The Islamic world with over 1.2 billion people, comprises six regions: North Africa, Sub-Saharan Africa, the Middle East, Central Asia, South Asia, and Southeast Asia. Except for a handful of countries in Southeast Asia and the Middle East, there are high and rising poverty levels everywhere. This is owing to high inequality and low productivity. In Indonesia alone, over half of the population - about 129 million are poor or vulnerable to poverty with incomes less that US$2 a day. Bangladesh and Pakistan account for 122 million each followed by India at approximately 100 million Muslims below poverty line.
A recent study undertaken by the Islamic Development Bank, Jeddah, has some shocking revelations. Just five of its 56 member countries - Indonesia, Bangladesh, Pakistan, Nigeria and Egypt account for over half a billion (528 million) of the world’s poor with incomes below $2 a day or below their national poverty lines. All these countries except Nigeria have Muslims constituting over 95 per cent of their respective population. With another five countries - Afghanistan, Sudan, Mozambique, Turkey and Niger, they account for over 600 million of the world’s poor. Among IDB non-member countries with significant Muslim population are India at around 150 million and Russia at 28 million. A large percentage of Muslim population in these two countries is poor. The poverty in most Muslim countries is accompanied by growing tensions and conflicts and therefore, deserves immediate attention of the international community. Policy makers across the globe recognize microfinance as a powerful poverty alleviation tool as it implies provision of financial services to poor and low-income people whose low economic standing excludes them from formal financial systems. Access to services such as, credit, venture capital, savings, insurance, remittance is supposed to help the poor to increase household income and economic security, build assets and reduce vulnerability. While exclusion of the poor from the financial system is a major factor contributing to their inability to participate in the development process, in a typical developing economy, the formal financial system serves no more than 20 to 30 per cent of the population. Building inclusive financial systems therefore, is a central goal of policy makers world wide.
How severe is financial exclusion among Muslims of the world? According to several studies, access to financial services in Muslim societies is either grossly inadequate or exclusive. In a recent study for the 2007 World Bank conference on Access to Financial Services, Patrick Honohan estimated the fraction of the adult population using formal financial intermediaries as a measure of financial access for over 160 countries. The study reveals that out of the 44 OIC member countries for which the estimate is available, in 17 countries only one-fifth or less of their adult population have access; in 21 countries one-fourth or less have access and in 31 countries one third or less have access to formal financial services. The numbers in non-member countries like India, are no less alarming. In a report submitted to the Ministry of Minority Affairs, a committee of top bankers under the chairmanship of Mr Nasser Munjee observes that just 20.3 per cent among the minority community had accounts in public-sector banks while this percentage is 79.7 per cent for the majority community.
A major initiative towards building inclusive financial systems and achieving poverty alleviation is formation of the Consultative Group to Assist the Poor (CGAP), a multi-donor consortium dedicated to advancing microfinance. As a way forward to realize its vision, CGAP has come up with 11 key principles of MF based on decade-long consultations with its members and stakeholders. In brief, the principles broaden the definition of microfinance - from micro-credit to provision of an array of financial services, such as, savings, insurance and remittance. They emphasize that access to microfinance and not cost of microfinance should be under focus in designing a poverty alleviation strategy. The strategy should aim at sustainability through a shift from a charity-based donor-dependent approach to a market-based for-profits approach emphasizing systemic efficiency and transparency and restricting use of donor funds to capacity building. The principles also underscore inclusiveness and integration of microfinance with the formal financial system.
Even while the principles reflect a consensus, they do not imply or advocate a single and uniform approach to microfinance. As CGAP emphasizes, “diverse approaches are needed. A one-size-fits-all solution will not work. Diverse channels are needed to get diverse financial services into the hands of a diverse range of people who are currently excluded. Making this vision a reality entails breaking down the walls that currently separate microfinance from the much broader world of financial systems.” In the context of Muslim societies, building inclusive financial systems would most certainly require integration of microfinance with Islamic finance.
Microfinance and Islamic finance have much in common. Both advocate entrepreneurship and risk sharing and believe that the poor should take part in such activities; focus on developmental and social goals; advocate financial inclusion, entrepreneurship and risk-sharing through partnership finance; involve participation by the poor. There are however, some points of difference, discomfort and discontent. Conventional microfinance is not for the poorest of the poor. There is a sizeable substratum within the rural poor whose lives are unlikely to be touched, let alone improved by financial services. They are not “bankable” in their own or their neighbor’s eyes, even when the bank is exclusively for poor people. Yet they desperately need some sort of assistance. An Islamic microfinance system, on the other hand, has a subsystem of zakah that exclusively targets the poorest of the poor. Zakah involves an “obligation” on the rich and not-so-poor to donate a specific percentage of income and wealth for the extremely poor and the destitute defined as per clear criteria. In addition to zakah that is obligatory, Muslims are encouraged to make voluntary donations called sadaqa that are free from any constraint regarding their use.
Most conventional microfinance providers charge rates of interest that are found to be high when benchmarked against mainstream banking rates. Several reasons are usually given in defence. First, returns on investment in micro-enterprise are very high, by the standards of banks and other investors - the reason being the miniscule size of investments compared to the earnings numbers. Hence, entrepreneurs can “afford” to pay high interest rates as cost of funds (sometimes as high as 60 to 70 per cent) as long as the same are lower than rates of return. And that interest rates are much less important to micro-enterprises than access, timeliness and flexibility. Second, interest rates on microfinance are pegged relatively higher, since they entail higher administrative charges, monitoring costs and are by definition, riskier than a traditional financing portfolio.
There is a general agreement that administrative and monitoring costs are higher with micro-financing. While this helps explain the differential in cost of financing of a microfinance portfolio as compared to a traditional portfolio, the method of financing need not be interest-based. Interest, regardless of it being high or low, is rejected by large sections of the Muslim societies as tantamount to riba - something prohibited in Islam.
In defense of prohibition of riba, proponents point out that the so-called high rates of returns on micro-projects are true only for the “successful” projects passing through “good times” and not true of all projects at all times. Interest related liability can aggravate the financial problems of a project experiencing bad times and hasten its failure. The pace, frequency and intensity of such failure is directly related to the levels of interest rates. In case of Islamic profit-sharing mechanisms on the other hand, there is a clear alignment between profitability of the project and cost of capital. The latter rises and falls in line with the realized profits of the venture. In case of Islamic debt financing too, the negative effects of financial risk arising out of use of fixed-rate financing are limited as compared to interest-based debt. This is because the former does not allow for compounding of the debt in case of possible default.
One of the potential benefits of microfinance in Muslim societies is the empowerment of Muslim women. While the ability of microfinance institutions to deliver financial services to rural women in gender-segregated societies is commendable, working with Muslim women is a sensitive issue that often raises accusations of meddling with social codes. Some Islamic microfinance institutions seek to overcome this through a shift in their focus from “women empowerment” to “family empowerment”. In a few other Islamic microfinance programmes, a culturally appropriate way has been found of empowering women through gender-segregated ownership of the financing entity and involving separate appraisal of loan applications by women who develop their own gender-sensitive products and strategies for the future.
From the above, it is clear that the cultural and religious sensitivities of the Islamic world are somewhat unique and these must be given due emphasis in any attempt to build inclusive financial systems. In the next part we will discuss salient features of an Islamic microfinance system, followed by a survey of landscape of Islamic microfinance programmes in part three.
(The author is a Senior Economist with the Islamic Development Bank, Jeddah and Founder, Manara Development Initiative in India. He may be reached at email@example.com)