Islamic Microfinance Dr. Turkhan Ali Abdul Manap - PowerPoint Presentation

Slide1

Islamic Microfinance

Dr. Turkhan Ali Abdul Manap

Islamic Research and Training Institute

Islamic Development Bank Group

turkhanali@isdb.org

May

18,

2014

Slide2

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

Slide3

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

Slide4

Basic Principle of Shariah Based Microfinance

Prohibition of Interest Care for the poor is a religious obligation in IslamAsset Based Financing Risk SharingSanctity of contractsFinancing 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”

Slide5

Sources of Islamic Microfinance

QuranSunnahIjma’a (jurist consensus)Ijtihad & Qiyas (analogy)

Sources of Islamic Microfinance

Islamic Microfinance Products Mechanism

Slide6

Factors to be considered while doing IMF

Trainings & Quality HR

Shariah Compliant Funds

Free from Gharar

Micro Takaful

Free from Interest

Financing

Shariah Vetted Products

Shariah Compliant Investments

Moral

Ethical

Social

Poverty Alleviation Element

Islamic

Micro

Finance

Ensure Shariah Compliance

Slide7

Islamic Microfinance Institution Worldwide

Slide8

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%

Slide9

Microfinance Models

Group lending

Solidarity Group

Community-Based Organization

Grameen Bank

Latin American Solidarity Group

Community Managed Loan Fund

S & L Association

Village Banking

Revolving Loan Funds

Slide10

“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

.

Slide11

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

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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!

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Sources of Group Fund

Membership Fees

Thrift Collections

NGO/Go Contribution

Loan Repayments

Fines & Penalties

Bank Loans

Slide14

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.

Slide15

Modes of IMF

Slide16

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

Slide17

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

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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

agri

machinery,farming

tools, small shops, carts, transport & other related

equipments

.

Slide19

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.

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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.

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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.

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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.

Slide23

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

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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.

Slide25

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

Raab

ul

Maal

/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.

Slide26

Customer

Islamic MF

Banks

&

MFIs

Zakah & Charity Waqf

Edu. Inst.

Skill training

Health

Character building

Goods

Profit

Partnership

Profit/loss

Qard

Monitoring System

Models for Islamic MF

Slide27

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)

Slide28

Islamic Alternatives to Microfinancing

Different alternatives:

Islamic MFIs

Islamic Banks

Specialized Institutions

Group-based microfinancing can be used (as it mitigates the CR)

Slide29

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

)

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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)

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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

Slide32

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

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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

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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

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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

Slide36

Microfinancing by Specialized Institutions

1. Cash

Waqf—waqf

established in the form of cash

Can be used for microfinancing

2. Qard

hassan

bank—nonprofit financial intermediary

Capital would be cash

waqf

Will receive current accounts

Provide

qard

hassan

(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)

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THANK YOU!

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Contact Information

Dr. Turkhan Ali Abdul Manap

Senior

Economist / ResearcherIslamic Research & Training Institute Islamic Development Bank Group P. O. Box 9201, Jeddah 21413Kingdom of Saudi Arabiaturkhanali@isdb.org