Islamic Microfinance Framework and Strategies

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islamic 341 microfinance 318 financial 249 institutions 137 republic 126 development 111 services 110 countries 99 financing 98 banks 90 banking 89 credit 81 member 80 poverty 79 micro 71 based 69 mfis 61 funds 60 finance 55 shariah 51

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c islamic development bank king fahd national library cataloging in publication data obaidullah mohammed khan tariqullah islamic microfinance development challenges and initiatives mohammed obaidullah and tariqullah khan a jeddah p cm isbn islamic finance islamic economy title dc cover design by mohammad ali asiri l
isbn

functions the functions of the institute are i to organize and coordinate basic and applied research with a view to developing models and methods for the application of shariah in the fields of economics finance and banking ii to provide for the training and development of professional personnel in islamic economics to meet the needs of research and shariah observing agencies iii to train personnel engaged in development activities in the bank s member countries
the basic condition for membership is that the prospective member country should be a member of the organization of the islamic conference oic and be willing to accept such terms and conditions as may be decided upon by the board of governors

the poor in the islamic world
shariah compliant instruments of ismf

recommendations annexure i poverty in isdb member countries annexure ii access to financial services in isdb member countries annexure iii regulatory framework for mfis and ifis in isdb member countries list of boxes list of abbreviations glossary of arabic terms
macro level islamic mf regulatory and supervision framework

finally as a companion of the above two works this paper on islamic microfinance development challenges and initiatives has been prepared as a strategic framework for systematically addressing the main challenges relating to policy initiatives to develop islamic microfinance services

acknowledgements the need to prepare this document was felt during the consultation process on the ten year framework and strategies for development of the islamic financial services industry a joint initiative of the isdb irti and the islamic financial services board ifsb and other stakeholders
hence the paper has benefited from the ideas observations and comments of a large number of policy makers practitioners and scholars of whom the following need special mentioning

mister naser al ziyadat director strategy general council of islamic banks and financial institutions bahrain
doctor mehmat barca economist statistical economic and social research and training centre for islamic countries sesrtcic ankara turkey

doctor savas alpay director general statistical economic and social research and training centre for islamic countries ankara turkey
mister sambou coly country manager oikocredit senegal doctor tariqullah khan division chief ibfd irti jeddah h

it goes on to argue that diverse approaches are needed to minimize exclusion and that the cultural and religious sensitivities of muslim societies must be given due emphasis in any attempt to build inclusive financial systems in order to bring a very large segment of the world s poor population into the fold of formal financial syste miss it undertakes an analysis of the levels of poverty in the isdb member countries and also juxtaposes measures of financial access to highlight the extent of exclusion in these countries

meso level initiatives constitute provision of education and training better coordination and networking technical assistance through awqaf and zakah funds provision of rating services specific to islamic microfinance institutions in view of their unique risks through creation of a rating fund

encourage formation of apex and regional industry associations with a view to develop of islamic microfinance through human resource development technical assistance operational standardization and financial product development facilitation of vertical and horizontal communication among islamic financial institutions advocacy and participation in policy dialogue v
create qard al hasan specific funds to support various qard al hasan based microfinance institutions across the globe iii

the provision of financial services to the poor helps to increase household income and economic security build assets and reduce vulnerability creates demand for other goods and services especially nutrition education and health care and stimulates local economies
it implies provision of financial services to poor and low income people whose low economic standing excludes them from formal financial syste miss access to services such as credit venture capital savings insurance remittance is provided on a micro scale enabling participation of those with severely limited financial means

a number of variants of the model exist but the key feature of the model is group based and graduated financing that substitutes collateral as a tool to mitigate default and delinquency risk
requirements they will have to fulfill in order to continue to have access to funding

it is a world where poor and low income people in developing countries are not viewed as marginal but rather as central and legitimate clients of their countries financial syste miss in other words this vision is about inclusive financial systems which are the only way to reach large numbers of poor and low the four model classification is based on john d conroy the challenges of microfinancing in south east asia financing southeast asia s economic development institute of southeast asian studies singapore

unless microfinance providers charge enough to cover their costs they will always be limited by the scarce and uncertain supply of subsidies from governments and donors
mfis need to produce accurate brigit helms access to all building inclusive financial systems consultative group to assist the poor world bank p xi

making this vision a reality entails breaking down the wallsa real and imaginarya that currently separate microfinance from the much broader world of financial syste miss in the context of muslim societies building inclusive financial systems would most certainly require integration of microfinance with islamic finance
the strategy should aim at sustainability through a shift from a charity based donor dependent approach to a market based for profits approach emphasizing systemic efficiency and transparency and restricting use of donor funds to capacity building

first returns on investment in micro enterprise are very high by the standards of banks and other investors a the reason being the miniscule size of investments compared to the earnings numbers
hence entrepreneurs can afford to pay high interest rates as cost of funds sometimes as high as sixty seventy percent as long as the same are lower than rates of return

from the above it is clear that the cultural and religious sensitivities of the islamic world are somewhat unique and these must be given due emphasis in any attempt to build inclusive financial systems and bring the over one billion muslims into the fold of formal financial syste miss
in a few other ismf programs a culturally appropriate way has been found of empowering women through gender segregated ownership of the financing entity and involving separate appraisal of loan applications by women who develop their own gender sensitive products and strategies for the future

the poor in the islamic world in this section we measure the extent of poverty and of exclusion in the islamic world
mali burkina faso and chad have ranks below at and respectively closely followed by niger and guinea at and

it reveals that out of the countries for which the estimate is available in as many as countries only onefifth or less of their adult population have access in countries one fourth or less have access and in countries one third or less have access to formal financial services

understanding the needs of the poor the needs of the poor in islamic countries are no different from the poor in other societies except that these are conditioned and influenced by their faith and culture in a significant way

recent experience of islamic mfis in the matter of offering shariah compliant deposit products refer to subsequent section for details also shows that they are yet to gain an adequate understanding of the needs of their clients

loans to the destitute may in fact make the poor poorer if they lack opportunities to earn the cash flow necessary to repay the loans
basic requirements like food shelter and employment are often more urgently needed than financial services and should be appropriately funded by government and donor subsidies

while islam strongly encourages charity from the giver s point of view it seeks to minimize dependence on charity from the beneficiary s point of view and restricts the benefits to flow to the poorest of poor and the destitute who are not in a position to generate any income and wealth

he said twice or thrice who will offer more than one dirham a man said i shall buy them for two dirha miss he gave these to him and took the two dirhams and giving them to the ansari he said buy food with one of them and hand it to your family and buy an axe and bring it to me
he the prophet asked have you nothing in your house he replied yes a piece of cloth a part of which we wear and a part of which we spread on the ground and a wooden bowl from which we drink water

direct involvement of the program in capacity building in the run up to income generation and technical assistance to the beneficiary commitment of top management of the program
as the holy quran asserts o ye who believe when you deal with each other in transactions involving future obligations in a fixed period of time reduce them to writing and let a scribe write down faithfully as between the parties the import and significance of this verse is often not fully understood

instruments for mobilization of funds instruments for mobilization of funds may be broadly divided into charity that includes zakah sadaqah awqaf gifts that include hiba and tabarru deposits that may take the form of wadiah qard al hasan and mudarabah and equity that may take the form of classical musharakah or the modern stocks

deposits in the form of wadiah qard al hasan and mudarabah have their parallel in savings current and time deposits respectively and are a regular source of funds for islamic microfinance institutions especially those in south east asia
instruments of financing instruments of financing may be broadly divided into participatory profitloss sharing pls modes such as mudarabah and musharakah sale based modes such as murabahah lease based modes or ijarah and benevolent loans or qard with service charge

the vast majority of clients are those with existing businesses and a good track record they can be financed through such financial products as murabahah musharakah and mudarabah which involve some form of profitsharing
unlike mainstream islamic finance that does not quite treat qard al hasan as a financing mechanism islamic microfinance has found this mechanism to be a pure and effective way of financing the poor

a combination of financing with islamic teachings and oaths

instruments of risk management instruments of risk management and insurance in islamic microfinance are based on the concept of guarantee kafalah and collateral daman
the mainstream islamic banks and financial institutions financing large corporations and high networth individuals may not be comfortable with the unique risks with microfinance

in the islamic countries current and potential providers of islamic mf are likely to be either the conventional mfis expanding the scope of their services to include islamic mf or the islamic fis expanding the scope of their services to include mf
interestingly these informal arrangements take on similar forms and can be divided into two rough categories individual providers and collective clubs or associations

also informal financial services are vulnerable to collapse or fraud where people can lose their money whether because of corruption lack of discipline or collective shocks like a natural disaster or a bad harvest

in the middle east north africa mena region several successful experiments have been undertaken recently i the sanadiq project at jabal al hoss in syria ii the mu assasat bayt al mal in lebanon and the iii hodeidah microfinance program in yemen

governance through committees with sound election and voting procedures iv project management team responsible for creating awareness of microfinance practices training of committee members v financial management of the funds based on standardized by laws and statutes for each of the village funds resulting in fair credit decisions and low transaction costs
the mu assasat bait al mal in lebanon is an affiliate of a political party a the hezbollah and comprises the hasan loan institution al qard al hasan and its sister organization called al yusor for finance and investment yusor lilistismar wal tamweel

south east asia in south east asia malaysia made an early beginning with tabung haji aimed at financing the hajj related expenditure of poor malaysian farmers who used to sell their only source of livelihood agricultural land for the purpose

recipients of nobel peace prize for the year grameen and prof yunus have provided a model of microfinance that is being replicated through one of the largest international networks of microcredit organizations for the poor in the world
grameen system in such cases works extra hard to assist the borrower in difficulty and makes all efforts to help her regain her strength and overcome her difficulties

see box iv islamic microfinance institutions ismfis in indonesia have displayed their sustainability and robustness in the face of grave financial crises even when the mainstream banks had to depend on governmental assistance to tide over serious financial proble miss it should be noted that indonesian bmts at the grassroots largely fall outside the financial regulatory mechanism since they operate as member based cooperative organizations similar to a musharakah structure without governmental assistance or intervention
its strong emphasis on its islamic roots has enabled itself to experiment with a dual system of islamic finance and a system of microfinance that is not just shariah compliant but actually uses islamic spiritual treatment along with financial and technical assistance to develop its micro enterprises and work towards elimination of poverty

a significantly large number of microfinance institutions especially in indonesia are organized as cooperatives registered under the cooperatives act and come under the purview of the ministries of cooperation and not the ministries of finance
it was felt that a bank that would be acceptable to all previous civil war opponents had to be an islamic one and this led to establishment of the azaouad finances plc

use of qard al hasan where only the actual service charge is recovered from the beneficiary does not allow the portfolio of financings to grow while inflation is likely to erode their real value seriously threatening their long term survival
unlike mainstream islamic bankers many islamic microfinance providers with multiple bottom lines are not comfortable with techniques like murabahah and ijarah lease purchase and financial lease variety and view them as interest basedloan substitutes

for instance successive governments in india have routinely provided through a network of microfinance outfits loans at interest rates grossly below the prime lending rate in the economy and would at periodic intervals waive the entire loan amount in the face of hardships such as crop failure or even small enterprises becoming sick consequently claiming to be more equitable than profit and loss sharing
another instance is the grameen system that cites the following features of its loans to be labeled differently than interest bearing conventional loans i cap on the total interest due ii no recovery in case of project failure iii no formal contract for interest payments iv no shareholder owner s as counterparty to receive interest etc

other problems that are usually cited with pls based modes as compared to sale and lease based modes are as follows one pls mechanisms require longterm involvement by the microfinance institutions in the form of technical business assistance which raises the cost of implementation

the absence of any real capital market activity by islamic microfinance providers may be due to various possible reasons such as the lack of awareness on the part of microfinance providers and or lack of conducive legal and economic environment
the individual borrower guarantee that is prevalent lifts the burden of loss of the business due to natural hazards death or disability of the borrower

a diverse range of products there is need and considerable scope for islamic microfinance providers to develop new products as solutions to a variety of financial proble miss however the right approach to product development is a strategic one that takes a holistic view of microfinance as a composite product meeting the needs for financing savingsand investment insurance remittance and other services
the annual fiqh seminars organized by dallah al baraka or those organized under the aegis of islamic fiqh academies have successfully resolved many intricate and complex issues in the past

the regulations should also encourage more effective microfinance delivery through establishment of new specialized formal non bank microfinance institutions expansion of branch network for existing institutions possible restructuring of existing banks to serve as rural specialized microfinance banks and allow for banks wholesaling to non bank microfinance institutions and using the non profit organizations with social agenda to reach out to poor

box v a guarantee product by grameen jameel initiative the grameen jameel initiative an innovative collaboration between grameen foundation and the abdul latif jameel group to fight poverty in the arab world through microfinance as its first transaction provided a million guarantee to dakahlya businessmen association for community development dbacd a leading microfinance institution mfi enabling it to secure a local currency loan of

it will also help in the development of bangladesh s local capital markets as it marks the first such securitization in the market and also the first aaa rated local certificates issue in bangladesh rated by the credit rating agency of bangladesh
box vi world s first micro credit securitization brac one of the world s largest ngos with over mm borrowers and employees has closed world s first micro credit securitization structured by rsa capital citigroup fmo and kfw

a beginning has already been made in securitization of micro credit in the domain of conventional microfinance by brac bangladesh

landscape the frenetic pace of growth of islamic finance has witnessed several landmark developments such as the establishment of the islamic financial services board ifsb the accounting and auditing organization of islamic financial institution aaoifi the international islamic rating agency iira the general council of islamic banks and financial institutions gcibifi at the international level and many other agencies at regional levels to provide meso level services to ifis
its objective is the development of islamic banking in indonesia through human resource development technical assistance operational standardization and financial product development facilitation of vertical and horizontal communication among islamic financial institutions advocacy and participation in policy dialogue

though safe efficient and reliable payments systems are critical to the effective functioning of the financial system most of islamic mfis or their conventional counterparts do not have access to such syste miss in the isdb member countries only some top islamic banks have access to systems such as electronic funds transfer and real time gross settlement system

as conventional microfinance markets mature and begin to integrate into the financial system the mainstream service providers rating agencies auditors management consultants and bank training institutes among others are starting to adapt to meet the needs of financial institutions that serve poor clients
strategic response in formulating a strategic response to the challenges an important question needs to be answered whether infrastructure and services should be microfinancespecific or whether microfinance skills should be absorbed by existing mainstream providers that work more broadly with mainstream ifis institutions like ifsb aaoifi gcibifi and iira

even there is a need for education for the clients in subjects like basic accounting and management accounting is important because of the unavoidable need to calculate profits in case of participatory financing methods such as mudarabah and musharakah
though the smaller microfinance institutions working for the poor may not be in a position to institute the systems themselves they may work through the larger islamic fis by forging alliances with them

the global network and its regional member networks can perform a variety of functions such as i initiating dialogue on legal frameworks regulations taxes ii resolution of divergence of views on shariah compliance iii providing exposure to worldwide microfinance good practices through development of resource center iv designing and conducting training programs in microfinance facilitation and management v development and maintenance of information base for use by member organizations vi creation of infrastructure such as credit rating facility for microfinance etc

a scheme of proper integration of the two types of institutions would do away with issues related to the desirability or otherwise of zakah funds being invested in speculative wealth creating assets in stead of getting spent on immediate needs of the poorest of the poor or issues of ethics of islamic microfinance institutions seeking profits and ignoring the unbankable
technical assistance through awqaf and zakah funds as a strategic meso level initiative to develop islamic microfinance it is important to institutionalize voluntary giving in order to guarantee sustainability of assets and their income generating abilities

two borrowers often view soft government money as grants or gifts and are less likely to repay loans from subsidized progra miss this is especially true in countries with a history of forgiveness programs for agricultural or other lending
in short governments are not good at offering credit directly to poor people even while government owned banks such as postal banks are fairly successful in savings mobilization or money transfer

banking sector regulation and supervision the growing maturity of microfinance across the globe has kept the issue of regulation and supervision of mfis in the front burner
poor clients are either left with no access to financial services or must revert to informal credit markets such as local moneylenders which are even more costly

for those financial institutions that capture deposits from the public and thus would generally be subject to prudential regulation some standard banking regulations need to be adjusted to accommodate microfinance governments should apply the more burdensome prudential regulation only when the financial system and depositor s money is potentially at risk
there are as many as member countries that have enacted laws and regulations specifically to govern mfis and there are as many as member countries that have enacted laws and regulations specific to ifis

in such a scenario the need for transparency and disclosure and the need to maintain a wall of segregation between the two subsystems is crucial
issues related to dual system some regulatory issues arise because of the existence of a dual system in most islamic countries a an islamic financial system co existing with a conventional system

stage one to make the islamic microfinance institutions appreciate the need for certain common performance standards stage two making it mandatory for the islamic microfinance institutions to get registered with identified or designated institutions and stage three to encourage development of network of islamic microfinance institutions which could function as quasi self regulatory organizations sros at a later date or identifying a suitable organization to handle the regulatory arrangements

using these mechanisms donors assume the role of enablers through funding credit and investment portfolios of mfis providing guarantees and safety nets to mfis capacity building facilitating mfi s access to domestic capital markets building the skill sets of technical service providers rating agencies consulting firms training facilities and supporting the operations of networks and associations
according to a recent survey of cgap member donors the world bank the asian development bank the inter american development bank and the european commission are among the largest public funders of microfinance

the deep initiative the deprived families economic empowerment program deep aims to develop a comprehensive package of financial and non financial services to meet the needs of the poor and very poor families of palestine who are the target group
the program is financed by the islamic development bank and the united nations development program and will initially operate as a pilot project for months before being transformed into a legal entity that will operate as an autonomous organization on a sustainable basis

financial services intervention maximizing the outreach of the lending activities to the palestinian poor and very poor people contributing to the mfis capacity building introducing islamic lending products maximizing the outreach of savings activities to the poor introducing micro insurance products the program would also seek to provide capacity building interventions aimed to strengthen the various intermediaries that will provide financial and promotional safety net interventions to the targeted poor and very poor households
promotional social safety net intervention provision of a wide array of nonfinancial services critical to the entry survival productivity competitiveness and growth of micro and small scale enterprises run and owned by the poor and very poor

an effective strategy for development of microfinance would require concerted efforts by all stakeholders the poor the cooperatives ngos the islamic banks the awqaf zakah funds the apex bodies isdb and isdb sponsored institutions as well as the government agencies such as ministries of finance cooperation the monetary authority and the capital market authority
as far as the poor are concerned they should perceive formal savings credit and financial services as safer and more attractive develop entrepreneurial abilities and acquire relevant education and skills and consider charity as temporary support only

some specific initiative that would go a long way in strengthening the islamic mf sector are at a micro level o participate in equity of islamic financial institutions with a view to creating specialized mf divisions o create qard al hasan specific funds to support various qard al hasan based microfinance institutions across the globe o create refinance facility to act as a whole seller of islamic microfinance products for a chain of islamic and conventional microfinance retailers o participate in equity of commercial takaful companies with a view to developing micro takaful products services also of retakaful companies

o encourage formation of apex and regional industry associations whose objective is the development of islamic microfinance through human resource development technical assistance operational standardization and financial product development facilitation of vertical and horizontal communication among islamic financial institutions advocacy and participation in policy dialogue o create zakah and awqaf funds at a global level dedicated exclusively for poverty alleviation and linked to microfinance institutions downstream and o help create rating mechanism in member countries for islamic microfinance institutions
at a macro level o assist member countries to develop a regulatory framework for islamic microfinance o support policy makers to ensure an enabling policy framework conducive to the development of islamic microfinance o support and facilitate the integration of zakah and awqaf in financial sector reforms and o build an effective alliance and forum of islamic microfinance providers and other stakeholders

name of member country mfis ifis republic of indonesia banking law law concerning banking a n cooperatives regulation micr law on cooperatives includes ifiinsti specific laws and regulations mature ifi sector islamic republic of iran the monetary and banking law of iran the law for usury isla the law for usury interest free interest free proj banking banking spec banking law covers mf as any other the law for the financing activity issuance of participation papers republic of iraq con no i hashemite kingdom of jordan banking law of development and banking law mat employment fund def is governed by includes ifimicr law no
specific nati other agencies are governed by their own regulations ban particular laws

list of boxes box i

technically it means exposing oneself to excessive risk and danger in a business transaction as a result of uncertainty about the price the quality and the quantity of the countervalue the date of delivery the ability of either the buyer or the seller to fulfil his commitment or ambiguity in the terms of the deal thereby exposing either of the two parties to unnecessary risks
bay salam a sale in which payment is made in advance by the buyer and the delivery of the goods is deferred by the seller

the term however is now used to refer to a sale agreement whereby the seller purchases the goods desired by the buyer and sells them at an agreed marked up price the payment being settled within an agreed time frame either in instalments or in a lump sum
istijrar same as bai istijrar istisna refers to a contract whereby a manufacturer contractor agrees to produce build and deliver a well described good or premise at a given price on a given date in the future

a musharakah contract is similar to a mudarabah contract the difference being that in the former both the partners participate in the management and the provision of capital and share in the profit and loss
profits are distributed between the partners in accordance with the ratios initially set whereas loss is distributed in proportion to each one s share in the capital

zakah the amount payable by a muslim on his net worth as a part of his religious obligations mainly for the benefit of the poor and the needy
the keeper can charge a fee even though in islamic culture it is encouraged to provide this service free of charge or to recover only the costs of safekeeping without any profit

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DOCUMENT WORD ANALYSIS

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AlHuda Material\islamic micro

KeyWords

islam microfin financial institute bankable finance developed service fund countries member NA republic regular program credit loan muslim rate access

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Number of Pages

98

Published Date

2009-01-08 14:16:55

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Islamic Microfinance Framework and Strategies

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