What is Islamic Microfinance? Making it a Sustainable Reality

Presenters PART I: Rafi-uddin Shikoh PART II: Atif R Khan

Agenda Presentation: 45 min Q&A: 30 min

Agenda Section 1: Global Microfinance Context (Part 1) Global Microfinance Drivers/ Opportunities What is Microfinance? Landscape key players Impact & Challenges Section 2a: Islamic Microfinance What is Islamic Microfinance? Key Islamic Microfinance drivers/ Opportunities Landscape Key players/ geographies Impact, Challenges & Opportunity Section 2b: Islamic Microfinance -- Part 2 to be delivered at the next session Islamic Microfinance core models Islamic Microfinance structures

Summary MICROFINANCE Banking for the poor Big need exists However poverty alleviation is too big a promise; Industry is growing but showing signs of problems (*primarily excess lending and aggressive collection; akin to sub-prime mortgage lending) However many success stories, best practices developing and growing. Problems should be removed. Islamic Microfinance in infancy making finance accessible to many low-income Muslims and with universal potential.

Global Microfinance Drivers 1. Addressing FINANCIAL EXCLUSION of low-income global population: Globally 49 percent of adults have deposit accounts in formal financial institution* 19% of developed world adults do not have bank accounts 72% of adults in the developing world do not have accounts Source: Financial Access 2010 Report, by CGAP and World Bank

Global Microfinance Drivers 1. Addressing FINANCIAL EXCLUSION of low-income global population: Globally 49 percent of adults have deposit accounts in formal financial institution* An estimated 72 percent of people living in Muslim-majority countries do not use formal financial services (CGAP Islamic Microfinance Note 2008) Source: Financial Access 2010 Report, by CGAP and World Bank

Global Microfinance Drivers 2. Addressing needs of MICRO-ENTERPRISES: Micro-enterprises have historically lacked access to financial products and services. Microfinance institutions have emerged to serve the smallest of these enterprises, while banking institutions have typically concentrated on large corporations. Source: Access Finance, World Bank, JANUARY 2010 ISSUE No. 30

Global Microfinance Drivers 1. FINANCIAL EXCLUSION of low-income global population 2. Addressing needs of MICRO-ENTERPRISES Unmet demand for finance is large, but the exact number (or even a rough but credible number) has been hard to pin down, with estimates ranging from half a billion people to three billion.* *Financial Access 2010 Report, by CGAP and World Bank

What is Microfinance? Microfinance services low income groups (extreme poor, moderately poormain clients), mostly not served by commercial banks. Services offered are Credit facilities, savings account, money transfers, remittances, insurance and even investment 1. Low-income population 2. Microenterprises

What is Microfinance? Pioneered the group-based responsibility model but other models exist* * Other models: Village model; Coop; Self-help groups (SHGs)

Landscape: Key Players MIX Global 100 -- As a group, surveyed institutions represented nearly 85 percent of the known pool of microfinance borrowers, serving 72 million borrowers with 37 billion USD in loans and holding 22 billion USD in deposits from 67 million microfinance clients. (MIX 2010 Report) Microfinance Information Exchange, Inc. access to financial and social performance information, including quarterly results, on more than 2,000 MFIs in the developing world covering 92 million borrowers.

Landscape: Key Players Top 100 Microfinance Institutions in the World: MIX 100 that are profitable and top performers in each of three areas: outreach, efficiency, and transparency

Landscape: Key Players

Impact Poverty alleviation: Many studies indicate positive impact over the last twenty years, as well as some findings that suggest limited or negative impact. Example: Since Kiva was founded in 2005: 680,458 Kiva lenders $279 million in loans 98.93% Repayment rate Work with: 146 Field Partners 450 volunteers around the world 60 different countries

Shortcomings Social fallout: Family issues High interest rates: Loan sharks, 30%, 40% even 60%+ Per year Excessive lending/ over indebtedness: Major defaults in India Aggressive debt collection: The past five years have seen the aggressive selling of loans to often illiterate villagers, followed by equally aggressive debt collection. As a result, the past decade witnessed more than 200,000 farm suicides in India. Reports India s leading rural journalist, The Hindu s P. Sainath: Those who have taken their lives were deep in debt. Exclusion: Poorest of the poor; Self-exclusion due to prohibition of interest for Muslims

Key Islamic Microfinance Drivers Indonesia, Bangladesh, Pakistan, Nigeria and Egypt - account for over half a billion (528 million) of the world s poor with incomes below $2 a day or national poverty line. Needs of the poor in Islamic countries are for the most part the same as the poor in other societies approximately 44 percent of conventional microfinance clients worldwide reside in Muslim majority countries*. Yet an estimated 72 percent of people living in Muslim-majority countries do not use formal financial services (CGAP Report 2008) A number of IFC-commissioned and other market studies suggest a strong demand for Islamic microfinance products: Surveys in Jordan, Algeria, and Syria, for example, revealed that 20 40 percent of respondents cite religious reasons for not accessing conventional microloans. (CGAP Report 2008) There is also a category of Muslim clients who use conventional products but prefer Islamic ones and tend to switch over once Islamic products become available. (CGAP Report 2008)

Key Islamic Microfinance Drivers Islamic microfinance has the potential to expand access to finance to unprecedented levels throughout the Muslim world. CGAP Islamic Microfinance: An Emerging Market Niche, Aug 2008

What is Islamic Microfinance? Microfinance and Islamic finance have much in common. Both emphasize the good of society as a whole. Both advocate entrepreneurship and risk sharing and believe that the poor should take part in such activities. Both focus on developmental and social goals. Both advocate financial inclusion. Both involve participation by the poor. There are however, some points of difference between the two. * * Intro. to Islamic Microfinance, Mohammed Obaidullah, IIBF

What is Islamic Microfinance? Islamic Approach to Poverty Alleviation:* 1) Charity (Sadaqa) - Zakat, Sadaqa Jariya or Waqf (endowment/ trust) 2) Economic empowerment. 3) Debt avoidance: Muslims are also warned against the dangers of incurring heavy debt. The Prophet Muhammad (peace be upon him) used to regularly supplicate Allah, I seek refuge with You from sin and heavy debt. When someone remarked, how often you seek refuge from heavy debt, he replied, when a man gets into debt, he speaks and tells lies, and he makes a promise and breaks it (Bukhari and Muslim). The best among you are those who are best in paying off debt (Muslim); 4) Cooperation: A hadith by the Prophet (peace be upon him) reinforces the principle of cooperation and mutual assistance. Believers are to other believers like parts of a structure that tighten and reinforce each other." (Al-Bukhari and Muslim) 5) Family cohesiveness: And covet not that whereby Allah has made some of you excel others. Men shall have a share of that which they have earned, and women a share of that which they have earned. And ask Allah of his bounty. Surely Allah has the perfect knowledge of all things (4:32) * Intro. to Islamic Microfinance, Mohammed Obaidullah, IIBF

What is Islamic Microfinance? Islamic Approach to Poverty Alleviation:* 6) Sharia Compliance of Finance Contracts: All contracts in Shariah must be free from certain forbidden elements. A brief overview of relevant norms is provided below: Freedom from Riba: Allah has permitted trade and forbidden riba. (2:275) Prohibition of interest (riba) is the central tenet of the system. Conventional interest on loans or savings, as a fixed return without sharing any risk, is considered unjust. Risk sharing: Because interest is prohibited, suppliers of funds become investors instead of creditors. The provider of financial capital and the entrepreneur share business risks in return for shares of the profit. Freedom from Gharar: The concept of gharar has been broadly defined by the Islamic scholars in two ways. First, gharar implies uncertainty. Second, it implies deceit. Shariah approved activities: Muslims cannot profit from activities considered immoral. For example, investing in businesses dealing with alcohol, gambling, casinos, pornography, or weapons of mass destruction is not allowed. * Intro. to Islamic Microfinance, Mohammed Obaidullah, IIBF

What is Islamic Microfinance? Forms of contracts (to be discussed in detail in Part II of presentation) Micro-credit Micro-savings MURABAHA (Cost plus profit sale) MUDARABA-BASED accounts IJARA (Leasing) MURABAHA-BASED term deposit accounts Micro-transfer Micro-Insurance MUDARABA (investment partnership; trustee profit sharing MUSHARAKA (JV profit sharing) QARD HASAN TAKAFUL

What is Islamic Microfinance? A FRAMEWORK Poverty Alleviation Responsibility Micro-credit Micro-savings Micro-transfer Micro-insurance Core Islamic Financing contracts Target Audience/ Need Illustration: 2012 DinarStandard

Islamic Microfinance: Landscape Currently Islamic microfinance is concentrated in a few countries, with Indonesia, Bangladesh, Pakistan and Afghanistan ranking in the top. According to the 2008 Consultative Group to Assist the Poor (CGAP) survey, Islamic microfinance accounts for about 0.5 per cent. of global microfinance despite a global Muslim population of about 1.2 billion. In a 2007 global survey on Islamic microfinance, CGAP collected information on over 125 institutions and contacted experts from 19 Muslim countries. The survey and a synthesis of other available data revealed that Islamic microfinance has a total estimated global outreach of only 380,000 customers. CGAP survey identified that over 70 percent of the products offered are Murabaha. Islamic MFIs generally offer only one or two Sharia-compliant products.

Islamic Microfinance: Landscape The Consultative Group to Assist the Poor (CGAP), Deutsche Bank, Islamic Development Bank (IDB) and Grameen-Jameel partnered to address new microfinance models with Shari ah compliancy through an Islamic Microfinance Award. 130 banks from 43 countries and Microfinance Institutions (MFIs) submitted their ideas for the award Winner: Al Amal Microfinance Bank of Yemen (AMB) Tameer Micro Finance Bank Ltd (TAMEER) - Pakistan Tanzania eco Volunteerism (TeV) - Tanzania Bina Insan Sejahtera Mandiri (BISMA) - Indonesia Centre for Women Co-operative Development (CWCD) - Pakistan

Islamic Microfinance: Landscape Bangladesh Case Study: IBBL (Islami Bank Bangladesh Limited) Introduced own version of microfinance: 'Rural Development Scheme (RDS)' in 1995. Modeled after the Grameen Bank model except that the scheme used Islamic modes of investment. Effective rate after rebate is 20% per annum, which is a major difference with typical MFIs. ASA, BRAC, BURO and many other MFIs effectively charge 30% interest per annum. IBBL one of the top 10 MFIs offering microfinance; IBBL reached about 11,000 villages (about 13% of total Bangladesh villages); and outstanding investments reached Taka 3752 million (USD 53.6 million). Products: saving plans; financing plans; MicroTakaful Issue in contract credibility Bai-muajjal (credit sale) Among alternative modes, Mudharabah is fraught with practical problems arising out of reluctance and/or inability among informal livelihood enterprises for proper accounting of results.

Islamic Microfinance: Landscape Indonesia Report: Why is Growth of Islamic Microfinance Lower than Conventional?* Out of 2200 some rural banks only 92 are Islamic but started in 1990s. Out of 40,000 microfinance cooperative, 3000 were Islamic (2003) 54.4% of respondents preferred Islamic MFI rather than conventional MFI (45.6%). Most of clients were Muslim and they preferred to choose Islamic MFIs, however in reality they chose MFI based on economic (low interest rates, low collateral and size of loan) and non-economic factors (such as quality of services variables easiness, speed, nearness, method and loan officers profile). BRI as a government supported entity has the biggest adoption. (conventional) BRI is a biggest five MFIs in the world (Microcredit Year, 2005) in terms of clients and their loans. As the MFIs clients prefer Islamic MFI compared to conventional, the demand for Islamic microfinance can be enhanced if the level of their economic and noneconomic factors can be brought to the levels of conventional MFIs. * Paper presented by Dian Masyita (PhD research scholar in Islamic Finance, Durham University, UK), Habib Ahmed (Professor of Sharjah Chair in Islamic Law and Finance at the Durham University, UK) at 8th International Conference on Islamic Economics and Finance

Islamic Microfinance: Opportunity Operational Efficiency/ Risk Management Opportunity for integrating Zakah and Awqaf with for-profit Shariah-compliant microfinance needs to be developed Use of Qard hasan Introduction of micro-takaful Islamic Microfinance for all globally

Business Media Research Advisory Rafi-uddin Shikoh E: rafishikoh@dinarstandard.com W: advisory.dinarstandard.com

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