Frontiers of Islamic Banking A Synthesis of Social Role and

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islamic 310 microfinance 301 financial 225 institutions 130 republic 126 services 102 financing 98 banking 93 development 91 banks 89 countries 83 micro 78 credit 76 poverty 74 finance 67 based 63 member 61 ifis 60 mfis 59 funds 53

DOCUMENT KEY POINTS

islamic research and training institute islamic development bank framework and strategies for development of islamic microfinance services an initiative undertaken jointly with the islamic financial services board ifsb and in consultation with other partner institutions and stakeholders
working paper for ifsd forum islamic microfinance development challenges and initiatives meridian president hotel dakar senegal may please send your comments to ibfd isdb

the poor in the islamic world
micro level islamic mf providers

mdgs poverty alleviation and mf box ii instruments of financing in islamic microfinance box iii replicating grameen model in muslim societies box iv shariah compliance with spiritual treatment box v a guarantee product by grameen jameel initiative
macro level islamic mf regulatory and supervision framework

el mahdi managing director unicons consultancy limited sudan mister sephudin noer director baitulmaal muamalat bank muamalat mister nurul islam executive vice president islami bank bangladesh misses ishrag dirar director microfinance bank of sudan mister dwiyanto director microfinance bank indonesia mister imran ahmed joint director islamic banking department state bank of pakistan mister mahmoud asaad project director sanadeq undp rural community jabal alhoss syria mister mohannad mohammad m

during the consultation process on the tyfs document and at the ifsi development forum held in kuwait as side activity of the idb bog meetings and organized jointly by idb irti ifsb and general council of islamic banks and financial institutions cibafi it was widely felt that there is a need to focus on islamic microfinance development as top priority initiative in order to align ifsi development with poverty alleviation
this present document uses a structure similar to one used in the well known study access to the poor a a comprehensive work undertaken by the consultative group to assist the poor cgap the multi donor consortium dedicated to advancing microfinance

the next three sections examine islamic microfinance at three levels a micro level microfinance institutions contracts products and resources meso level financial infrastructures and macro level policy and regulatory framework

meso level initiatives constitute provision of education and training better coordination and networking technical assistance through awqaf and zakah funds provision of rating services specific to islamic microfinance institutions in view of their unique risks through creation of a rating fund
it is observed that the idb member countries that have islamic finance specific regulations do not have micro finance specific regulations and vice versa with the sole exception of pakistan

the provision of financial services to the poor helps to increase household income and economic security build assets and reduce vulnerability creates demand for other goods and services especially nutrition education and health care and stimulates local economies
it implies provision of financial services to poor and low income people whose low economic standing excludes them from formal financial syste miss access to services such as credit venture capital savings insurance remittance is provided on a micro scale enabling participation of those with severely limited financial means

the monterrey consensus that heads of state and government adopted at the international conference on financing for development in explicitly recognized that microfinance and credit for micro small and medium enterprisesa as well as national savings schemes are important for enhancing the social and economic impact of the financial sector

members of these small groups are trained regarding the basic elements of the financing and the requirements they will have to fulfill in order to continue to have access to funding

of all the models above the grameen model and the village bank model the four model classification is based on john d conroy the challenges of micro financing in southeast asia financing southeast asia s economic development institute of southeast asian studies singapore

it is a world where poor and low income people in developing countries are not viewed as marginal but rather as central and legitimate clients of their countries financial syste miss in other words this vision is about inclusive financial systems which are the only way to reach large numbers of poor and low income people
key principles of mf a major initiative towards achieving the mdgs is formation of the consultative group to assist the poor cgap a multi donor consortium dedicated to advancing microfinance

to sum up the principles broaden the definition of mf from micro credit to provision of an array of financial services such as savings insurance and remittance
the strategy should aim at sustainability through a shift from a charity based donor dependent approach to a market based for profits approach emphasizing systemic efficiency and transparency and restricting use of donor funds to capacity building

first returns on investment in micro enterprise are very high by the standards of banks and other investors a the reason being the miniscule size of investments compared to the earnings numbers
hence entrepreneurs can afford to pay high interest rates as cost of funds sometimes as high as sixty seventy percent as long as the same are lower than rates of return

from the above it is clear that the cultural and religious sensitivities of the islamic world are somewhat unique and these must be given due emphasis in any attempt to build inclusive financial systems and bring the over one billion muslims into the fold of formal financial syste miss

examine the challenges facing the development of islamic microfinance services with a view to promoting dialogue among the various stakeholders to integrate islamic microfinance services in national financial sector development policies of member countries
facilitate policy financial infrastructure and financial institution development with a view to making financial services accessible and affordable to the masses and

an analysis of data provided in annexure i reveals that only five of the member countries a indonesia bangladesh pakistan nigeria and egypt account for over half a billion million of the world s poor with incomes below a day or national poverty line
mali burkina faso and chad have ranks below at and respectively closely followed by niger and guinea at and

it reveals that out of the countries for which the estimate is available in as many as countries only one fifth or less of their adult population have access in countries one fourth or less have access and in countries one third or less have access to formal financial services

understanding the needs of the poor the needs of the poor in islamic countries are no different from the poor in other societies except that these are conditioned and influenced by their faith and culture in a significant way

recent experience of islamic mfis in the matter of offering shariah compliant deposit products refer to subsequent section for details also shows that they are yet to gain an adequate understanding of the needs of their clients
indeed many islamic fis seek to artificially smoothen returns on their deposits on the basis of a fear of losing clients if realized volatile returns are passed on to savers

loans to the destitute may in fact make the poor poorer if they lack opportunities to earn the cash flow necessary to repay the loans
basic requirements like food shelter and employment are often more urgently needed than financial services and should be appropriately funded by government and donor subsidies

while islam strongly encourages charity from the giver s point of view it seeks to minimize dependence on charity from the beneficiary s point of view and restricts the benefits to flow to the poorest of poor and the destitute who are not in a position to generate any income and wealth

transformation of unproductive assets of the beneficiary into income generating ones through rigorous valuation on the basis of price discovery through auction method involvement of the larger community in the process
begging is right only for three people one who is in grinding poverty one who is seriously in debt or one who is responsible for compensation and finds it difficult to pay

o ye who believe when you deal with each other in transactions involving future obligations in a fixed period of time reduce them to writing and let a scribe write down faithfully as between the parties the import and significance of this verse is often not fully understood
while the conventional system provides for simple interest based deposits donations and loans the islamic financial system comprises an array of instruments for mobilization of funds financing and for risk management

instruments for mobilization of funds instruments for mobilization of funds may be broadly divided into charity that includes zakah sadaqa awqaf gifts that include hiba and tabarru deposits that may take the form of wadiyya qard hasan and mudaraba and equity that may take the form of classical musharaka or the modern stocks

instruments of financing instruments of financing may be broadly divided into participatory profit loss sharing pls modes such as mudaraba and musharaka sale based modes such as murabaha leasebased modes or ijara and benevolent loans or qard with service charge

instruments of risk management instruments of risk management and insurance in islamic microfinance are based on the concept of guarantee kafala and collateral damanah

for example in case of the syria based sanadiq members facing adversities are provided the option of a short term emergency loan against payment of a fixed fee
the mainstream islamic banks and financial institutions financing large corporations and high networth individuals may not be comfortable with the unique risks with microfinance

in the islamic countries current and potential providers of islamic mf are likely to be either the conventional mfis expanding the scope of their services to include islamic mf or the islamic fis expanding the scope of their services to include mf
interestingly these informal arrangements take on similar forms and can be divided into two rough categories individual providers and collective clubs or associations

also informal financial services are vulnerable to collapse or fraud where people can lose their money whether because of corruption lack of discipline or collective shocks like a natural disaster or a bad harvest

islamic microfinance institutions display wide variations in the models instruments and operational mechanis miss while in terms of reach penetration and financial prowess islamic microfinance institutions lag far behind their conventional counterparts they certainly score better in terms of richness and variety

some of the unique features of this model are i musharaka type structure owned and managed by the poor ii financing based on the concept of murabaha a high profit rates with net profits shared among members iii good governance through committees with sound election and voting procedures iv project management team responsible for creating awareness of microfinance practices training of committee members v financial management of the funds based on standardized by laws and statutes for each of the village funds resulting in fair credit decisions and low transaction costs
the mu assasat bayt al mal in lebanon is an affiliate of a political party a the hezbollah and comprises the hasan loan institution al qard al hasan and its sister organization called al yusor for finance and investment yusor lil istismar wal tamweel

south east asia in south east asia malaysia made an early beginning with tabung haji aimed at financing the hajj related expenditure of poor malaysian farmers who used to sell their only source of livelihood agricultural land for the purpose

recipients of nobel peace prize for the year grameen and prof yunus have provided a model of microfinance that is being replicated through one of the largest international networks of microcredit organizations for the poor in the world
the key features of grameen model such as entrepreneurship development among the poor lending to groups based on mutual guarantee small sized recurring loans have all now become features of the text book model of microfinance

see box iv islamic microfinance institutions ismfis in indonesia have displayed their sustainability and robustness in the face of grave financial crises even when the mainstream banks had to depend on governmental assistance to tide over serious financial proble miss it should be noted that indonesian bmts at the grassroots largely fall outside the financial regulatory mechanism since they operate as member based cooperative organizations similar to a musharaka structure without governmental assistance or intervention
its strong emphasis on its islamic roots has enabled itself to experiment with a dual system of islamic finance and a system of microfinance that is not just shariahcompliant but actually uses islamic spiritual treatment along with financial and technical assistance to develop its micro enterprises and work towards elimination of poverty

as such the system poses a serious challenge to the regulator a how to strike a balance between the need to strengthen the linkage between formal financial system and the bmts while retaining the benefits of flexibility and independence
central asia out of the countries with large muslim populations in central asia afghanistan azerbaijan kazakhstan tajikistan uzbekistan kyrghizstan only the former two have witnessed experiments in islamic microfinance

a significantly large number of microfinance institutions especially in indonesia are organized as cooperatives registered under the cooperatives act and come under the purview of the ministries of cooperation and not the ministries of finance
shariah boards mainstream islamic financial institutions provide comfort to their stakeholders that they conform to islamic finance principles by setting up shariah supervisory board ssb s

for instance successive governments in india have routinely provided through a network of microfinance outfits loans at interest rates grossly below the prime lending rate in the economy and would at periodic intervals waive the entire loan amount in the face of hardships such as crop failure or even small enterprises becoming sick consequently claiming to be more equitable than profit and loss sharing
another instance is the grameen system that cites the following features of its loans to be labeled differently than interest bearing conventional loans i cap on the total interest due ii no recovery in case of project failure iii no formal contract for interest payments iv no shareholder owner s as counterparty to receive interest etc

there are still others who are aware of the difference and realize the need to repay the loan but assert that qard hasan in its pure form provides them with flexibility right in deciding when to repay
one borrowers display an initial preference for the profit sharing mechanisma that is mudaraba as it is perceived to be more islamic in spirit

other problems that are usually cited with pls based modes as compared to sale and lease based modes are as follows one pls mechanisms require long term involvement by the microfinance institutions in the form of technical business assistance which raises the cost of implementation

the absence of any real capital market activity by islamic microfinance providers may be due to various possible reasons such as the lack of awareness on the part of microfinance providers and or lack of conducive legal and economic environment
the annual fiqh seminars organized by dallah al baraka or those organized under the aegis of islamic fiqh academies have successfully resolved many intricate and complex issues in the past

a diverse range of products there is need and considerable scope for islamic microfinance providers to develop new products as solutions to a variety of financial proble miss however the right approach to product development is a strategic one that takes a holistic view of microfinance as a composite product meeting the needs for financing savings and investment insurance remittance and other services
given that microfinance projects deal with local products and markets often dealing with a few known types of commodities and assets such as poultry bee keeping fisheries dairy it is possible on the part of the financier to generate reliable business forecasts and develop products with realistic sharing ratios and expected returns

the regulations should also encourage more effective microfinance delivery through establishment of new specialized formal non bank microfinance institutions expansion of branch network for existing institutions possible restructuring of existing banks to serve as rural specialized microfinance banks and allow for banks wholesaling to non bank microfinance institutions and using the nonprofit organizations with social agenda to reach out to poor

box v a guarantee product by grameen jameel initiative the grameen jameel initiative an innovative collaboration between grameen foundation and the abdul latif jameel group to fight poverty in the arab world through microfinance as its first transaction provided a million guarantee to dakahlya businessmen association for community development dbacd a leading microfinance institution mfi enabling it to secure a local currency loan of

it will also help in the development of bangladesh s local capital markets as it marks the first such securitization in the market and also the first aaa rated local certificates issue in bangladesh rated by the credit rating agency of bangladesh
box vi world s first micro credit securitization brac one of the world s largest ngos with over mm borrowers and employees has closed world s first micro credit securitization structured by rsa capital citigroup fmo and kfw

for example it should be conceptually possible to establish an spv special purpose vehicle as a mudaraba or on the basis of wakala that would purchase small ijara portfolios of microfinance providers and create a large enough portfolio against which securities could be issued in the capital market

landscape the frenetic pace of growth of islamic finance has witnessed several landmark developments such as the establishment of the islamic financial services board ifsb the accounting and auditing organization of islamic financial institution aaoifi the international islamic rating agency iira the general council of islamic banks and financial institutions gcibifi at the international level and many other agencies at regional levels to provide meso level services to ifis
its objective is the development of islamic banking in indonesia through human resource development technical assistance operational standardization and financial product development facilitation of vertical and horizontal communication among islamic financial institutions advocacy and participation in policy dialogue

though safe efficient and reliable payments systems are critical to the effective functioning of the financial system most of islamic mfis or their conventional counterparts do not have access to such syste miss in the idb member countries only some top islamic banks have access to systems such as electronic funds transfer and real time gross settlement system

as conventional microfinance markets mature and begin to integrate into the financial system the mainstream service providers rating agencies auditors management consultants and bank training institutes among others are starting to adapt to meet the needs of financial institutions that serve poor clients
strategic response in formulating a strategic response to the challenges an important question needs to be answered whether infrastructure and services should be microfinance specific or whether microfinance skills should be absorbed by existing mainstream providers that work more broadly with mainstream ifis institutions like ifsb aaoifi gcibifi and iira

even there is a need for education for the clients in subjects like basic accounting and management accounting is important because of the unavoidable need to calculate profits in case of participatory financing methods such as mudarabah and musharakah
though the smaller microfinance institutions working for the poor may not be in a position to institute the systems themselves they may work through the larger islamic fis by forging alliances with them

the global network and its regional member networks can perform a variety of functions such as i initiating dialogue on legal frameworks regulations taxes ii resolution of divergence of views on shariah compliance iii providing exposure to worldwide microfinance good practices through development of resource center iv designing and conducting training programs in microfinance facilitation and management v development and maintenance of information base for use by member organizations vi creation of infrastructure such as credit

a scheme of proper integration of the two types of institutions would do away with issues related to the desirability or otherwise of zakah funds being invested in speculative wealth creating assets in stead of getting spent on immediate needs of the poorest of the poor or issues of ethics of islamic microfinance institutions seeking profits and ignoring the unbankable
technical assistance through awqaf and zakah funds as a strategic meso level initiative to develop islamic microfinance it is important to institutionalize voluntary giving in order to guarantee sustainability of assets and their income generating abilities

two borrowers often view soft government money as grants or gifts and are less likely to repay loans from subsidized progra miss this is especially true in countries with a history of forgiveness programs for agricultural or other lending
in short governments are not good at offering credit directly to poor people even while government owned banks such as postal banks are fairly successful in savings mobilization or money transfer

the purpose of these limits or ceilings existing in some idb member countries such as algeria armenia libya syrian arab rep tunisia ueac and umoa countries is to protect consumers from unscrupulous lenders and excessively high interest rates
it costs much more to make many small loans than a few large loans and governments normally set ceilings with mainstream commercial banks in mind not the more costly microcredit

there are as many as member countries that have enacted laws and regulations specifically to govern mfis and there are as many as member countries that have enacted laws and regulations specific to ifis

for those financial institutions that capture deposits from the public and thus would generally be subject to prudential regulation some standard banking regulations need to be adjusted to accommodate microfinance governments should apply the more burdensome prudential regulation only when the financial system and depositor s money is potentially at risk
issues related to dual system some regulatory issues arise because of the existence of a dual system in most islamic countries a an islamic financial system co existing with a conventional system

specifically the developments brought about by the activities of the accounting and auditing organization of islamic financial institutions aaoifi and the islamic financial services board ifsb are worth mentioning
define products and scope of activities clearly ensuring shariah compatibility free from interest riba and complexity gharar enable institutions to engage in fee based activities

stage one to make the islamic microfinance institutions appreciate the need for certain common performance standards stage two making it mandatory for the islamic microfinance institutions to get registered with identified or designated institutions and stage three to encourage development of network of islamic microfinance institutions which could function as quasi self regulatory organizations sros at a later date or identifying a suitable organization to handle the regulatory arrangements
recent progress in the policy framework to fight money laundering and terrorism financing should provide guidance in the matter of selecting the downstream organizations such as ngos that function as retailers of microfinance

using these mechanisms donors assume the role of enablers through funding credit and investment portfolios of mfis providing guarantees and safety nets to mfis capacity building facilitating mfi s access to domestic capital markets building the skill sets of technical service providers rating agencies consulting firms training facilities and supporting the operations of networks and associations

the deep initiative the deprived families economic empowerment program deep aims to develop a comprehensive package of financial and non financial services to meet the needs of the poor and very poor families of palestine who are the target group

financial services intervention maximizing the outreach of the lending activities to the palestinian poor and very poor people contributing to the mfis capacity building introducing islamic lending products maximizing the outreach of savings activities to the poor introducing micro insurance products the program would also seek to provide capacity building interventions aimed to strengthen the various intermediaries that will provide financial and promotional safety net interventions to the targeted poor and very poor households
promotional social safety net intervention provision of a wide array of non financial services critical to the entry survival productivity competitiveness and growth of micro and small scale enterprises run and owned by the poor and very poor

an effective strategy for development of microfinance would require concerted efforts by all stakeholders the poor the cooperatives ngos the islamic banks the awqaf zakah funds the apex bodies idb and idb sponsored institutions as well as the government agencies such as ministries of finance cooperation the monetary authority and the capital market authority
as far as the poor are concerned they should perceive formal savings credit and financial services as safer and more attractive develop entrepreneurial abilities and acquire relevant education and skills and consider charity as temporary support only

at a micro level o participate in equity of islamic financial institutions with a view to creating specialized mf divisions o create qard hasan specific funds to support various qard hasan based microfinance institutions across the globe o create refinance facility to act as a whole seller of islamic microfinance products for a chain of islamic and conventional microfinance retailers o participate in equity of commercial takaful companies with a view to developing microtakaful products services also of retakaful companies

at a macro level o assist member countries to develop a regulatory framework for islamic microfinance o support policy makers to ensure an enabling policy framework conducive to the development of islamic microfinance o support and facilitate the integration of zakah and awqaf in financial sector reforms and o build an effective alliance and forum of islamic microfinance providers and other stakeholders

name of member income poverty index country human population below poverty a index a day day national population no of poor in rank poverty line in millions millions united arab emirates

created in republic of kazakhstan law on banks and banking activity banking new islamic finance law on microlending regulation experiment organizations covers ifis no ifi specific laws or regulations

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DOCUMENT WORD ANALYSIS

Main Category

AlHuda Material\islamic micro

KeyWords

islam finance fund mfis institute developed agricultural financial bankable oper credit rate client econometric mfi loan program beneficiarie imfi sustain

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Number of Pages

80

Published Date

2007-11-12 11:59:55

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Frontiers of Islamic Banking A Synthesis of Social Role and

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