Islamic Microfinance-An Inclusive Approach With Special Reference to Pakistan Muhammad...

8/3/2019 Islamic Microfinance-An Inclusive Approach With Special Reference to Pakistan Muhammad Khaleequzzaman Associate Professor School of Islamic Banking & Finance Internationa

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Islamic Microfinance-An inclusive

Approach with Special Reference toPakistan

Pfeiffer University Colloquium on Microfinance: Banking on theFuture Exploring Microfinance as Service,

North Carolina, USA

30th September 2011

Presented By:Muhammad Khaleequzzaman

Associate Professor/ConsultantSchool of Islamic Banking and Finance

International Islamic University Islamabad Pakistan


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Contents

Poverty and gap analysis

Issues of microfinance

Why Islamic microfinance?

Demand for Islamic microfinance

Some experiences and products of Islamic microfinance

Compatibility of Islamic framework with microfinanceprinciples

Issues relating to MFIs and Islamic banks

Recommendations for mainstreaming sustainable Islamicmicrofinance

Islamic Microfinance-An inclusive Approach with Special Reference to Pakistan


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Poverty and Gap Analysis


Incidence of Poverty

Planning Commission GoP (2009) 24.5%

Task Force on Food Security 36.1%

UNDP HPI-1 Pakistan 77th among 108

LDCs

MF Industry Assessment-Pakistan [22.3% + 22.5%vulnerable = 44.8%]

Financial Access (Access to Finance Study 2009)

Formally Served 12%(Female: 4%)

Informally Served 32%

Financially Excluded 56%(Female: 68%)


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Poverty and Gap Analysis


Microfinance SpreadMicrofinance Providers [PMN Network] 29 MFIs

Coverage Econ. Survey 3% [1.6 mil. Poor]

Coverage PMN 18% [I mil. Poor]

Coverage Microwatch 13

Estimated Cost to Reach 3.0 mil. target [3 times of presentcoverage]

US$ 600- to 700 million (Rs. 49 to 57 billion) PMN


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Islamic Microfinance-Sustainability &Mainstreaming [M. Khaleequzzaman]

Issue of Microfinance (Contd..)

Ambiguous financial transactions

Flat rates of interest

Un-explained fees

Hidden charges, etc.

High cost debt economy than real economy

Separates finance from real economy

Absence of cooperation from MFI when clients businessloses

De-capitalization of funds in high inflation economies



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Islamic Microfinance-Sustainability &Mainstreaming [M. Khaleequzzaman]

Issue of Microfinance (Contd..)

Exclusion of certain segments from development process

Self-exclusion by Muslim populations due to prohibition ofinterest Interest based financial services become irrelevant

Poorest of the poor can not technically access MF

Women in gender segregated societies cannot benefit from

MFIs, hence lose empowerment opportunity

Value neutral system

Without much concern of ethics

Risk transfer instead of risk sharing

Emphasis on debt instead of trade comparatively more chancesof mis-utilization of funds



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Why Islamic Microfinance?

Interest is prohibited primarily to render justice

Interest is transgression into the wealth of borrower as moneyis sterile and cannot re-produce

Interest determined ex-ante Unjust distribution of productionresults

In Islamic finance, primarily, profits determined ex-post

Financial institutions shares business results Economic inefficiencies of interest are obvious

Mounting cycles of high cost debt more likely find leakageshence unproductive mixed impact on poverty alleviation

Risk sharing and asset building focus of Islamic financeprovides link between finance and economic activity Resultis entrepreneurship and real sector transformation



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Why Islamic Microfinance?

Islamic finance facilitates inclusion

Religious and faith based settings mark the need for Islamicfinance

Muslim populations self-excluded owing to prohibition findaccess to microfinance programs

Poverty alleviation programs of Islam are indiscriminating

where non-enterprising poorest of the poor are also includedthrough support of zero return Qarz Hassan (beneficence loan)and Zakat(religious tax on wealthy Muslims)

Islamic finance promotes investment climate

MFI being partner of entrepreneur, greater expertise isavailable to entrepreneur in terms of availability of information,

skills, efficiency and profitability

In view of risk management and asset building focus, Islamicfinance exhibits systemic as well as individual advantagesover conventional finance establishing strong link betweenfinance and economic activity



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Why Islamic Microfinance? (Contd..)

Islamic finance offers more efficient social capital MFI and clients are considered one unit than separate entities as in

conventional finance

Moral and ethical values embodied in religious teachings result in exitof negative social capital


Negative SocialCapitalNegative SocialCapital

MFIy Sense ofsocialresponsibilityy Justicey

Risk sharing

Clientsy Joint Liabilityy InformationdisclosureySelf-esteemy Necessity ofrepayment

-Deceit andCoercion

-Mistrust

Idleness/Niggardliness

-SelectionBias

-Inefficiency

-WillfulDefault


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Is there any demand for Islamic Finance, after all?

Surveying Organization Surveyed Country(ies) Preference (%)for Islamic MF

CGAP 08 Jordan, Algeria, and Syria 20 - 40%

PlaNet Finance 07 West Bank and Gaza 35% - 60 %

USAID 02 Jordan 24.9%

IFC/FINCA 06 Jordan 32%

Frankfurt School of Fin & Mgmt 06 Algeria 20.7%

IFC sponsored Study Yemen 40%

IFC 2007 Syria 43-46%

Bank Indonesia 2000 Indonesia (East Java) 49%

NRSP Azad Kashmir (Pakistan) 90%

Islamic Microfinance: An Emerging Market Niche, Focus Note No. 49, CGAP, Washington DC, 2008



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Islamic Microfinance - A Tool for Financial

Inclusion [M. Khaleequzzaman]

Institutions Mode of Finance

7 Sudanese Islamic Banks Murabaha, mudaraba, musharaka, and savingdeposit [SIB Productive Families]

Islamic Cooperatives and RuralBanks of Indonesia

Cooperatives Members Musharaka(integrated with Zakat Fund)

Rural Banks Various modes

Islami Bank Bangladesh, SocialInvestment Bank and AlFalah &Rescue

IBB Mostly bai muajjalSIBL - Recourse generation - Cash Waqf andFinancing through various modes

Jordan Islamic Bank Red/able Musharaka

UNCDF Yemen (HMFP) Murabahah and Mudarabah

Sanabel (12 Arab countries, 64

MFIs meeting 80% of MFneeds)

Murabaha, Mudaraba, Musharaka

Amana Ikhtiar Malaysia andIslamic Pawn Broking

AIM interest free loan

AlRahnu short term interest free loanagainst collateral at market value

Some experiences in Islamic Microfinance International



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Institution Mode of Finance/Rangeof Financing

Purpose of financing

Islamic ReliefPartner HSBC

Murabaha [USD 115-335]

Working capital, equipments, tools,house renovation, etc.

Akhwat Qarz hassan [USD 115-335]

Microenterprise, liberation of moneylender loan, house finance

KarakorumCooperativeBank

Murabaha [USD 115-1725]

Agricultural inputs, Working capital,equipments, flour machines, woodcutting saw, welding plant, livestock,fruit processing, etc

NRSP* Murabaha [USD 115-575]

-do-

Muslim Aid Murabaha [USD 57 - 335] Agricultural inputs, W/C, livestock

CDWC** Murabaha, Salam,Istisna [USD 115- 335]

Agricultural inputs, Liquidity,Equipment

*National Rural Support Program

**centre for women cooperative development

Some experiences in Islamic Microfinance National



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Microfinance should diversify into Islamic financial products

Comfort level of both systems provides opportunity


Conventional MF Islamic MF

Increased access to financialservices

Inclusion by offering interest free financialservices

Social collateral-Exclusion ofphysical collateral

Islamic social capital ensures informationdisclosure and productive use of borrowedcapital

Joint Liability ensures repayment Mutual guarantee (Kafalah) serves thesame purpose

Micro-insurance to meet businessand health/life related losses isbased on interest and speculation

Islamic insurance (takaful) serves the samepurpose but compensation materializesthrough cooperation of the insured onesand beneficiary shares the business result,too.


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Issues of Islamic MF Suppliers perspective

Regarding MFIs Sub-optimal performance

Limited number of MFIs (i.e. 5 8), hence marginal outreach

Uneconomic size of finance (Rs. 12000 15000) sustainability ofmicroenterprise not ensured

Sustainability

Limited resource base donor driven practices lead to unsustainableoperations

Legal restriction to collect savings of clients enabling to generateresource base

Product concentration

Reliance on Islamic banking products with corporate features withoutany effort to innovate

Preference of fixed profit related modes and neglect of risk sharingproducts which ensure more productive investment



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Issues of Islamic MF

Regarding MFIs Virtually no capacity building for MFIs

Limited or no Shariah advisory (Advisory in Islamic law relating tofinancial transactions) for MFI operations

Lack of training opportunities

Missing Common platform for standard setting and reporting

Lack of standardization in operating procedures and productdevelopment

Lack f financial discipline



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Issues of Islamic MF (Contd..)

Regarding Islamic banks

Perception about microfinance as high risk area Disregarding: high rate of recovery

Access to savings

Microfinance a business case Opportunity for highly productiveshort term liquidity

Informal sector environment Islamic banks articulate credit worthiness to physical collateral

Regulatory constraints

Absence in rural areas

Asymmetric information and agency problem

High monitoring cost

Limited concern for corporate social responsibility towardspoverty alleviation

Prime Islamic value being ignored

Limited opportunity afforded to poor to become integral part ofeconomically active population



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Some Recommendations

Mainstreaming Sustainable Islamic

Microfinance Models and Products



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Some Recommendations1. Downscaling Islamic Banking Operations

Possible Course of Action: Phase I:

Linkage with MFIs [Credit Lines based on Mudaraba + savingservices]

Benefits to MFIs: Sustainable funds, Capacity building,Governance, Sharia advisory, and Financial discipline

Benefits to Islamic Banks: Higher return on short termliquidity, Outreach, low monitoring cost, Market access inrural and remote areas, Zero cost saving deposits



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Some Recommendations1. Downscaling Islamic Banking Operations (Contd..)

Possible Course of Action: Phase II

Extension to financial markets while Linkage continues[Leverage + Product development + Technology transfer]

Technology transfer helps developing customized products

Extension of Islamic banking branches through low cost Huband Spoke Model

Experience leads to establish Islamic MF subsidiaries inaddition to linkages

Market leverage through Islamic securitization



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Some RecommendationsEXAMPLE of LINKAGE

Islamic Bank

MF NGO MF NGO MF NGO

ClientsClients

Clients

ClientsClients

Clients

ClientsClients

Clients

Savings Financing

Sharia

Advisory &

Technology

Transfer



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Some Recommendations2. Inclusion of poorest of the poor

First Stage Non-returnable Zakat and sadaqat (Islamic taxand donations) fulfill basic consumption needs, developmentof entrepreneurship and provide capital investment

Second Stage Zero return working capital for some initialperiods

Third Stage Fixed return financing for working capital

Zakatand Sadaqaat(Islamic tax and donations)

Islamic finance(Murabaha)

Basic need

fulfillment

Development of

entrepreneurship

Capital

investment

Working

capital

Transformation of hard core poor as entrepreneure



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Some RecommendationsProduct Offering from standardized to customized products

Phase I [1st to 3rd cycle]

Murabahah (deffered payment cost plus sale

Salam (forward sale)

Phase II [4th to 5th cycle]

Ijara (lease of assets) Diminishing Musharaka (Redeemable partnership)

Phase III [Graduated after 5th cycle, selected clients]

Mudaraba (partnership of capital and management)

Istijrar (suppliers credit) Micro venture capital

Transformation of micro to small enterprises the linkcompletely missing at present

Combination /Risk management



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3.V

enture Capital Funds Suitable for transition of microenterprise to small enterprise

Venture capital is sustainable, scalable, and market driveninstrument

Small businesses cannot attract traditional venture capitalists,therefore, Micro-funds to be established (by Islamic banks) for longterm investments (say 5 years)

Musharakah (Islamic partnership between MFI and client) should bethe mode of finance

Fund is managed by a fund management company

Participation of fund provider in decision making process willprovide management assistance, technical advice, monitoring, andmitigate agency conflict

Periodical accounts would help to evaluate fair value of businessassets

Divesting can be gradual instead of one time redemption to save thebusiness from any shock



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4. CashW

aqfModel: Building Islamic Social Capital Waqfmeans donating property, separating from private

ownership and dedicating its usufruct to charitable purpose

AllowsWaqif(provider of fund) to build social capital without anyexpectation to get back capital investment or return

Reason is purely religious to expect reward from God

Cash waqfcertificates of varying denomination allow anyonefrom any social class to participate

How the fund can work?

Establish a cash waqffund to be managed by a trust company

Invest fund in Sharia compliant business opportunities

Use returns of these investments for microfinance operations Part of fund can be invested in microenterprises throughMusharakah whose part of profit realized by fund manager canbe used for welfare of the poor

Islamic banks can also establish trust/subsidiaries for thispurpose



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THANKSQ & A


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