Transcript Grassroots Community Empowerment

Applying Islamic Finance
Principles to Microfinance
ABYAN AHMED, MUSLIM AID UK
WHAT IS ISLAMIC FINANCE?
 Refers to a system of banking that is consistent with Islamic
Law(Sharia) principles
 This system reflects Islam's teachings on wealth distribution, social
and economic Justice.
 The basic practices and principles of Islamic Finance date back to the
early part of the seventh century. (Islamic Finance: A Euromoney
Publication, 1997)
 Islamic finance is currently estimated at $1 trillion with an expected
growth rate of 15 percent per year ( Forbes)
PRINCIPLES OF ISLAMIC FINANCE

Prohibition of Interest

Risk sharing

Social Mission

Prohibition of speculative behaviour

Sanctity of contracts

Shariah-approved activities.
PROHIBITION OF INTEREST

The prohibition is strict, absolute and unambigous.
The Holy Qur'an in verse 278 of Surah Al-Baqarah states:
"O ye who believe! fear Allah and give up what remains of your demand
for riba, if ye are indeed believers."

Riba means any fixed or guaranteed interest payment on cash advances or
on deposits.

Islam encourages the earning of profits but forbids the charging of interest

To replace interest, the ideal mode of financing under the Islamic banking
system is "Financing on Profit & Loss Sharing" (PLS) basis
Islamic Modes of
Financing
MUSHARAKA- Equity Participation
Explained
The Bank and the client will place their share capital
together on a joint venture. Both of them share the risk and
reward according to a predetermined ratio.
MUDARABA-Profit Sharing
Bank provides all the money and the client provides
their expertise, skills and invests this money in an
attractive business. Profits are shared according to a
predetermined ratio, loss is entirely borne by the
Bank.
MURABAHA- Cost Plus Financing
This involves the purchasing of goods by a bank at the
customer’s request, to be sold to the customer at an
agreed mark-up.
MURABAHA
 Can achieve the goals of microenterprise lending
 Eliminates the need for written records (especially useful for when dealing
with illeterate client)
 Well-defined contract exists
 There is no opportunity for abuse on the part of the client through inaccurate
or false record-keeping
 Asset-based – can prevent diversion of funds for consumption
 A fixed contract creates simple and straight forward procedures
 lower adminstrative costs and monitoring cost for the institution
SMEs & MUSHARAKA
SMEs
•
No access to conventional financial systems
•
Lack collateral
•
High transaction cost
Benefits for the client

If the business doesn’t succeed the risk is shared with the MFI

Payments can include buy out and profit sharing component
Benefits for the MFI

Share of losses is compensated with receiving a share of all profits realised

Has greater upside potential if the business is successful – unlike an interest based loan where
the MFI earns a fixed interest payment
Why Islamic Microfinance?
•
Over 600 million of the worlds poor are Muslims (IDB,2008)
•
Access to financial services in the Islamic world is either inadequate or exclusive
•
There is a high demand for Islamic banking especially in low income predominantly Muslim
Societies (Ibrahim, 2004)
•
Islamic banking techniques could give thousands of entrepreneurial poor access to
microfinance—especially those who fear breaching their religious beliefs
•
Interest based loans may lead prospective entrepreneurs to refrain from pursuing
productive activities as the cost of failure is too high
Cont….…
•
Islamic finance seeks to finance business activity which will lead to
the economic empowerment of the poor, rather than merely lend to the
poor for consumption.
•
The focus on financing real, tangible economic activity fits very well
with the goals of microfinance
•
Microfinance is already more structurally aligned to applying Islamic
equity financing structures.
•
Islamic Microfinance can increase financial penetration which is vital
for poverty alleviation
SIMILIARITIES
Both systems

Advocate entrepreneurship

Risk sharing

Strongly believe the poor should take active part in their own
development.

Financial Inclusion

Represent unconventional solutions to financial needs

They start from egalitarian approaches
ISLAMIC MICROFINANCE
& SUSTAINABILITY
 One of the guiding principles of Microfinance is that the programme must ensure financial
sustainability
 Apart from financing on a profit & loss basis Islamic Microfinance can also use service
charge to cover their costs
 Service charge is a legitimate mechanism for pursuing sustainability
MUSLIM AID, SRI LANKA: MURABAHA
•
Muslim Aid launched it’s first Islamic microfinance
Pilot scheme in April 2007 with Amana Investments
Ltd.
•
Used the Murabaha model and purchased
commodities for 28 entrepreneurs
•
Funds totaling $4,640 were distributed
•
Repayment rate was 95% by the end of first year
Impact Assessment
•
40% of our clients reported they are much better off
•
45% said their sales and production improved,
whilst 20% a significant improvement
“I can buy more raw materials with this money
without having to pay high interest so I will be
able to expand my business and earn higher
profits,” said Noorul Rizwan, who sells cloth,
makes paper bags and cooks food for sale from
her home to support her three school-going
children.
JABAL AL HOSS, SYRIA: MURABAHA
•
A UNDP run programme in one of the poorest
areas in Syria.
•
22 self reliant local financial institutions have
been established consisting of 4,691 members
•
Each start up is self financed
•
When ever repayment is satisfactory, UNDP
provides an additional capital injection
•
Profit margin on Murabaha is 2.5%
•
A source of income
•
Repayment reached 100% by the end of the first
year of operation (Brandsma, 2004)
FINCA, AFGHANISTAN: MURABAHA
•
FINCA loans are based on Murabaha
principles, they don’t charge interest, but
a markup rate.
•
Providing Shariah-compliant loans has
made it possible for FINCA to expand in
areas of Afghanistan where other MFIs
have been turned away for charging
interest.
•
•
•
•
•
•
•
Clients: 41,213
Village Banks: 5,529
Portfolio: $8,324,142
Average loan size: $329
Staff members: 387
Clients per CO: 187
PAR: 0.6%
Islamic Microfinance
OPPORTUNITIES
CHALLENGES
Provide access to credit to
many of the poor in Muslims
Countries
Needs to include
Business Development
Services
Asset-based mode of
financing can prevent
diversion of funds for
consumption
Need to develop a uniform
regulatory and legal
framework for the Islamic
Finance system
Islamic finance can resolve the Moral Hazard problem
Lack of qualified
manpower
Musharaka and Mudaraba
are more attractive to SMEs
Murabaha generates
high initial
transactions costs
Conclusion

Diverse approaches are needed- making this a reality entails breaking down the walls real and
imaginary that currently separate microfinance from the much broader world of financial systems

In the context of poor people in Muslim societies, building inclusive financial systems would most
certainly require integration of microfinance with Islamic finance.

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 onebillion Muslims into the fold of formal financial systems.
MUSLIM AID: Towards Economic Empowerment
THANK YOU!
Muslim Aid PO Box 3
London E1 1WP
Contact:
[email protected]
[email protected]