Slide 1

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 2

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 3

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 4

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 5

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 6

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 7

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 8

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 9

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 10

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 11

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 12

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 13

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 14

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 15

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 16

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 17

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 18

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 19

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 20

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 21

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 22

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 23

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 24

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 25

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 26

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 27

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 28

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 29

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 30

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 31

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 32

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 33

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 34

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 35

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 36

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 37

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 38

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 39

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 40

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 41

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 42

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 43

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 44

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 45

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 46

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 47

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 48

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 49

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 50

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 51

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 52

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat


Slide 53

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 9
Islamic Microfinance

Learning Objectives
Upon the completion of this chapter, the reader should be able
to:
1.
Be familiar with the history and basic components of
Islamic microfinance and the benefits to society
2.
Identify key Islamic finance products that have been
used for microfinance
3.
Understand the differences between Islamic
microfinance institutions and conventional microfinance
institutions
4.
Be familiar with the major Islamic microfinance
institutions in the modern world
5.
Understand the corporate social responsibility role of
Islamic banks in financing micro-enterprises

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

• Microfinance is the provision of small-scale financial
services to the poor (usually excluded from the formal
financial services)
• Islamic microfinance is the process of providing
small-scale financial services, based on Sharī‘ah
concepts, to the poor who may be excluded from formal
financial services
• Islamic microfinance aims to provide necessary
credit facilities to the poor and/or low-income
individuals who may not have enough finance to engage
in normal financial transactions in formal financial
institutions

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

The early initiatives to alleviate poverty and promote
security in the Muslim communities include:
-

•

The institution of zakat (compulsory alms)
Waqf (charitable endowment)
The praiseworthy qard hasan (benevolent loans)

The informal savings clubs introduced by conventional
microfinance initiatives in the 16th century in Europe through
cooperative projects were tinted with interest, hence did not
serve the real objective of microfinance as a means of
assisting the entrepreneurial poor

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

The History of Islamic Microfinance Institutions
•

As an alternative, the revival of Islamic financial services
brought about the proper structuring of the Islamic models
on microfinance to assist the entrepreneurial poor

•

The history of modern Islamic finance started in rural
Islamic microfinance in the remote village of Mit Ghamr in
Egypt back in 1960s

•

Number of financial institutions offering Islamic products
were established across the Muslim world in the 70s and 80s

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

History of Islamic Microfinance Institutions
The 1990s and the new millennium ushered in a period of
consolidation of Islamic finance products
•

The joint partnership initiative of Grameen-Jameel opened
the Gulf Cooperation Council (GCC) countries to
microfinance initiatives

•

The Islamic microfinance model
- excludes exploitative tendencies e.g. charging
interest
- empowers able entrepreneurs whom only contribution
to the business venture is their expertise

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Components of Islamic Microfinance
Islamic microfinance is an umbrella concept that consists of:

•

Micro-lending

•

Micro-saving

•

Micro-insurance (preferably known as micro-takaful)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-lending
•

Micro-lending (also called micro-credit)

•

Involves the provision of credit facilities in the form of
interest-free loans based on the principle of qard hasan

•

Flexibility in terms of repayment of the loan

•

Micro-lending is provided for:

-

the entrepreneurial poor, to assist them to grow their
income
the low-income individuals in order to assist them to
grow their physical asset base

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-savings
•

Micro-savings based on the concept of wadi’ah
(safekeeping) in Islamic finance, which is the underlying
concept of savings account (deposits) in the formal banking
system

•

Micro-savings allow low-income individuals to secure capital
or profits realised in a savings account, thus enabling saving
and management of finances

•

Clients accumulate capital and profits in the micro-savings
account which allows them to plan for the repayment of any
micro-lending from which they might benefit

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Micro-takaful
•

Where members of a specified group of low-income
individuals mutually protect one another from risk through
collaborative takaful

•

The mutual risk transfer arrangement within the group will
ultimately benefit all members of the group plus dependants

•

Micro-takaful is relevant for certain risks that are beyond
the financial capacity of the members of the group
individually

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor
Table 9.1: Three Aspects Of Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

‘Microfinance’ and ‘Micro-credit’
The two terms are different in terms of meaning, scope and
application
•

‘Microfinance’ The whole range of small-scale financial
services provided for the benefit of the poor or low-income
individuals (micro-lending, micro-saving, and micro-takaful)

•

‘Micro-credit’ Small loans or financial assistance extended
to poor families practically excluded from formal financial
services (micro-credit is part of the parcel of microfinance)

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance
•

One major difference between conventional microfinance
and Islamic microfinance framework is prohibition of
interest-bearing credit facilities and interest-yielding
deposits

•

Modern conventional microfinance schemes dominated by
interest-based products that can further impoverish lowincome individuals

•

Likely impact of high interest rates on microfinance schemes
is counter-productive

•

High interest rates exclude low-income households unable to
afford micro-credit facilities

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

Islamic microfinance offers multiple sources of income through
partnership and entrepreneurial commercial activities between
the financial institution and the clients
Islamic approach to poverty alleviation is a holistic framework
that excludes counter-productive element e.g. riba and gharar
•

Interest rates violate fundamental basis of Islamic
commercial law regardless whether high or low, so are
prohibited
•

The prohibition of riba safeguards against financial
exploitation and oppression by the few rich
•

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Prohibition of Riba in Islamic Microfinance

The Islamic approach to the management of micro-credit
schemes is highly sensitive to clients who are unable to
redeem their loans within the contractual period:
-

be given additional time

-

in some extreme cases, the loans may be written off
completely

-

in some other extreme situations, remittal of credit
facilities may be considered

Learning Objective 1.1

Islamic Microfinance: Providing
Credit to the Entrepreneurial Poor

Box 9.1: Features of
Islamic Microfinance

Be familiar with the history
and basic components of
Islamic microfinance and
the benefits to society

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Modes of Islamic Microfinance
•

An Islamic microfinance institution adopts debt or equity
modes of finance for its financing requirements

•

The
-

debt-creating modes include:
qard hasan (benevolent loan)
murabahah (mark-up sale)
ijarah (lease contract)
salam (forward sale)
bai-bithaman ajil (deferred payment sales)

•

The
-

equity financing modes include:
mudarabah (trust partnership)
musharakah (joint venture partnership)
musaqah (share-cropping), etc.

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Most Commonly Used Modes of Islamic Microfinance:

•

Salam as a mode of financing agriculture

•

Mudarabah mode of combating unemployment

•

Bai Muajjal-Murabahah mode of providing working capital

•

Diminishing Partnership for Housing Microfinance

•

Non-for-Profit Modes of Islamic Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Salam as a Mode of Financing Agriculture
•

Salam regarded as the most viable tool for financing
agriculture

•

Salam a contract where the bank is the buyer of the
commodity and the farmer is the seller who undertakes to
embark on future delivery

•

Bai salam a contract where the seller undertakes to supply
specific goods to the buyer at a future date in exchange of
advance price which is fully paid on the spot

•

Parallel salam a separate contract distinct from the initial
bai salam where the Islamic bank is the seller of the
commodity based on deferred payment

•

The two contracts must be distinguishable from each other

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

The Applicability of the Salam Contract
•

•

Salam contract is used in Islamic commercial transactions
-

To meet liquidity needs of traders for import/export
business

-

To meet financial needs of small farmers

Salam contract is important in the financing of microfarming, small-scale farming where farmers require funding
to grow crops and feed their family up to the harvest time

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.1: Profits from Islamic Micro-credit Schemes
for Agriculture

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Mudarabah Financing for Combating Unemployment
•

Mudarabah is an Islamic finance contract where:
-

an Islamic bank as an investor exclusively provides
capital for a business project
an entrepreneur provides the management expertise

•

Mudarabah a trust partnership finance mechanism
structured as a tool to combat unemployment and create
jobs

•

Mudarabah can be a good product for entrepreneurial
activities, especially when there is a large amount of skilled
unemployed labour

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Types of Mudarabah Contractual Arrangements
The two types of Mudarabah contractual arrangements are:
•

Mudarabah al-Mutlaqah (Unrestricted Trust Financing):
where the particular business in which the microentrepreneur will invest the capital finance is not specified
or restricted

•

Mudarabah al-Muqayyadah (Restricted Trust Financing):
where the bank or Islamic microfinance institution (the
capital provider) specifies or restricts the business in which
the capital finance may be invested

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.2:
Mudarabah Model
of Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

Bai Muajjal or Bai-bithaman ajil (BBA) a sale where parties
agree to deferment of payment to a future date – meaning
that there is already an element of Murabahah

•

When Murabahah is combined with Bai Muajjal, it becomes a
microfinance product which is one of the most commonly
used instruments by the Islamic MFIs

•

The mark-up price in the Murabahah contract is settled as a
deferred payment based on Bai Muajjal

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Bai al-Mu’ajjal-Murabahah Model of Providing Working
Capital
•

The parties must know the cost price and the profit or markup in Murabahah transactions

•

In Bai Muajjal, cost price and the profit or mark-up is the
deferment of the payment of the price regardless of whether
the parties are aware of the cost and mark-up

•

The parties must fix price of commodity and the terms of
payment at the time of concluding the contract to prevent
any element of gharar in the contract

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.3: Bai al-Mu’ajjal-murabahah Model of
Microfinance

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
•

Housing microfinance is a means of providing shelter for
low-income individuals

•

A diminishing partnership is known as musharakah
mutanaqisah, an Islamic financial product structured to
strategically provide access to housing for the poorest

•

The Islamic MFI and the client form a partnership contract
where they purchase a property and lease it out for a
specified term

•

The client buys a specified number of units every month out
of the shares of the Islamic MFI which automatically
decreases the capital ownership of the MFI

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Diminishing Partnership for Housing Microfinance
The capital ownership of the Islamic MFI diminishes gradually
until the client buys the total capital share in the property (out
of the profit distributed over a period of time)
•

The title passes to the client and he/she owns the property

•

In situations where the poor clients do not have funds to buy a
small portion of the capital share, qard hasan, zakat or
waqf funds may be provided for such purpose
- If qard hasan is given, the client only needs to repay
the capital amount
- If it is a zakat or waqf grant, there is no need for repayment

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Non-for-Profit Modes of Islamic Microfinance
•

The non-for-profit modes of Islamic microfinance are
(i) zakat, (ii) waqf and (iii) qard hasan

•

Islam institutionalised a number of mechanisms including
zakat, waqf, qard hasan and sadaqah to ensure that wealth
circulates among all the members of the society between
the rich and the poor

•

A hybrid framework for these mechanisms will drastically
alleviate poverty in the society

•

Despite the non-for-profit nature of the hybrid model, it can
be easily modified to accommodate the profit-oriented
modes

Learning Objective 1.2

Islamic Microfinance Products

Identify key Islamic finance
products that have been
used for microfinance

Figure 9.4:
Model of
Islamic
Microfinanc
e using nonfor-profit
modes

Learning Objective 1.3

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

•

The revival of Islamic finance services in the 20th century in a
formalised form brought with it the Islamic microfinance
schemes

•

The Islamic finance products have been structured to suit the
requirements of the modern microenterprises and microcredit
schemes

•

There are a number of operational and functional differences
between the Islamic microfinance institutions and the
conventional MFIs

•

Islamic banking and finance, with its microfinance framework,
is inclusive in its approach to reach out to the disadvantaged
and poor and embed true social justice in society

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs

Sources of Fund:
•

The conventional MFIs get their funds from:
Interest-bearing loans
Foreign donors
Central Banks
Government

•

The Islamic MFIs get their funds (with the exception of
interest-bearing loans) from:
- Equity finance products applied in the finance of
microenterprises
- Islamic charitable sources such as waqf, zakat and sadaqah

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Modes of Financing
•

Conventional MFIs utilise interest-based modes of financing

•

Islamic MFIs utilise Islamic financial instruments which are
either equity-based or debt-based

•

Various financial instruments can be used to finance different
kinds of enterprises:
- A profit-sharing mode could be used for a microenterprise
where the microenterprenur and the MFI share the profit
- Salam and Parallel Salam may be more appropriate for
micro-farming

- Mudarabah trust financing may be utilised in order to
combat the curse of unemployment

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Financing the Poorest
•

The framework of the conventional MFIs completely
excludes the poorest from the microfinance net

•

Islamic microfinancing scheme ensures that no segment
of the population is excluded
- Zakat involves the provision of grants to the poor for
consumption
- Qard hasan involves the provision of benevolent loans
to the poor for their entrepreneurial needs
- The mechanism of zakat and sadaqah may be combined
with the microfinance activities to manage default of
repayment that might be occasion by extreme poverty

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Funds Transferred to Beneficiaries
•

In the conventional MFIs, once a loan has been
approved:
A part of the principal is deducted by the institution for
different funds
The beneficiary pays interest on the total amount
approved
The beneficiary may divert the funds to non-productive
means

•

Alternatively, the Islamic MFIs
-

Prevent the diversion of the funds to non-productive
means since no cash is handed out to the beneficiaries
Do not make any deductions

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Guarantee and Group Dynamics
•

In the conventional MFIs, the repayment of the loan
remains the sole responsibility of the borrower

•

In the Islamic MFIs, group guarantee in the repayment of
the loans takes the form of kafalah (guarantee)
-

Any of the group members can stand in as a guarantor
for the repayment of the loan

-

In the event of any default in the repayment of the
loan, the group members might agree to give such a
member qard hasan to pay his or her instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions

Objective of Targeting Women
•

The conventional MFIs consider women seeking
microcredit as a means of women empowerment
Recent research suggests that:
- Men more often encourage women to take credit facilities
- Men spend the borrowed money while the women are
held responsible for the repayment of the instalments
since they got the credit facilities

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Major Differences between Islamic MFIs and
Conventional MFIs
•

In the Islamic MFIs
-

The objective of targeting women differs from that of
the conventional MFIs

-

The target group is the family

-

Women and their spouses are made to sign the
contract as the target is the family and not the
women alone

-

Both parties are liable for the repayment of the
instalments

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Work Incentives of Staff Members
•

The work incentive of the staff of the conventional MFIs is
mainly monetary gains from salary

•

The work incentives of the staff of Islamic MFIs are both
monetary and religious
-

In addition to earning a living, the staffs of Islamic MFIs
also perform a socio-religious duty of alleviating poverty
within the society

-

Such an incentive gives the staff more zeal to work
efficiently towards the realization of the vision of the
Islamic MFIs

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Social Development Programme
•

The Social Development Programme of the conventional
MFIs is secular and in some cases goes against the ideals of
Islam

•

The Islamic MFIs put in place a social development
programme where the ethical, social, behavioural aspects of
Islamic ideals are brought to the fore
-

The Islamic MFIs programme helps in promoting the
idea of brotherhood and partnership among
beneficiaries who are morally compelled to repay their
instalments regularly as at when due

Islamic Microfinance Institutions
versus Conventional Microfinance
Institutions

Learning Objective 1.3
Understand the differences
between Islamic
microfinance institutions
and conventional
microfinance institutions.

Dealing with Default
•

In the conventional MFIs
-

•

Group and centre pressure used to deal with arrears
and default
In the event that this pressure does not work, the MFIs
result to threats and sale of assets

The Islamic MFIs have more sustainable and reasonable
ways to deal with defaults and arrears

-

Members in a group guarantee one another through
kafalah (spirit of brotherhood)
The group may provide qard hasan to defaulting
member which may be used to settle the arrears
Members will do their utmost to pay back their loans in
order to fulfil their religious obligations

Learning Objective 1.4

Notable Islamic Microfinance
Institutions

Be familiar with the major
Islamic microfinance
institutions in the modern
world.

•

The Islamic microfinance industry is growing at a fast pace
in Muslim-dominated communities across the world

•

While some of the Islamic MFIs are developmental
institutions, others specifically target poor Muslim
communities

•

Four Islamic microfinance institutions are selected in four
different countries for case studies
-

Akhuwat in Pakistan

-

Hodeidah Microfinance Programme in Yemen

-

Islami Bank Bangladesh Limited

-

Amanah Ikhtiar Malaysia

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Two schools of thought regarding the financing of
microenterprises:
•

The first school believes that financing microenterprises is
part of the Corporate Social Responsibility (CSR) role of the
Islamic banks and financial institutions

•

The second school believes that financing microenterprises
requires designated MFIs

The sources of credit facilities:
•

The institutional sources are the corporate financial
entities such as banks and cooperatives

•

The non-institutional sources include credit facilities from
money lenders, friends, and family members

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale
•

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

In practice, institutional sources of credit exclude the
microenterprenurs from formal financial services because:
1.

Microentrepreneurs are unable to provide the
demanding physical collateral for such loans

2.

Microenterprises are considered ‘high risk’ business
entities because of the high rate of failure among young
small business

3.

Extending credit facilities to microenterprises is
considered uneconomical due to the high running cost
involved per unit of credit

On the other hand, interest rates for non-institutional loans
(i.e. money lenders) are too excessive for the condition of the
low-income individuals

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Financing Microenterprises by Islamic Banks: The
Emergence of MFIs
The establishment of MFIs has introduced a new concept of
banking, lending and financing for microenterprises
•

Grameen Bank is one of the pioneering MFIs that provided
the entrepreneurial poor an opportunity to get access to credit
facilities without the formal requirement of physical collateral
•

Grameen-Jameel was launched in 2003 through a jointventure between Bangladeshi Grameen Foundation and the
Saudi Arabian Abdul Latif Jameel Group
•

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

•

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Grameen-Jameel has formed strategic partnership with MFIs
in the Middle East and North African (MENA) countries by
increasing their capacity through the provision of:
-

Financial support

-

Technical assistance

-

Training

-

Access to best practices in the field

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Traditional role of Islamic banks and financial institutions
include:
-

accepting deposits

-

managing savings and current accounts

-

engaging in partnership financing

•

Islamic banks and financial institutions also assume social
function which is an aspect that relates to modern CSR roles

•

The social benefits of Islamic banking and finance are
extended to provide credit facilities to low-income
individuals who are excluded from the conventional banking
facilities

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

Role of Islamic Banks in Financing Micro-enterprises
•

Financing small and medium enterprises (SMEs) is
considered as a means to alleviate poverty, derivable from
the banks and financial institutions

•

Islamic banks and financial institutions are expected to:
-

Establish a department/division of the bank dedicated
to Islamic microfinance

-

Alternatively, a subsidiary of such an Islamic bank may
be established to carry out microfinance functions

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

The Social Role of Islamic Bank
•

Imperative that Islamic banks establish, manage and
consolidate the microfinance institutions to fulfil their social
role

•

Concept of fair dealing and justice in financial matters
compels Islamic banks to reach out for all classes of people
in the society

•

There are no separate banks for the rich and others for the
poor

•

The social dimension of the objectives of Islamic banks is
the promotion and support of (SMEs)

Learning Objective 1.5

Financing Micro-enterprises by
Islamic Banks: Rationale

Understand the corporate
social responsibility role of
Islamic banks in financing
micro-enterprises.

•

SMEs which are viable means of combating poverty through
the creation of employment opportunities

•

Extension of credit facilities to the poor leads to more
equitable distribution of wealth amongst members of society

•

Islamic banks or financial institutions may either establish a
subsidiary or create departments to administer microfinance
function and extend credit to low-income individuals

Key Terms and Concepts

•

Bai al-salam

•

Micro-lending

•

bai al-mu’ajjal

•

Micro-savings

•

Corporate social
responsibility (CSR)

•

Micro-takaful

•

Microfinance

•

Microfinance institutions
(MFIs)

•

Entrepreneurial poor

•

Financial exclusion

•

Informal savings club

•

Mudarabah

•

Kafalah

•

Mudarabah al-muqayyadah

•

Micro-farming

•

Mudarabah al-mutlaqah

•

Micro-credit

•

Musharakah Mmutanaqisah

Key Terms and Concepts

•

Muzakki

•

Parallel salam

•

Qard hasan

•

Riba

•

Sadaqah

•

Takaful

•

Wadi’ah

•

Waqf

•

Zakat