ISLAMIC MICROFINANCE : OPPORTUNITIES AND CONSTRAINTS
I- Genesis of Microfinance
CGAP2 (Consultative Group to Assist the Poor), the world’s largest think tank concerned with the advancement of microfinance and located at World Bank Headquarters in Washington, has defined microfinance as “the provision of a set of financial products to all those excluded from the formal or conventional financial system.”
It is true that Humanity has experienced over time various forms of microcredit, which were used informally under pressure from differences between social classes as well as for solidarity purposes.
The rich man has always helped his poor neighbor by offering him different means of survival (money, food, clothing, supplies…). The poor classes have always found a way to set up solidarity circles for the collection of money or goods in order to provide for the mutual needs of each other’s members of said solidarity circles: there is talk of “tontines” in West Africa, of “tandas” in Mexico, of “tandas” in ‘cheetu’ in Sri Lanka, ‘arisan’ in Indonesia or ‘Jamiia جمعية’ in Egypt.
However, the real emergence of microcredit in its contemporary form comes unequivocally from Professor Muhammed Yunus whose central idea was to reverse the logic of loan based on guarantee, in funds to place solidarity at the center of credit and proclaim the right of the poor to bank loans.
After several informal attempts, Dr. Yunus founded Grameen Bank in the 1970s in Bangladesh to begin the first modern experiment in entrepreneurial response to the banking exclusion of the poorest. Grameen Bank’s approach is that the loan is granted to an individual, usually a woman, if he or she is part of a group of 4 or 5 people, who undertake to assist the borrower in managing the loan. The rapid achievement of strong results, with repayment rates close to 97%, allowed the Grameen bank model to be exported worldwide.
The year 2005 was proclaimed by the UN as the International Year of Microcredit and in 2006, Muhammed Yunus – the pioneer of microfinance – received the Nobel Peace Prize together with Grameen Bank.
Like conventional microfinance, Islamic microfinance is essential to fill the gap left by banking institutions when it comes to financing excluded populations and very small businesses.
II- Foundations and principles of Islamic microfinance
Islamic microfinance is inspired by the same source as Islamic finance. Although they do not have the same target, the two concepts complement and converge in terms of foundations and principles based on the precepts of the Koran and the Shariah.
The Sira Nabaouia (behavior of the prophet) is full of examples encouraging the individual to create and develop small projects instead of giving alms.
The Qur’an also encourages investment through small grants and encourages formalization regardless of their importance “… Do not tire of writing the debt and its term, whether it is small or large, it is more equitable with Allah and more right for the witness and more likely to dispel doubts. But if it is a present commodity that you are negotiating with each other, then there is no sin in not writing it.” Albakarah 282
Thus, the principles of Islamic microfinance are the same as those that we find in Islamic finance:
- The ban on interest-bearing loans (Riba)
In accordance with the Shariaa, which prohibits making any return on financial transactions (interest), Islamic microfinance products have a fixed repayment rate with no possibility of making a profit on the interest rate.
- Prohibition of illicit assets and activities
Islamic microfinance has an obligation of social responsibility. Thus, certain sectors of activity, prohibited from the ethical point of view and the Sharia, are excluded from the funding. This is the case with gambling, tobacco, alcohol, pig breeding, arms and pornography.
- The existence of an underlying asset
Islam perceives money as an instrument for creating value and facilitating trade which cannot be exchanged. The role attributed to money in Islam is indeed clearly explained as a potential capital that can only become real after association with another resource, in this case work and effort, with the aim of creating productive activity. It is merely a means of exchange, without any intrinsic usefulness. The prohibition on the trade in money therefore rules out any profit from a purely financial transaction. This is why it cannot be bought and sold as a product, and the value of non-asset-backed money cannot increase over time.
- The prohibition of uncertainty (GHAHAR) and speculation (MAYSIR)
Risk taking is not forbidden in Islam, on the contrary, it is even encouraged because, in addition to the commercial margin and in the absence of interest rates, it is the only recognized source of profitability. Uncertainty or asymmetry in the terms of a contract is, however, prohibited as they are a source of speculation. It is thus prohibited to buy or sell a good whose price or characteristics would be defined later.
- Profit and loss sharing (3P)
By sharing risk between investors and clients, Islamic microfinance becomes more attractive to borrowers who will not assume all the risk alone, as in many conventional products.
These principles underpin the financial engineering efforts that Islamic Microfinance (IMF) is called upon to carry out on an ongoing basis. If, for example, conventional microfinance finds its success in the margin loan that it offers to its clients, the MFI can under no circumstances lend money with a counterparty whatever its nature at the risk of falling into the Riba. As this constraint is one of the most important obstacles to the development of Islamic microfinance, it is therefore incumbent on financial engineers to seek solutions such as Mourabaha and Salam from charistic sources and the jurisprudence of lawyers (FOKAHA’A).
The principles of tangibility and profit and loss sharing (3P) are behind the design of innovative products that mark the distinction of Islamic microfinance such as Mudharaba, Mucharaka, Ijara and Istissna’a
On another level and without any hindrance to the above principles, Islamic microfinance has proved to be well able to develop other services tailored to the needs of small traders and professionals excluded from conventional finance, such as micro-insurance through Takaful and micro-savings through participatory deposits.
As a still emerging field, based on perpetual financial engineering, the researchers designed triangular financing involving an Islamic MFI, a client and a provider simultaneously to ensure the tangibility of microcredit on the one hand and to reduce counterparty risks on the other. This approach has boosted agricultural value-chain projects where it has been applied.
Islamic Microfinance Vs Conventional Microfinance
|Conventional Microfinance||Islamic Microfinance|
Interest free loan: kardh hassen
Salem : campaign credit, advance on goods with profit margin
|Working capital / stock financing||Mourabaha- Triangular Mourabaha|
|Joint venture investments: rarely practiced||
Mudharaba with risk taking
No interest but risk sharing for a declining Musharaka
|Micro-insurance||Micro – Takaful|
|Rescheduling with interest||Unrequited rescheduling except Ijara|
Variable interest rate
Fixed rate over the duration of the financing
|Fixed rate over the duration of the financing|
III- The Rise of Islamic Microfinance
These excesses created an opportunity for Islamic microfinance institutions to take the lead. Indeed, Islamic MFIs should Islamic microfinance has undergone remarkable development in recent years for a variety of reasons both exogenous and endogenous
Observers agree that conventional microfinance presents, under performance constraints, a risk of drift from the principles of its emergence. Indeed, viewed as a means of combating poverty in developing countries, through the financing of income-generating activities for poor households, conventional MFIs are often called into question and one wonders about the population actually affected as well as about the difficult reconciliation between both social objectives and MFI sustainability objectives.
In several cases, prioritization of financial performance has led these MFIs to take a selective approach to the wealthiest clients at the expense of the poorest. Better still, in some countries, credit rates are being applied at levels close to those of usury, which can in no way be beneficial to the poor. Subhabrata and Laurel (2016) found that, instead of improving the incomes of disadvantaged populations, conventional microfinance had the effect of further worsening the situation of the poor by increasing their income debt level.
At the same time, benefit from the proper adaptation of their products to the needs of the poor, and at the same time exploit the strong potential for expansion offered by a large proportion of the population of Muslim-majority countries that refuse conventional financial services.
According to World Bank Group’s 2017 Report, only 14% of the world’s 1.6 billion Muslims rely on banks.
The Kardh hassen, the fixed rate and zero-rate rescheduling are major and attractive assets that make Islamic microfinance a strong lever for fighting poverty and encouraging inclusion.
This means that Islamic microfinance seems to better safeguard the principles and rationale of microfinance in general, principles that traditional MFIs seem to abandon because of a lack of a perfect balance between the objective of profitability and that of ensuring the well-being of clients belonging to low socio-economic classes.
True to the principles of Islamic finance and enjoying the above-mentioned advantages, Islamic microfinance, despite its recent appearance, has been able to take a place in the international financial landscape.
In 2013, Islamic microfinance accounted for less than 1% of global microfinance transactions. It occupies a tiny place in the global microfinance landscape, but has tended to grow for several years. According to a study by CGAP, almost a third of MFIs report having launched Islamic microfinance activities in the period 2013-2018.
Geographically, 64 per cent of institutions that provide Islamic microfinance products are located in East Asia and the Pacific, and 28 per cent in the Middle East and North Africa. Islamic microfinance affects 1.28 million clients in 19 countries, with the majority in Bangladesh, Sudan and Indonesia.
Islamic microfinance seems to be an incubator for the socio-economic development of the African continent. Moreover, according to a study by the World Bank Group (2017), Islamic finance can contribute to economic development, given its direct link with physical assets and the real economy.
IV - Weaknesses and Barriers
However, Islamic microfinance has a number of inherent obstacles to its development:
- The Mudharaba product, which assumes that the Islamic MFI shares risks with the beneficiary, requires the beneficiary to be transparent about profits and losses. This can generate high operating costs for micro-entrepreneurs who then have to keep formal accounts.
- Some of Mourabaha’s bad practices have led to numerous controversies targeting Islamic microfinance, accusing it of disguising conventional interest loans.
- The cumbersome administrative procedures associated with the charistic requirements for the release of funds constitute a major obstacle that financial engineers and researchers must address by introducing electronic means of payment by promoting the digitalization of processes.