Mainstreaming Islamic Microfinance – An Inclusive Approach Muhammad Khaleequzzaman

1. Mainstreaming Islamic Microfinance – An Inclusive Approach Muhammad Khaleequzzaman Head Islamic Banking School of Islamic Banking & Finance International Islamic University Islamabad Pakistan Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

2. Mainstreaming Islamic Microfinance – An Inclusive Approach Contents • Poverty and gap analysis • Issues of microfinance • Role of Islamic microfinance for inclusion – Case of Islamic Microfinance • Review of some Islamic banking products for use in microfinance • Mainstreaming – Issues and some recommendations Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

3. Mainstreaming Islamic Microfinance – An Inclusive Approach Poverty and Microfinance Landscape • Incidence of Poverty • PRSP (2003) 32.1% • Economic Survey (2009) [PC: 24.5% TFFS: 36.1% • Financial Inclusion –(Access to Finance Study 2009) • Formally Served 11% • Informally Served 33% • Financially Excluded 56% • Microfinance Providers [PMN Network] 32 • Coverage as % of Potential Poor Population • Economic Survey 3% 1.6 m Active Borr. • PMN 18% 1.0 m Active Borr. • Microwatch 13% • To reach 3.0 million target, US$ 600- to 700 million (Rs. 49 to 57 billion) is required [PMN 2007] Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

4. Mainstreaming Islamic Microfinance – An Inclusive Approach Issue of Microfinance • Weakening Social Collateral • Hidden transcript – Some women borrowers committed suicide [Rahman, A., “Micro Credit Initiatives ……. Who Pays?”, World Development, Volume 27, No.1, 1999.] • Poorest are rarely looked after [Hashemi, S, and Rosenberg, R. ”Graduating the poorest ……..CGAP, Washington DC, USA. ] • Mistargetting/Program officers bend rules in unobservable way [Baker, J. L, “Evaluating the Impact of Development Projects on Poverty- …….”, The World Bank, Washington DC., 2000. ] • Brokerage raises cost of already expensive transaction [Barki, Husna, & Shah, Mehr, “The Dynamics of Microfinance Expansion in Lahore”, PMN, and ShoreBank Islamabad, Pakistan, 2007] • Violation of social collateral by lenders themselves [Bastelaer, “Does Social Capital Facilitate the Poor’s Access to Credit? …………….., The World Bank Washington, USA] {list is long} Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

5. Mainstreaming Islamic Microfinance – An Inclusive Approach Issue of Microfinance • Sustainability • Most of the programs are not sustainable in Pakistan • Overall Operational and Financial Sustainability records at 89% and 74%, respectively. • High interest rates eats up sustainability of clients • Transparency • Flat interest rates, un-explained fees, hidden charges • High Cost Debt Economy than Real Economy • Separates finance from real economy • Absence of cooperation when client loses • Exclusion • Self-exclusion due to prohibition of interest • Poorest of the poor and Women in gender segregated societies Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

6. Social Capital Reinforcement Negative Social Capital Negative Social Capital -Deceit and Coercion -Selection Bias • MFI • Fard al Kafayah • Adl • Ihsan • Clients • Joint Liab. • Info. Discls. • Self-esteem • Payment -Mistrust -Inefficiency -Idleness -Willful Default Mainstreaming Islamic Microfinance – An Inclusive Approach Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman] Role of Islamic Microfinance helps resolving Issues 1. Developing social capital among clients and MFI instead of clients only

7. Mainstreaming Islamic Microfinance – An Inclusive Approach 2. Meeting Demand For Islamic Microfinance (20-98%) Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

8. Mainstreaming Islamic Microfinance – An Inclusive Approach Role of Islamic Microfinance helps resolving Issues 3. Promoting Entrepreneurship • Debt not allowed in Islam as usual practice • Asset creation and entrepreneurship is promoted 4. Transparency and Sanctity of Contracts • Islamic values prevent violation of contract and require disclosure of full knowledge relating to financial transaction Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

9. Mainstreaming Islamic Microfinance – An Inclusive Approach Mainstreaming Islamic Microfinance: Issues for Mainstreaming • Regarding MFIs • Limited number of IMFIs (i.e. 4 – 6) • Limited resource base of IMFI • Ineligibility of collecting savings • Product concentration in Murabaha • Capacity building of MFI • Sharia advisory • Regarding Islamic banks • Perception about microfinance as high risk area • Informal sector environment • Absence in rural areas • Absence of credit guarantee scheme Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

10. Mainstreaming Islamic Microfinance – An Inclusive Approach Mainstreaming Islamic Microfinance: Some Recommendations 1. Downscaling Islamic Banks • Corporate Social Responsibility: Fard al Kafaya • Business case:Profits and high rate of recovery • Limitations: Informal sector/regulatory implications, absence in rural areas • Possible Course of Action: • Phase – I: • Linkage with MFIs [Mudaraba or Musharaka] • Urban Operation through Islamic MF Division or Cell • Phase – II • Linkage continues • Extension of branches in rural areas Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

11. Islamic Bank MF NGO MF NGO MF NGO Clients Clients Clients Clients Clients Clients Clients Clients Clients Savings Financing Mainstreaming Islamic Microfinance – An Inclusive Approach Sharia Advisory & Technology Transfer Mainstreaming Islamic Microfinance: Some Recommendations LINKAGE Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

12. Mainstreaming Islamic Microfinance – An Inclusive Approach Mainstreaming Islamic Microfinance: Some Recommendations 2. Downscaling Commercial Banking and Establishing IMFBs – • SBP Guidelines • Full-fledged Islamic Microfinance Banks (IMFBs) • Islamic Microfinance Services by Full-Fledged Islamic Banks • Islamic Microfinance Services by Conventional Banks • Islamic Microfinance Services by Conventional Microfinance Banks Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

13. Mainstreaming Islamic Microfinance – An Inclusive Approach Mainstreaming Islamic Microfinance: Some Recommendations 3. Involving Cooperatives • Legitimacy: Cooperative societies Act, 1925 • Bodies corporate, Eligible to collect savings and intermediate for financing • Members of Provincial Cooperative Banks (Refinancing Facility) • Number of cooperatives: • Pakistan: > 40,000 with 4.30 mil members • Punjab: >30,000 with 1.20 mil members • Transformation of PCBs to MFIs • Pakistan: > 3.40 million approx. • Punjab: > 1.20 million approx. Example – Karakorum Coop. Bank under conversion in phased program [Total 6 branches 2 Islamic MF Branches] Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

14. Mainstreaming Islamic Microfinance – An Inclusive Approach 5. IFI takes assets as agent of SPV 11. Payment of Exercise Price Originator (IFI) (Ijara Assets) Clients 6. IFI (as agent of SPV) leases assets to clients 1. SPV is created 8. Rent 7. Rent 4. Payment Vendor Special Purpose Vehicle (SPV) 3. Price 9. Rent 2. SPV issues sukuk Investors/IBs 10. Redemption of sukuk Some Recommendations 4. Market Leverage • Once Ijara and Musharaka/Mudaraba have accumulated, IBs or IMFIs (as group) may securitize by issuing sukuk Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

15. Transformation of hard core poor Mainstreaming Islamic Microfinance – An Inclusive Approach Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman] Some Recommendations 5. Inclusion • Diversification of approach and products includes self-excluded • Zakat and sadaqat – divine tools of grant – enables poorest of the poor to benefit from microfinance – systematic approach meeting consumption and then production needs

16. Mainstreaming Islamic Microfinance – An Inclusive Approach Some Recommendations 6. Order of Product Offering • Phase – I [1st to 3rd cycle] • Murabaha • Salam • Phase – II [4th to 5th cycle] • Ijara • Diminishing Musharaka for durable assets only • Phase – III [Graduated after 5th cycle] • Mudaraba & Musharaka Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

17. Liquidity requirements(hiring of tractor & implements, sowing, purchase of water, hiring of labour, etc.) Input requirements(seed, fertilizer, pesticides) Advantages: Meeting total needs, lower credit risk Some Innovations: Murabaha & Salam – Agricultural Financing Liquidity Liquidity Need Inputs in kind Inputs in kind Liquidity Need Hiring for land prep. Hiring for land prep. Sale of fertilizers, seed, pesticides Hiring for Harvest + Marketing Exp. J U N S A L A M A P R M U R A B N O V S A L A M N O V Delivery Payment Delivery Mainstreaming Islamic Microfinance – An Inclusive Approach Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]

18. Mainstreaming Islamic Microfinance – An Inclusive Approach Some Innovations:Istijrar: [Taking from supplies bit by bit] Repeated Sale Contract:An agreement between a buyer and a seller that the buyer will take from seller the goods he needs with or without fixing the price and without explicit offer and acceptance at each time. This has been agreed by majority of schools from the viewpoint of Istehsan. Need for the Instrument:In case of daily or weekly supplies, it is not practicable to execute Murabahah each and every time. Two types: 1. The price is paid after a predetermined period 2. MFI leaves some money with the buyer and he uses this money for purchase of goods whenever needed but in a predetermined period What is Required: Product Development Effort Islamic Microfinance-Sustainability & Mainstreaming [M. Khaleequzzaman]

19. Mainstreaming Islamic Microfinance – An Inclusive Approach THANKS Islamic Microfinance - An Inclusive Approach [M. Khaleequzzaman]