Financing the Poor: Towards an Islamic Microfinance

An Islamic Finance Industry Perspective

Iqbal Khan and Aamir A. Rehman

Harvard Law School - 14 April 2007

Agenda

I. Islamic finance is an inclusive proposition

II. Engaging the poor is not easy

III. Industry has potential to lead and address the situation

IV. Next stages

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Islamic finance is more than financial contracts

 Fundamental tenants are derived from Shariah

– Absence of interest-based transactions
– Avoidance of economic activity involving speculation
– Prohibition on production of goods and services which contradict the values of Islam

 Concept is grounded in ethics and values

– Principles akin to ethical investing
– Emphasis on risk-sharing and partnership contracts

 Islamic finance offers an alternative paradigm

– Asset-backed transactions with investments in real, durable assets
– Stability from linking financial services to the productive, real economy
– Credit and debt products are not encouraged
– Restrains consumer indebtedness

 Islamic banking is community banking

– Serving communities, not markets
– Open to all-faith clients
– Instruments of poverty-reduction are inherent part of Islamic finance – zakat & qard hasan channels

Industry is outcome of CSR and ethical principles

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Industry has not yet reached full potential

 Industry initially had to demonstrate commercial viability

– First Islamic bank established in 1975
– Initial market strategy focus on revenue-generating projects

 Industry is young and gaining mainstream relevance

– Industry-building infrastructure setup as recently as 1991 (AAO-IFI)
– Reputational risk management led to careful dealing with non-regulated charities industry

 Industry is building stakeholder connectivity

– State-controlled waqf and zakat institutions not proactively engaged with Islamic finance
– Regulatory hurdles imposing investment restrictions in government-owned institutions

 Islamic banking develops link to economy

– Robust banking system enables economic development
– Vehicle for financial and economic empowerment
– Deepening bankable population and unlocking “dead capital”

 Responsibility of poor was sidelined for growth first

– Industry began as MitGhamr Savings Associations (1963)
– Nile Delta experiment to mobilise local villager savings for local socio-economic development

Islamic finance has not forgotten the poor

Financing the Poor: Towards an Islamic Microfinance | 4
I. Islamic finance is an inclusive proposition

II. Engaging the poor is not easy

III. Industry has potential to lead and address the situation

IV. Next stages

Financing the Poor: Towards an Islamic Microfinance | 5

Bottom of Pyramid market carries additional
responsibility
 Engaging the poor requires balance between profitable and responsible lending
– Lending enterprise needs to be wary of debt spiral
– Engagement programme must be self-sustaining

Lending profitably Lending responsibly

 Despite engagement of less privileged customers  Prevent over-indebtedness
 May not be responsible financing:  Microfinance is good example
– Sub-prime lending – Fiduciary business to uplift poor
– Debt consolidation companies – Affordable lending to enable sustainability

 Bottom of Pyramid market has long been neglected

– Market is well underserved – half of planet live on less than $2 a day¹
– Islamic finance has ready moral and product framework to assist
– Islamic finance can unlock bankable wealth and enable “trickle down” effect

Source: 1. HBS Bulletin March 2007

Assisting the poor is a pillar of Islam

Financing the Poor: Towards an Islamic Microfinance | 6
I. Islamic finance is an inclusive proposition

II. Engaging the poor is not easy

III. Industry has potential to lead and address the situation

IV. Next stages

Financing the Poor: Towards an Islamic Microfinance | 7

Islamic microfinance is a complementary initiative to
Islamic finance

Islamic finance Microfinance

New-market Reaches previously under-

Focus on uplifting the poor
innovation banked population

Asset
Finance based on worthiness of ventures and assets, and not based on wealth
orientation

Core concern Routed in Shariah-compliance Fair access to capital

Models advocate: - financial inclusion

Equitable - entrepreneurship
- risk-sharing through partnership financing

Microfinance mission reflects part of Islamic ethos

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Microfinance fits the spirit of Shariah-based industry
development

Shariah-based solutions
 Industry needs to shift from Shariah-
compliant to Shariah-based  Income-sharing products

– Mindset of consumer debt is not in Islamic spirit  Shift from debt-based

product offering
– Investment and debt for productive use is
allowed
– Microfinance provides credit for the real
economy

 Microfinance fits need of Muslim Indebtedness

Savings &
communities Investments

– Muslim-countries in spectrum of poverty and

underdeveloped social infrastructure x
– Islamic microfinance will attract under-banked
and underserved “economically active” poor
Shariah-compliant products
 Islamic finance provides interest-free
 Letter of the law
solutions for job creation
 Replicating conventional
– Musharaka/Mudaraba PLS arrangements
credit service offering
– Murabaha/Ijara commodity purchases

Islamic microfinance supports industry morals and ground needs

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Islamic finance is a platform to build microfinance

Partnership – Bring capital market access via Islamic

– Create charitable funding channels for
finance industry and match with efficient
Microfinance institution
institutions
– Combine Islamic finance industry
– Initiate joint ventures with successful,
synergies and distribution assistance
business-run enterprises
2 3
Philanthropic Commercial
1 4

– Assist in building Islamic microfinance – Build scale and reach of Islamic

institutions with Islamic finance products microfinance managers
– Use charitable endowments as start-up, Organic – Migrate successful models to other
risk-free capital markets

Industry can build commercial partnerships with Microfinance managers

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I. Islamic finance is an inclusive proposition

II. Engaging the poor is not easy

III. Industry has potential to lead and address the situation

IV. Next stages

Financing the Poor: Towards an Islamic Microfinance | 11

Islamic microfinance requires combined efforts

Requires institutional will

Modest capital commitment

Best-of-breed microfinance institutions

Create successful partnership formula

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Thank you

rehman@post.harvard.edu