Financing)

Sale based and hiring modes (murabahah, salam, ijarah) Profit-sharing modes (Musharakah and mudarabah)

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Islamic MFIs-Features (2)

Amount transferred to the poorest As Islamic modes are sale based the price of the asset is

paid (no deductions are allowed) Group Dynamics

Islamic values of brother/sister-hood improves cooperation among the group members

Financing the poorest Zakat and other charities can supplement MFI activities

(non-diversion of funds)

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Islamic MFIs-Features (3)

Social Development Program behavioral, ethical, and social aspects in light of Islamic

teachings Targeting the family through women

Spouse co-signs the contract dealing with women more efficient and convenient Women disseminate knowledge to children

Dealing with Arrears/Default Less aggressive and use Islamic teachings to recover

loans

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Islamic MFIs and Sustainability Mitigating Credit Risk (CR)

CR mitigated by social collateral (group-based lending) Solving Moral Hazard (MH) Problem

As asset/good given instead of Cash, chances of diversion and default decreases

Economic Viability High administrative costs Reasonable finance costs

Islamic MFIs can resolve the CR problem and the MH problem, but not the Economic Viability problem

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Problems facing Islamic MFIs

1. Dilution in the Application of Islamic Modes of Financing Main mode- murabahah or bai-muajjal.

It is difficult to go out with the clients and buy the goods/assets from faraway markets

IMFIs delegates someone else (and inspects later) Alternative is to use Profit-sharing modes

Problem is the moral hazard problem--No book-keeping and difficult to monitor

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Problems facing Islamic MFIs

2. Lack of Funds Most MFIs get their funds from external sources Islamic MFIs have difficulty in getting funds from

these sources Operations and expansion of activities affected Islamic MFIs have not yet tapped the sources of

funds from Islamic institutions (like zakah, waqf, and other charities)

3. Training Training can enhance efficiency but is costly

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Conclusion

Islamic approach to microfinance has certain advantages Diversified asset and liability structures Social collateral stronger Potential to target the poorest through

complementary programs Asset-based modes of financing can prevent

diversion of funds for consumption Lack of funds hampering its growth

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Microfinancing by Specialized Institutions

1. Cash Waqf—waqf established in the form of cash Can be used for microfinancing

2. Qard hassan bank—nonprofit financial intermediary Capital would be cash waqf Will receive current accounts Provide qard hassan (interest free loans) for microfinancing

3. MFI based on Awqaf and Zakat Returns from waqf given for investment purposes and

zakat funds for consumption purposesUse the same operational format as MFIs (as it suits

the MSEs)

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THANK YOU!

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Contact Information

Dr. Turkhan Ali Abdul ManapSenior Economist / ResearcherIslamic Research & Training Institute Islamic Development Bank Group P. O. Box 9201, Jeddah 21413Kingdom of Saudi Arabiaturkhanali@isdb.org