As the blog series on Islamic Microfinance Challenge is wrapping up, below is a summary of the main points that the posts, comments, and challenge winners made.
Business Model for Islamic Microfinance: What does it need?
- Market segmentation from day one: In conventional microfinance, an MFI begins usually with one product which does not fit the needs of many clients running diverse enterprises; over time it begins to segment the market and to diversify their products. The same principle has to be applied to Islamic microfinance and MFIs have to begin by segmenting their market into subsectors and by designing special product/s and or using different instrument/contract for each subsector of the market.
- MFI/Bank should think as an investor and not only as a creditor: In order to implement the above, for Musharaka and Mudaraba, not only must the institution get involved in buying the cows or the baby cows, but also, it must get involved in a more careful monitoring of the project, provision of some vet services and counseling. It cannot just lend money, retrieve it, and make a profit. In most cases, we are talking about partnership, not simply a lending operation.
- Takaful/Microinsurance: Micro insuring the enterprise’s assets against theft and death in the case of animals and livestock is also part of the model. There is a bigger incentive for the MFI to do that under such a model. We have seen that in the case of TeV that the beehives are insured and that the insurance cost is added to the price. In the case of Farz Foundation (Halal Livestock product) each animal is insured against theft and death too. Alamal bank¹ said that they will also insure all of the leased items under their new leasing product.
- Savings: Wherever regulation allows, savings should be a core element of an Islamic microfinance business model. As in conventional microfinance, it is believed that more Muslims would benefit from savings than from loans². Since the majority of savings accounts Muslims have access to earn interest, there is a disincentive for Muslims to hold bank accounts. Also, having Shariah-compliant savings accounts will help mobilize deposits and instill a culture of savings as well as contribute to economic development.
Potential Social Benefits/Impact:
When such a business model, specially the Profit/Loss sharing instruments, is implemented on a wide scale, it is expected to have the following potential social benefits/impact:
- Target more poor people: Such a model will enable the MFI/bank to focus on poorer people compared to those targeted by conventional microfinance. Many of those who are too poor to accept to be indebted or those who would be excluded by the group (in the case of a group lending methodology) or by the MFI because they could not provide a guarantor etc. would qualify to benefit under such a model should they have the human resources and the will and determination to learn and to work hard etc.
- Less likely to have over-indebtedness problems: Such a model would require a more thorough investigation of the client, especially because Sharia compliant models do not use any kinds of guarantee except against negligence behaviors. Moreover, the MFI will have to make sure that its funds are going towards economic activity/enterprise development. In fact, the MFI will be the one who will buy those assets in most of the cases. Due to this set-up, it will not be possible for an MFI to make profit and to flourish while its clients are suffering, as was the case in Andhra Pradesh in India, for instance.
- More focus on productive economic activities which would contribute to the GNI: It is also expected that such a model will focus more on productive economic activities instead of commerce activities. These activities contribute more to the GNI of the country.
- More job creation: There is a near consensus that the conventional microcredit is not a good job creation tool as risk-averse lenders tend to focus more on those who already have an enterprise and are looking to expand. Implementing such a model might change this equation and the focus could be more on those who have human capital and have the skills or can acquire those skills which might lead to creating jobs/enterprises for them.
- Less problems attracting financing resources: Though it took the conventional microfinance sector years to attract commercial sources of financing, it is expected that this will not be the case under such a model. This is not only because the conventional microfinance paved the road and showed success but more fundamentally, it is because Islam seeks to alleviate poverty and circulate wealth in the economy. So far it is believed that this did not happen because Islamic MFIs failed to show a promising successful and profitable model which would convince those banks to take risk and to finance the MFI portfolio on Musharaka or Mudaraba basis. However, should such a model be developed and operational, it is expected that Islamic banks and even Islamic businesspeople will not be reluctant to provide the needed financing. An example is Al Amal bank in which investors invested $6-7 million when its portfolio is $2.5 million.
- Deeper Market Research: This is to better understand the size and segments of demand on one hand and to try to come up with a group of products which would reply to such a demand on a large scale.
- Capacity Building: Capacity building is needed at all levels to realize the full potential of Islamic microfinance. More efforts should be made to train Islamic MFIs managers and staff. This includes the development of training courses and training of trainers and the development of a group of consultants who can train the MFIs and advise them³.
- Financing Pilots: At the micro and institutional levels, international donor agencies can play a major role in expanding access to finance among poor Muslims by funding pilot projects which provide the opportunity to test various Islamic microfinance business models.
- Global Financial Reporting Standards: The Islamic Development Bank and Islamic financial standard setters (such as IFSB or AAOIFI) should consider developing global financial reporting standards, adapted to microfinance, to build the infrastructure for transparency in the global Islamic microfinance sector. This infrastructure would entail comprehensive disclosure guidelines on Islamic microfinance accounting principles, pricing methodologies, financial audits, and eventually, rating services.
- Benchmarks: The MIX should also consider creating a new group in its reports and begin tracking those products which are offered according to Islamic Sharia law, their outreach, average loan/investment size, etc. which will allow over time to have a good idea about those products and to compare them with conventional products too.
We look forward to your thoughts on this issue through comments.
¹ All of Al-Amal bank clients are insured against death and total disability. The insurance include covering the balance of the loan and paying the family of the client an amount of 20,000 YER which is equivalent to almost 100 USD.
² In most of the cases you give one loan to a household or you make one investment with them while each member of the household can have a savings account. Also, many poor families who do not need a loan will be happy to have the opportunity to have a savings account.
³ In this regard, the operational tools and manuals which were developed by Deutsche Gesellschaft fürTechnische Zusammenarbeit (GTZ) for use in Indonesia in 2007 can be something to build on instead of beginning from scratch.
The success of conventional MFIs should not be a reason to emulate that effort under the islamic banner, for several reasons. Primarily, the former one was a women based lending business, and relied too much on peer pressure and joint liablity. Whether women from the Muslim community would come out to be equally enterpreneurial is the first concern, if at all they are allowed to come out of the socially constructed coccoons. I’m not sure whether the joint liability stick is compliant with Islamic principles, which if not, wud sound like a too risky business. Nevertheless, source of funding itself had been and continues to be a major hinderance in piloting these models successfully. As pointed out by you, a funding thru a Musharaka-Mudarabah model with a bank will leave the MFI with a paltry surplus just enough to run the daily show, and not the kind of ‘expansion’ which one wud look at always.
Monitoring end use is an unaccomplished dream still for the big listed MFIs. Though all preaches a complete ‘economic activity’ funding, a good majority of these loans find their way towards pure consumption purposes. Enforcing this better under islamic model is desired, but seems to be not so plausible.
I think that microfinance in Islamic countries need more capacity building acutely a lot of capacity building because most of these countries have this ignorant problem ,for example Sudan the poor people the that microfinance targeted them if any bank gave them finance they can’t find there path out of poverty because they don’t know how to use these money , the idea is not give them only the money I think giving them small business will be more helpful or business idea that they can gain benefit and find there way out of poverty from it and thanks
I like that this article talks about the importance of savings. Savings services are important for microfinance anywhere in the world as I have learned with my time as an intern at Opportunity International (opportunity.org). With that being said, I believe savings services world be even more vital with the current political instability in the middle east. It would serve as some layer of protection. Is this true? Is it easier or harder to save in politically unstable climates?
An excellent piece and well thought through.
It is actually one of the most time tested business models, e.g. Landowners provided their assets (land) for use of entrepreneurs (farmers) and the profit was shared; providing livestock to herdsmen to manage etc. To make this work it has to work on a true risk and profit sharing mechanism thus ensuring alignment of both parties. The best part of this mechanism is that it gives the BOP an opportunity without burdening them with debt and increasing their financial risk. In my view it needs three additional enhancements:
1. There needs to be a buyback mechanism so that the entrepreneur can eventually own the asset with the profits generated and provide an exit for the owner (MFI).
2. There needs to be true advice and expertise provided to the entrepreneur, hence an expert or master entrepreneur who shares in the profits (or losses) and provides real value.
3. This expertise along with the monitoring will add to the cost if conventional mechanisms are used (the point Ninoj pointed out), hence add technology to manage the process, e.g.Tracking cash through mobile receipts and payments.
In my view this can be the next disruptive innovation in financial inclusion.
The Islamic microfinance of women is a very important step to cover the need of women for such support, especially in this age full of shortcomings and lack of what life events require under the limited income