Developing Islamic microfinance

By: Professor Michael Skully, a professor of banking at Monash University.

Some argue that lending to the poor may have even greater merit than a simple charitable donation. The rationale is that with a loan, the money, when it is returned, can be lent again to others and so the long-term impact on poverty through such lending is much greater. This is a view that would be strongly shared by most microfinance practitioners.

Islamic microfinance institutions (IMFIs) have a marked advantage over their conventional counterparts in that they are well placed to coordinate their efforts with that of local Muslim charities.

So whereas conventional MFIs cannot effectively service the poorest of the poor, IMFIs can do so indirectly in combination with local charities: the latter can meet the living needs and the IMFI can then help the client break from the poverty trap.

As overall Islamic fi nance has become more developed, others have started to revisit microfi nance and identifi ed its significant potential both ethically as an important undertaking and fi nancially as the returns on investment can be considerable. At least part of this new attention can be traced to microfinance’s greater coverage in the world press.

The Islamic Development Bank (IDB) itself allocated specifi c funding for IMFIs. The World Bank’s Consultative Group Against Poverty (CGAP) in August 2008 also recognized Islamic microfi nance as an important, but separate, standing with the release of its “Islamic microfi nance: An emerging market niche” publication. The APEC Advisory Group similarly in 2008 also allocated one of its formal meeting papers to the topic of Islamic microfinance.

There are no doubt many other such examples of mainstream, non-Islamic institutions giving it similar attention. In 2010, for example, CGAP together with the IDB and others sponsored the ‘Islamic Microfinance Challenge’ with a major prize available to the winner.

So in 2011, despite the CGAP title, Islamic microfi nance can hardly be considered a market niche. It has instead become a key aspect of the Islamic finance industry.

These recent IMFI developments differ from those of the past on two counts. The first is that Islamic finance is no longer confined solely to specialist microfinance institutions and the second is the development on international IMFI networks.

On the IMFI front, several Islamic banks have found that microfi nance fi ts well with their own business strategy and gives them a further advantage over their conventional banking competitors. It is therefore perhaps not surprising that Islamic banks were featured strongly in the 2010 CGAP challenge.

Indeed, the Al-Amal Microfi nance Bank (AAMB) from Yemen was the end winner of the US$100,000 prize. In its first two years of operations, AAMB had some 15,000 borrowers and 20,000 savers. Its group and individual financing arrangements have now captured a quarter of Yemen’s microfinance industry.

On the networking front, Islamic microfinance professionals are learning from past mistakes, selecting those models that have worked best, and then seeking refinements to achieve even better results.

The Islamic microfi nance network is now one Islamic example and of course, though not strictly Islamic, the Grameen Foundation could also provide assistance to Muslim clients.

Just as some Islamic banks are starting to expand across national borders, it is hoped that more IMFIs take a similar regional, if not global, approach to facilitating future business.

The importance of this support, while perhaps obvious, should nevertheless be re-stated. In order to escape poverty, people need to increase their income generating capacity and this is normally done through a combination of improved skills and working capital or equipment.

When faced with the choice of continued poverty and paying interest, many may be tempted to borrow. Others, when faced with either paying interest or not borrowing, may select the latter.The CGAP research suggests that some two thirds of the Muslim world’s
microfi nance customers would prefer Islamic microfi nance and perhaps a third (at least in Yemen) would rather go without if none is offered.

So there is certainly a large potential market. As some 72% of the people living in Muslim countries do not use formal financial services, the potential for Islamic finance, particularly Islamic microfi nance, remains very promising and will hopefully attract additional investment accordingly.