Islamic Microfinance Dr. Turkhan Ali Abdul Manap Islamic Research and Training Institute

1. Islamic Microfinance Dr. Turkhan Ali Abdul Manap Islamic Research and Training Institute Islamic Development Bank Group turkhanali@isdb.org May 18, 2014

2. Background • In the last 50 years, different development strategies have been used to resolve the problem of poverty • Most of these programs failed • “Microfinance” initiated in the mid-1970s appears to be the ‘new paradigm’ to eradicate poverty

3. Introduction (2) • Limited access to finance is key constraint to private sector growth • The poor do not qualify to get funds from institutional sources (banks) • lack of collateral • too much risk • too costly

4. Basic Principle of Shariah Based Microfinance • Prohibition of Interest • Care for the poor is a religious obligation in Islam • Asset Based Financing • Risk Sharing • Sanctity of contracts • Financing in Halal/Shariah Compliant Activities. • Micro Takaful ( Islamic Micro Insurance) • Beneficial for both Muslim and non-Muslim “Assisting the poor is a pillar of Islam”

5. Sources of Islamic Microfinance • Quran • Sunnah • Ijma’a (jurist consensus) • Ijtihad & Qiyas (analogy) Islamic Microfinance Products Mechanism Sources of Islamic Microfinance

6. Micro Takaful Free from Interest Financing Free from Gharar Shariah Compliant Funds Shariah Vetted Products Trainings & Quality HR Shariah Compliant Investments Factors to be considered while doing IMF Poverty Alleviation Element Moral Ethical Social Islamic Micro Finance Ensure Shariah Compliance

7. Islamic Microfinance Institution Worldwide

8. Global - Islamic Microfinance Industry • 300+ Islamic Microfinance Institutions operating in 32 Countries • USD 1 billion Market Size. • Indonesia, Bangladesh, Pakistan and Afghanistan have 80% share of Global Islamic Microfinance industry (CGAP) • 2 Million Active financing Clients • Murabahah & Qarz-e-Hasan are the Major Products. • Share of Islamic Microfinance in Islamic Finance industry & Microfinance Industry is less than 1%

9. Microfinance Models Group lending Community-Based Organization Solidarity Group Community Managed Loan Fund S & L Association Grameen Bank Latin American Solidarity Group Village Banking Revolving Loan Funds

10. “Flavors” of Microfinance Models Grameen Model: Pioneered by Grameen Bank in Bangladesh in the late 1970s, now extends world-wide through grameen replicators. Village Banking: Developed by John Hatch in Latin America in the mid-80s, focus is on forming independent village banks. Self-Help Groups (SHGs): Savings-led approach pioneered by Myrada and PRADAN in India in the mid-80s. Similar to Village Banking, focus is on developing community-run Self-Help Groups. ASCAs, ROSCAs, small Credit Unions, etc.: Similar groups have been operating formally and informally around the world for hundreds of years.

11. The Grameen Model • Solidarity Group of potential clients form groups (5 members). • Undergo training for a few days. • Joint responsibility: if a member defaults all members have to pay for her or else the entire group excluded from future loans • Center meets every week, elects Center Leader • Regular savings by all members . • Loan appraised & approved first by peers in solidarity group and finally approved by the Centre Leader. • Loan disbursed directly to individuals • All loans repaid in 50 equal installments • A five-member group is in turn part of a larger “center” composed of eight groups

12. The Self Help Group (SHG) • A homogeneous group of about 15 to 20 who live in the same neighborhood • Every member to save a small amount regularly. Pooled savings kept in a savings bank account in SHG’s name • Transaction costs of both the poor and bank reduced ! • SHG to use pooled thrift to give interest bearing loans to members – decisions taken in group meetings • Every member learns prioritization and financial discipline. Their capacities to think and handle larger resources improves! • Depending on the SHG’s maturity, bank gives loan to the SHG as a multiple of the pooled savings. Bank loan added to the SHG kitty. • Adequate & sustained access to financial services!

13. Sources of Group Fund • Membership Fees • Thrift Collections • NGO/Go Contribution • Loan Repayments • Fines & Penalties • Bank Loans

14. Village Bank • works with groups of 30-60 members, usually all women. • As soon as the village bank is inaugurated, it receives its first loan from the implementing agency for on-lending to the individual members of the village bank. • The sponsoring agency spends one to three months in setting up each bank, organizing the election of a management committee and training its members, as well as developing the rules and regulations to govern the village bank. • The first individual loan (usually US$ 50) is repaid on a weekly basis in equal installments of principal and interest over a four-month period. • The village bank collects these payments at regular meetings • At the end of the 16th week; it repays the entire loan principal plus interest to the implementing agency. • The funds circulating back and forth between the implementing agency and the village bank for loans to members constitute the external account. • If the village bank repays in full, it is eligible for a second loan. If the village bank is unable to pay the amount due, the implementing agency stops further credit until reimbursement is made.

15. Modes of IMF

16. Modes for Islamic Microfinance • Murabaha Financing • Ijarah Financing • Bai Salam Financing • Qard-e-Hasana • Zakah • Mirco Takaful • Working thru linkages – Wakalah / Musharakah and Mudarabah • New & Innovative Concepts

17. Modes for Islamic Microfinance • Murabaha Financing: • Murabaha is the sale of goods on cost plus profit basis. • Islamic Microfinance Bank (IsMFB) can purchase the required goods from market then sells the goods on credit to the client for a known profit. • Application: • Purchase of raw material, live stocks, goods for cottage industry, agricultural products, PCOs etc

18. Modes for Islamic Microfinance • Ijarah Financing: • Ijarah is an Islamic alternative for leasing • As per the concept of Islamic Micro Leasing, an IsMFB can lease certain fixed assets to individual microfinance customers. • The assets would be purchased by IsMFB either directly or through the agency agreements with the customer • The asset would remain in the ownership and risk of IsMFB through out the lease period • Application • Include agrimachinery,farming tools, small shops, carts, transport & other related equipments.

19. Modes for Islamic Microfinance • Bai Salam Financing: • A type of Sale with spot payment and delivery at a deferred date • Mainly used for agriculture outputs. • Application: • Islamic bank could purchase agricultural products like rice, wheat, pulses, etc from small farmers to be delivered after a specified period on a future date against full payment of the selling price at spot.

20. Modes for Islamic Microfinance • Qard e Hasana • Islamic banks/MFIs can utilize charity funds for providing Qard-e-Hasana to MF clients • A special trust or fund could be established • Applications: • Small cash loan at zero percent could be given as Qard to eligible microfinance customers. • Could also be used as an additional incentive loan for timely payment history.

21. Modes for Islamic Microfinance • Zakah Funds • Zakah from individual and government can be an ideal & helpful source used for poverty alleviation. • Zakah or special Waqf Fund could be established • Applications: • The fund can be used to provide training, providing health care, education to the needy. • Could be given in kind eg: Tools, equipments, raw material, trading goods etc. • Provision of basic food items.

22. Modes for Islamic Microfinance • Micro Takaful: • An ideal alternative to Conventional insurance, based on a concept of ‘mutual insurance’. Unlike premium, clients pay donations to the Waqf. • From the pool of funds, the needs of the affected are fulfilled. • Waqf invests funds in profitable avenues but only that are permissible in Shariah like Murabaha, Tijarah, Salam, Istisna, Ijarah, Musharakah, Mudarabah, Sukuk etc. • Applications: • It can be applied to provide credit cover in case of death, permanent disability, insolvency. • Can be done for live stock, crop, theft, fire etc.

23. Modes for Islamic Microfinance • Developing linkages with MFIs/NGOs: • Rather than getting into the operational side of managing the microfinance assets Islamic Bank can develop special linkages with other active MFIs & NGOs. • Islamic Microfinance Product menu could be shared • It could Result in efficiencies for Islamic bank’s Microfinance program in form of lower costs, better outreach, low default rate, efficient recovery, etc

24. Modes for Islamic Microfinance • These linkages can be developed along the following lines: • Wakalah • Islamic bank (IB) can appoint a specialized MFB/MFI as Wakeel to manage the Special Musharkah Pool (SMP) for a fixed fee. • The Wakeel using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc. • Profits of the Pool after deducting the related costs (including agency fee) shall be distributed as per the Musharkah or Mudarbah agreement between MBL and depositors.

25. Modes for Islamic Microfinance • Mudarabah/Musharakah • IB will enter into a Mudarabah or a Musharakah agreement with a specialized MFB/MFI. • The MFB/MFI will work as Mudarib/working partner while IB would be the RaabulMaal/Sleeping partner. • The MFB/MFI using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc. • Profits earned by the Mudarbah/Musharkah would be distributed between MBL and the MFB/MFI according to the pre agreed ratio at the gross profit level.

26. Models for Islamic MF Monitoring System Islamic MF Banks & MFIs Goods Zakah & Charity Waqf Edu. Inst. Profit Partnership Health Customer Profit/loss Qard Character building Skill training

27. MFIs-Main Features • Interested individuals must form a group • Several Groups form a Center • Center has weekly meetings • An official from the MFI attends the meetings and all transactions take place in these meetings (bank goes to the people)

28. Islamic Alternatives to Microfinancing • Different alternatives: • Islamic MFIs • Islamic Banks • Specialized Institutions • Group-based microfinancing can be used (as it mitigates the CR)

29. Islamic MFIs-Features (1) • Islamic MFI retains the basic operational format of MFIs • Going to the Clients • Weekly/Monthly Repayments • A Social/Development Program (to fulfill the social role of Islamic finance) • IMFIs have some distinguishing features: • Sources of Funds • Other than external sources, can also use funds from zakah, awqaf, and other forms of charities • Use of funds (Mode of Financing) • Sale based and hiring modes (murabahah, salam, ijarah) • Profit-sharing modes (Musharakah and mudarabah)

30. Islamic MFIs-Features (2) • Amount transferred to the poorest • As Islamic modes are sale based the price of the asset is paid (no deductions are allowed) • Group Dynamics • Islamic values of brother/sister-hood improves cooperation among the group members • Financing the poorest • Zakat and other charities can supplement MFI activities (non-diversion of funds)

31. Islamic MFIs-Features (3) • Social Development Program • behavioral, ethical, and social aspects in light of Islamic teachings • Targeting the family through women • Spouse co-signs the contract • dealing with women more efficient and convenient • Women disseminate knowledge to children • Dealing with Arrears/Default • Less aggressive and use Islamic teachings to recover loans

32. Islamic MFIs and Sustainability • Mitigating Credit Risk (CR) • CR mitigated by social collateral (group-based lending) • Solving Moral Hazard (MH) Problem • As asset/good given instead of Cash, chances of diversion and default decreases • Economic Viability • High administrative costs • Reasonable finance costs Islamic MFIs can resolve the CR problem and the MH problem, but not the Economic Viability problem

33. Problems facing Islamic MFIs 1. Dilution in the Application of Islamic Modes of Financing • Main mode- murabahah or bai-muajjal. • It is difficult to go out with the clients and buy the goods/assets from faraway markets IMFIs delegates someone else (and inspects later) • Alternative is to use Profit-sharing modes • Problem is the moral hazard problem--No book-keeping and difficult to monitor

34. Problems facing Islamic MFIs 2. Lack of Funds • Most MFIs get their funds from external sources • Islamic MFIs have difficulty in getting funds from these sources • Operations and expansion of activities affected • Islamic MFIs have not yet tapped the sources of funds from Islamic institutions (like zakah, waqf, and other charities) 3. Training • Training can enhance efficiency but is costly

35. Conclusion • Islamic approach to microfinance has certain advantages • Diversified asset and liability structures • Social collateral stronger • Potential to target the poorest through complementary programs • Asset-based modes of financing can prevent diversion of funds for consumption • Lack of funds hampering its growth

36. Microfinancing by Specialized Institutions 1. Cash Waqf—waqf established in the form of cash • Can be used for microfinancing 2. Qardhassan bank—nonprofit financial intermediary • Capital would be cash waqf • Will receive current accounts • Provide qardhassan (interest free loans) for microfinancing 3. MFI based on Awqaf and Zakat • Returns from waqf given for investment purposes and zakat funds for consumption purposes Use the same operational format as MFIs (as it suits the MSEs)

37. THANK YOU!

38. Contact Information Dr. Turkhan Ali Abdul Manap Senior Economist / Researcher Islamic Research & Training Institute Islamic Development Bank Group P. O. Box 9201, Jeddah 21413 Kingdom of Saudi Arabia turkhanali@isdb.org