Financing the Poor: Towards an Islamic Microfinance An Islamic Finance Industry Perspective

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 • Islamic finance is an inclusive proposition • Engaging the poor is not easy • Industry has potential to lead and address the situation • Next stages

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

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

Islamic finance is an inclusive proposition • Engaging the poor is not easy • Industry has potential to lead and address the situation • Next stages

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

Islamic microfinance is a complementary initiative to Islamic finance Islamic finance Microfinance Reaches previously under-banked population Focus on uplifting the poor New-market innovation Finance based on worthiness of ventures and assets, and not based on wealth Asset orientation Routed in Shariah-compliance Fair access to capital Core concern Models advocate: - financial inclusion - entrepreneurship - risk-sharing through partnership financing Equitable Microfinance mission reflects part of Islamic ethos

x Microfinance fits the spirit of Shariah-based industry development Shariah-based solutions • Industry needs to shift from Shariah-compliant to Shariah-based • Mindset of consumer debt is not in Islamic spirit • Investment and debt for productive use is allowed • Microfinance provides credit for the real economy • Microfinance fits need of Muslim communities • Muslim-countries in spectrum of poverty and underdeveloped social infrastructure • Islamic microfinance will attract under-banked and underserved “economically active” poor • Islamic finance provides interest-free solutions for job creation • Musharaka/Mudaraba PLS arrangements • Murabaha/Ijara commodity purchases • Income-sharing products • Shift from debt-based product offering Savings & Investments Indebtedness Shariah-compliant products • Letter of the law • Replicating conventional credit service offering Islamic microfinance supports industry morals and ground needs

Partnership 2 3 Philanthropic Commercial 1 4 Organic Islamic finance is a platform to build microfinance • Bring capital market access via Islamic finance industry and match with efficient institutions • Initiate joint ventures with successful, business-run enterprises • Create charitable funding channels for Microfinance institution • Combine Islamic finance industry synergies and distribution assistance • Assist in building Islamic microfinance institutions with Islamic finance products • Use charitable endowments as start-up, risk-free capital • Build scale and reach of Islamic microfinance managers • Migrate successful models to other markets Industry can build commercial partnerships with Microfinance managers

Islamic microfinance requires combined efforts Requires institutional will Modest capital commitment Best-of-breed microfinance institutions Create successful partnership formula

Thank you rehman@post.harvard.edu

Financing the Poor: Towards an Islamic Microfinance An Islamic Finance Industry Perspective