Islamic microfinance

Under red hot sun in the month of June, a 7-year old child was sitting outside my house playing with something. He was looking unaware of the intensity of the heat. On asking, what he was doing, the child replied that her mother is working in the next door house and he is waiting for her. Like this incident, one can see a crippled person sitting in front of petrol Pump near Malir Halt, Karachi looking for every passing by car for some help. These are two examples but our country is full of these. By a rough estimate, 40-50 per cent population of Pakistan lives under the poverty line i.e. with $ 1.5-2.0 daily for their livelihood. Minimum wage has set this standard as Rs 6,500 i.e. not for a person but for a family on monthly basis.

The dilemma in Pakistan is that instead of looking into ground realities, the bureaucrats sitting in Islamabad are still banking on figures that show declining trend of poverty in the country. The advisors and other notable persons in the previous regime were advocating that trickle down effect of growth would soon dent the poverty factor. But like Chicago Boys of Chile, the PhDs hired during Pinochet regime to rehabilitate Chile’s economy (who tried to rehabilitate Chile’s economy with their dogmatic ideas) the experiment of trickle-down theory has also failed in Pakistan in alleviating its poverty. Finally, the Chicago Boys ran out of the country in Chile and this is what we are witnessing in Pakistan right now.

However, in crisis like these, people of broader vision come up with ideas to break such kind of stalemates. This is what happened in a country one notch above to our population remaining part of Pakistan till 1970 i.e. Bangladesh.

Here, Muhammad Younus, professor of economics, launched a project in 1985 starting with meager amounts to finance lower strata of the society that later transformed in to Gramene Bank of Bangladesh. His basic objective was to make financing available at the doorsteps of downtrodden for changing their lives. The movement gained pace and now in every part of the world it is being replicated. Commenting on his efforts, Muhammad Younus once described it a result of his passion. He frankly said that if he had been a banker, he would have never thought of launching this project. This goes with an old saying that in fact world has always been changed by the people regarded as mad and not by those who were clever enough to remain within the status quo.

This raises the question that what microfinance does refer to? In fact it is the provision of providing financial services to low-income clients, including consumers and the self-employed. Microcredit may not be confused with the microfinance, which addresses a full range of banking needs for the poor people. In essence microfinance lies very close to Islamic finance that asks for shouldering social responsibilities as well

Islamic microfinance represents combination of two fast growing markets in the world i.e. microfinance and Islamic finance. Though both of these markets have small access to the population in the Muslim block at this point of time, but they have great future ahead of them. However, at this point of time Islamic microfinance is highly concentrated in a few countries with top three as Indonesia, Bangladesh and Afghanistan i.e. 80 per cent of global outreach. Its size is also quite dismal at the moment i.e. $200-300 million as compared to $25 billion on conventional side that is being projected for $250 billion to match current needs.

 According to microfinance information exchange, the current figure of microfinance worldwide is just $7 billion loaned to 30 million customers through 1,200 microfinance institutions. But this represents only formal sector.

Now coming back to Islamic microfinance, this is the same story that goes with Islamic financial assets standing at around $500 billion globally with Sukuk market at $47 billion against trillions of dollars on conventional side. The Islamic Insurance (Takaful) has just reached to the premium turnover of $5 billion against conventional insurance turnover of $3.7 trillion. However, in spite of small presence of Islamic microfinance, its bright side is that 44 per cent of clients of conventional microfinance reside in the Muslim world, so their conversion to this mode of financing is easy to come by.
The basic issue of Islamic micro financing is the same as that of Islamic finance in general — it is costlier than conventional microfinance. Further going, conventional microfinance is also costlier than normal banking finance, so obviously without cost cutting one can not think of its smooth sailing. Though its recovery is better but still its business models are in process of development.
Basic Islamic microfinance contracts used in the business are: Murhabah sale, Ijarah (leasing contract), Musharakah and Mudarbah (profit and loss sharing) and Takaful (mutual insurance).
In promotion of Islamic microfinance three countries — Indonesia, Pakistan and Bangladesh — are prominent. In Indonesia, the government through its legislation has provided support to this mode of financing and now in that country 105 new Islamic banks are in operation. In Pakistan, the State Bank of Pakistan (SBP) has allowed creation of new Islamic microfinance banks or to open its branches through Islamic banks, conventional banks or through conventional microfinance banks. In Pakistan, available figure on microfinance including Islamic microfinance is just $286 million. The banking finance against this figure stands at $35.9 billion. SBP has set its target to raise microfinance customers in 2010 to 3 million and in 2015 to 10 million from 1.3 million right now. High cost of financing in this sector is the main impediment. Overall the cost per borrower in Pakistan on microfinance is estimated at Rs2,262,000 which is the highest in the region. Debt to equity ratio in this sector is 2.6 per cent whereas equity to assets stands at 28.1 per cent. Average loan size is Rs8,000 to Rs100,000 and normally person with income of Rs12,500 qualifies for the loan. According to one survey 91.4 per cent loans are obtained for the expansion of current businesses and not for the new businesses. The procurement of funds for the business is the problematic area.

In Iran, the dominant role of microfinance is done through Qardae Hasna which is considered charities and not Islamic microfinance. Through this facility, 3 million families meet their personal expenses. The size of this fund in Iran is around $5.5 billion. Apart from this facility which binds its customers to refund principal only microfinance activities in Iran are informal.

The outreach of Islamic microfinance is very limited. Bangladesh has 100,000 customers as compared to 8 million in its conventional sector. In Indonesia, the figure is less than 100,000. Like conventional microfinance, its customers are mainly females. In the West Bank and Gaza, the numbers are 100 per cent whereas in Bangladesh, Jordan, and Saudi Arabia the numbers are 90 per cent, 80 per cent and 86 per cent respectively of overall customers. In Pakistan this is 40 per cent.

Islamic microfinance is still a niche. For moving forward, it requires a suitable business model providing way outs in reducing its borrowing cost. If one succeeds in expanding its outreach than obviously one can hope its role in alleviation of high poverty in Pakistan. This would be in addition to what we are doing through Benazir Income Support Fund. Another idea is to establish Qardae Hasna Fund mainly financed through Zakat recoveries.   However, to move forward one requires great vision that normally does not exist in bureaucrats and politicians with ad-hoc mindsets.