ISLAMIC MICROFINANCE & POVERTY REDUCTION
Apr 9 - 15, 2012
Over the last few years, microfinance has been increasingly recognized as an important component in poverty alleviation strategies. Poor households face difficulty in generating regular and substantial income to save for future and are extremely vulnerable to economic, political, and physical downturns. A little drop in income or increase in expense can have a disastrous effect on their already low standard of living. They have limited access to health care facilities and have low literacy rate and poor living conditions.
Death, sickness, or accident may force them to dispose their property or some of the productive assets, which in turn further decreases income and current livelihood. The frequency of losses is also greater for the poor due to man-made and natural disasters. Yet they desperately need some sort of assistance.
In these circumstances, the true revolution of microfinance occurs when this tool gives a chance to people who were denied the access to the financial market, opens new perspectives, and empowers people who can finally carry out their own projects and ideas with their own resources, and escape assistance, subsidies, and dependence.
Commercial banks are normally excluded from the domain of microfinance. Concerns about the lack of real profitability of microfinance prevented banks from getting involved in microfinance. The inherent risks posed by microfinance and the widespread belief that the poor are poor because of their lack of skills, kept traditional banks, including Islamic banks, away from microfinance.
Many elements of microfinance, however, can be considered consistent with the broader goals of Islamic banking. Microfinance advocates entrepreneurship and risk sharing and believes the poor should take part in such activities.
It is also noticed that traditional microfinance institutions based on compounding interest causes serious hardship on the borrowers in servicing their debt. It is, therefore, important that access to credit is provided to the poor on more humane, interest-free basis. This may be possible if the microfinance system is integrated with zakat and waqf institutions.
Zakat and sadaqah as instruments of charity occupy a central position in the Islamic scheme of poverty alleviation. Zakat is the third among five pillars of Islam and payment of zakat is an obligation on the wealth of every Muslim based on clear-cut criteria. Zakat has been variously described by scholars as a tool of redistribution of income, a tool of public finance, and of course, as a mechanism of development and poverty alleviation. Rules of Shariah are clear and elaborate in defining the nature of who are liable to pay zakat and who can benefit from zakat.
The first and foremost category of potential beneficiaries is the poor and the destitute. A greater degree of flexibility exists with respect to beneficiaries of sadaqah. The primary issue with zakat and sadaqah-dependent institutions is the issue of sustainability as they are essentially rooted in voluntarism. Funds mobilized through charity could fluctuate from time to time and may not lend themselves to careful planning and implementation.
The issue of sustainability is addressed in the institution of awqaf through creation of permanent and income-generating physical assets. Awqaf has historically been the major vehicle for creating community assets. On the flip side, the restrictions on development and use of assets under waqf for pre-specified purposes introduce rigidity into the system. Undoubtedly, it is important to preserve and develop assets under waqf to add to productive capacity and create capabilities for wealth creation. Awqaf may also be created specifically to impart knowledge and skills in entrepreneurship development among the poor as microfinance alone cannot create wealth unless combined with entrepreneurial skills. Indeed all technical assistance programs can be organized as awqaf.
While zakat funds must be distributed to the destitute and poorest of poor, this institution could be integrated with microfinance. This may be attempted by seeking to push such individuals through zakat distribution out of dire poverty to levels, where they are no longer regarded as "unbankable" by microfinance institutions (MFIs). A linkage if established between the MFIs and zakat funds would enhance the effectiveness of microfinance towards achieving poverty alleviation.
Zakat is a cornerstone of the values that govern Islamic economics. It created the first universal welfare system in human history. It specifies the manner in which zakat revenue is to be raised and who pays it. On the expenditure side, it sets forth the uses of zakat revenue. Like a modern budget, it describes the economic order that it attempts to establish and express the ideals and aspirations of society. As a fiscal mechanism, zakat performs some of the major functions of public finance, which deals with social security entitlement system like food subsidy, education, health care etc. Thus, Islam discourages accumulation of personal assets and encourages eradication of poverty.
Zakat is free money. It is a grant for the poor, it may be reiterated that zakat is an Islamic charitable fund and therefore, no form of interest or profit can be made from it. It is free money and it a right of the poor and hence may be used in Islamic microfinance. Although traditional interest - based microcredit has evolved as an important tool for poverty alleviation, it is failing to attain desired effects for many reasons: a major portion of loan disbursed to the poor is diverted to fulfill their basic consumption needs that leave them with smaller investable fund and hamper business profitability.
MODEL OF MICROFINANCE USING ISLAMIC NOT FOR PROFIT MODES
Despite zakat and waqf, Islam has the potential to provide various schemes and instruments that can be advanced and adapted for the purpose of microfinance in Islamic banks.
Mudarabah has the potential to be adapted as Islamic microfinance scheme. Mudarabah is where the capital provider or microfinance institution (rabbul mal) and the small entrepreneur (mudarib) become a partner. The profits from the project are shared between capital provider and entrepreneur, but the financial loss will be borne entirely by the capital provider. This is due to the premise that a mudarib invests the Mudarabah capital on a trust basis; hence it is not liable for losses except in cases of misconduct. Negligence and breach of the terms of Mudarabah contract, the mudarib becomes liable for the amount of capital.
Musharakah can also be developed as a micro finance scheme where Islamic bank will enter into a partnership with micro entrepreneurs. If there is profit, it will be shared based on pre-agreed ratio, and if there is loss, it will then be shared according to capital contribution ratio. The most suitable technique of Musharakah for microfinance could be the concept diminishing partnership or Musharakah Mutanaqisah.
Another form of Musharakah is Musaqat. Musaqat is a profit and loss sharing partnership contract for orchards. In this case, the harvest will be shared among all the equity partners (including entrepreneur as a partner) according to the capital contributions. All the Musharakah principles will be applicable for this form of Musharakah. This scheme, however, could be of high risk, since it needs the capital and expertise to directly involve in the business especially in managing the orchards.
Using Murabahah as a mode of microfinance requires Islamic bank to acquire and purchase asset or business equipment then sells the asset to entrepreneur at mark-up. Repayments of the selling price will be paid on installment basis. The Islamic bank will become the owner of the asset until the full settlement. This scheme is the most appropriate scheme for purchasing business equipment. This mode of financing has already been introduced in Yemen in 1997.
Ijarah by definition is a long term contract of rental subject to specified conditions as prescribed by the shari'ah. Unlike conventional finance lease, the lessor (Islamic bank) not only owned the asset but takes the responsibility of monitoring the used of asset and discharges its responsibility to maintain and repair the asset in case of mechanical default that are not due to wear and tear. The bank should first purchase the asset prior to execution of an Ijarah contract. The bank takes possession of the assets and subsequently offers the asset for lease to customer. The bank then is responsible for the risks associated with the asset.
Another simple concept that can be advanced for microfinance purposes is Qardhul Hasan or simply means an interest free loan. Islamic bank can provide this scheme to the entrepreneurs who are in need of small start-up capital and have no business experience. The Islamic bank then will only be allowed to charge a service fee. The term of repayment will be on installment basis for an agreed period. The scheme is also relevant for micro entrepreneurs who are in need of immediate cash and has good potential to make full settlement. Here, the Islamic bank will bear the credit risk and they need to choose the right technique to ensure repayments will be received as agreed.
There are a number of shari'ah compliant microfinance schemes, notably those operated by Hodeibah microfinance program in Yemen, the UNDP Murabahah based microfinance initiatives at Jabal al-Hoss in Syria, Qardhul Hasan based microfinance scheme offered by Yayasan Tekun in Malaysia, various schemes offered by Bank Rakyat Indonesia, and Bank Islam Bangladesh.
Among South Asian countries Bangladesh leads the group with organizations like Islami Bank Bangladesh, Social and Investment Bank, Al-Fallah and Rescue. Akhuwat in Pakistan is notable for its unique mosque-based model. India with its second largest Muslim population in the world has witnessed some experiments largely outside its formal financial system, such as, AICMEU and Bait-un-Nasr.
Comparatively, Qardhul has an, Murabahah and Ijarah schemes are relatively easy to manage and will ensure the capital needs (Qardhul Hasan), equipments (Murabahah) and leased equipments (Ijarah) for potential micro entrepreneurs and the poor. Participatory schemes such as Mudarabah and Musharakah, on the other hand, have great potentials for microfinance purposes as these schemes can satisfy the risk sharing needs of the micro entrepreneurs. These schemes, however, require specialized skills in managing risks inherent in the structure of the contract.
Government with the help of Islamic banks could select microfinance schemes to help and reduce poverty and to empower the vulnerable. This strategy had been employed as part of the PRSP (Poverty Reduction Strategy Paper) in ultimately assisting Pakistan to reduce poverty in alignment with the MDG.