Mohammad Abdul Mannan concluding his three-part article on Islamic microfinance

The Islamic non-governmental organisations (NGOs), cooperatives and microfinance institutions (MFI) have been encountering the challenges numerous challenges from the very beginning.

Funding Islamic microfinance programme (IMP) is the major challenge. In order to cover the poor living below the poverty line, a huge fund is required. Due to the lack of fund, many Islamic NGOs, MFIs and cooperatives have failed to reach the poorest of the poor. Having a misconception about Islamic views towards modernisation and empowerment of women, donors and developing agencies very often show little or no interest in funding Islamic NGOs-MFIs. Consequently, Islamic microfinance (IM) is yet to expand its country-wide outreach effectively. So, national and international Islamic donors and development agencies should come forward to provide fund to Islamic NGOs-MFIs. Alternatively the Islamic commercial banks and NGOs may initiate the microfinance programme in the country.

Conventional NGOs-MFIs have sufficient trained, skilled and experienced manpower. They are familiar with rural poverty and have gained experiences on poverty alleviation strategies since the independence of Bangladesh. They have a good relationship with national and international donors and development agencies. On the other hand, Islamic NGOs-MFIs are working in limited areas with a limited number of religiously motivated and skilled, but less experienced, manpower. As a result, despite their willingness, they are unable to expand their activities all over the country.

Due to a lack of knowledge on Islamic rules, all clients do not have any idea about the Islamic modes of transaction. To stop violation of Islamic rules, the clients need to be imparted with shariah knowledge. They have little or no interest to examine the nature and methods of IMP. Under such a situation, the main goal of introducing IM may not be achieved.

IM is a model to reach many poor people on sustainable basis and it would have an impact on their lives. If we fail to reach the larger segment of the poor people, the impact of IM will be limited. Again, after reaching a large section of people, if we cannot sustain the success, the whole thing will collapse. And, of course, there is no point of reaching so many people on sustainable basis without making a positive change in their lives. If we agree on this definition of success, then we can begin talking about the challenges facing IM to build such a model.

The first challenge for those who are interested in building such a model is to recognise that there is a problem, and to admit that we failed so far in applying the definition of success. Some MFIs that have been in the market for a decade serving only 4-5 thousand active borrowers thought they are doing great and there is no problem; and if they have more money they would serve more people. If we do not know that we are sick we will not go to the doctor; and if we do not recognise that we have not succeeded yet, we will not do anything to change the course of our actions.

We need to think about the sustainability of the model from the beginning. The MFIs will have to cover all its cost with a margin of profit from its own operations and not from donations or sadaqat or zakat. The donations should be used to sustain the organisation, and not to channel them to the clients. We must remember that only sustainable MFIs/banks can reach a greater number of poor people. If we can encourage rich people to invest in poor people’s projects and both have profits, we might reach a point where there will be no poor except those who do not have any human capital and need relief.

In the conventional microfinance, there was a debate whether micro-credit is something that can serve all the poor. Though there are still differences, the majority agreed that the destitute poor will always need charity. The goal is to help the ultra poor families to rely on themselves through linking them with MFIs. Until this is clear and well defined, people will keep getting confused and the proposed solutions will continue to be confusing. One of the challenges we need to overcome while trying to build an IM business model is to change some terminology we have been using, like investment instead of loan; investor instead of creditor.

IM in spite of the richness of fiqh literature, remains highly murabahah-centric (not an interest bearing loan, it is an acceptable form of credit sale under shariah). Profit-loss-sharing, though highly acclaimed as “ideal” is hardly used. The “actual” number of institutions based on zakah, awqaf and qard al-hasan is nowhere near the vast potential these institutions and instruments offer. Agency problems with profit and loss sharing (PLS) in mainstream Islamic finance have already been highlighted as a matter of grave concern that pushes Islamic FIs to opt for debt-based products. They become particularly acute in rural setting.

Integrated model of Islamic microfinance: Diversion of micro-credit for consumption purpose by the borrowers is one of the main reasons of credit default in conventional microfinance. Besides, charging a generalised interest and at a higher rate has also hindered poverty alleviation through credit rationing. These basic challenges of conventional microfinance can be resolved if an Islamic microfinance institution is designed in an integrated manner by incorporating the two basic and traditional institution of Islam, the Awqaf and the Zakah with Islamic microfinance into a single framework.

Although creating such a singular institution may be premature in the present context, such an integrated model may effectively resolve fund inadequacy of Islamic MFIs by using funds from the Zakah and the Awqaf. The IMFIs may use the Zakah fund to meet basic consumption needs of the hardcore poor target group in the first place, as, in principle, no return can be realised from Zakah fund. Zakah fund may also be used in providing the capital investment or providing the business initiation fund; but no return should be charged for that. However, the Awqaf funds may be used as investable fund in providing capital investment and working capital financing for the micro-businesses.

Such an integrated model may reduce the chances of loan default because the basic inherent tendency of the poor to use the loan fund for consumption purpose will be met. As their basic consumption needs are covered, the poor micro-entrepreneurs may be in better position to focus on their business alone. Since Islamic financing modes are based on the principle of social justice and equity and Riba is prohibited, Islamic MFIs are likely to yield better benefit if they are properly designed.

There still remains a debate if micro-credit can serve all the poor including the poorest of the poor. Despite differences the majority agree that the destitute poor will always need charity.

Microfinance involves providing credit without collateral to the marginally poor. Weaknesses of conventional microfinance such as charging high fixed interest rates, credit diversion, credit rationing and nonconformity with the Islamic faith necessitate the creation of IM. There is an opportunity for Islamic microfinance to grow by catering to the needs of the underprivileged people.

Islamic microfinance integrated with two traditional Islamic tools of poverty alleviation — Zakat and Awqaf – in an institutional set-up, will be able to reach the ultra poor. Besides, this model will be financially viable and sustainable in the long run, and will ensure proper use of Zakah funds which do not require any return. This will create a win-win situation for all stakeholders. All these factors will lead to lower default rates and graduation from poverty will be higher.

The writer is Managing Director, Islami Bank Bangladesh Limited

sultan@islamibankbd.com

SOURCE: The Financial Express