islamic microfinance: a potential tool for poverty alleviation in tanzania

1. islamic microfinance: a potential tool for poverty alleviation in tanzania 3RD AFRICAN ISLAMIC FINANCE SUMMIT 19TH – 20TH MAY, 2016 Hyatt Regency, DSM – Tanzania BY DR. ABDULRAHMAN J. NKOBA

2. ORGANIZATION • INTRODUCTION • MICROFINANCE AND POVERTY ALLEVIATION • MICROFINANCE INDUSTRY IN TANZANIA • ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION • TANZANIA: ADAPTABILITY OF ISLAMIC MICROFINANCE • CONCLUDING REMARKS

3. INTRODUCTION • Poverty as a global phenomenon and the biggest moral challenge of this century • Concern of United Nations • LDCs most affected • Lack of Capital as an Obstacle to Poverty Alleviation • The Role of Microfinance Institutions • Establishment of MFI/NGOs • Grameen Bank of Bangladesh • BancoSol of Bolivia • Bank Rakyat Unit Desa System of Indonesia • Juhudi Scheme of KREP in Kenya

4. INTRODUCTION CONT... • Conventional Microfinance and Poverty Reduction – The Evidence • Mixed Results • Complaints and obstacles • The Issue of Religion • Conventional Microfinance and Poverty Alleviation in Tanzania • The same complaints, obstacles and issues.

5. INTRODUCTION CONT... • Main Question and Argument • Question: Why is Poverty still prevalent and in some cases the situation has even turned out to be worse? • Argument: The main reason for the failure to eradicate poverty is to be found in the Poverty Alleviation Mechanism Itself. The efficacy of Lender/Borrower or Creditor Relationship should be revisited!!! • Solution: Islamic Microfinance may be a better alternative.

6. MICROFINANCE AND POVERTY ALLEVIATION • Microfinance Models • Grameen Bank Model: targeting the poor mostly women groups. • Village Bank Model: Involves an implementing agency that establishes individual village banks with about thirty to fifty members. A bank repaying in full is eligible for subsequent loans. • Credit Union Model: Credit unions mobilize savings, provide loans for productive purposes and have membership which are generally based on some common bond. • Self Help Groups: It pools together its members’ savings and uses the savings for lending.

7. MICROFINANCE AND POVERTY ALLEVIATION CONT... • Major Issues in Microfinance • Financing for Economically Active • Not usually appropriate for chronically poor • Not for a person with no entrepreneurial or technical skills • High cost of Financing • Most conventional microfinance providers charge rates of interest that are found to be high when compared to mainstream banking rates • Women Only Approach

8. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW • THE NEED FOR MICROFINANCE • Tanzania is one of the poorest countries in the in the world with a GNI of just 400 USD per capita in 2007. Tanzania is ranked 93nd in the UNDP’s of the human poverty index making reducing poverty an important focus point for the Tanzanian Government. • Development Strategies: • National Poverty Eradication Strategy (NPES) (1997) • Development Vision 2025 (1999).

9. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • THE NEED FOR MICROFINANCE CONT.. • Growth and Poverty Reduction Plan (MKUKUTA) [Covering 2005-2010) • These poverty reduction strategies have also introduced microfinance in Tanzania. Microcredit is seen as a source of future growth

10. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • MICROFINANCE INSTITUTIONS IN TANZANIA • The Role of MFIs Tanzania • Microfinance institutions operating in Tanzania provide financial services to the SMEs mainly in the form of micro credit with an exception of cooperative based microfinance institutions, which are predominantly savings based.

11. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • TYPES OF MFIs • The credit based institutions number between 80 and 100 out of which 42 are registered members of the Tanzania Association of Microfinance Institutions (TAMFI), the local microfinance network. • The main microfinance institutions can be categorized as non governmental organizations (NGOs), Cooperative based institutions namely SACCOs and SACCAs while the third category is banks.

12. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • TYPES OF MFIs CONT... • NGOs • The major players in the NGOs category include PRIDE Tanzania, FINCA (Tanzania), Small Enterprise Development Agency (SEDA) and Presidential Trust for Self-Reliance (PTF). Others, which are relatively smaller in size, include Small Industries Development Organization (SIDO), YOSEFO, SELFINA, Tanzania Gatsby Trust, Poverty Africa and the Zanzibar based Women Development Trust Fund and Mfuko. There rest consists of very tiny programmes scattered throughout the country mainly in the form of community based organizations (CBOs).

13. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • Banks • Banks that are actively involved in microfinance services delivery include the National Microfinance Bank (NMB), CRDB bank, Akiba Commercial Bank (ACB) and a few Community/regional banks namely, Dar es Salaam Community Bank, Mwanga Community Bank, Mufindi Community bank, Kilimanjaro Cooperative Bank, Mbinga Community Bank and Kagera Cooperative Bank.

14. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • MFIs CONCENTRATION AND OUTREACH • Urban versus Rural Distribution: The distribution with respect to the concentration of microfinance activities in Tanzania is skewed in favor of the urban areas leaving rural areas grossly under served. Most MFIs with an exception of tiny rural based SACCOs are reluctant to extend their services to the rural areas due to poor infrastructure, high risk and high cost of operation. The latter is brought about by the fact that rural areas in Tanzania by nature are sparsely populated.

15. THE MICROFINANCE INDUSTRY IN TANZANIA: AN OVERVIEW CONT... • MFIs CONCENTRATION AND OUTREACH CONT... • MFIs in Tanzania put together serve a combined client population of about 400,000 SMEs, which is only around 5% of the total estimated demand. • Commercial banks: 50,000 Clients • NGOs: 220,000 clients • PRIDE Tanzania being the largest single player accounts for about 29% of the market share in this category or 16% of the existing total market share.

16. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION • THE ISLAMIC APPROACH TO POVERTY ALLEVIATION • Charity Funds: Zakah and Sadaqa as Instrument of Poverty Alleviation • Commercial Approach: When Zakah and Sadaqa collected are inadequate the recourse must be found in commercial approach: i.e. The use of IMFIs • Islamic microfinance institutions should be able to mobilize savings for onward financing. The approach entails sharing of profits which is consistent with Shariah.

17. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Islam Seeks to Minimize Dependence on Charity and Encourages Entrepreneurship. • The following hadith not only underscores the above argument but also demonstrates how to design and implement a strategy of poverty alleviation: • Narrated AnasibnMalik: A man of the Ansar came to the Prophet (peace be upon him) and begged from him.  • 1. He (the Prophet) asked: Have you nothing in your house? He replied: Yes, a piece of cloth, a part of which we wear and a part of which we spread (on the ground), and a wooden bowl from which we drink water.

18. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Hadith Cont.... • 2. He said: Bring them to me. He then brought these articles to him and he (the Prophet) took them in his hands and asked: Who will buy these? A man said: I shall buy them for one dirham. He said twice or thrice: Who will offer more than one dirham? A man said: I shall buy them for two dirhams. • 3. He gave these to him and took the two dirhams and, giving them to the Ansari, he said: Buy food with one of them and hand it to your family, and buy an axe and bring it to me.

19. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT.. • Hadith Cont... • 4. He then brought it to him. The Apostle of Allah (peace be upon him) fixed a handle on it with his own hands • 5. and said: Go, gather firewood and sell it, and do not let me see you for a fortnight. • 6. The man went away and gathered firewood and sold it. When he had earned ten dirhams, he came to him and bought a garment with some of them and food with the others.

20. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT. • Hadith Cont... • The Apostle of Allah (peace be upon him) then said: This is better for you than that begging should come as a spot on your face on the Day of Judgment. 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. (Sunan Abu Dawood, Kitab al-Zakah, Book 9, Number 1637).

21. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Hadith Cont... • The components of the hadith can be seen to emphasize the following fundamental conditions of a successful microfinance program: • Access of the poorest of the poor to the program • Careful assessment of the financial health of the poor; enquiry blended with empathy; insistence on contribution and beneficiary stake;

22. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Hadith Continues... • 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; • Meeting of basic needs on a priority basis and investment of the surplus in a productive asset; • Direct involvement of the program in capacity building in the run-up to income generation and technical assistance to the beneficiary; Commitmentof top management of the program;

23. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Hadith Cont.... • Technical assistance in the form of imparting requisite training to the beneficiary for carrying out the business plan/income-generating project; monitoring through a time-bound schedule and impact assessment through a feed-back mechanism; and • Transparent accounting of operational results and liberty to use part of income to meet higher needs.

24. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Hadith Cont... • In a nutshell, the Islamic approach to poverty alleviation is more inclusive than the conventional one. It provides for the basic conditions of sustainable and successful microfinance, blending wealth creation with empathy for the poorest of the poor

25. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Additional Aspects • The Need for Proper Documentation • Proper documentation is a fundamental requirement of financial transactions in the Islamic framework. Allah (S.W.) says:  • “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” (2:282) • Indeed, lack of proper documentation and accounting by beneficiaries (the poor entrepreneur) is a major challenge confronting microfinance.

26. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT.. • Additional Aspects cont... • Mutual Cooperation and solidarity • A common feature of successful Islamic microfinance is group-based financing and mutual guarantee within the group. Mutual cooperation and solidarity is a norm central to Islamic ethics. On this the holy Quran says:  • "Assist one another in the doing of good and righteousness. Assist not one another in sin and transgression, but keep your duty to Allah" (5:2)

27. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • Additional aspects cont... • A famous hadithby the Prophet (pbuh) reinforces this principle of cooperation and mutual assistance. “Believers are to other believers like parts of a structure that tighten and reinforce each other." (Al-Bukhari and Muslim) • Free from Riba, Gharar, Jahl and Dharar • The Islamic approach to poverty alleviation needless to say, must also be free from riba, gharar, jahland darar.

28. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE • Instruments for Mobilization of Funds • Charity • Zakah • Sadaqah • Awqaf; • Gifts that include hibaand tabarru • While sadaqah, hibaand tabarruhave parallels in conventional microfinance, such as, donations or contributions, zakahand awqafhave a special place in the Islamic system and are governed by elaborate fiqhirules.

29. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Deposits: may take the form of wadiah, qard al-hasan and mudarabah. Deposits in the form of wadiah, qard al-hasan and mudarabah have their parallel in savings, current and time deposits respectively and are a regular source of funds for Islamic microfinance institutions.

30. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT.. • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Equity: may take the form of classical musharakah or the modern stocks. Microfinance institutions also have the option of raising funds through participatory modes, such as, musharakah or modern equity

31. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Instruments of Financing • Participatory Profit-Loss Sharing Modes • Mudarabah Modes • Muzara’ah is a form of mudarabah contract in farming where microfinance institution can provide land or monetary capital for farming product in return for a share of the harvest according to the agreed profit sharing ratio. • Musharakah modes.

32. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Sale Based Modes • A Typical example of a sale based mode is the Murabahah. Using murabahahas a mode of microfinance requires microfinance institution to acquire and purchase asset or business equipment then sells the asset to entrepreneur at mark-up.

33. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Lease-Based Modes or Ijarah • Unlike conventional finance lease, the lessor (Islamic microfinance institution) not only owned the asset but takes the responsibility of monitoring the used of asset and discharges its responsibility to maintain and repair the asset in case of mechanical default that are not due to wear and tear. The Islamic microfinance institution should first purchase the asset prior to execution of an ijarahcontract.

34. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • IjarahMuntahiaBitamleekis an elaborate concept of ijarahwhere the transfer of ownership will take place at the end of the contract and pre-agreed between the lessor and the lessee. In this case, the entrepreneurs can just rent the asset over a period of time and pay the rentals at regular intervals. The entrepreneur as a lessee will be responsible to safeguard the asset whereas the lessor will monitor their usage.

35. ISLAMIC MICROFINANCE AND POVERTY ALLEVIATION CONT... • SHARIAH COMPLIANT INSTRUMENTS OF MICROFINANCE CONT... • Benevolent Loans or Qard • Unlike mainstream Islamic finance that does not quite treat qard al-hasanor simply means an interest free loan as a financing mechanism. Islamic microfinance institution can provide this scheme to the entrepreneurs who are in need of small start-up capital and have no business experience. The term of repayment will be on instalment basis for an agreed period.

36. TANZANIA: ADAPTABILITY OF ISLAMIC MICRO FINANCE CONT • POTENTIAL MICROFINANCE PROVIDERS • Informal Islamic Microfinance Providers • Individual microfinance informal providers in Tanzania may include friends and relatives, traders, processors, and input suppliers. Loans in the Islamic framework must based on qard al-hasan. • Member Based Organizations • Community banks, credit unions, Savings and Credit Cooperative (SACCOS). The SACCOSs may be of greater importance to the poor entrepreneurs in Tanzania both in the rural and urban areas.

37. TANZANIA: ADAPTABILITY OF ISLAMIC MICRO FINANCE CONT.. • POTENTIAL MICROFINANCE PROVIDERS CONT.. • Non-Government Organizations [NGOs] • Islamic NGOs usually have multiple bottom lines and pursue social objectives in addition to microfinance. The Zakahand Sadaqah-based organizations fall in this category. NGOs can clearly lead the way in the development of Islamic microfinance. • Islamic Banks • The two Islamic Banks operating in Tanzania hold enormous potential for the development of Islamic Microfinance.

38. TANZANIA: ADAPTABILITY OF ISLAMIC MICRO FINANCE CONT.. • POTENTIAL CHALLENGES • Shariah Compliance • Shariah compliance is indeed the differentiating factor between a conventional and Islamic microfinance institution. The two Islamic banks in the country provide comfort to their stakeholders that they conform to Islamic finance principles as they have set up Shariah Supervisory Board (SSB)s. The challenge before Islamic microfinance institutions is therefore to seek alternatives to the above approach.

39. TANZANIA: ADAPTABILITY OF ISLAMIC MICRO FINANCE CONT.. • POTENTIAL CHALLENGES CONT... • Linkages with Banks and Capital Market • If microfinance is to help build inclusive financial systems, it must develop strong linkages with the formal banking sector and the capital markets. The absence of such linkages may constitutes a major challenge to policy makers interested in bringing the“excluded” and “non-bankable” into the fold of formal financial systems.

40. CONCLUDING REMARKS • In the light of our discussion the following recommendations are offered: aforementioned observation we do recommend the following: • Integrating Islamic Banks with Islamic Microfinance by either: • Downscaling Islamic Banking Operations • Intermediating through MFIs or Microfinance NGOs:

41. CONCLUDING REMARKS CONT... • Encourage the Establishment of more Islamic Microfinance Organizations   • Providing Risk Mitigation through Takaful (Islamic Insurance) • Developing Social Capital to Improve the Quality and Commitment of All Stakeholders END THANK YOU