Micro, small and medium enterprises (MSMEs) referred to
as the “backbone of the economy” due to their significant
contribution in employment creation and national GDP,
continue to face severe difficulties in accessing credit from
the banking system. Mainstream financial intermediaries
often view them as inadequately capitalized, lacking in
collateral, led by inexperienced management or operators
and thus too risky to provide credit. In cases where credit is
offered, it comes with a high cost to MSMEs.
Due to shortfalls in the banking system, government and
non-government entities have taken initiatives to support
the development and growth of MSMEs. One area of such
support is access to credit as collateral seems to be the
only barrier. This is achieved through the establishment of
a Credit Guarantee Scheme (CGS). It is estimated that there
are over 2,000 CGS in almost 100 countries, as reported by
the World Bank.
Role and Benefits of Credit Guarantee Scheme
CGS acts as a third-party intermediary risk sharer and
facilitator between a bank and MSME seeking financing.
According to the World Bank, ‘CGS provides third-party
credit risk mitigation to lenders (financiers) through the
absorption of a portion of lender’s losses on the loans (credit
facilities) made to SMEs in case of a default, typically in
return for a fee.’
CGS has shown enormous potential to positively contribute
towards increasing access to credit for MSMEs especially in
a professional (non-politicised) institutional environment.
However, CGS has been criticised on several counts such
as higher costs of credit due to the guaranteeing party’s
administration costs, increased danger of moral hazard
and turn-around time, being subsidy-dependent, and the
weakening of credit discipline.
Shari’a Concerns on existing Credit Guarantee Schemes
CGS is not only important for MSMEs to access finance,
but also to issuers of Islamic bonds (sukuk). According
to Reuters, the demand for credit guarantee is gaining
attraction for the issuers of sukuk in markets where credit
and political risks pose a greater challenge. For example, the
Danajamin Nasional Berhad in Malaysia, GuarantCo and the
Britain export credit agency have at different times issued a
guarantee to facilitate Islamic bonds, particularly corporate sukuk.
But were these Shari’a-compliant guarantees? What are the
Shari’a concerns associated with the conventional credit
guarantee schemes? In order to understand the Shari’a
concerns, we have to examine the designs and associated
elements of CGS. While most designs take into account
several elements, below are only three of them.
- Risk Sharing: While there are some CGSs that provide
100% coverage, majority provides guarantee coverage
in the range between 60% and 80%, so that the credit
risk is shared between the financier, customer and
guarantor. This partial coverage is highly recommended
as it limits moral hazards from the financier and the
customer. However, there are Shari’a concerns with
regards to the terms of contractual agreement designed
to achieve this. Existing guarantees have been drafted
conventionally by observing only the country’s laws
rather than the Shari’a requirements. Thus, unless the
agreement is crafted by avoiding invalidating factors
of a contract from a Shari’a perspective, the whole
guarantee design will not be suitable for Islamic financial
institutions or issuers of sukuk.
- Fees: In order to meet administrative costs and
become sustainable, CGS usually charge specific fees.
While the fees can differ from one CGS to another,
a registration fee for processing the application is
a common requirement. According to a discussion
paper on CGS published by OECD, the fee is 1%
of the loan amount in Europe and other developing
countries. Other fees might include an annual or per
loan fee of 1% to 2% as well as membership fees.
These fees are largely paid by borrowers and a portion
by financial institutions receiving the guarantees.
Charging fees to customers for the guarantees is
deemed impermissible in classical Shari’a schools of
thought. However, there are divergent opinions among
contemporary Shari’a scholars on charging fees due
to the commercial nature in which these guarantees
are requested by the beneficiary. However, some
scholars don’t allow them, while others allow some of
these fees with certain restrictions and modifications.
Thus, unless the types of fees and the manner in
which they are imposed are thoroughly evaluated and
modified, participation in CGS with above fees becomes
repugnant to Shari’a.
- Risk management: Majority of CGS use risk management
tools such as reinsurance, loan sales or portfolio
securitization. While Shari’a recognises the need to
manage risks, the above mechanisms are problematic in
Shari’a. Thus, risk management mechanisms should also
consider Shari’a-compliant requirements.
Three models can be considered to structure CGS that satisfy the Shari’a requirements.
- Takaful Insurance Model. At the corporate level, this
model was adopted by the Islamic Corporation for
Insurance of Investment and Export Credit (ICIEC). It can
also be in the form of mutual credit guarantee whereby
associations, groups or individuals come together in
order to assist each other in the provision of guarantee
to fellow members.
- Islamic Social Finance Model. Islamic social finance
contracts are employed to design the scheme. This
ranges from using sadaqa or waqf or a combination of
- Partnership Model. This involves a guarantor partnering
with Islamic financial institution to share profit or loss
from financing MSME clients.
In conclusion, CGS is becoming popular in both Muslim and
non-Muslim countries and are thus beneficial to various
business segments that lack access to finance due to a lack
of collaterals or political risks, among others. Unfortunately,
the conventional CGS fall short to attract partnerships with
Islamic financial institutions due to the Shari’a concerns
highlighted above. To resolve these concerns, we must pay
attention to CGS designs and its elements, and adopt or
design appropriate Shari’a-compliant models.