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Creating an Islamic Microfinance Model - The Missing
Dimension
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This admission gives credence to the growing movement to promote
socially responsible/ethical ventures - both large and small. But given this
emphasis where is Islamic finance in the world of microfinance? Missing the point of economic development Most economic development projects
focus on grandiose infrastructure or industrial projects. While jobs are a
necessary outcome the process of empowering individual producers to become
economically self sufficient is usually not a part of the equation. In the process we end up
with large ventures that may provide jobs to thousands in the local
population but only tangentially. In other words, an oil refinery which
requires skilled labour will only hire workers that have experience or that
have the capacity to be trained for work in the refinery. Or we give people their fish but
don’t teach them to fish themselves. What is Microfinance? Microfinance
is usually defined as the provision of financial services and products to
those whose low economic standing excludes them from conventional financial
institutions or programs. These can include microcredit,
small scale venture capital, savings, and some forms insurance. Access to
each of these services is provided on a micro-scale allowing those with
severely limited financial means to participate. Theoretically, the main point of
departure for microfinance from conventional credit/finance systems comes
from the concept of joint liability. In this concept a group of individuals form an
association to apply for financing. Members of these small groups are trained
regarding the basic elements of the financing and the requirements they will
have to fulfil in order to continue to have access to funding. Financings are disbursed to
individuals within the group after they are approved by other members in the
group. Repayment of the financing (a loan in this example) is a joint
responsibility on all of the group’s members. In other words they share the risk.
If one defaults, the entire group’s members suffer. It’s a rudimentary but
effective credit scoring mechanism that may mean a temporary suspension from
the program and therefore no access to financing for the group or other
penalties. In most
cases, microfinance programs are structured to give credit up to a maximum
amount and require repayment within a short time period – usually a few weeks
or at most a few months. How Microfinance changed development When
the first modern microfinance experiments were being conducted in the 1960s
and 1970s, the dominant development programs focused on a particular aspect
toward which donor resources could be directed. For example, a farmer needing
seeds to plant for produce was given seeds for cash crops or he was given
loans at interest rates below market to lessen the financial burden of
repayment. But what was not happening was the grass roots support of people
who aspired to be self sufficient but did not have a ready business idea or
skill/craft. What
Dr. Muhammad Yunus of This
effort gave individuals and families the financial fuel they needed to stand
on their own feet without the repressive burden of repaying moneylenders
beyond their means. Borrowers used loan proceeds to buy raw materials to
manufacture products for sale in the market; purchase livestock to sell
milk/eggs; or open small shops.
The
World Bank now estimates that there are over 7000 microfinance institutions,
serving some 16 million poor people in developing countries. The total cash
turnover of MFIs world-wide is estimated at US$2.5
billion and the potential for new growth is outstanding. The Microcredit Summit estimates that US$21.6 billion is
needed to provide microfinance to 100 million of the world's poorest
families. Other
estimates tell us that worldwide, there are 13 million microcredit borrowers,
with USD 7 billion in outstanding loans, and generating repayment rates of 97
percent; growing at a rate of 30 percent annual growth. Despite all this less
than 18% of the world’s poorest households have access to financial
services (Grameen Foundation Similarities between IF and Microfinance So
we now return to where we started – where is Islamic finance in the world of
microfinance? If Islamic finance is growing so rapidly all over the world why
don’t we hear about it more in microfinance circles? After all, both systems advocate
entrepreneurship and risk taking through partnership finance. They are
also forms of finance which represent unconventional solutions to financial
needs, focusing on cash-poor but promising business activities. And most
importantly, both Islamic finance and microfinance theoretically start from
egalitarian approaches as they are open to all customers with different and
sometimes coinciding needs without setting any apparent restriction to
different categories of clientele. But
it’s interesting to note that Islamic Finance principles are still not widely
adopted by conventional microfinance and microcredit
institutions. According to Dr. Abbas Mirakhor, Executive Director of the IMF: "[An]
important function of Islamic finance that is seldom noted … is the ability of Islamic
finance to provide the vehicle for financial and economic empowerment … to
convert dead capital into income generating assets to
financially and economically empower the poor..." Of
note in this regard is a theoretical framework for a mudarabah
based microfinance program which was advanced by Atif
Raza in the Summer 2005 issue of Islamica Magazine. (see related links) Why this state of affairs? Why
has Islamic finance not been seen more widely in the micro-finance field? According
to Mayadeh al-Zoghbi, a
microfinance professional ??, Islamic finance principles are difficult to implement
on a profit and loss sharing basis in rural settings. They require
long-term involvement by the microfinance institutions (MFI) in the form of
technical/business assistance which raises the cost of implementation. In
addition, there is too much uncertainty in profit/loss sharing models for MFIs to be able to understand and predict their present
and future cash flows. Therefore, in microfinance too, as in the world of
high finance, Islamic
debt and leasing instruments dominate. For
example, the Hodeida Microfinance Programme in • a
well-defined contract exists, with pre-defined amounts According
to the United Nations Human Settlements Programme (UN Habitat), “Microfinance
services, including some compliant with Islamic law (Shari’ah) in the Arab
region, tend to be limited to credit for enterprise... The most commonly used
Islamic transaction is one in which the MFI [microfinance institution]
purchases goods at the request of the 'borrower' and then sells the goods to
the 'borrower' for a fee to cover administrative costs, with repayments in
instalments (Murabaha).” My
conversations with Ms. Al-Zoghbi and other
microfinance professionals yielded few results for MFIs
using Islamic finance. In fact, in addition to the Hodeida Programme in Bridging the Gaps In
many ways, the world of microfinance has followed the conventional world in
its use of Islamic debt based instruments to limit risk while being able to
more easily anticipate returns. While
on the surface this is understandable, the curious part of the puzzle is that
microfinance is already more structurally aligned to applying Islamic equity
financing structures. As mentioned previously, microfinance programs are
based on group sharing of risk and personal guarantee while maintenance of
trust and honesty is tied to the availability of future funds. This
model should allow for the inclusion of a Musharaka
based model, or in the least, a model of collective guarantee. MFIs which look to implement Islamic finance in their
programs can also develop Mudarabah based programs
on the contours proposed by Atif Raza Khan in a Summer 2005 issue of Islamica
Magazine. In short, MFIs can find Islamic finance a
natural fit in their programs – both debt and equity based. |
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