islamic microfinance to micro entrepreneurs_shardjono_short for conference_08012011sdn

8/13/2019 Islamic Microfinance to Micro Entrepreneurs_shardjono_short for Conference_08012011sdn

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ISLAMIC MICROFINANCE TO MICRO ENTREPRENEURS

BY: SAEBANI HARDJONO

Candidate Doctor of Islamic Economics & Finance (IEF) TRISAKTI - Jakarta - Indonesia

Microfinance has become one of the most sustainable and effective tools in the fight against global poverty.

Islamic microfinance has the potential to not only respond to unmet demand but also to combine the Islamicsocial principle of caring for the less fortunate with microfinances power to provide financial access to the

poor.

DEPOK - WEST JAVA - INDONESIA


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Segala puji[2] bagi Allah, Tuhan semesta alam [3]

All the praises and thanks be to Allah, the Lord of the Alamin (mankind, jiin and all that exists).

[2] Alhamdu (segala puji). memuji orang adalah karena perbuatannya yang baik yang dikerjakannya dengankemauan sendiri. Maka memuji Allah berrati: menyanjung-Nya karena perbuatannya yang baik. lain halnyadengan syukur yang berarti: mengakui keutamaan seseorang terhadap nikmat yang diberikannya. kitamenghadapkan segala puji bagi Allah ialah karena Allah sumber dari segala kebaikan yang patut dipuji.

[3] Rabb (tuhan) berarti: Tuhan yang ditaati yang Memiliki, mendidik dan Memelihara. Lafal Rabb tidak dapatdipakai selain untuk Tuhan, kecuali kalau ada sambungannya, seperti rabbul bait (tuan rumah). 'Alamiin(semesta alam): semua yang diciptakan Tuhan yang terdiri dari berbagai jenis dan macam, seperti: alammanusia, alam hewan, alam tumbuh-tumbuhan, benda-benda mati dan sebagainya. Allah Pencipta semua alam-alam itu.

There is no proper equivalent to Rabb in the English language. It means the One and the Only Lord forall the universe. Its Creator, Owner, Organizer, Provider, Master, Planner, Sustainer, Cherisher, andGiver of security.

Surat Al -Fatihah which is As- Sab Al -Mathani (i.e. the seven repeadtedly recited Verses) and the GrandQuran which has been given to Rasulullah (Sahih Al -Bukhari, 6/4474). It gives of two kinds:

1. Guidance of Taufiq and it is totally from Allah, i.e. Allah opens ones heart to receive the truth(fr om disbeli ef to Beleive in I slami c M onotheism).

2. Guidance of Irshad through preaching by Allahs Messengers and pious preachers who preach thetru th, i.e. I slami c Monotheism.

Cited by Saebani H ardjono - Source: DR. Mu hammad Muh sin K han and DR. Muhammad Taqi-ud-Din Al - Hilali, (1996), The Noble Quran, Darussalam, Global Leader In Islamic Books.


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ISLAMIC MICROFINANCE TO MICRO ENTREPRENEURS

(A STUDY BASED ON INSTITUTIONAL NETWORK APPROACH)

BY: SAEBANI HARDJONO


Introduction

This presentation consists mainly with four different parts .

First, Islamic banking and the investment mode , and the Islamic bank practices inIndonesia.

Second, microfinance and Islamic microfinance in general and an Indonesian context. Third, the concept of Networks and the Financial & Societal Sector Institutions.

Forth, how Islamic microfinance develops and establishes different networkrelationships,

The Aim and Objective To study Islamic microfinance in relation to the micro entrepreneurs based on the institutional

networking, especially in the case of Indonesia.

To give a better understanding an important role of Islamic microfinance in the effort ofalleviating poverty through facilitates the poorest working with micro credit.

Method

In writing this paper author implements the method of literature study/review based onavailable reference materials.


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Part one : Islamic bank - A bank without interest

An Islamic bank may be defined as a financial intermediary: The objectives, operations, principles and practices must conform to Islamic Law (Shariah); All its operations and activities without interest (Alam, 2001). The aim of Islamic economics [(Molla et.al. (1988)]: Is not only the elimination of interest -

based transactions but the owner of capital and the entrepreneurs: sharing the result . It differs from an interest-based system in which the risk is mainly borne by the entrepreneur. We can call Islamic banking as participatory banking.

Islamic banks as observed by International bodies

Prof. Wohlers- Schraf (1983), in his study entitled Arab and Islamic Bank conducted byDevelopment Centre, Organization of Economic Co-operation and Development (OECD), reportedthat Islamic bank can play a vital role in economic growth and development.

He has mentioned that:

Islamic banking is trying to develop the relationship between finance on one hand andindustry and commerce on the other. This new relationship is the basis of the Islamiceconomic system being set up .

Though Islamic principles have yet to be put to the test in the competitive of international finance, the two systems are similar in that they both strive for closer ties between financialintermediation and economic asset creation. Islamic banks could make a useful contributionto economic growth and development particularly in a situation of recession, stagflation andlow-growth level because the core of their operation oriented towards productiveinvestment.

Islamic Banks Around The World

Nassief (1989), Ahsan (1989), and Kazarian (1991) observed:

More than 70 Islamic banks and Insurance houses are rendering interest-free services in Asia,

the Middle East, the Far East, Africa and Europe and North American countries.

The Islamic Society of North America Canada (ISNA, 2000), has initiated Islamic banking

activities and started lending interest-free funds to their customers especially for

housing and other projects.


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Islamic Banks Around the-World

The Islamic Society of North AmericaCanada (ISNA, 2000), has initiated Islamic

banking activities in recent years and started lending interest-free funds.

Western banks such as, the KleinworteBenson, Citibank and ANZ Grindlays alsostarted to adopt the pattern of Islamicbanking in cost-plus financing.

Islamic banks have emerge around the world: includes in North America Canada, Europe, Africa, andAsia.

All countries a round the world, both in the North and in the South, need more venture capital. Loancapital is available, particularly from industrialized countries but at high interest rates.

Islamic Bank in Indonesia

2001 - 2007: Islamic (sharia) banking in Indonesia was experiencing a high growth . 2008: The growth of Islamic banking is still able to enjoy high growth , given a climate

conducive in form of Indonesian macroeconomic conditions well enough, although not

free from negative influences of global econom ic recession.

2009 - the future: Growth and development of Islamic banking in Indonesia can not be

separated from macroeconomic conditions.

Indonesian macroeconomic conditions would surely affect on the banking industry in

general and for Islamic (sharia ) banks as well.

Macroeconomic prospects of Indonesia

Growth and development Islamic banks, r equir e a str ong economic foun dation --the

achievement of positive economic growth in the country. To keep the economic growth is

a prerequisite for the development of the banking sector, including Islamic banks.

Indonesia's economic growth in 2008, in a global recession, still recorded a positive

growth of 6.1% which is supported by the improvement in private investment, public

purchasing power which is still quite strong

Economic growth affects people's income and ability to make consumption and savings .


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The capacity of banking to finance the real sector has been supported by public funds in

the form of savings.

The national economic growth has a positive impact on the growth of Islamic banking . The decline in inflation pressures and the strengthening of the rupiah giving space for

Bank Indonesia to gradually lower the BI rate in order to encourage the real sector.

For the banking sector, it suggests positive prospects for stimulating the real sector, especially in

the microfinancing .

Indonesia Islamic Banking Prospects

Indonesian Islamic (sharia) b anking industry in 2009 still to enjoy the high-growth, i.e.

in the range of 38% with the establishment of new Islamic banks--is higher compared to

banking growth in national.

The growth includes the growth of Third Parties Fund, the amount of financing, the

increasing number of customer accounts, and the amount of funded economy sectors.

Instead of macroeconomic conditions that are still conducive, micro factors in the

banking industry and Islamic finance also affect the acceleration of the development of

sharia banking industry , which includes:

o Planned opening of new Islamic bankso Optimizing the business capacity of Islamic banks; ando Support national Islamic financial environment, includes an Islamic

microfinancing.

Completion of Tax Law perfection (VAT) at the beginning of the year 2008 also be a

gateway for the entry of new investors into the sector of national Islamic banking

industry, thereby expanding the industrial capacity.

Coordinating Minister for economy committed to remove murabaha double tax also be

strong drivers of Islamic banking products marketing.

Besides the prospects are affected by macro economic as described above, Karnaen A.

Perwataatmadja, and Hendri Tanjung deliver prospects in terms of internal factors which are

strengths for the development of Islamic banks , as follows:

1. The support of Muslims who are the majority population .

2. The existence of Islamic banks in accordance with the needs and expectations of people,

with the advantages as follows:

a. Encourage togetherness between the parties by sharing the risk: losses and profits.

b. Murabaha financing and bai bithaman can be done without physical collateral.


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c. Financing mudaraba will not burden customers with fixed costs that are

determined in advance . Customer obligation is to share the results reasonably in

conform with agreements and business development.

d. Customers get yield subject to their performance and development of the banks

that are transparent to the customer in mind.

e. Occurs balance between the funds channeled to assets to be foundation, because

each loan is based on a reality.

f. Provide free interest loans, called Qardul-hassan , which is distributed to the right

people, funds are collected from Zakat, Infak, and Alms, and cash waqaf.

g. No worry about the cost of money because the interest is not known.

h. Not charge interest, so m ore resistant to the negative influences of globalization

monetary turmoil.

i. Competition among Islamic banks do not eradicate each other since they work in

a partnerships network with the motto fastabiqul khoirot.

Challenges , in order to maintain such high growth is in more sustainable.

Five major challenges of sharia banking in addition to other challenges that also need to be dealt

wisely [(Agustianto, (2007)], as follow: human resources, financing problem, regulation aspect,

optimization of networking services, and product innovation.


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Modes of Investment of Islamic Banks

Islamic banks use various modes of investment such as:

Mudaraba,

Musharaka,

Murabaha,

Bai-Muajjal,

Bai-Salam, and

Quard E-Hasan.

Mudaraba or (Capital Financing ) is an Investment through self employed entrepreneur.

Musharaka or investment under partnership .

Murabaha is a cost plus sales on cash basis.

Bai-Muajjal is a cost plus sales under deferred payment .

Bai-Salam is an Advance Purchase or Hire-Purchase under Shirkatul Milk Ijara or leasing .

Quard-El-Hasan means an interest-free loan given to the needy people in a society.

In order to know Islamic banking procedures that all Islamic banks in many Muslim countries followto invest their funds under various modes of financing; a detailed description of each mode is given

below.

Modes of Investment of Islamic BankThe modes or techniques of accepting deposits and lending funds to

customers differ from conventional banks.


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Mudaraba or capital financing: Under the Mudaraba mode or the Capital Trust

Islamic banks supplies the entire capital of the business and the customer gives his time andexpertise: a relationship between the supplier of capital and the user of capital . The bank andthe customer work together and share profits and losses [( Khoja and Ghuddah (1997)]

In essence is based on the concurrence of those who have capital with those who expertise toearning halal profit (lawful) which will be divided between them in ratios agreed upon.

The investor is known as Rab -Al-Mal meaning the owner of the property and theentrepreneur is called Mudarab meaning the manager of capital.

When the venture ends, the entrepreneur returns the entire capital to the bank, along with anagreed proportion of profit. If there is any loss, it is born by the bank.

The advantage with this partnership is that it combines the efforts of human beings and theirskills with the capital; which contribute the development of society and assists to solveunemployment problems by utilizing manpower resources in a productive way .

Musharaka or partnership financing :

Musharaka means a profit sharing joint venture . The bank and the customer contributecapital jointly .

They also contribute managerial expertise and other essential services at agreed proportions.

Profit or losses are shared according to the contract. agreed upon. An individual partner does not become liable for the losses caused by others.

Due to this joint venture this technique is also known as Equity Participation investment. Profit is distributed according to a predetermined ratio, and loss, if any is also sharedaccording to the capital ratio.

Both the bank and the customer take part in the management and control of theentrepreneurial activities.

Murabaha (Mark-up or costs-plus-profit based financing)

Murabaha means a cost -plus profit based financing [( Khoja & Ghuddah (1997)]. Islamic banks which undertake the purchaser of commodities requested by the customer and

then resell them on Murabaha to whom promised to buy for its cost price plus a margin of profit agreed upon previously by the two parties.

The bank agrees to purchase for a client who will then reimburse the bank in a stated time period at an agreed upon profit margin. The mark-up price that the bank and the buyer agreeto is mainly based on the market price of the commodity.

The bank earns a profit without bearing any risk.


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Quard E Hasan (interest-free loan)

Quard E Hasan means an interest-free loan given by the Islamic bank to the needy people. The practice of dealing with this sort of investment differs from bank to bank. Quard E Hasan is normally given to needy students, small producers, farmers, entrepreneurs

and economically weaker sections of the society, who are not in a position to obtain loan orany financial assistance from any other institutional sources.

The main aim of this loan is to help needy people in a society in order to, make them self-sufficient and to raise their income and standards of living.


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Part two : Microfinance - A Contextual Review

Microfinance is globally acknowledged as an effective instrument in alleviating poverty.

Microfinance refers to finance services such as credit, savings, insurance provided for low-income people or widely called economically active poor .

Microfinance emerged in the 1970s as social innovators to offer financial services to the

working poor - who were considered "un-bankable" because of their lack of collateral .

These tiny loans are enough for hardworking micro-entrepreneurs to start or expand small

businesses such as weaving baskets, raising chickens, or buying wholesale products.

Income from these businesses provides better food, housing, health care and education for

entire families, and most important, additional income provides hope for a better future.

Lesson from Grameens Founder - Nobel Prize winner Mohammed Yunus.

Grameen Foundation:

States its goal that is simple to see poor people, especially the poorest and those l ivi ng i n

har der to r each areas, have access to microfi nance and technology and as a result of access

to these services, move themselves out of pover ty .

Envisions a world where the poor have broken the generational chain of poverty and lead

lives of respect, dignity and opportunity. Collaborates with local organizations and allies around the globe to provide products and

services that allow them to :

1) reach deeper into poor communities with microfinance.

2) provide access to microfinance and technology services among the poor and poorest.

3) ensure they are moving out of poverty over time . Their mission is to enable the poor, especially the poorest, to create a world without poverty.

In all its work, Grameen foundation embraces and draw inspiration from its core values are:

to empower the worlds poor, especially the poorest women; accountable for transparency and measurable results, including social and financial

performance;

a difference in the lives of the poor;

partnerships with those who can advance the mission before acting alone; respect, invest in and promote local social entrepreneurs and local ownership; and,honor the

voice, professionalism and integrity of all staffs and volunteers.


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Microfinance in Indonesia

Indonesia is made up of more than 17,000 islands and is home to nearly 230 million people . Nearly

half the population lives under the $2.50/day poverty line.

The population are considered near - poor , living just above the poverty line. The risk of a household falling below the poverty line is very high. Over 38 percent of poor

households in 2004 were not considered poor in 2003,

The countrys vulnerabil ity to price shocks particularly increases in rice prices. Over 75 % of

the poor spend a quarter of their incomes on rice .

When rice prices increase, as they did in 2006, millions of people fall back into poverty . Rural households account for about 57 pe rcent of the countrys poor, and almost two -thirds of

poor households involved in agriculture, such as fishing and farming. Urban poverty is on the rise and the conditions in urban areas are comparatively worse. The islands of Java and Bali contain 59 p ercent of Indonesias population, and 57 percent of

its poor nearly 140 million people.

Despite a continuous reduction in poverty rates over the last several decades, nearly half of

the population still lives below the $2.50/day poverty line.

The demand for microfinance services is immense . Despite the existence of over 50

thousands registered microfinance institutions , very few are targeting the poor and poorest.

More than 50 % of Indonesias entire opulation remains without access to formal financial

services .

Maping Microfinance in Indonesia

Microfinance is globally acknowledged as an effective instrument in alleviating poverty .

Microfinance refers to finance services such as credit, savings, insurance provided for low-income

people or widely called economically active poor . And as we know, year 2007 is becoming theInternational Year of Microcredit (Microfinance) as what the United Nations has mentioned.

Indonesia micro finance institutions can be divided into two categories , i.e., bank and non-

bank sectors:

o BRI (Peoples Bank of Indonesia) and BPR (Rural Bank) , mostly private, belong to

bank sector.

o While non-bank sector can be classified into two kinds: formal and non formal . Formal category includes:

o cooperative,


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o LDKP/Rural Credit Financing Institution ( Lembaga Dana dan Kredit Pedesaan ),o pawnshop, ando BKD/ rural credit association (Badan Kredit Desa ); is supervised by BRI on behalf

of BI (Central Bank of Indonesia). LDKP gets formal status as local governments

institution.

Non-formal micro finance institutions are carried out by NGOs and self-help groups .

The demand driven for micro finance development is so great:

98.5% business entity in Indonesia or 41.8 million of business units are in micro category , Of which, less than 10 million of business units get finance services from formal market .

The rest (>30 million),are mostly trapped into informal market called money lenders . The interest rates charged by money lenders are so high (ranging from 20%-50% per month).

The Indonesian government indeed does not stay doing nothing to face this situation. Government has

implemented projects and programs, most of them with micro finance component . These programs

have wide scale and great outreach to the people.

There are 70 projects of government institutions (supported donors, with budget almost US

$300 millions) which have a micro finance component. Different from many other countries in which micro finance is developed by NGOs , in

Indonesia micro finance development role is hold by government.

Unfortunately, the main weakness of government project is that it is not sustainable . Psychologically in encountering such a project, the people consider it as grant so that

sometimes it is not repaid .

Furthermore, the interest applied is subsidized which results in negative impact or distortion

on micro finance (commercialization) industry.

Further, based on lessons learned from the best practitioners over the world, it was agreed that in

developing micro finance require 4 important following points:

1. reaching the poorest

2. reaching and empowering women

3. building financially sustainable institution

4. measurable positive impact


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In Indonesia, micro finance approaches can be categorized into 4 kinds :

Saving led microfinance Credit led microfinance.

Micro banking. Lingkage model

1. Saving led microfinance

Financial mobilization is based on capacity of the poor (saving) . It is also membership based,

of which membership and participation are crucial aspects. Some forms of institutions within

the communities are: self-help groups (SHGs), Credit Union (CU), Koperasi Simpan

Pinjam / KSP (savings and credit cooperative ), etc.

2. Credit led microfinance

The main source of finance is not from saving mobilization of the poor but from other source

intended for the poor (credit). Therefore, considerable amount of fund is needed for the poor

through credit service, such as Badan Kredit Desa / BKD (rural credit association ), Lembaga

Dana Kredit Pedesaan/LDKP (rural credit financing institution ), Grameen Bank model, ASAmodel, dll.

3. Micro banking

It refers to banking sector designed to conduct micro finance services. It includes BRI

(Peoples Bank of Indonesia ) and BPR ( rural banks ). Moreover, BRI is acknowledged as the

giant of microfinance institution (Bank) in the world .

4. Lingkage model (self-help group and bank)

It is on the basis of operating the existing institutions, both informal social organization thatis often called Kelompok Swadaya M asyarakat/KSM ( self-help group ) and formal financeinstitutions ( bank ). The two different natures of institutions are organized and linked based on mutual symbiosis and benefits . Bank will get greater number of clients (outreaching), whilethe poor can get access to financial support. In Indonesia, it is widely recognized as PolaH ubungan B ank dan Kelompok Swadaya M asyarakat/ PHBK ( Bank-Self-Help Groups

Linkage ) in 1988.

Indonesia, eventually is often called as micro finance laboratory in the world , considering the

availability of various kinds of micro finance in the country and great need of development.


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Is required a forum to develop micro finance . The objective of the forum is to build micro finance as industry to reach the poor widely. The Indonesian Movement for Microfinance Development (Gema PKM ) as a forum

consisting of 7 stakeholders, i.e., government, finance institutions, NGOs, private sector,

academicians/researchers, mass organizations, and funding institutions .

Data Institutions and Statistic of Microfinance in Indonesia

No Institution Unit Creditor Credit Saver Saving

1 BPR 2,148 2,400,000 Rp9,431,000,000,000 5,610,000 Rp9,254,000,000,000

2 BRI Unit 3,916 3,100,000 Rp14,182,000,000,000 29,870,000 Rp27,429,000,000,000

3 Badan Kredit

Desa

5,345 400,000 Rp197,000,000 480,000 Rp380,000,000

4 KSP 1,097 665,000 Rp531,000,000,000 na Rp85,000,000,000

5 USP 35,218 na Rp3,629,000,000,000 na Rp1,157,000,000,000

6 LDKP 2,272 1,300,000 Rp358,000,000,000 na Rp334,000,000,000

7 Pegadaian 264 16,867 Rp157,697,252,000 No Savers No Savings

8 BMT 3,038 1,200,000 Rp157,000,000,000 na Rp209,000,000,000

9 Credit Union& NGO

1,146 397,401 Rp505,729,317,823 293,648 Rp188,014,828,884

TOTAL 54,444 9,479,268 Rp28,951,623,569,823 36,253,648 Rp38,656,394,828,884

Data compi led by Gema PKM , October 2004

Only less than 25% of micro enterprises can be served through micro finance institutions. Actually,

there are some constraints to develop microfinance in Indonesia. T he most problems , such as:

1. Legal and regulatory framework

2. Wholesaler of microfinance

Micro finance is becomes burning issue in Indonesia.

High-Level Policy Meeting on Micro finance and Rural Finance in Asia (26-28 F eb 2004 in

Yogyakarta) 13 centr al banks of A sian countri es and related ministries from Afghanistan,

Bangladesh, Cambodia, I ndia, L aos, M alaysia, Nepal, Pakistan, Phil ippin e, Sr i L anka,

Thai land, Vietnam, and I ndonesia formulated strategies and policies to support micro

financing sector.

Micro finance is believed as effective and strategic instrument to alleviate poverty . Komunike

Yogyakarta 2004 statement that really promoted micro finance was declared.


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Islamic Microfinance

Conventional microfinance products have been very successful in Muslim- majority

countries. One of the earliest microfinance programs originated in Bangladesh with the

experience of the Grameen Bank initiated by Nobel Prize winner Mohammed Yunus. The Muslim- majority countries, such as Indonesia and Pakistan, have a vibrant microfinance

industry; approximately 44 % of conventional microfinance clients worldwide reside in

Muslim countries.

Yet, conventional microfinance products do not fulfill the needs of many Muslim clients . Just

as there are mainstream banking clients who demand Islamic financial products, there are also

many poor people who insist on these products.

Indeed, Sharia compliance in some societies may be less a religious principle than a cultural

one -- and even the less religiously observant may prefer Sharia compliant products.

Islamic finance has boomed in recent years; but what has hit the headlines is big money that is

moved around, following the principles of Islamic law.

Since the Grameen Bank in Bangladesh and its founder, Professor Muhammad Yunus, who

was awarded the Nobel Peace Prize in 2006, microcredit and microsavings have been widely

discussed as instruments of poverty alleviation and local development.

But Islamic microfinance has hardly been mentioned in this context , i.e., the collection of

small savings and the provision of small loans based on Shariah. An estimated 72 percent of people living in M usli m-majori ty countri es do not use formal

financial services (Honohon 2007). 1 Even when financial services are available, some people

view conventional products as incompatible with the financial principles set forth in Islamic

law.

Some microfinance institutions (MFIs) have stepped in to service low-income Muslim clients

who demand products consistent with Islamic financial principles leading to the emergence

of Islamic microfinance as a new market niche .

Islamic microfinance represents the confluence of two rapidly growing industries :microfinance and Islamic finance . It combines the Islamic social principle of caring for the

less fortunate with microfinances power to provide financial access to the poor.

Unlocking this potential could be the key to providing financial access to millions of Muslim

poor who currently reject microfinance products that do not comply with Islamic law. Islamic

microfinance is still in its infancy, and business models are just emerging.


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2007 s global survey on Islamic microfinance, CGAP (Consultative Group To Assist the Poor)

collected information on over 125 institutions and contacted experts from 19 Muslim countries as

such: .

Estimated the global outreach of only 380,000 customers and accounts or 0.5% of total

microfinance outreach.

Islamic microfinance is very concentrated in a few countries , with the top three countries:

I ndonesia, Bangladesh, and A fghani stan, accounting for 80 percent of global outreach .

Total assets of Islamic financial products is estimated at US$500.5 billion (The Banker 2007) and the

Islamic finance industrys 100 largest banks have posted an annual asset growth rate of 26.7 %,

outpacing the 19.3 % growth rate of their conventional counterparts (Kapur 2008).

Discovering Islamic Microfinance

There are numerous small enterprises , some of remarkable ingenuity in solving their technical

problems in a difficult environment, but all facing one core problem: lack of access to credit .

The bank offered two main products .o Mudarabah: the bank carefully selected highly profitable large enterprises, invested in

them and shared the profit, gaining in some cases up to 80 per cent.

o Murabahah: the bank bought e.g. machinery and sold it to its customers, to be repaid

in instalments with a fixed mark-up , not much different from conventional credit .

Any type of speculative lending would have been against Islamic law. Then there was qard al-hasan : charitable microcredit without any profit-sharing or mark-up

and the only type of unsecured lending permitted under Shariah. This represented only an

insignificant proportion of the bank's portfolio and reached but a small number of clients .

Islamic Microfinance in Indonesia

Indonesia is probably the country with the greatest diversity of both conventional and Islamicmicrofinance. The former evolved over a period of over one hundred years , preceded by a history of

informal finance of unknown depth, the latter, still on a modest scale, over a period of fifteen years.

Indonesia possesses one of the most differentiated microfinance infrastructures in the

developing world:

o Comprising some 6,000 formal and 48,000 semi-formal registered microfinance unitso Serving about 45 million depositors and 32 million borrowers; 800,000 channelling

groups ; and Millions of informal financial institutions and self-help groups.


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In contrast to many other countries, the large majority of microfinance institutions in

Indonesia are found in rural and peri-urban areas .

There is hardly an institutional type of microfinance that is not found in Indonesia. One of the

most successful microfinance models worldwide, the reformed Bank Rakyat Indonesia (BRI)

units, were designed by Harvard Institute for International Development (HIID), early 1980s.

Islamic finance in Indonesia, the largest Muslim country, has evolved since around 1990 ,

mainly in response to political demands from Muslim scholars and organizations.

The first Islamic cooperatives were established in 1990, followed by rural banks in 1991 and

the first Islamic commercial bank in 1992 .

In 1998 , Bank Indonesia gave official recognition , as part of a new banking act, to the

existence of a dual banking system, conventional and Islamic , or shariah-based.

This led to the establishment of a second Islamic Commercial Bank (ICB) and, untilDecember 2003, of eight Islamic Commercial Banking Units (ISBU) (out of a total of 138

commercial banks, comprising a total of 299 banking offices), with a continuing upward

trend, reaching 3 (ICBs) and 19 (ICBUs) in December 2005.

The growth pattern of Islamic rural banks has been quite different. After an initial period of

growth until 1996 when they reached a total of 71, their number almost stagnated during and

after the financial crisis, reaching 78 by 1998 and a mere 84 by 2003 (out of a total of 2,134

rural banks), and 92 by December 2005.

The first Islamic cooperative was established in 1990. Rapid expansion started after 1996 , asa result of promotion by Center for Micro Enterprise Incubation (PINBUK), a non-

government organization (NGO), and continued throughout the financial crisis, but stagnated

after 1999 at around 3,000 and then declined to less than 2,900 as of 2003 (out of a total of

some 40,000 microfinance cooperatives).

Highlights of the evolution of Islamic finance include (as of December 2003):

Origins of Islamic finance due to initiatives by Muslim scholars around 1990. Islamic cooperatives: Start in 1990, rapid expansion after 1996, stagnation in 1999,

followed by decline; 2,900 Islamic microfinance cooperatives out of 40,000

Islamic microbanks (BPRS): Initial growth since 1991 until 1996 followed by stagnation; 84

out of a total of 2,134 rural banks.

Islamic commercial banks: continuing upward trend since 1992; 2 Islamic banks and 8

Islamic banking units out of 138 commercial banks.

Recognition of a dual, conventional and Islamic banking system, by Bank of Indonesia (BI)

in 1998.


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Indonesia gives insight into the development of Islamic microfinance because of its dual

conventional/Islamic microbanking system , which includes both conventional rural banks (Bank

Perkreditan Rakyat or BPRs) and Sharia-compliant rural banks (Bank Perkreditan Rakyat Syariah or

BPRSs ).

BPRSs are privately owned and are regulated and supervised by Bank Indonesia . They are

licensed to offer banking services ( loans and savings facilities, but no payments services) in a

district area only. As of December 2006, there were 1,880 BPRs and 105 BPRSs.

BPRSs are more socially oriented than BPRs . Their mission statement calls for supporting the

community and, in particular, microentrepreneurs . They also have strong links with

Indonesian Muslim mass movements , such as Nahdlatul Ulama or Mohammedia .

Each BPRS has a Sharia board to monitor the conformity of products to Islamic principles.

However, board rulings are not consistent, and consequently, Islamic microfinance products

can vary widely depending on the specific BPRS.

BPRSs primarily offer murabaha products and savings services based on a revenue sharing

model . They have been quite successful at mobilizing savings for the community, and their

loan to-deposit ratio is over 110 percent.

BPRSs are meeting a growing demand for Sharia compliant microfinance products . Their rate

of growth has been impressive, from March to December 2007 , these banks :

o Murabaha receivables increased by 26 %;o

Musharaka Financing increased by 27 %, ando Mudaraba financing increased by almost 50 %

(Bank of Indonesia 2007).

BPRSs can be profitable but nevertheless, like many microfinance providers, they face several

challenges in reaching sustainable scale.

Islamic Commercial Banks

The market leaders in Islamic finance in Indonesia are the commercial banks. During the

reporting period, 1991-2003, they focused on medium- and large-scale finance.

We are now observing the beginnings of a slow expansion into microfinance . Since BI gave official recognition in 1998 to a dual banking system, conventional and Islamic

banks, interest in Islamic microfinance that has spread among commercial banks, inspired by

religious concerns and fuelled by low rates of non-performing loans.

Islamic commercial banks, as of 2003, accounted for a mere 0.74 per cent of total assets of

the banking sector. However, during 2001-03 the share of Islamic commercial banks hasincreased from 0.17 per cent to 0.74 per cent and stood at 2.19 per cent in December 2005.


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Most remarkable is the difference in performance between conventional and Islamic commercial

banks in relative terms:

The Islamic banks lend more of the funds deposited, with a loan-to-deposit ratio

(LDR)/financing-to-deposit ratio (FDR) of 97 per cent compared to 54 per cent of the totalcommercial banking sector;

Their gross non-performing loans ratio (NPLR) is persistently lower , and the improvement of

their performance is faster than that of conventional banks after the financial crisis.


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Part three : Institutions and its influence on Microfinance

DR Nurul Alam developed an analytical frame of references to study the lender-borrowerrelationships between different financing organizations (FO) and rural-based small and cottageindustries (SCI) b ased on Business System institutional approach. [Whitleys (1992a) ]

The different of small and cottage industries (SCI) as well as financing organizations (FO) ofsimilar nature are grouped and institutionalized into different SCI systems and FinancingSystems .

The theoretical model is also used to carry out a comparative study as to how financingorganizations under different financing system differ from each other while lending fundstowards SCI owners under different SCI systems.

Therte are four components of different SCI systems and financing systems . ( DR Nurul Alam).

These components are:

nature of organization , market organization, employment systems and authority and control systems .

Accor dingly to Whitley (1992b) a comparative analysis of the business system is the systematicstudy of these configurations and as to how they become established in markets.

The Islamic financing system is seen as a financing business system of its own, with a foundation based on religion , having its own rules governed by the Islamic laws . These rules differ from those ofother financial systems.

There are three different financial systems such as :

MBFS (Market Based Financing System), such as conventional banks, CFS ( Cooperative Financing System) , and TMLS ( Traditional Money Lending System), viewed as particular arrangements of

hierarchy-market relations that become institutionalized and relatively successful in a

particular context .

A similar arrangement is also done to institutionalize different rural-based small and cottageindustries.

Different small and cottage industries (SCI) of similar nature are thus, grouped into three differentsystems , such as:

Grass-root level (GL), Season-based (SB) and

Semi-mechanized (SM) SCI systems.


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Different financing organizations and small and cottage industries under different Financing Systemsand SCI Systems are regarded as economic actors acting within these organizational fields.

These four major componenets of financial institutions:

Islamic Financing System (IFS). Cooperative Financing System (CFS).

Market Based Financing System (MBFS).

Traditional Money Lending System (TMLS).

can be seen in this following diagram.

Economic Actors

IFS

CFS

TMLS

MBFSMarket BasedFinancing Systems

Islamic Financing Systems

Traditional Money Lending System

CooperativeFinancing Systems

Major Financial Institutions

Concepts of Janssons (2000) network institutional model was also taken into consideration for

developing this theoretical frame of references.

Network institutional model [ Jansson (2000)] highlights network relationships between the

multinational corporations (MNC) in India and major external parties in the product/services market

like:

customers,

intermediaries, competitors and suppliers .


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There are so many factors in the society system influencing the lending and borrowing system .

This system consists of:

political, legal, government, family clan, religion, and country culture

How the influence of each of those factors can be seen as the diagram below.

Economic Actors

(FOs & SCIs)

PoliticalSystems

LegalSystems

Govern-ment

FamilyClan

Religion

CountryCulture

How each of those factors inf luence the lending & borrowing systemSociety


24/33


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As of 2004, of about 42% (or 1.456 units) of BMT and 29%(or 160 units) of Swamitra

cooperatives operate in Java.

In Central Java, the Bukopin regional office in Semarang is in charge of 11 Swamitras and

Solos office handles 14 Swamitra units.

While BMTs account for 447 units approximately 13% of total BMTs in Indonesia. The

nature of BPRs locality can be traced from their ownerships, offices, a nd branch offices.

Local investors, private or local government, own most of the BPRs. The reason is simple ; they know

more about their hometowns and their future prospects. The nature of BPRs locality is also

determined by rules and regulations.

Islamic Microbanks /Rural Banks ( BPRS ) in Indonesia

During the 15-year period 1989-2003, the total BPR sector had grown to 2,134, comprising 2,050conventional BPR and 84 BPRS.

The development of Islamic micro bank has almost come to a standstill after a promising

start in the early 1990s.

BPRS grew at an overall average of 12 per year during the 6-year period, 1991-96 , when

their number had reached 71. When the Asian financial crisis hit Indonesia, 1997 and 1998,

their growth slowed down to less than 4 per year .

During the following five years, 1999-2003 , their net growth almost stagnated , averaging 1 per year : 7 were newly established, 2 were closed at the beginning of 2004. Their total

number was 84 in December 2003 (down to 82 in February 2004).

The average growth rate of the conventional BPR during the 15-year period was 137

institutions per year--compared to only 6.5 BPRS per annum during a 13-year period.

Conventional rural banks have thus grown more than 20 times faster than Islamic rural banks per year.

Moreover, average assets of BPRS amount to only 38 per cent of the assets of conventional BPR;

during 2001-2003, total assets of the BPRS grew (nominally) by 70 per cent , compared to a growthrate of 173 per cent of the total BPR sector.


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Part four : Concept of Network and the promotion of different networks

by Islamic Microfinance Proces

A common feature in the network approach is the focus on the system of enterprises instead of an

enterprise being an independent unit. Here, the enterprise is regarded as a node in a system of

commercial and relations, where production is regarded only as a part of the activities of the enterprise

[(cf. Rasmussen. 1988)].

Different Types of Network

Kanter [Rasmussen (1986)] has developed three typologies of network, namely: Instrumental

network, Personal network, and Symbolic network. .

These typologies include:

Instrumental network: relations as e.g. in supply and sales contacts , PR relations etc. Personal or (affective) network: where contacts between people are rooted in sympathy or mutual

support , exchange of information and as a mutual inspiration.

Symbolic or (moral) networks: are rooted in common attitudes towards a specific goal (political,

ethnic, religious, moral etc.).

Below we disply the diagram of the different types of networks.

Industrial

Network

Actors

Activity

Resources

PersonalNetwork

NETWORK

1 Instrumental Network

2 Personal or (affective) network

3 Symbolic or (moral) network

Instrumental network: e.g. in supply and sales contacts, PR relationsPersonal (affective) network : rooted in sympathy or mutual support.Symbolic (moral) network : a rooted in common attitude/goal (political,ethnic, religious, moral)

Different Types of Networks


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Network then can be viewed from various relations that are built among the various actors in society,

such as: transaction, communication, instrumental, sentiment, authority/power, kinship and

descent relati on [Kuklinski & Knoke, (1988)].

Network consists of relations that act as a bridge between two sets of: persons, objects,events, or nodes .

Network, as observed by Easton (1989) from the perspective of different theory-constitutive

metaphors, is def in ed as: relationships and positions, str uctur es and pr ocesses .

Network can be divided into three different group such as formal, social , and business

networks [Johannisson et.al. (1912)].

In the modern business, inter-organizational relationships enable firms to meet the challenge of modern business of simultaneously achieving economy in production (Hkansson, 1993).

Relationships furthermore provide firms with an identity , which sets the direction of future

development .

The improvement of industrial activities and the development of the same depend on good

network relations among interested groups within and outside the organization.

In industrial sectors technological development depend on technical exchange between different

actors ; This exchange leads organizations to form of relations that stands as a base for a network.

Network may be classified into two groups ;

external or inter organizational and internal or intra -organizational networks.

Inter and intraorganizational Network

A well-established relation with source institutions outside the organization is essential in attaining ahigher level of performance in organizational activities. While a cohessive internal networks are

needed to strengthen the organization.


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Inter organizational network emerges as the actor forms a relationship with the outside or external

source.

Thus an external network means relations of an organizational unit to other organizations .

Inter-organizational network consists of all organizations linked by a specified type of

relations and is constructed by finding the ties between all organizations in a population

[Aldrich (1979, p.281)].

Intraorganizational network is an internal networks or is a link or relation that builds among the

individual actors within the organization .

Personal Network

Personal network is a relation between persons that is based on both social and business activities.

" Personal Networks are constituted by relationshi ps based on t rust and thus establi shed through an

elaborate learni ng process, encompassing both the joint hi story of the parti es in volved and their

assumed futu re (Johannisson & Gustafsson, 1984) ."

The personal network of entrepreneurs and their small firms/ventures combine social and business

dimensions .

This network may be divided mainly, into two types , such as:

social network and business network ,

on which excessive research studies have been carried out [Johannisson (1990), Aldrich, (1976), Cook

& Emerson (1984), Anderson & Carlos (1976)],.

Industrial Networks

Industrial activities are mainly concerned with the production of goods and distribution of the same tothe end consumer in the society.

Industrial network is based on actors /entrepreneurs relationship in various processes from the stage

of:

production till the distribution stage.


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Industrial network is a relationship that takes place among all actors that are involved in making the

industrial functions efficient and effective .

A network is defined as a model or metaphor, which describes a number, usually a large number, of

entities, which are connected .

In the case of industrial as opposed to, say, the entities are actors involved in the economic processes

which convert resources to finished goods and services for consumption by end users (Axelsson and

Easton (1994 ).

In an industrial network , there are actors/entrepreneurs at several levels [Johansson & Hkansson

(1993, p.24, cf.) Axelsson & Easton (1994)].

There are five characteristics of actors/entrepreneurs :

(1). Per for m and contr ol activi ties,

(2). Develop relati onship th rough exchange process,

(3). Activi ties on contr ol over resour ces,

(4). Goal or iented (i.e. the general goal of actors is to increase their contr ol over n etwork), and

(5). Di ff erenti al kn owledge about activit ies, resour ces and other actors in the network.

Network Model

Different networks may have different aspects of linkage (Janssons, 1999), such as: purpose, types and structure

Purpose of linkage may be either instrumental or social . Economic actors/entrepreneurs in a certain

environment establish relationships for instrumental reason or social reason .

Instrumentality is defined as purposive action, i.e. organizational units are assumed to make

conscious, intentional decisions to establish linkages for example exchange of products to

increase profit (Jansson, 1999, p.4).

Organizational units may also establish their relations for social reasons . Actors

/entrepreneurs between two organizations could share liking of each other or may belong to

similar group like similar types of job or social status . A linkage may also grow between

actors of different units due to same cultural group , for example, Muslim or Hindu culture.


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Microfinance system and micro enterprise system i.e., are connected and promoted by networking,

among each others, through a group of micro entrepreneurs as i.e., may be established by a five

members each .

Each group then appoints their group leader who will then make a Team Team of five leaders who then appoints Team leader Team leader who will communicate to microfinance institution/Islamic bank , to get loan .

In the diagram below we will see how this networking flows.

PL

DF

FSHC

SM

MFS Institution MES

IntraOrganizational

NW

Economic Actors

IslamicBank

Economic Actors

IntraOrganizational

NW

TEAM

GROUPMICRO ENTREPRENEURS

Micro Finance & Micro Enterprise Networking

Micro Finance System Micro Enterprise System

5 - 5

In the society , there is Social exchange which is related to three different social factors such as:

individual attri butes,

social group and cultur al group .

Social exchange , in contrast to economic exchange, , as Jansson (1999, p. 4) argues, is signified by

unspecif ied obligation as it involves the principle that one person does another a f avor , and while

there is a general expectation of some futu re retur n , its exact natur e is not sti pulated in advance .

Structural characteristics of linkages consists of degree of interdependency , commitment to exchange

partners , duration of relationships, i.e. long or short term relationships, scope of exchange relations,

the degree of stableness and scope.


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Social Network and social exchange network

A social network consists of social tie or relations and characterized by social norms , based on

cultu re, family, relatives and f ri ends and acquaintances (Anderson & Carlos (1976).

Social network can also be defined as a relationship that enables one to collectinformation about the conduct and behavior of others in society.

Thus a social network bears a great importance in the pre-start up stages of an enterprise .

Business activities normally originate from the exchange of goods and services. Social exchange

theory is based on individuals or organizations, considered as unitary actors . The author (1987 p.

150) further reports,

It is the basic assumption in exchange network analysis that individual actors behavior reflects

the structu re of network.

The Islamic banks in the microfinancing very much relly to the role of the social network , consists of

reli gious groups, social leaders, and local leaders , to get information, support and entrust before the

banks lend the loan to the borrowers. It is known as the Network Triangle , that can be framed up as

below.

Religious GroupSocial LeadersLocal Leaders

IslamicFinancing

System (IFS)

GL SystemSB SystemSM System

The Network Triangle

As it can be seen, the Network Triangle connected the three very important elements in the

microfinance :

Islamic Financing System (IFS), Religious Group, Social Leaders, Local Leaders, and Financial Institutions such as Grass-root Level (GL) System, Season-Based (SB) System, and

Semi-Mechanised (SM) System.


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The relation between Islamic banks and customers in the Islamic microfinance system is very close ,

personal, and deep .

The banks supervisors using networking and personal approach to the religious group to tap any

necessity information of the customers: i.e., their habit and their dayly life activities .

To get the efficient and effective in collecting an information concerning the distribution of loan and

saving prospect, banks promote to the customer to make a group of five and appoints their own leader.

Every five of leaders then they have been asked to make a Team and appoints one of the memebers as

a Team leader. This system has been institutionalized among the customers which is lender and

borrower relation then established.

We can see here clearly that Islamic banks have initiated and promoted of networking in the

Islamic mirofinance to the entrepreneurs to built relation, intra or inter organizational.

The members become fammiliar each other and the role of religious group, social leaders, an

local leaders becomes emerge.

Trust, participation, and the religious value as the underlying back bone of the relation will

tightening this networking to achieve the goal for every member.

Islamic banks hold as a center role of networking, influencing, and promote a better

networking in the microfinancing and entrepreneurs activities .

Conclusion

Islamic banking in the microfinance system is holding a center role in developing the

relationship and networking between finance institutions and intrepreneurs.

Microfinance is globally acknowledged as an effective instrument in alleviating poverty

refers to finance services such as financing, savings, insurance provided for low-income

people or widely called economically active poor .

Indonesia microfinance development role is hold by government. Unfortunately, that it is not sustainable . The people consider it as grant so that sometimes it is not repaid.

Microfinance system and micro enterprise system are connected and promoted by networkingamong each others, through a group of micro entrepreneurs established by each member.

The Islamic banks in the microfinancing very much relly to the role of the social network,

consists of rel igi ous groups, social leaders, and local l eaders , to get information, support and

entrust before the banks lend the loan to the borrowers. It is known as the Network Triangle.

.Jakarta, November 15th, 2010

SAEBANI HARDJONO



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REFFERENCE

1. Alam, Mohammed Nurul Dr., A Comarative Study of Financing Small and Cottage Industries by Interest-Free Banks, Sultan Qaboos University Sultanate of Oman.

2. Alam, Mohammed Nurul Dr., A Comparative Study Between Islamic and ConventionalBanking Systems, Sultan Qaboos University Sultanate of Oman.

3. Alam, Mohammed Nurul Dr., Institutionalization and Development of Saving Habits ThroughBai-Muajjal Mode of Financing, Sultan Qaboos University Sultanate of Oman.

4. Alam, Mohammed Nurul Dr., Micro-Credit to Micro-Entrepreneurs by Islamic Banks:Promotes Different Networks, Sultan Qaboos University Sultanate of Oman.

5. Alam, Mohammed Nurul Dr., Microfinance: An Innovative Solution, Sultan QaboosUniversity Sultanate of Oman.

6. Alam, Mohammed Nurul Dr., The Islamic Banking System in Different Socio-CulturalEnvironment Context, Sultan Qaboos University Sultanate of Oman.

7. Alam, Mohammed Nurul Dr., Various Techniques Followed by Islamic Banks With Regardsto The Acceptance of Deposite and Investment of Fund, Sultan Qaboos University Sultanateof Oman.

8. Bank Indonesia, (2002) Blue Print Islamic Indonesia Banking , Jakarta: Bank Indonesia.9. Gramen Foundation, http://gramenfoundation.org/ , 50 F Street NW, 8th Floor Washington,

DC. 200001. USA.

10. GTZ-Profi, (http://www.profi.or.id ), Collects information about MFIs, consisting of BPRs,cooperatives, credit unions, pawnshops, BMTs, BKDs, and microfinance divisions ofcommercial banks (incl. BRI units),

11. Haron, Sudin and Wan Nursofiza Wan Azmi, (2009), Islamic Finance and Banking SystemPhilosophies, Principles and Pract ices, McGraw-Hill (Malaysia) Sdn. Bhd.

12. Ismawan, Bambang MS, D rs., (The Indonesian Movement for Microfinance Development,Bina Swadaya and Secretary General of Gema PKM.

13. Jamal, Khurrum Faisal, (2006), Comparative Study of Islamic Banking Between Malaysiaand Pakistan.

14. Seibel, Hans Dieter, (2008), Islamic microfinance in Indonesia: the challenge ofinstitutional diversity, regulation, and supervision, SOJOURN: Journal of Social Issues inSoutheast Asia, April 1, 2008 .

Saebani Hardjono

Candidate Doctor IEF TRISAKTI Jakarta Indonesia 15th 2010
http://gramenfoundation.org/http://gramenfoundation.org/http://gramenfoundation.org/http://www.profi.or.id/http://www.profi.or.id/http://www.profi.or.id/http://www.highbeam.com/Search.aspx?q=author:%22Seibel%2c+Hans+Dieter%22http://www.highbeam.com/Search.aspx?q=author:%22Seibel%2c+Hans+Dieter%22http://www.highbeam.com/Search.aspx?q=author:%22Seibel%2c+Hans+Dieter%22http://www.highbeam.com/Search.aspx?pid=3954&sort=DT&sortdir=Dhttp://www.highbeam.com/Search.aspx?pid=3954&sort=DT&sortdir=Dhttp://www.highbeam.com/Search.aspx?pid=3954&sort=DT&sortdir=Dhttp://www.highbeam.com/Search.aspx?q=%20pubdate:%5b20080329;20080404%5dhttp://www.highbeam.com/Search.aspx?q=%20pubdate:%5b20080329;20080404%5dhttp://www.highbeam.com/Search.aspx?q=%20pubdate:%5b20080329;20080404%5dhttp://www.highbeam.com/Search.aspx?pid=3954&sort=DT&sortdir=Dhttp://www.highbeam.com/Search.aspx?pid=3954&sort=DT&sortdir=Dhttp://www.highbeam.com/Search.aspx?q=author:%22Seibel%2c+Hans+Dieter%22http://www.profi.or.id/http://gramenfoundation.org/

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