Islamic Microfinance
Dr. Turkhan Ali Abdul Manap
Islamic Research and Training Institute
Islamic Development Bank Group
turkhanali@isdb.org
May 18, 2014
Microfinance
Background
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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
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Introduction (2)
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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
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Basic Principle of Shariah Based
Microfinance
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Prohibition of Interest
Care for the poor is a religious obligation in
Islam
“Assisting the
Asset Based Financing
poor is a pillar
Risk Sharing
of Islam”
Sanctity of contracts
Financing in Halal/Shariah Compliant Activities.
Micro Takaful ( Islamic Micro Insurance)
Beneficial for both Muslim and non-Muslim
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Sources of Islamic Microfinance
Sources of
Islamic
Microfinance
Islamic Microfinance
Products Mechanism
• Quran
• Sunnah
• Ijma’a
(jurist
consensus)
• Ijtihad &
Qiyas
(analogy)
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Factors to be considered while doing IMF
Moral
Ethical
Poverty Alleviation
Social Element
Micro Takaful
Free from
Interest
Financing
Ensure Shariah
Compliance
Free from
Gharar
Islamic
Micro
Finance
Shariah
Compliant
Funds
Shariah Vetted
Products
Trainings &
Quality HR
Shariah
Compliant
Investments
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Islamic Microfinance Institution Worldwide
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Global - Islamic Microfinance Industry
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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%
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Microfinance Models
Group lending
Community-Based
Organization
Solidarity Group
Grameen Bank
Latin American
Solidarity Group
Community
Managed Loan
Fund
Village Banking
Microfinance
S & L Association
Revolving Loan
Funds
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“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.
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The Grameen Model
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Solidarity Group of potential clients form groups (5 members).
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Undergo training for a few days.
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Joint responsibility: if a member defaults all members have to pay for her or
else the entire group excluded from future loans
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Center meets every week, elects Center Leader
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Regular savings by all members .
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Loan appraised & approved first by peers in solidarity group and finally
approved by the Centre Leader.
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Loan disbursed directly to individuals
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All loans repaid in 50 equal installments
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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)
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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 !
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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!
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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
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Membership Fees
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Thrift Collections
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NGO/Go Contribution
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Loan Repayments
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Fines & Penalties
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Bank Loans
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Village Bank
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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.
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Modes of IMF
Microfinance
Modes for Islamic Microfinance
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Murabaha Financing
Ijarah Financing
Bai Salam Financing
Qard-e-Hasana
Zakah
Mirco Takaful
Working thru linkages – Wakalah /
Musharakah and Mudarabah
New & Innovative Concepts
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Modes for Islamic Microfinance
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Murabaha Financing:
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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:
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Purchase of raw material, live stocks, goods for
cottage industry, agricultural products, PCOs etc
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Modes for Islamic Microfinance
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Ijarah Financing:
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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
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Include agri machinery,farming tools, small shops, carts,
transport & other related equipments.
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Modes for Islamic Microfinance
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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
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Qard e Hasana
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Islamic banks/MFIs can utilize charity funds for providing Qard-eHasana to MF clients
A special trust or fund could be established
Applications:
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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
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Zakah Funds
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Zakah from individual and government can be an
ideal & helpful source used for poverty alleviation.
Zakah or special Waqf Fund could be established
Applications:
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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
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Micro Takaful:
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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:
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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.
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Modes for Islamic Microfinance
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Developing linkages with MFIs/NGOs:
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Rather than getting into the operational side of managing the
microfinance assets Islamic Bank can develop special linkages
with other active MFIs & NGOs.
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Islamic Microfinance Product menu could be shared
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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
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These linkages can be developed along the
following lines:
Wakalah
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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.
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Modes for Islamic Microfinance
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Mudarabah/Musharakah
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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.
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Models for Islamic MF
Monitoring System
Goods
Zakah &
Charity
Waqf
Edu.
Inst.
Profit
Islamic
MF
Banks
Health
Customer
Partnership
&
MFIs
Profit/loss
Character building
Microfinance Skill training
Qard
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MFIs-Main Features
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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)
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Islamic Alternatives to Microfinancing
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Different alternatives:
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Islamic MFIs
Islamic Banks
Specialized Institutions
Group-based microfinancing can be used
(as it mitigates the CR)
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Islamic MFIs-Features (1)
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Islamic MFI retains the basic operational format of
MFIs
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Going to the Clients
Weekly/Monthly Repayments
A Social/Development Program (to fulfill the social role of
Islamic finance)
IMFIs have some distinguishing features:
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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)
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Amount transferred to the poorest
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Group Dynamics
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As Islamic modes are sale based the price of the asset is
paid (no deductions are allowed)
Islamic values of brother/sister-hood improves cooperation
among the group members
Financing the poorest
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Zakat and other charities can supplement MFI activities
(non-diversion of funds)
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Islamic MFIs-Features (3)
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Social Development Program
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Targeting the family through women
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behavioral, ethical, and social aspects in light of Islamic
teachings
Spouse co-signs the contract
dealing with women more efficient and convenient
Women disseminate knowledge to children
Dealing with Arrears/Default
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Less aggressive and use Islamic teachings to recover
loans
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Islamic MFIs and Sustainability
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Mitigating Credit Risk (CR)
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Solving Moral Hazard (MH) Problem
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CR mitigated by social collateral (group-based lending)
As asset/good given instead of Cash, chances of diversion
and default decreases
Economic Viability
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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
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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)
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Alternative is to use Profit-sharing modes
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Problem is the moral hazard problem--No bookkeeping and difficult to monitor
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Problems facing Islamic MFIs
2. Lack of Funds
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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
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Training can enhance efficiency but is costly
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Conclusion
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Islamic approach to microfinance has certain
advantages
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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
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Microfinancing by Specialized
Institutions
1. Cash Waqf—waqf established in the form of cash
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Can be used for microfinancing
2. Qard hassan bank—nonprofit financial intermediary
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Capital would be cash waqf
Will receive current accounts
Provide qard hassan (interest free loans) for microfinancing
3. MFI based on Awqaf and Zakat
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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 / Researcher
Islamic Research & Training Institute
Islamic Development Bank Group
P. O. Box 9201, Jeddah 21413
Kingdom of Saudi Arabia
turkhanali@isdb.org
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