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SME financing under Islamic banking — challenges remain

Owners and managers of a large number of SMEs have a deeper craving for Shariah-compliant financial services than large businesses and companies. The conventional banking system has done little to satisfy the borrowing needs of SMEs, thereby making way for Islamic banks to fill the gap. However, the lending to corporate and consumer sector is so huge that it will take Islamic Banking Institutions (IBIs) a long time to increase the share of SMEs in the overall financing mix. Some Islamic banks like Meezan Bank and Dubai Islamic Bank (Pakistan) have already up-scaled their lending to SMEs.

For boosting SME financing, Meezan Bank has partnered with Karandaz, a private company established by UK’s DFID and the Bill and Melinda Gates Foundation to promote access to finance for small businesses. This arrangement, along with a large network of branches, has helped the bank reach out to SMEs in semi-urban and rural areas.

Dubai Islamic Bank is taking advantage of its expertise in product development and has been making efficient use of Murabaha, Wakala and Istithmar, etc. to meet working capital requirements. For the financing of SMEs’ long-term fixed capital needs, a different range of products with innovative versions of Musharaka and Ijarah are being offered.

Bank Islami and National Bank of Pakistan have also inked agreement with Akhuwat Foundation for facilitation of disbursements and receipt of loan instalments in the respective accounts of SME borrowers.

Despite all this, multi-step documentation and bringing the cost of SME credit at par with conventional banks are some of the challenges being faced by IBIs. Despite the inclination for Shariah-compliant borrowing, SMEs are not aware of Islamic banking products, which is also a key impediment to growth in Islamic financing of SMEs. Islamic banks in Pakistan have been too obsessed with making conventional banking products Shariah-compliant. Islamic banks, and Islamic banking windows of conventional banks, do have product information available in Urdu, but the problem is that product details are replete with Shariah related jargon and owners and managers of SMEs don’t understand them. The best way to promote Islamic financing of SMEs is to train branch level bank staff in communicating the specifics of a financial product in simple language with potential borrowers.


Shariah-compliant trade-related products can provide about 90 percent of the financial solutions needed by small businesses. There are a number of Islamic products offered across the globe for importers as well exporters that also facilitate routine local trade-related needs. These products include Murabaha (cost-plus financing), Salam and Istisna (forward sales), Wakalah (agency-based contract), Musawamah (bargain sale) and Musharakah (partnership contract).

Import-financing and the purchasing of raw material is met through the Murabaha. The Istisna, Salam and Musawamah are used to help clients finance their entire trading cycles, including meeting overhead expenses (i.e. immediate cash for payment of salaries, utility bills etc). The Musawamah is a sale with no reference to the cost incurred on buying the goods that are being sold by the client to get the financing facility. The Musharkah may be used as an alternative for running finance and discounting of export bills, and to meet the complete trade-inventory cycle.

Islamic finance, if tackled properly and in a planned way, can lead to a high growth of the Shariah-compliant banking system in the Muslim world in particular, and worldwide, in general. Broadly, it all depends upon conducive and supportive legal and policy frameworks and the channelizing of the robust demand for Shariah-compliant products in the right direction.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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