Finance & Banking

ISLAMIC MICROFINANCE AND FINANCIAL INCLUSION MUFTI ISMAIL EBRAHIM DESAI CEO AND CHAIRMAN OF GLOBAL ISLAMIC FINANCIAL SERVICES FIRM, SOUTH AFRICA

Significant segments of population are
disadvantaged in Muslim countries,
particularly in Central Asia, Sub-Sahara
Africa and the MENA region. They have
no proper access to formal banking –
conventional or Islamic. Banks, in particular, are not
strategically focused on reaching out to the needy.
Private and foreign financial institutions or banks
seek to maximise profits for their shareholders/
stakeholders by building businesses in relatively
easier urban areas. Rural infrastructure projects,
microfinance and rural development are generally
left only to public sector institutions because of the
assumed high risk that is associated with lending
and financing micro enterprises.

Given the rate of high poverty among the lowincome groups and the unavailability of adequate collateral, financing these groups is normally associated with greater risk as reflected in the banks’ high non-performing loans in some countries like Egypt and Morocco.

In this background, Islamic microfinance may be
used as a tool for financial inclusion and poverty
alleviation in both Muslim and non-Muslim countries.
Its significance is paramount, as it can be a means
for propagation of Islam, although admittedly Islamic
banking and finance has been careful in aligning
itself to any non-financial objectives. Having said
that, Islamic microfinance can be used to portray
economic and financial values of Islam. Irrespective
of the ultimate objectives, Islamic microfinance can
provide finance to the poor or the people with good
expertise without any start-up capital.

EMPOWERING THROUGH ISLAMIC MICROFINANCE

Islamic microfinance is based on sound Islamic
financial and economic principles. Islam encourages
self-employment and empowerment rather than
just donating money and food to the needy for
consumption. Providing tools for production to
the poor is better than donation of consumable
charity. Through this, the self-employed poor
can be empowered to care for themselves and
their families on a sustainable basis. There is a
definite synergy between this thinking and that of
contemporary multilateral institutions (e.g. United
Nations Development Programme and the World
Bank), which also recognize microfinance as a
means of eradicating inequality and poverty. Islamic
microfinance has great relevance to the Sustainable
Development Goals (SDGs) – an important
development agenda being pursued by an increasing
number of countries around the world.

ISLAMIC MICROFINANCE TARGETS THE VERY POOR WHO ARE CAPABLE OF WORKING IN THE PRODUCTION OF GOODS OR SERVICES.

Islam offers various means for eradicating income
inequality, such as through zakat (compulsory
charity) and sadaqa (general giving), given directly
to the poor to solve their urgent needs. Hence,
Islamic microfinance targets the very poor who are
capable of working in the production of goods or
services. Consequently, while zakat should be paid
only to specific people, Islamic microfinance has a
bigger scope. It can be used to mitigate negative
impact of high unemployment among the youth in
poor geographies.

As the below figure suggests, the rate of
unemployment is skyrocketing, especially among
the Muslim youth. The story is not grossly different
in other poor countries with significant non-Muslim
populations. In such countries, Islamic microfinance
can be used to finance Small and Medium-sized
Enterprises (SMEs). This could lead to a solution
to hyper unemployment and the challenges facing
SMEs in accessing suitable finance. The Sudanese
and Pakistani experiences have shown that
Islamic microfinance has had a positive impact on
income generating activities. In addition, Islamic
microfinance has also been used to finance
graduate students as part of a programme targeting
the unemployed youth in Sudan.

Despite the positive impact of Islamic microfinance in many Muslim countries, conventional lenders
still dominate the market. Most of the Islamic microfinance lenders are small and face greater challenges
in reaching out to their customers and expanding their businesses. These challenges include lack of basic
infrastructure, rudimentary financial infrastructures, and far and unreachable markets. It has negatively
impacted accessibility of Islamic microfinance and has indeed contributed to the cost of finance.

Other challenge facing Islamic microfinance in Muslim countries is the riskiness of financing poor
borrowers. This stems from the small size of their finances, the remote residential areas of the poor from
the urban cities, and their uncollateralized risk. In addition, many Muslims countries have only recently
recognized the importance of microfinance as a tool of empowering the low-income, reducing the problem
of unemployment, and elevating poverty.

Weakness of Islamic microfinance infrastructure owes to the following:

Limited spread of Islamic financial institutions;

• Lack of relevant financial regulations;

• Unavailability of popular Islamic microfinance agencies; and

• Ineffectiveness of microfinance as a whole.

A step towards making Islamic microfinance effective in the
context of Islamic banking and finance is to increase the share
of this type of business from merely 1% to about 5% in the next
three to five years

For this to happen a strategic approach towards
Islamic microfinance must be delineated. Although
the countries like Bangladesh are recognised for the
provision of microfinance, other models, especially
in Malaysia and Pakistan, must also be considered.

The World Bank plans to end extreme poverty by
end of 2030. Some empirical evidence has shown
that people in the poorest regions of rural Africa
can lift themselves out of extreme poverty in just
five years. Thus, this can become a reality if proper
means and tools of microfinance exist. This will
facilitate the particular needs of the poorest, if their
diversity is considered. Diversification of the Islamic
microfinance products may represent the right
intervention for achieving better financial inclusion
among the poorest in Muslim communities.

THE READINESS OF ISLAMIC MICROFINANCE
Islamic microfinance can be effective for creating
hope not only for the poor and those above the
poverty line as shown by traditional microfinance.
In this respect, the unique needs of extremely poor
Muslims who opted out of traditional microfinance
must not be ignored. The primary reason for many
deserving Muslims to voluntarily exclude from
microfinance is the incidence of interest. Other
reasons for exclusion are purely economic in nature,
as many of the potential users of microfinance
refrain from it because they believe that they would
not be able to pay back loans – the affordability
trap. This has something to do with the risk appetite
of such individuals and families.

Islam does not differentiate between the poor
based on the conventional notion of poverty.
Rather it divides the poor into two main categories:
fuqara (singular faqeer) and masakeen (singular
miskeen). Fuqara are those who do not have enough
substances to satisfy their basic needs for one day,while masakeen are the people that do not have
enough substances to satisfy their basic needs for
the whole year. While fuqara may be offered help
from zakat, the masakeen may also be helped from
other sources of sadaqa. In other words, different
solutions may be delineated for different segments,
based on their peculiar conditions.
In this way, Islamic microfinance must move
beyond its conventional counterpart to achieve
better and more effective social and financial
inclusion. Islamic microfinance is also expected to
be more ethical, as it focuses on social responsibility,
in addition to profit maximization. It is ethical in two
ways: in the choice of the recipient of funds, and
in terms of leniency it shows towards those who
cannot afford to pay at all or delay. This is in line
with Quranic injunction of:

And if someone is in
hardship, then [let there be]
postponement until [a time
of] ease. But if you give [from
your right as] charity, then it
is better for you, if you only
knew. [Holy Quran, 2:280].

Despite being an excellent tool for poverty
alleviation and financial inclusion, conventional
microfinance has not fully succeeded in the
Muslim countries. As stated earlier, the failure
of microfinance therein is not necessarily due to
inherent inefficiency of the conventional model but
it is primarily due to the attitude of Muslims towards
interest. Islamic microfinance, based on interest-free
loans, zakat, sadaqa and waqf, is relevant to global
efforts for poverty alleviation. Islam provides tools
that are universal, and if used strategically, they will
bring benefits to all, irrespective of their religious
beliefs.

Islam recognises the right of the poor in the
wealth of the rich Muslims in the form of zakat.
When this is combined with the prohibition of
interest, this gives rise to a universally relevant
model of microfinance. Furthermore, sale contracts
(salam and istasna’, etc.), profit and risk sharing
arrangements like murabaha, musharaka and
muzara’a (sharecropping), and ijara can also be used
to address the diverse business needs of the poor
who look for SME financing

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