What is Islamic Microfinance? Making it a Sustainable Reality

What is Islamic Microfinance?
Making it a Sustainable Reality

Presenters
• PART I: Rafi-uddin Shikoh
• PART II: Atif R Khan

www.EthicaInstitute.com | www.DinarStandard.com

Agenda
• Presentation: 45 min
• Q&A: 30 min


Agenda
Section 1: Global Microfinance Context (Part 1)
• Global Microfinance Drivers/ Opportunities
• What is Microfinance?
• Landscape – key players
• Impact & Challenges

Section 2a: Islamic Microfinance
• What is Islamic Microfinance?
• Key Islamic Microfinance drivers/ Opportunities
• Landscape – Key players/ geographies
• Impact, Challenges & Opportunity

Section 2b: Islamic Microfinance -- Part 2 to be delivered at the next session
• Islamic Microfinance core models
• Islamic Microfinance structures


Summary
• MICROFINANCE…Banking for the poor
• Big need exists – However poverty alleviation is too big a
promise; Industry is growing but showing signs of problems
(*primarily excess lending and aggressive collection; akin to
sub-prime mortgage lending)
• However many success stories, best practices developing and
growing. Problems should be removed.
• Islamic Microfinance in infancy making finance accessible to
many low-income Muslims and with universal potential.


Global Microfinance Drivers
1. Addressing “FINANCIAL EXCLUSION” of low-income global population:
Globally 49 percent of adults have deposit accounts in formal financial
institution*

19% of developed world adults do not have bank accounts
72% of adults in the developing world do not have accounts
Source: Financial Access 2010 Report, by CGAP and World Bank


1. Addressing “FINANCIAL EXCLUSION” of low-income global population:
Globally 49 percent of adults have deposit accounts in formal financial
institution*

An estimated 72 percent of people living in Muslim-majority
countries do not use formal financial services
(CGAP Islamic Microfinance Note 2008)

Source: Financial Access 2010 Report, by CGAP and World Bank


2. Addressing needs of MICRO-ENTERPRISES:
Micro-enterprises have historically lacked access to financial products
and services. Microfinance institutions have emerged to serve the
smallest of these enterprises, while banking institutions have typically
concentrated on large corporations.

Source: Access Finance, World Bank, JANUARY 2010 | ISSUE No. 30


1. “FINANCIAL EXCLUSION” of 2. Addressing needs of
low-income global population MICRO-ENTERPRISES

“Unmet demand for finance is large, but the exact
number (or even a rough but credible number) has
been hard to pin down, with estimates ranging from
half a billion people to three billion.*”
*Financial Access 2010 Report, by CGAP and World Bank


What is Microfinance?
• Microfinance services low 1. Low-income population
income groups (extreme 2. Microenterprises
poor, moderately poor-
main clients), mostly not
served by commercial
banks.
• Services offered are Credit
facilities, savings account,
money transfers,
remittances, insurance and
even investment


What is Microfinance?
Pioneered the group-based
responsibility model but other
models exist*

* Other models: Village model; Coop; Self-help groups (SHGs)


Landscape: Key Players
– MIX Global 100 -- As a group, surveyed institutions
represented nearly 85 percent of the known pool of
microfinance borrowers, serving 72 million borrowers
with 37 billion USD in loans and holding 22 billion USD in
deposits from 67 million microfinance clients. (MIX 2010
Report)

Microfinance Information Exchange, Inc. access to
financial and social performance information, including
quarterly results, on more than 2,000 MFIs in the
developing world covering 92 million borrowers.



Top 100 Microfinance
Institutions in the World:
MIX 100 that are profitable
and top performers in each
of three areas: outreach,
efficiency, and
transparency


Impact
• Poverty alleviation: Many studies indicate positive
impact over the last twenty years, as well as some
findings that suggest limited or negative impact.
• Example:
• Since Kiva was founded in 2005:
• 680,458 Kiva lenders
• $279 million in loans
• 98.93% Repayment rate
• Work with:
• 146 Field Partners
• 450 volunteers around the world
• 60 different countries


Shortcomings
• Social fallout: Family issues
• High interest rates: “Loan sharks”, 30%, 40% even 60%+ Per year
• Excessive lending/ over indebtedness: Major defaults in India
• Aggressive debt collection: “The past five years have seen the
aggressive selling of loans to often illiterate villagers, followed by
equally aggressive debt collection.” As a result, the past decade
witnessed more than 200,000 farm suicides in India. Reports India’s
leading rural journalist, The Hindu’s P. Sainath: “Those who have
taken their lives were deep in debt.”
• Exclusion: Poorest of the poor; Self-exclusion due to prohibition of
interest for Muslims


Key Islamic Microfinance Drivers
• Indonesia, Bangladesh, Pakistan, Nigeria and Egypt - account for over half a billion
(528 million) of the world’s poor with incomes below $2 a day or national poverty
line.
• Needs of the poor in Islamic countries are for the most part the same as the poor in
other societies …approximately 44 percent of conventional microfinance clients
worldwide reside in Muslim majority countries*.
• Yet an estimated 72 percent of people living in Muslim-majority countries do not
use formal financial services (CGAP Report 2008)
• A number of IFC-commissioned and other market studies suggest a strong demand
for Islamic microfinance products: Surveys in Jordan, Algeria, and Syria, for
example, revealed that 20–40 percent of respondents cite religious reasons for not
accessing conventional microloans. (CGAP Report 2008)
• There is also a category of Muslim clients who use conventional products but prefer
Islamic ones and tend to switch over once Islamic products become available. (CGAP
Report 2008)


Key Islamic Microfinance Drivers

“Islamic microfinance has the
potential to expand access to
finance to unprecedented levels
throughout the Muslim world.”
CGAP Islamic Microfinance: An Emerging Market Niche, Aug 2008


“Microfinance and Islamic finance have much in common.
Both emphasize the good of society as a whole. Both advocate
entrepreneurship and risk sharing and believe that the poor
should take part in such activities. Both focus on
developmental and social goals. Both advocate financial
inclusion. Both involve participation by the poor. There are
however, some points of difference between the two.” *

* Intro. to Islamic Microfinance, Mohammed Obaidullah, IIBF


• Islamic Approach to Poverty Alleviation:*
1) Charity (Sadaqa) - Zakat, Sadaqa Jariya or Waqf (endowment/ trust)

2) Economic empowerment.
3) Debt avoidance: Muslims are also warned against the dangers of incurring heavy debt. The
Prophet Muhammad (peace be upon him) used to regularly supplicate “Allah, I seek refuge with
You from sin and heavy debt”. When someone remarked, “how often you seek refuge from heavy
debt”, he replied, “when a man gets into debt, he speaks and tells lies, and he makes a promise
and breaks it” (Bukhari and Muslim). “The best among you are those who are best in paying off
debt” (Muslim);
4) Cooperation: A hadith by the Prophet (peace be upon him) reinforces the principle of cooperation
and mutual assistance. “Believers are to other believers like parts of a structure that tighten and
reinforce each other." (Al-Bukhari and Muslim)

5) Family cohesiveness: “And covet not that whereby Allah has made some of you excel others. Men
shall have a share of that which they have earned, and women a share of that which they have
earned. And ask Allah of his bounty. Surely Allah has the perfect knowledge of all things” (4:32)



• Islamic Approach to Poverty Alleviation:*
6) Sharia Compliance of Finance Contracts: All contracts in Shariah must be free from certain
forbidden elements. A brief overview of relevant norms is provided below:
• Freedom from Riba: “Allah has permitted trade and forbidden riba.” (2:275) Prohibition of
interest (riba) is the central tenet of the system. Conventional interest on loans or savings, as
a fixed return without sharing any risk, is considered unjust. Risk sharing: Because interest is
prohibited, suppliers of funds become investors instead of creditors. The provider of financial
capital and the entrepreneur share business risks in return for shares of the profit.
• Freedom from Gharar: The concept of gharar has been broadly defined by the Islamic scholars
in two ways. First, gharar implies uncertainty. Second, it implies deceit.
• Shariah approved activities: Muslims cannot profit from activities considered immoral. For
example, investing in businesses dealing with alcohol, gambling, casinos, pornography, or
weapons of mass destruction is not allowed.



• Forms of contracts (to be discussed in detail in Part II of presentation)


A FRAMEWORK

Poverty Alleviation
Responsibility

Core Islamic
Micro-credit Financing contracts
Micro-savings
Micro-transfer
Micro-insurance
Target Audience/
Need

Illustration: © 2012 DinarStandard


Islamic Microfinance: Landscape
• Currently Islamic microfinance is concentrated in a few countries, with
Indonesia, Bangladesh, Pakistan and Afghanistan ranking in the top.
According to the 2008 Consultative Group to Assist the Poor (CGAP)
survey, Islamic microfinance accounts for about 0.5 per cent. of global
microfinance despite a global Muslim population of about 1.2 billion.
• In a 2007 global survey on Islamic microfinance, CGAP collected
information on over 125 institutions and contacted experts from 19
Muslim countries. The survey and a synthesis of other available data
revealed that Islamic microfinance has a total estimated global outreach
of only 380,000 customers.
• CGAP survey identified that over 70 percent of the products offered are
Murabaha. Islamic MFIs generally offer only one or two Sharia-compliant
products.


• The Consultative Group to Assist the Poor (CGAP), Deutsche Bank, Islamic
Development Bank (IDB) and Grameen-Jameel partnered to address new
microfinance models with Shari’ah compliancy through an Islamic
Microfinance Award.

• 130 banks from 43 countries and Microfinance Institutions (MFIs)
submitted their ideas for the award,

– Winner: Al Amal Microfinance Bank of Yemen (AMB)
– Tameer Micro Finance Bank Ltd (TAMEER) - Pakistan
– Tanzania eco Volunteerism (TeV) - Tanzania
– Bina Insan Sejahtera Mandiri (BISMA) - Indonesia
– Centre for Women Co-operative Development (CWCD) - Pakistan


– Bangladesh Case Study: IBBL (Islami Bank Bangladesh Limited)
Introduced own version of microfinance: 'Rural Development Scheme
(RDS)' in 1995. Modeled after the Grameen Bank model except that
the scheme used Islamic modes of investment.
– Effective rate after rebate is 20% per annum, which is a major
difference with typical MFIs. ASA, BRAC, BURO and many other MFIs
effectively charge 30% interest per annum.
– IBBL one of the top 10 MFIs offering microfinance; IBBL reached about
11,000 villages (about 13% of total Bangladesh villages); and
outstanding investments reached Taka 3752 million (USD 53.6 million).
– Products: saving plans; financing plans; MicroTakaful
– Issue in contract credibility –Bai-muajjal (credit sale) Among alternative
modes, Mudharabah is fraught with practical problems arising out of
reluctance and/or inability among informal livelihood enterprises for
proper accounting of results.


– Indonesia Report: Why is Growth of Islamic Microfinance Lower than Conventional?*
– Out of 2200 some rural banks only 92 are Islamic but started in 1990s. Out of 40,000
microfinance cooperative, 3000 were Islamic (2003) 54.4% of respondents preferred
Islamic MFI rather than conventional MFI (45.6%).
– Most of clients were Muslim and they preferred to choose Islamic MFIs, however in
reality they chose MFI based on economic (low interest rates, low collateral and size
of loan) and non-economic factors (such as quality of services variables easiness,
speed, nearness, method and loan officers’ profile).
– BRI as a government supported entity has the biggest adoption. (conventional) BRI is
a biggest five MFIs in the world (Microcredit Year, 2005) in terms of clients and their
loans.
– As the MFIs clients prefer Islamic MFI compared to conventional, the demand for
Islamic microfinance can be enhanced if the level of their economic and non-
economic factors can be brought to the levels of conventional MFIs.
* Paper presented by Dian Masyita (PhD research scholar in Islamic Finance, Durham University, UK), Habib Ahmed (Professor of Sharjah Chair
in Islamic Law and Finance at the Durham University, UK) at 8th International Conference on Islamic Economics and Finance


Islamic Microfinance: Opportunity
• Operational Efficiency/ Risk Management
• Opportunity for integrating Zakah and Awqaf with
“for-profit” Shariah-compliant microfinance needs to
be developed
• Use of Qard hasan,
• Introduction of micro-Takaful
• Islamic Microfinance for all globally


Business Media  Research  Advisory

Rafi-uddin Shikoh
E: rafishikoh@dinarstandard.com
W: advisory.dinarstandard.com


Questions
& Answers


What is Islamic Microfinance? Making it a Sustainable Reality

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