2006-11-21 03:58:48 UTC
By Sajjad Chowdhry,
Posted on Nov 18, 2006
The recent awarding of the Nobel Peace Prize to Dr. Muhammad Yunus and
the Grameen Bank of Bangladesh highlights a new awareness of the potential
and power of microfinance programs. What's more, the Nobel committee has
validated the link between poverty alleviation and peace saying, "Lasting
peace can not be achieved unless large population groups find ways in which
to break out of poverty."
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
What Dr. Muhammad Yunus of Bangladesh started in the mid to late 1970s was
to focus on people who generally did not have the means to fund a new
business or craft. Inspired by the terrible Bangladesh famine of 1974, he
made a loan of $27 to a group of 42 families enabling them to create small
items for sale without the heavy burdens of repaying moneylenders who
charged exorbitant rates of interest.
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.
Rice-husking: a popular business with Grameen Bank borrowers. Image:
7000 Micro-Finance Institutes serving 16 million poor people - World
Total Turnover for MFI's estimated $2.5-$7 billion. Repayment Rates of
US$ 21.6 Billion needed to provide microfinance to 100 million of the
world's poorest families
- Microcredit Summit estimate
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 USA).
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
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 Yemen based its
endeavours on a Murabaha model citing its ease of use. A case study of the
program cited that the use of Murabaha "eliminates the need for written
records, often unavailable at the micro enterprise level or if available (20
percent of HMFP clients keep books), the client may be unwilling to share
them." Other reasons to prefer Murabaha over equity based financing methods
. a well-defined contract exists, with pre-defined amounts
. there is no opportunity for abuse on the part of the client through
inaccurate or false record-keeping. i.e. falsely claiming losses where there
. a fixed contract creates a less complicated process and a lower
implementation cost to the institution
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 Yemen the only other bona fide attempts at applying
Islamic finance to microfinance were limited to Akhuwat in Pakistan and the
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
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.