Islamic Financing for SMEs
Presented By:
M.Shoaib Malick
Unit Head-SME-Meezan Bank Limited
Islamic Financing for SMEs
Introduction to Islamic Banking
Significance of SME Sector
Difference Between Islamic Banking & Conventional Bank
How IB, can address business needs (100%)
Comparison of Islamic Mode of Finance and Conventional
Islamic Modes of Financing
• Short Term Modes of Islamic Financing
• Long Term Modes of Islamic Financing
• Trade Finance Facilities in Islamic Banking
Challenges in SME Financing
Conclusion
Significance of SME Sector
1 Total Population
182Mn
100%
2 Financially Included
18.2Mn
10%
3 Financially Excluded
163.8Mn
90%
4 Financially Excluded-Major Sector
SME
5 90% of all private enterprises
SME
6 SMEs access to finance from banking sector:
• Pakistan
• India
• Bangladesh
04%
33%
32%
7 SME lending of total credit
06%
8 Surveyed Facts
• Hard to borrow from banks
• Not even have a bank account
51%
31%
Contribution of SME Sector to Economy
Overall Economy
100%
80%
30%
25%
SME Sector
35%
75%
60%
40%
20%
0%
GDP
Exp. Mfgd
Mfgd-value
Goods
Non-Agri
added
Labor
Force
Current Status of SME Financing:
 SME financing witnessed continues decline by
banks/DFIs since 2008.
 Due to consistent decline in this sector, share of SMEs
also reduced from 16% to 6% in overall advances of banks
in last 4-5 years.
Reasons for downfall:
 Adverse economic conditions.
 Law and order situation.
 Shortage & rising costs of electricity and other utilities.
Reasons for downfall:
 Growing NPLs.
 Natural catastrophes also hamper this sector badly in
consecutive years of 2010 & 2011 and created wipeout
situation for small sized units.
 Banks also took a risk-averse posture from this sector,
due to deteriorating business conditions for SMEs.
5 Years trend of SMEs
Status of SME Financing (Rs. In Billions)
4,000.00
3,500.00
3,000.00
2,500.00
2,000.00
1,500.00
1,000.00
500.00
0.00
SME O/s
Total O/s
`Dec-07
437.40
2,700.90
`Dec-08
383.00
3,191.80
`Dec-09
358.90
3,555.30
`Dec-10
334.00
3,489.73
`Dec-11
294.31
3,546.35
`Jun-12
247.86
3,785.87
5 Years trend of SMEs
SME Borrowers Vs Total Borrowers (In Thousands)
6,000
5,000
4,000
3,000
2,000
1,000
0
SME Borrowers
Total Borrowers
`Dec-07
185
4,781
`Dec-08
215
4,544
`Dec-09
214
4,419
`Dec-10
211
3,909
`Dec-11
168
3,733
`Jun-12
148
3,618
5 Years trend of SMEs
SME NPLs Vs Total NPLs (Rs. In Billions)
500.00
450.00
400.00
350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
Total SME NPLs
Total NPLs
`Dec-07
41.30
437.40
`Dec-08
61.50
383.00
`Dec-09
79.30
358.90
`Dec-10
96.50
334.00
`Dec-11
95.40
294.31
`Jun-12
96.40
247.86
9.4%
16.1%
22.1%
28.9%
32.4%
38.9%
SME Financing For Working Capital
 Key portion of financing is used for working capital in SMEs, which
constitutes 76% of total SME lending.
 However other is followed by Trade Financing & Long term/Fixed Investment.
Working Capital Requirement for SMEs
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
120,426
Fixed
Investment
12,319
173.823
29.336
Working Capital
No. of Borrowers
Out.Amount (Rs in
Billions)
Trade Fiance
8,680
25.854
SMEs provide a significant portion of
jobs world wide
SME contribution to formal country employment Median values
70
60
50
40
30
20
10
0
Low Income
Middle Income
Source. Ayyagari, Beck and Demigirguc/kunt. 2003
High Income
GDP Contribution of the SME sector increases, and
informality decreases with income
100
SME Sector, 16%
90
SME Sector, 39%
SME Sector, 51%
80
70
Informal ,47%
60
Informal , 30%
50
Informal , 13%
40
30
Residual, 37%
20
Residual, 31%
Residual, 36%
10
0
Low Income
Middle Income
High Income
Definition of Riba
Any increase over and above the price, without due
consideration is Riba
Distinguishing Features
We find the differences are on three levels:
1. Conceptual & Socio-religious level
- not money lenders
- cannot deal with interest & non permissible industries
2. Business model & Governing framework
- IB actively participates in trade and production process
- Governing framework in terms of Shariah Advisor &/or SSB
Distinguishing Features
3. Product Level Implementation
- usually asset backed & involve trading/renting of asset &
participation on profit & loss basis
- Implementation is not just a mere change of paper work and
terms but it involves
- having the right intention,
- the correct sequence of steps and timing of execution
15
PERCEPTION OF ISLAMIC BANKING
Islamic Banking
Parties:
Limit:
Rate:
Tenor:
Purpose :
Bank & Client
Rs 10.00 Mn
K+2
1 year
To buy Cotton
Conventional Banking
Parties:
Limit :
Rate:
Tenor :
Purpose :
Bank & Client
Rs 10.00 Mn
K+2
1 year
To buy Cotton
PERCEPTION OF ISLAMIC BANKING
Islamic Banking
Parties:
Limit:
Rate:
Tenor:
Purpose :
Bank & Client
Rs 10.00 Mn
K+2
1 year
To buy Cotton
=
Conventional Banking
Goods
OWNERSHIP
Services
Parties:
Limit :
Rate:
Tenor :
Purpose :
Bank & Client
Rs 10.00 Mn
K+2
1 year
To buy Cotton
Islamic Banking
Basic Difference between Islamic and Conventional
Modes of Finance
Conventional
Money
Client
Bank
money + money (interest)
Islamic Banking
Basic Difference between Islamic and Conventional
Modes of Finance
Islamic
Bank
Goods &
Services
money
Client
Income Statement
Sales
xxx
Liability/Deposit Products
Raw Material
xxx
Murahaba
Direct Labor
xxx
Istisna/Tijarah
Over Head
xxx
Cost of Goods Sold
Gross Profit
xxx
Operating Expenses
Admin. & Gen. Exp
xxx
Salaries
xxx
Utilities
xxx
Other
xxx
Net Profit
xxx
Istisna/Tijarah
Deposit Products
Balance Sheet
Current Assets:
Stocks
Receivable
Cash in hand
Advances & Deposit
xxx
xxx
xxx
xxx
Fixed Assets:
Plant & Machinery
Land & Building
Total Assets
xxx
xxx
xxx
Owner’s Equity:
Capital
xxx
Murahaba/Import Murahaba/FIM/LC
Istisna/Tijarah/Bai-Salam/Usance-Murahaba
Deposit Products
Murahaba/Istisna/Tijarah/LG
DM/Ijarah/Murahaba
Musharka
Liabilities:
Creditors
xxx
Financial Liabilities
xxx
Total Liabilities & Equity
Murahaba/LGs/Ijarah/Tijarah
Difference Between Islamic Banking
& Conventional Bank
Conventional Banks
Islamic Banks
1. The functions and operating modes of conventional banks are
based on fully manmade principles.
1. The functions and operating modes of Islamic banks are
based on the principles of Islamic Shariah.
2. The investor is assured of a predetermined rate of interest.
2. In contrast, it promotes risk sharing between provider of
capital (investor) and the user of funds (entrepreneur).
3. It aims at maximizing profit without any restriction.
3. It also aims at maximizing profit but subject to Shariah
restrictions.
4. It does not deal with Zakat.
4. In the modern Islamic banking system, it has become one
of the service-oriented functions of the Islamic banks to
be a Zakat Collection Centre and they also pay out their
Zakat.
5. Lending money and getting it back with compounding interest is
the fundamental function of the conventional banks.
5. Participation in partnership business is the fundamental
function of the Islamic banks. So we have to understand
our customer's business very well.
6. It can charge additional money (penalty and compounded
interest) in case of defaulters.
6. The Islamic banks have no provision to charge any extra
money from the defaulters. Only small amount of
compensation and these proceeds is given to charity.
Rebates are give for early settlement at the Bank's
discretion.
Difference Between Islamic Banking
& Conventional Bank
Conventional Banks
Islamic Banks
7. Very often it results in the bank's own interest becoming
prominent. It makes no effort to ensure growth with equity.
7. It gives due importance to the public interest. Its
ultimate aim is to ensure growth with equity.
8. For interest-based commercial banks, borrowing from the
money market is relatively easier.
8. For the Islamic banks, it must be based on a Shariah
approved underlying transaction.
9. Since income from the advances is fixed, it gives little
importance to developing expertise in project appraisal and
evaluations.
9. Since it shares profit and loss, the Islamic banks pay
greater attention to developing project appraisal and
evaluations.
10. The conventional banks give greater emphasis on creditworthiness of the clients.
10. The Islamic banks, on the other hand, give greater
emphasis on the viability of the projects.
11. The status of a conventional bank, in relation to its clients,
is that of creditor and debtors.
11. The status of Islamic bank in relation to its clients is
that of partners, investors and trader, buyer and
seller.
12. A conventional bank has to guarantee all its deposits.
12. Islamic bank can only guarantee deposits for deposit
account, which is based on the principle of alwadiah, thus the depositors are guaranteed
repayment of their funds, however if the account is
based on the mudarabah concept, client have to
share in a loss position..
Financing Product Comparison Islamic
Vs.
Conventional Bank
Islamic Product
S.#
Conventional Products
Working Capital Finance
1
a) Murabaha
b) Murabaha - Spot
c) Istisna - Export & Local
d) Meezan Tijarah - Export & Local
e) Murabaha FE-25 Export & Import
Current Finance / Running Finance
2
Murabaha - Pledge
Cash Finance
3
a) Ijarah - Plant & Machinery
b) Ijarah - Sale & Lease Back for Plant & Machinery
c) Diminishing Musharika - Plant & Machinery
d) Diminishing Musharika - Premises / Land for Commercial use
e) Diminishing Musharika - Sale & Lease Back (Plant & Machinery; Premises
Land & Building)
f) Musharaka
Demand Finance / Term Finance
Meezan Bank Limited
Financing Product Comparison Islamic
Vs.
Conventional Bank
S.#
Islamic Product
Conventional Products
Export Related Facilities:
1
a) Bai Salam against Discrepant Export Sight Bills
b) Bai Salam against Export sight contract
c) Murabaha against Accepted export Usance Bill (Bank Risk Line)
d) Murabaha against Un-accepted export Clean Usance LC
e) Murabaha against un-Accepted export Discrepant Bills under Usance LC
f) Murabaha against export Usance Contract
Finance Against Foreign Bills
2
a) Murabaha against Un-accepted Local Usance LC
b) Murabaha against Accepted Local Usance LC (Bank Risk Line)
Local Bill Purchases
3
a) Istisna – Export
b) Islamic Export Refinance Facility (IERF) Part I & II - under Murabaha
c) Islamic Export Refinance Facility (IERF) - under Istisna (Local and Export)
and Tijara (Local and Export)
Finance Against Packing Credit Part - I &
II
Financing Product Comparison Islamic
Vs.
Conventional Bank
S.#
Islamic Product
Conventional Products
Import Related Facilities:
1
2
3
a) Sight LC under MMFA
b) Sight LC under Master Agency Agreement (For Ijarah & Diminishing
Musharaka)
c) Sight LC wihthout MMFA (Exceptional Cases)
d) Usance LC without MMFA
f) Usance LC under MMFA (Exceptional cases)
g) Usance LC under Master Agency Agreement (for Ijarah and Diminishing
Musharaka)
a) Local LC(Sight) without MMFA
b) Local LC (Sight) under MMFA (Exceptional cases)
c) Local Usance LC wihtout MMFA
d) Local Usance LC under MMFA (Exceptional cases)
a) Murabaha - Financing of Imported Merchandise (FIM) Pledge
b) Murabaha - Financing of Imported Merchandise (FIM) Spot
4
Import Letter of Credit
Inland Letter of Credit
Finance Against Imported Merchandise FIM
Finance Against Trust Receipt
Letter of Guarantee
1
Meezan Bank Limited Letter of Credit
Letter of Guarantee / Shipping Guarantee/Standby
Letter of Guarantee / Shipping
Guarantee
Short Term Financing Needs
Long Term Financing Needs
• Raw Material
• Acquisition/replacement/
expansion of fixed assets,
plant & machinery
• Overheads / Utilities
• Finished Goods
• Trade receivable financing
• Rental financing
Issues & Challenges of SMEs
Demand
Supply
Lack of Collaterals to Meet Bank’s Requirements
Shortage of Marketing Skills-(Bank Side)
Informal Organizational Structures
SMEs perceived as high risk borrowers
Informal Accounts & Management System
Corporate Finance Mindset
Lack of Credit & Collateral History
Lack of Infrastructure for SME Business
Low Level of Financial Literacy
High Lending Costs
Reluctance on part of SMEs
Absence of SME R&D Centers in Banks
External Shocks
•Plain Murabaha
•Advance Payment Murabaha
•Suppliers Credit Murabaha
•SLC under MMFA
•Tijarah
•Istisna
•Diminishing Musharaka
•Ijarah
•Bai Salam
• Plain Murabaha
Murabaha
Agreement
Agency Agreement
Order Form
Purchase of Goods
by Agent
Payment of
Murabaha Price
Offer &
Acceptance
(Murabaha
Contract)
Intimation of
possession of
goods by the agent
(Declaration)
Payment of
Purchase Price*
*Payment of purchase price is either direct payment to supplier or through customer account
For Detail
• Advance Payment Murabaha
Murabaha
Agreement
Agency
Agreement
Order Form
Payment of
Purchase Price*
Payment of
Murabaha Price
Offer &
Acceptance
(Murabaha
Contract)
Intimation of
possession of
goods by the agent
(Declaration)
Purchase of Goods
by Agent
*Payment of purchase price is either direct payment to supplier or through customer account
• Credit Murabaha
Murabaha
Agreement
Payment of
Murabaha Price
Agency Agreement
Order Form
Purchase of Goods
by Agent
Payment of
Purchase Price*
Offer &
Acceptance
(Murabaha
Contract)
Intimation of
possession of
goods by the agent
(Declaration)
*Payment of purchase price is either direct payment to supplier or through customer account
• SLC under MMFA
Murabaha
Agreement
Agency Agreement
Order Form & LC
Application
Establishment of
LC
Receipt of Import
Documents
Payment of
Murabaha Price
Retirement of LC
Through
Murabaha
Offer &
Acceptance
(Murabaha
Contract)
Intimation of
possession of
goods by the agent
(Declaration)
• Tijarah
Master Tijarah
Agreement
Agency Agreement
Written Offer
Payment of Tijarah
Price upon
Acceptance
Payment of
Murabaha Price
Retirement of LC
Through
Murabaha
Offer &
Acceptance
(Murabaha
Contract)
For Detail
Delivery of Goods
& Acceptance of
Delivery by bank
Intimation of
possession of
goods by the agent
(Declaration)
Thank You