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Islamic Microfinance – An idea whose time has come in India?
As a plethora of financial inclusion models emerge across India, vast segments of the Muslim community still remain under-banked. In recent years, a handful of leading financial players have developed Shariah-compliant funds for the Indian market. However, full-fledged Islamic banks are yet to make inroads into the microfinance sector. Many Muslims hail from low income groups across India and typically lack access to bank credit, as documented in the Sachar committee report (2006). In such a scenario, can Islamic microfinance be the tipping point for bringing an end to the financial exclusion of the Muslim community?
032 Islamic Microfinance – An idea whose time has come in India?

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Latent demand in India

Islamic scholars such as Dr Rahmatullah of AICMEU are of the view that poor Muslims are reluctant to avail of bank credit since the payment of interest (known as riba) is forbidden under Islamic jurisprudence.  Thus, it would be worth debating whether Shariah-compliant banking practices, which usually entail profit-and-loss sharing, asset financing and equity participation, can be emulated in the microfinance sector in order to catalyze the financial mainstreaming of the Muslim community. Shariah-compliant banking practices in the microfinance sector do not entail the payment/ acceptance of usury. Islamic products such  as Murabaha, Musharaka and Mudharaba can be tweaked in accordance with the needs of microfinance clients.

Dr Shariq Nisar, a Shariah expert, points out that Muslims, who constitute 15% of the Indian population, mostly belong to poorest sections of society. “India has the second largest population of Muslims in the world, and many a time, the Muslim population is geographically concentrated, which indicates that there is market potential for Islamic microfinance,” explains LB Prakash, a consultant with MISFA, Afghanistan. Several poor and orthodox Muslims are wary of availing of the services of MFIs on religious grounds, as interest payment is mandatory, points out Dr Rahmatullah. A few MFIs, which operate in regions with a high concentration of Muslims, are now seriously considering a foray into Islamic microfinance.

Nirantara, an MFI which is based in Bidar, a district of North Karnataka, is planning to develop Islamic banking products to cater to the religious sensibilities of its Muslim clientele. While stating that 40-50% of his clients are muslims, the founder of Nirantara, Niranjan Sheelvanth, emphasizes on reaching out to orthodox members of the community as well as winning the trust of clerics by launching an Islamic product portfolio. Products, which are attuned to the religious sensibilities of the Muslim community, would be beneficial for Nirantara as it expands into other districts of Karnataka, where there may be a higher degree of Shariah compliance and a less favourable attitude towards the payment of riba as witnessed in Kolar last year.

Type of Islamic banking products suitable for Indian MFIs

Close attention would have to be paid to the type of Islamic banking products, which could be adapted to the needs of clients. Murabaha is highly popular as an Islamic banking product due to its similarity to conventional interest-bearing loans, according to Dr Shariq Nisar. Under the murabaha banking method, the financial institution buys and resells goods to the entrepreneur at a fixed mark-up, which is akin to an interest payment. The pros and cons of Islamic banking product offering would have to be factored in by the MFI. LB Prakash of MISFA alluded to the practical difficulties for MFIs in purchasing and reselling products (take for instance, raw materials/ machinery needed by micro-entrepreneurs) through a Murabaha contract, in a country like India, which may lead to an increase in operating costs, and therefore increased cost of lending for the client.

On the other end of the spectrum, Murabaha can help lower costs for microfinance clients in agricultural sector. The Shariah scholar Mohammad Palath from the Al Jamia Institute, Kerala, described how a Murabaha scheme developed by an Islamic MFI had shielded paddy cultivators in Sri Lanka from rising costs of fertilizers and raw materials. He advocates the launch of a similar Murabaha-based microfinance product for paddy cultivators in Kerala. “Murabaha is possible where the beneficiary’s repayment capacity is properly ascertained and reasonably justified,” explains KK Ali, the CEO of Alternative Investments And Credits Ltd (AICL), an NBFC run on Isamic banking principles in Kerala.

Musharaka, wherein the banker and entrepreneur enter into a profit-sharing agreement based on the proportion of investment, is a widely used Islamic banking product. Nonetheless, scholars and practitioners have voiced their apprehensions about the viability of Musharaka products in the microfinance sector, as most of the low income clients would be not able to provide the necessary seed capital while entering into a profit sharing agreement with the bank, which would play the role of a venture capitalist.

Dr Rahmatullah of AICMEU, contends Mudarabaha – whereby the bank provides capital and the entrepreneur, in turn, uses his technical know-how without making any investment – would be more suitable compared to Musharaka for a developing economy. KK Ali, the CEO of AICL, also echoes similar views about the benefits of Mudarabaha for microfinance clients. The profit is shared on a pre-determined basis and the loss arising from the business is borne entirely by the bank. The prospects of fixed asset financing can also be explored for mature microfinance clients who are graduating into the small and medium enterprise segment. Murabaha and ijara (leasing of assets for fixed period and price) would be suitable for such clients, according to Dr Rahmatullah.

Islamic microfinance has gathered momentum across Muslim countries in South Asia as demonstrated in the case of Islami Bank in Bangladesh. Apart from Murabaha, Musharaka and Mudharaba, Islami Bank’s microfinance wing also provides Bai-Muajjal (a long term credit-sale agreement, wherein both the buyer and seller agree on a deferred payment*) and Bai-Salam (a sale contract wherein the buyer makes advance payment to the Islamic bank for the purchase of goods). Obaidul Rehman, Senior Vice President and Head of Rural Development Scheme at Islami Bank, cites a steady demand for Islamic microfinance products in Bangladesh.

Legal barriers and mounting operating costs

A foray into Islamic microfinance can be fraught with challenges under the current Indian regulatory environment. The Reserve Bank of India has not permitted Islamic banks to operate in India. Nonetheless such a restriction can be circumvented by non-banking financial companies, charitable society trusts and cooperative societies, as they can add Islamic microfinance products to their repertoire.

The RBI has also not permitted non-banking financial companies to offer depositary services. This implies that NBFC-MFIs run on Islamic banking principles would not be able mobilise public deposits. Such a clause would hinder Islamic NBFCs’ access to funds, feels Dr Shariq Nisar. The RBI, for its part, would have to be briefed about the different modes of Shariah-compliant funding. Concerns are also being voiced about the operating costs of launching Islamic products in the Indian microfinance market. Interest-free lending may increase operating costs for NBFCs, states Ravi Shankar, the Executive Vice President of Marketing and Microfinance, Fullerton India Credit Company Limited. Equity participation, he feels, may turn out a long drawn out process for MFIs. Mohammad Palath of Al Jamia Institute points out that operating costs are generally higher for Islamic microfinance institutionsMudharaba, can pose a financial risk for MFIs.

Moreover, investors/ banks, which fund Islamic NBFCs, may not always react favourably to loss-bearing transactions. It is indeed imperative to find techniques to lower monitoring costs for transactions involving equity participation, asset financing and profit-sharing in the microfinance sector. Joint liability/ self-help group models, which are used by conventional MFIs, can help mitigate risks of moral hazard, and in turn, reduce monitoring costs. Just as in any standard MFI, Islamic Bank has in place a joint liability group model, wherein each member gives a personal guarantee for the repayment of the investment. The bank’s microfinance wing has reported a recovery rate of 99%. This bears testimony to the fact that joint liability group models are indeed compatible with Islamic banking.

Grass-root level awareness

Microfinance clients would have to be apprised of the different types of Islamic banking techniques and greater awareness would also have to be created at a grassroot level. To start with, clients should be able to distinguish between partnership agreements, which prevail in Islamic banking and conventional microfinance, which is characterised by a debtor-creditor relationship. “Since most of the microfinance clients are less educated, they will take more time in appreciating the difference,” explains Shariq Nisar. Awareness of the benefits of Islamic banking is almost negligible among potential microfinance clients.

Seminars across colleges and places of worship and awareness campaigns could help draw the masses to Islamic microfinance, suggests Dr Rahamatullah. Before awareness is created, more market research can be conducted on the nature of credit requirements among Muslim microfinance borrowers and appropriate product development strategies can be formulated accordingly by prospective Islamic microfinance players. In a diverse country such as India, MFIs would need to roll out Islamic banking products only in those regions which are highly Shariah compliant (LB Prakash of MISFA states that Shariah compliance varies from one region to another.) MFIs, which are seriously considering a foray into the hitherto untapped Islamic microfinance market, would need to develop products with low operating costs. Appropriate institutional structures for Islamic banking – which can function smoothly under the current RBI regime – would have to be determined.

References
* Structuring Islamic Finance Transactions; 2005, Abdulkader S. Thomas, Stella Cox, Bryan Kraty

About the authors:

Priyanka Jayashankar, Doctoral Researcher, Maastricht School of Management, The Netherlands

Ms Priyanka Jayashankar holds a basic degree in economics, and is a trained journalist. She has completed her M.Phil and MBA from the Maastricht School of Management, The Netherlands. Currently, she is pursuing her doctoral research from the same institute with a special focus on the marketing strategies of microfinance institutions. An alumna of the Asian College of Journalism, Chennai, Ms Priyanka had worked for Business Line where she has published several articles.

Robert V. Goedegebuure, PhD
Associate Professor International Business, Maastricht School of Management, The Netherlands

Prof Goedegebuure holds a PhD in International Business from the Rotterdam School of Management (Erasmus University, the Netherlands). He has worked in areas such as marketing research and statistics. He has specialized in the impact of internationalization on firm strategies and industrial policy. He has performed research projects for the Dutch Ministry of Economic Affairs, and European and international institutions. In addition he has authored numerous courses in marketing and marketing research.

Source :
Microfinance Focus
 
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