Quick Deck on Islamic Finance/Microfinance projects

1. YOUTHSCHOOL
Islamic microfinance and its application to the
youthschool projects.

2. About us
• YouthSchool is a charity established in Scotland, with the aim of creating a
personal development and training programme that will support young people
in developing countries to access meaningful employment and make a
positive contribution to their community. (http://www.youthschool.org)
• Our chairman, and founder, is Ken Imrie who also heads up the Outreach
programme at the Princes Trust, in Scotland.
• Ahmed Alikhan, is a consultant to Youthschool and also an employee of
Barclays bank, working in Scotland.
• We intend to incept ethically financed micro-projects in disadvantaged
communities.
• We will be utilising Islamic microfinance packages to fund these micro-ventures.

3. Key differentiators between Islamic
finance & conventional finance
• Predicated on the recognition of a supreme creator, Who has laid down laws
required for individual and social harmony.
• Most striking difference is that no amount of interest can be charged on loans.
• Islam encourages trade but prohibits usury; hence profits can be legitimately
generated through the buying and selling of products and services but not
through the borrowing and paying of interest on loans=> money cannot
generate money.
• Enforces the sharing of risk.
• Prohibition of investment in any ventures for which core activity prohibited by
shariah; gambling, alcohol and tobacco, pornography and most arms trade
companies.
• Spirit of Islamic finance also encourages social responsibility and thus the fair
distribution of wealth throughout society, either through charitable acts or
ethical trade.

4. What’s wrong with interest?*
* Above slides reprinted by the kind permission of
Ethica Institute of Islamic Finance™
http://www.ethicainstitute.com/

5. Conventional Microfinance
• Microfinance: Financing tool that sustainably provides very small loans to the
working poor.
• Pioneered by Professor Muhammad Yunus, in 1970’s leading to creation of
Grameen Bank.
• Humble beginnings; $26 loan has transformed into $4bn in loans with over 4m
borrowers. (2005 statistic)
• Typically works by implementation of a self-selecting borrowing group. Loans
provided in tranches to various participants and peer pressure/assistance ensures
project success and hence repayment.
• Critics cite very high interest rates as barriers to becoming truly self sufficient.
• Astronomical 22% interest rate (on declining basis) charged by Grameen bank and
as high as 50% by other institutions. (2005 statistics)
• Borrower has to repay loan, including interest, even if his or her business fails.
• Lender’s strategy is thus geared towards recovering debt as opposed to maximing
profit, the latter being more beneficial to the micro-entrepreneur.
• Interest is against Islamic principles; The Qur’an states that “Allah hath permitted
trade and forbidden usury” (From Surah Al Bakarah, verse 275)

6. Islamic finance and Microfinance – a
match made in heaven !
• Innovative, interest free alternative to conventional microfinance.
• Islamic finance products similar in nature to venture capital and private equity
structures, so precedent in conventional finance exists.
• Based on equity sharing; If business does not make a profit, nothing is paid.
• Lender’s perspective shifts towards helping the business maximise profits (win-win
situation).
• Key operational aspects of IF microfinance same as conventional, using peer
group pressure/assistance model where syndicate selects reliable borrowers
and ensures project success/repayment.
• Youthschool has embodied the Islamic principle of assisting the economically
disadvantaged, in that our sole purpose is not to make profits but to also create
a “social return”.
• Therefore our ROI model will be different to a for profit organisation, in that we
reinvest profits back into the community (capability building), however the basic
structure of the products are the same.

7. Summary of India Youthschool initiative
• The Youthschool pilot in India will focus on schools in the area which have the
support of leadership in these institutions.
• The Youthschool model engages with local partners who are dynamic and
young volunteers, on the ground, who have a desire to precipitate positive
change in their communities.
• These local partners will be our partner on the ground helping us to
coordinate with the project participants (i.e. School leadership, local
government, micro – entrepreneurs etc.)
• We intend to select 2 or 3 pilot projects initially with an investment size of
approximately 40,000INR
• Profit or revenue calculation and tracking may initially be challenging for a
young entrepreneur. We will train them over time to do basic accounting.
• Therefore, the investment mechanism will initially be Qard Hasanah (Interest
free loan, no profit sharing) to keep the calculations simple.
• We have a variety of specialists which we will invoke, on the ground, to help
this project become a success. These people will work with our local partner.

8. Appendix A -A typical Islamic microfinance
model (Mudarabah)
1. A group of 5 clients approach an Islamic microfinance bank for investment capital for 5 separate projects;
2. After assessing feasibility for each of the 5 projects, the bank draws up separate contracts, explaining repayment
schedules and profit-sharing percentages, and underscoring the possibility of larger investments in future
depending on their individual performances; Bank initially invests in 2 individuals.
3. These first 2 individuals start trading and repay back the principle to a pre-determined schedule. Profits
generated are shared on a pre-agreed profit rate. E.g. 20% Lender, 80% micro-entrepreneur.
4. Payments can also be calculated on a Revenue based model.
5. If the event of losses, only what remains of the investment is re-paid
6. Bank assesses performance of first 2 individuals and decides whether to re-invest. Might decide that it will
increase investment for rates of return >10%, maintain for 0-10% or not invest again for loss making individuals
(depending on reasons for losses).
7. At this juncture, Bank commences investing in another 2 individuals in syndicate.
8. Bank pauses to review success of investments and then decides whether to invest in 5th member of syndicate,
using same repayment schedule and profit-sharing agreement as for previous 4 individuals.
9. Same method used to extend financing facilities to rest of community.
• In calculating profit , client only needs to provide; purchase price, sales price and quantity purchased.
• Islamic law does not allow you to contractually condition future investment sizes on past performance but can
use that as an unenforceable pledge to encourage client not to downplay profits achieved (in order to retain
more for themselves through deception).
• Peer pressure/assistance ensures that syndicate members select each other on the basis of trust and
competencies, as all members do not receive funds immediately and some will only be able to participate after
initial successful ventures.

9. Appendix B - Example of Mudarabah
repayments
Initial principal £2,000
Bank % of profit 20%
Entrepreneur % Profit 80%
Period Profit Bank Shares Entrepreneur Share Principal (owed) Bank profit Entrepreneur Profit (Gross) Entrepreneur Profit (Net)
1 £200 20 0 2000 £40 £160 £60
2 £200 19 2 1800 £38 £162 £62
3 £200 18 3 1700 £36 £164 £64
4 £200 17 4 1600 £34 £166 £66
5 £200 16 5 1500 £32 £168 £68
6 £200 15 6 1400 £30 £170 £70
7 £200 14 7 1300 £28 £172 £72
8 £200 13 8 1200 £26 £174 £74
9 £200 12 9 1100 £24 £176 £76
10 £200 11 10 1000 £22 £178 £78
11 £200 10 11 900 £20 £180 £80
12 £200 9 12 800 £18 £182 £82
13 £200 8 13 700 £16 £184 £84
14 £200 7 14 600 £14 £186 £86
15 £200 6 15 500 £12 £188 £88
16 £200 5 16 400 £10 £190 £90
17 £200 4 17 300 £8 £192 £92
18 £200 3 18 200 £6 £194 £94
19 £200 2 19 100 £4 £196 £96
20 £200 1 20 0 £2 £198 £98
£420 £1,580

10. References used
• http://www.ethicainstitute.com
• Poverty to Profit, by Atif Raza Khan (Islamica magazine,
summer 2005)