Designing Products for Islamic Microfinance

1. Designing Products for Islamic Microfinance Ahmed Ali Siddiqui Executive Vice President Product Development & Shariah Compliance Meezan Bank Limited July 21, 2009

2. Presentation Overview • Islamic Product Development • Product Design for Microfinance • Target Market • Compatibility with Islamic Finance • Modes for Islamic Microfinance • Model for Islamic Microfinance Banks • Possible options for Micro-Business • Road Map for Islamic banks • The Way Forward

3. Islamic Product Development Importance • New Product Development & Research is an important area in which all Islamic Banks need to focus. • To make Islamic banking as a alternative banking system, it is necessary to develop products in a manner in which they are not only Shariah complaint but also practical and marketable. • It enables Islamic bank to satisfy customers’ needs, and compete in today's competitive financial services environment.

4. Islamic Banking Products • All transactions are generally asset-based • It is socially-responsible banking because it operates under Shariah restrictions • Does not permit financing of prohibited goods / Industries • Ethics and moral values play a major role in investment decisions. Not a choice but a must

5. Product Development Basic Permissibility & Prohibition

6. Sources of Shariah • The Holy Qur’an • The Sunnah of the Holy Prophet (SAW) • Ijma’ (consensus of the Ummah) • Qiyas (Anology)

7. Sources of Shariah • Three Prohibited Transaction • Riba • Riba Al Nase’ah • Riba Al Fadhl • Maysir • Gharar • Al Jahalah, Bai Qablal Qubz etc.

8. Prohibition of Riba And Allah has permitted trading and forbidden Riba (Al Baqara 275)

9. Islamic Banking Basic Difference between Islamic and Conventional Modes of Finance Conventional money Bank Client money + money (interest)

10. Islamic Banking Goods & Services money Basic Difference between Islamic and Conventional Modes of Finance Islamic Bank Client

11. Product Development - Process Product Development for Islamic banks • Need Identification • Selection of mode / modes • Concept Paper & Refinements • Approval of Concept paper by Shariah, legal, business • Detail Product Program • Legal Documentation • Final Approval • Soft Launch • Full Launch • Refinement / Improvement

12. Product Development Deciding Factors • Market Survey • Shariah Compliance : Mode, Nature of assets involved, Process, Documentation; • Risk profile – Depositors • Cash flow – Assets side • Possibility of managing mismatch- Liquidity Vs. Profitability • Risk mitigation measures • Legal matters • Regulatory aspects, SBP / SECP: In vogue, Seeking changes through effective case presentation

13. Useful Resources AAOIFI Shariah & Accounting StandardsPractice by Other Islamic banks locally & abroadFocus Research / Discussions with customerInputs from Shariah ExpertsPrevious Ruling by different Shariah Boards

14. Product Design for Islamic Microfinance Finance

15. Target Market • The potential target market of Microfinance is the population below the poverty line who are willing to work themselves out of the poverty vicious cycle. • Also includes the population in Transitory Non-poor and Transitory Vulnerable categories. • The Transitory Non poor have a tendency to move above and below the poverty line. • Transitory vulnerable are transitory non-poor that have high probability of getting poor. • Poor People or the Poverty Line is defined as person or household whose annual income is less than US $ 2 per day

16. Microfinance & Islamic Finance Need & Compatibility: • For Muslim majority country great need for Islamic MF exist and large target segment is averse to the interest based microfinance products. • Both MF & IF emphasize ethical, moral & social factors to promote equality and fairness for the good of the society. • Risk Sharing, individual duties, property rights and sanctity of contracts are part and parcel of Islamic code of finance. • Both advocate entrepreneurship, risk sharing, partnership finance and participation of poor in economic activity. MECHANICS

17. Microfinance & Islamic Finance • 80% of Islamic Microfinance is concentrated in Indonesia, Bangladesh and Afghanistan. • Approximately 44% conventional microfinance clients worldwide reside in Muslim countries (Source: MF Info Ex). • Different studies have revealed that in countries like Syria, Jordan, Yemen, Algeria, Gaza 24% - 60 % responded showed preference for Islamic financial products. MECHANICS

18. Islamic Microfinance Products General Characteristics of Microfinance Products: • Normally MF products are not backed by physical collateral they usually mitigate risk by use of social collateral & PGs. • Repayments are kept small and in frequent installments (weekly/monthly), which makes it easier for the client. • Financing is done for production purpose rather then consumption. • Financing is usually made to members of a group and peer pressure from group members is used to ensure repayment. • Recovery rates are generally higher around 95%, which reflects that the poor are not un-bankable, as considered by the conventional banks.

19. Islamic Microfinance Products Key State Holders: - Microfinance Customers- Islamic Microfinance Provider - Fund Providers / Investors- NGOs and Government Agencies- Regulators - MF Linkage Partners

20. Modes for Islamic Microfinance

21. Islamic Modes for Microfinance • Product options for Islamic Microfinance • Murabaha Financing • Ijarah Financing • Bai Salam Financing • Qard-e-Hasana • Zakah • Mirco Takaful • Working thru linkages – Wakalah / Musharakah and Mudarabah • New & Innovative Concepts

22. Islamic Modes for Microfinance • Murabaha Financing: • Murabaha is the sale of goods on cost plus profit basis. • Islamic Microfinance Bank (IsMFB) can purchase the required goods from market then sells the goods on credit to the client for a known profit. Application: • Purchase of raw material, live stocks, goods for cottage industry, agricultural products, PCOs etc

23. Islamic Modes for Microfinance • Ijarah Financing: • Ijarah is an Islamic alternative for leasing • As per the concept of Islamic Micro Leasing, an IsMFB can lease certain fixed assets to individual microfinance customers. • The assets would be purchased by IsMFB either directly or through the agency agreements with the customer • The asset would remain in the ownership and risk of IsMFB through out the lease period Application Include agri machinery,farming tools, small shops, carts, transport & other related equipments.

24. Islamic Modes for Microfinance • Bai Salam Financing: • A type of Sale with spot payment and delivery at a deferred date • Mainly used for agriculture outputs. Application: • Islamic bank could purchase agricultural products like rice, wheat, pulses, etc from small farmers to be delivered after a specified period on a future date against full payment of the selling price at spot.

25. Islamic Modes for Microfinance • Qard e Hasana • Islamic banks/MFIs can utilize charity funds for providing Qard-e-Hasana to MF clients • A special trust or fund could be established Applications: • Small cash loan at zero percent could be given as Qard to eligible microfinance customers. • Could also be used as an additional incentive loan for timely payment history.

26. Islamic Modes for Microfinance • Zakah Funds • Zakah from individual and government can be an ideal & helpful source used for poverty alleviation. • From Zakah special Waqf or fund could be established Applications: • The fund can be used to provide training, providing health care, education to the needy. • Could be given in kind eg: Tools, equipments, raw material, trading goods etc. • Provision of basic food items.

27. Islamic Modes for Microfinance • Micro Takaful: • An ideal alternative to Conventional insurance, based on a concept of ‘mutual insurance’. Unlike premium, clients pay donations to the Waqf. • From the pool of funds, the needs of the affected are fulfilled. • Waqf invests funds in profitable avenues but only that are permissible in Shariah like Murabaha, Tijarah, Salam, Istisna, Ijarah, Musharakah, Mudarabah, Sukuk etc. Applications: • It can be applied to provide credit cover in case of death, permanent disability, insolvency. • Can be done for live stock, crop, theft, fire etc.

28. Islamic Modes for Microfinance • Developing linkages with MFIs/NGOs: • Rather than getting into the operational side of managing the microfinance assets Islamic Bank can develop special linkages with other active MFIs & NGOs. • Islamic Microfinance Product menu could be shared • It could Result in efficiencies for Islamic bank’s Microfinance program in form of lower costs, better outreach, low default rate, efficient recovery, etc

29. Islamic Modes for Microfinance These linkages can be developed along the following lines: Wakalah • Islamic bank (IB) can appoint a specialized MFB/MFI as Wakeel to manage the Special Musharkah Pool (SMP) for a fixed fee. • The Wakeel using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc. • Profits of the Pool after deducting the related costs (including agency fee) shall be distributed as per the Musharkah or Mudarbah agreement between MBL and depositors.

30. Islamic Modes for Microfinance Mudarabah/Musharakah • IB will enter into a Mudarabah or a Musharakah agreement with a specialized MFB/MFI. • The MFB/MFI will work as Mudarib/working partner while IB would be the Raab ul Maal/Sleeping partner. • The MFB/MFI using its time tested operational model would provide financing to MF clients based on murabaha, ijarah, etc. • Profits earned by the Mudarbah/Musharkah would be distributed between MBL and the MFB/MFI according to the pre agreed ratio at the gross profit level.

31. HOLISTIC APPROACH MEEZAN BANK MICROFINANCE CENTRE Business Advisory & Accounting School Vocational Training Microfinance Office Medical Clinics Incubator

32. Incubators Example # 1 Acquire 2-3 acres of farm land and establish a milk center wherein 50 individuals will be provided a financing to buy 2 cows each i.e. 100 cows per center. Advantage • You Create 50 individuals into business persons • Provides economies of scale in procurement of animals, fords, medicine, etc.. • Provide a better opportunity to sell the milk to large companies like Nestle & Engro at a premium.

33. Incubators Example # 2 • Acquire 1 Acre of Land and establish a textile stitching unit with 100 stitching machines where one man owns one machine. • Many Textile will be able to outsource to these individuals.

34. Micro Business models & modes • 1. Capital Up to PKR 1,000 / USD 13 only • Micro Business Opportunities within this Capital Limit • Selling Confectionary Items. • Mending leather boots, bags, belts etc. • Stitching bed with jute. • Sharpening knives used in kitchen or for cutting meats. • Distributing tools for work to construction laborers. • Selling Mobile Phone accessories and mobile/internet cards. • Selling Balloons at Parks and other public places. • Selling Popcorns at Parks and other public places. • Selling vegetables and fruits. • Selling stationary items. • Selling woven caps, miswak, tasbeeh, non-alcoholic perfumes, Islamic books etc at a mosque. • Selling seasonal dry fruits at parks. • Islamic Financing Alternatives Used • Zakah / Qard-e-Hasan / Ijarah (for durable assets) / Murabaha (for consumable assets / Istisna (where manufacturing of premise involved) / Diminishing Musharakah (where the asset can not be solely financed by funds provided by bank).

35. Micro Business models & modes • 2. Capital PKR 1,000 – 5,000 / USD 14 – 63. • Micro Business Opportunities within this Capital Limit • Financing bicycles on which milk can be distributed. • Financing bicycles on which newspapers can be distributed. • Financing Ironing machine and funds for 2 months electricity charges. • Financing Sewing machine and funds for 2 months electricity charges. • Financing machine for making fried potatoes. • Financing ice cooler to enable sale of frozen desserts. • Financing coal stove for baking sweet potatoes • Selling vegetables, fruits, animal feed etc with little more variety and capital. • Financing juicers for selling fresh fruit juices. • Selling plastic kitchenware. • Selling plastic toys. • Islamic Alternative Used • Zakah / Qard-e-Hasan / Ijarah (for durable assets) / Murabaha (for consumable assets / Istisna (where manufacturing of premise involved) / Diminishing Musharakah (where the asset can not be solely financed by funds provided by bank).

36. Micro Business models & modes • 3. Capital PKR 5,000 – 10,000 / USD 63 - 125 • Micro Business Opportunities within this Capital Limit • Financing domestic cattles. • Construction of a road-side cabin in allowed premises • Financing computer on which typing work can be outsourced. • Financing chopping machines for meat processing for a service fee. • Financing washing machines for better laundry services. • Financing road side cabin infrastructure for selling fresh juices, burger etc. • Financing material and tools for becoming electrician, carpenter, welder etc. (Training Provided). • Financing material/tools to plumber, mason, watch repairing etc. • Financing training to learn repairing various forms of hardware • Expanding the already mentioned opportunities with more variety and capital. • Islamic Alternative Used • Zakat / Qard-e-Hasan / Ijarah (for durable assets) / Murabaha (for consumable assets / Istisna (where manufacturing of premise involved) / Diminishing Musharakah

37. Micro Business models & modes • 4. Capital PKR 10,000 – 50,000 / USD 125 - 625. • Micro Business Opportunities within this Capital Limit • Financing CNG Rickshaw. • Financing ingredients for catering services for parties/festivities. • Financing stock in trade. • Financing road side food cabin. • Financing motorcycles for distributors to expand coverage. • Financing motorcycles to enable outstation jobs for riders. • Financing a photocopier, scanner, printer etc. • Financing tools and materials required for becoming a key maker. • Selling battery operated toys at a park/play area. • Selling Patties, Sweets (Jalebi, Imrati), Samosas, Namak Parey etc. in a residential area. • Islamic Alternative Used • Zakat / Qard-e-Hasan / Ijarah (for durable assets) / Murabaha (for consumable assets / Istisna (where manufacturing of premise involved) / Diminishing Musharakah

38. Micro Business models & modes • 5. Capital PKR 50,000 – 100,000 / USD 625 – 1250. • Micro Business Opportunities within this Capital Limit • Financing Taxi for fare / Small vans • Financing a shop / stall in a shopping centre to sell garments, shoes, perfumes etc. • Financing machinery/equipment for cottage industries. • Selling economical plastic/silverware crockery at a weekly bazaar. (IB may buy premise for that). • Selling cut piece garments, dress specific accessories for men/women, artificial jewellery etc. • Financing infrastructure (chairs, stove, wheel cabin, ingredients) for a restaurant offering better variety. • Islamic Alternative Used • Zakat / Qard-e-Hasan / Ijarah (for durable assets) / Murabaha (for consumable assets / Istisna (where manufacturing of premise involved) / Diminishing Musharakah

39. Road Map for Islamic banks

40. Possible Options for Islamic banks Following options could be adopted by Islamic bank for Microfinance Options • MF counters in existing branches • Standalone MF Branches • Establishment of Independent subsidiaries • Developing Linkages with NGO-MFIs

41. Option of Islamic MF Business Option 1: MF counters in existing branches • Requires minimal changes in organizational structure. • Cost effective. • No approval required from SBP. Lower monitoring • Counter Manger either Report to Branch Manager or the Division at Head Office-as per bank’s discretion

42. Option of Islamic MF Business Option 2: Standalone MF Branches MF Exclusive Branches with separate MF Division at head office. • More focus approach • Separate policies and business model • No separate license & fee required. • Administrative & operating Head office cost will be shared

43. Option of Islamic MF Business Option 3: Establishment of Independent subsidiaries Islamic Banks can also establish MFBs with independent board & management. Existing branches having substantial MF growth potential may be clubbed together & transformed into an independent MFB as a subsidiary of the IB. • Independence & focused approach • Separate Business model & strategies • Support from parent group • Operating cost would be higher

44. Option of Islamic MF Business MECHANICS Option 4: Developing Linkages with NGO-MFIs • Partnership with the NGOs. • No change in the organizational structure. • No approval required from Central bank • Banks may opt for whole-sale financing to NGO-MFIs for their on-lending needs, and/or • Banks may develop linkages/agency arrangements for extending loans through NGO-MFIs

45. Challenges for Islamic banks MECHANICS Key challenges for success • Commitment from Highest Level • Require a Separate Mindset & Business approach • New Sector • Cost efficient Infrastructure development • Diversified Product Development • Developing Linkage • Getting to the target market • Business Approach & Sustainable growth • Monitoring & Recovery

46. Downscaling Pros & Cons Pros for entering in MF • Close to Philosophy of Islamic bank to alleviate poverty • Large untapped Market • Emerging Segment • High demand for Islamic MF product • Attractive Returns Cons • High Operational Cost & Overheads • Require Separate Business model • Risky • Regulations

47. The Way forward • Entering to Islamic microfinance arena by Islamic banks will help in uplifting a large segment of population esp in the Muslim world • It will lead to the economic development of the poor • Islamic banks are expected to perform in this area as part of their mission Islamic banks needs to put resources in this area to develop a “suitable business model & own fit”according to their operating environment.

48. JAZAK ALLAH