ISLAMIC MICROFINANCE: AN INCLUSIVE FINANCIAL SYSTEM
SAQIB MASOOD CHISHTI
July 26 - Aug 1, 2010
Microfinance is the financial solution to the basic financial needs of the poor people, which are denied by the conventional commercial banking. Microfinance is usually defined as the provision of basic financial products and services to the under privileged segment of the society which has not access to the conventional financial institutions. Access to finance or credit is the fundamental right of every entrepreneur who is willing to expand or start his or her business but this right is denied by current financial system of commercial banks.
The microfinance system, initiated by Dr Younus in late 1970's, showed a ray of hope and empowerment to the poor people of the society. Access to financial services enabled poor people to enhance their income and accumulate savings to cope with vulnerability at the time of financial crisis. World Bank estimates that there are over 7000 financial institutions serving about 1600 million poor people in the developing countries. Due to high repayment rates, shorter loan tenure and easily available funding, microfinance has become lucrative business for many institutions around the world. Presently microfinance services are being offered by many formal and informal systems such as specialised microfinance organizations, NGO's, non-bank financial institutions and conventional banks. It has been observed that interest rate of microfinance industry is much higher than commercial banks. The high interest rate is defended by arguing that since there is high transaction cost involved in microfinance so usually high interest rate is charged as compared to commercial banks. Poor people need access to financial services regardless what cost is charged. However, there are instances that due to high interest rate, a poor person gets trapped into the vicious circle of debt and is compelled to receive loan again and again to fulfill the business needs and ultimately microfinance borrower approaches to default.
It is true that current microfinance system can provide financial solution to the financial problems of the poor people but it is not viable for the poorest of the poor. Traditional micro financing with lacking social responsibility, exorbitant interest rate and so called risk mitigation conditions is not able to tap extremely poor segment of the society. Furthermore, poor population of the world is largely residing in the Muslim countries, which do not like conventional micro financing on the religious grounds and prefers to stay away from current financial system. Islamic microfinance can be a useful tool for greater inclusion of that segment of society, which is hesitant to avail conventional services.
For last few years, Islamic banking is becoming an alternate of conventional banking system around the world and growing at a rapid pace. Islamic microfinance has the potential to attract a large segment of the society. It is a financial system based on Islamic laws (or Shariah principles) and philosophical base lies in Adl (justice) and Ihsan (benevolence). Based on these principles, Islamic microfinance disallows exploitation and reduces income disparity among the society.
In some Muslim countries, conventional microfinance is rejected due to its interest based nature and non-compliance with the Shariah, which prohibits Riba. Moreover, conventional micro financing is also disliked due to charging of exorbitant interest rates and processing charges. These shortcomings also undermine the efforts of governments in reducing the poverty level and promoting the entrepreneurship.
Islamic microfinance has a viable solution to address such deficiencies with the help of affordable financial services complying with the Shariah. It also promotes the social justice and includes the large segment of population that is excluded by conventional financial system.
In Pakistan, conventional microfinance has served about seven per cent of poor households of the country however still there is a large chunk of population that is yet deprived of financial services. These are poorest of the poor who are not even being served by conventional microfinance or they are unable to afford high cost of financing and other conditions.
SHARIAH BASED MICROFINANCE PRODUCTS
As a whole, Islamic microfinance is at its early stages in different Muslim countries and much work is required to bring it at par with conventional micro financing. Currently, different Islamic microfinance institutions around the world are offering various products.
MUSHARKA (CAPITAL SHARING):
It is an equity participation agreement between the entrepreneur and the Islamic Microfinance Institution (IMFI) in which both are sharing capital and labour for a joint venture. There may be more than two partners and all partners are entitled to participate in the management and labour of the project but it is not necessary. The profit is distributed according to the pre-agreed ratio whereas loss is borne by each partner as per share of capital invested.
MUDARBA (TRUSTEE FINANCING):
An agreement between an entrepreneur and IMFI according to which, IMFI provides required capital for a particular project while the entrepreneur invests labour and expertise. The profit sharing ratio is determined at the time of agreement where entrepreneur receives profit share as a reward of his/her labour. Loss is borne by the financier and entrepreneur. The success of this product depends on the integrity and honesty of the entrepreneur. This product is appropriate in case of large financing whereas in micro enterprise where accounts are not maintained properly and transactions are not recorded, its monitoring requires huge cost.
MURABAHA (COST PLUS MARKUP):
It is most commonly used mode of Islamic microfinance and based on sale contract between the IMFI and the entrepreneur in which rather advancing loan to the entrepreneur, IMFI buys goods from the market on requisition and sell to the borrower with profit. Under this arrangement, mark-up is received to cover the administrative costs and the cost of goods plus markup is returned usually in equal installments over a defined financing period and the goods are owned by the financier until the last installment is settled. This product can be used for financing the working capital and fixed capital. Many argue that it is similar to interest based transaction just interest rate is being named as markup but there is a difference in both transactions. In Murabaha, IMFI sells an asset for deferred period and receives profit that is known as trade activity and has been declared halal in Islamic Shariah whereas advancing cash based loan and charging interest is purely interest based transaction that has been declared haram in Islam.
It is an Islamic form of leasing in which IMFI buys the required asset or property and leases it to the entrepreneur against installments for an agreed period. The IMFI being the owner of the asset receives fixed or variable installments on account of rental for use of the asset. The customer has option to buy the asset at the end of the contract, called Ijara-wa-Iqtina (lease purchase). In such case, each payment made is considered as partly payment for purchase of the asset and at the end ownership is transferred to the leaseholder.
QARD-AL-HASANAH (BENEFICENCE LOANS):
It is the benevolent loan in which lender does not expect any return or profit on the principle and purely lend the needy people to help them rather getting any benefit from them. However, IMFI is allowed to receive a service fee from the borrower to cover the administrative and transaction cost but it should not be associated with the maturity or loan amount.
Pakistan is known as a market of near about 20 million microfinance clients while conventional micro financing has served just seven per cent of those. Microfinance market in Pakistan has not developed as much as in the other parts of the region and their efficiency is far less than the regional peer. Pakistan is a country of about 97 per cent Muslim population where Islamic banking has grown at a rate of 59 per cent per annum since 2005 but this growth of Islamic financial system has not served millions of entrepreneurs lying below the poverty line and reluctant to avail the financial services from conventional microfinance institutions.
State Bank of Pakistan has issued guidelines for the establishment of Islamic microfinance Banks/Institutions but no serious efforts have been made yet for the development and promotion of the Islamic microfinance. Currently, Islamic microfinance is being practiced by few organisations on limited scale such as Akhuwat, Islamic Relief, Farz Foundation but no large bank/organisation has been established.
Recently, HSBC Amanah has signed an agreement with Islamic relief, an international development and relief organisation, to provide financial services to the non-banked community in accordance with the Shariah rules. According to the agreement, HSBC Amanah will finance the microfinance activities and staff training of the Islamic relief which is already working on the Shariah based products in Rawalpindi. There is a need to promote such linkages adopting bank-NGO models that have been very successful in conventional micro financing.
Benazir Income Support Program, established by the present government with the initial allocation of Rs34 billion for 2008-09 and estimated Rs70 billion for the current financial year, aims to provide cash assistance of Rs1000 per month per family to estimated five million families. No doubt, this program is helping thousands of families through cash payments. Nevertheless, this whole amount will be used for non-productive purposes and would not help to overcome the poverty rather stimulate inflation. Such programs are fatal for the poor people because these expenditures would have zero impact on economic activities in the country and promotes dependency on the government assistance. It could be much better if this amount was used for the establishment of "Benazir Islamic Microfinance Bank" to provide Shariah compliant financial products and services to the poorest of the poor and encourage entrepreneurship among them. Financial assistance with the thought of repayment would be helpful in reducing the poverty and inclusion of deprived people into the financial system. Successful launching of such an institution on sustainable grounds would be a role model for other players to come ahead with the rationale of sustainable Islamic microfinance institution.
Qard-al-Hasanah product can be used to fulfill the consumption needs of the poor people and other products should focus on income generating activities and employment generation for the poor. Islamic commercial banks should also play their role in widening the reach and scope of Islamic microfinance through utilising the excess liquidity for this purpose. IMFI's can be formed on Musharakah based financing by the conventional and Islamic banks following the SBP guidelines. We should have faith that Islamic microfinance has the capacity to flourish in the country similar to the Islamic banking. However, there is a need of extensive research and support for the establishment and development of sustainable Islamic micro financing products and institutions.
The writer is an employee of Khushhali Bank Limited. Views expressed in this article are those of the writer and not of his employer bank.