Financing the Poor: Towards an Islamic Microfinance An Islamic Finance Industry Perspective Iqbal Khan and Aamir A. Rehman Harvard Law School - 14 April 2007

Financing the Poor: Towards an Islamic Microfinance | 2 I.Islamic finance is an inclusive proposition II.Engaging the poor is not easy III.Industry has potential to lead and address the situation IV.Next stages Agenda

Financing the Poor: Towards an Islamic Microfinance | 3 Industry is outcome of CSR and ethical principles Islamic finance is more than financial contracts  Fundamental tenants are derived from Shariah –Absence of interest-based transactions –Avoidance of economic activity involving speculation –Prohibition on production of goods and services which contradict the values of Islam  Concept is grounded in ethics and values –Principles akin to ethical investing –Emphasis on risk-sharing and partnership contracts  Islamic finance offers an alternative paradigm –Asset-backed transactions with investments in real, durable assets –Stability from linking financial services to the productive, real economy –Credit and debt products are not encouraged –Restrains consumer indebtedness  Islamic banking is community banking –Serving communities, not markets –Open to all-faith clients –Instruments of poverty-reduction are inherent part of Islamic finance – zakat & qard hasan channels

Financing the Poor: Towards an Islamic Microfinance | 4 Islamic finance has not forgotten the poor Industry has not yet reached full potential  Industry initially had to demonstrate commercial viability –First Islamic bank established in 1975 –Initial market strategy focus on revenue-generating projects  Industry is young and gaining mainstream relevance –Industry-building infrastructure setup as recently as 1991 (AAO-IFI) –Reputational risk management led to careful dealing with non-regulated charities industry  Industry is building stakeholder connectivity –State-controlled waqf and zakat institutions not proactively engaged with Islamic finance –Regulatory hurdles imposing investment restrictions in government-owned institutions  Islamic banking develops link to economy –Robust banking system enables economic development –Vehicle for financial and economic empowerment –Deepening bankable population and unlocking “dead capital”  Responsibility of poor was sidelined for growth first –Industry began as MitGhamr Savings Associations (1963) –Nile Delta experiment to mobilise local villager savings for local socio-economic development

Financing the Poor: Towards an Islamic Microfinance | 5 I.Islamic finance is an inclusive proposition II.Engaging the poor is not easy III.Industry has potential to lead and address the situation IV.Next stages

Financing the Poor: Towards an Islamic Microfinance | 6 Assisting the poor is a pillar of Islam Bottom of Pyramid market carries additional responsibility  Engaging the poor requires balance between profitable and responsible lending –Lending enterprise needs to be wary of debt spiral –Engagement programme must be self-sustaining  Bottom of Pyramid market has long been neglected –Market is well underserved – half of planet live on less than $2 a day¹ –Islamic finance has ready moral and product framework to assist –Islamic finance can unlock bankable wealth and enable “trickle down” effect Lending profitably  Despite engagement of less privileged customers  May not be responsible financing: –Sub-prime lending –Debt consolidation companies Lending responsibly  Prevent over-indebtedness  Microfinance is good example –Fiduciary business to uplift poor –Affordable lending to enable sustainability Source: 1. HBS Bulletin March 2007

Financing the Poor: Towards an Islamic Microfinance | 7 I.Islamic finance is an inclusive proposition II.Engaging the poor is not easy III.Industry has potential to lead and address the situation IV.Next stages

Financing the Poor: Towards an Islamic Microfinance | 8 Islamic microfinance is a complementary initiative to Islamic finance Microfinance mission reflects part of Islamic ethos Microfinance Islamic finance Reaches previously under- banked population Focus on uplifting the poor Models advocate:- financial inclusion - entrepreneurship - risk-sharing through partnership financing Routed in Shariah-compliance Fair access to capital Equitable Core concern New-market innovation Finance based on worthiness of ventures and assets, and not based on wealth Asset orientation

Financing the Poor: Towards an Islamic Microfinance | 9 Islamic microfinance supports industry morals and ground needs Microfinance fits the spirit of Shariah-based industry development  Industry needs to shift from Shariah- compliant to Shariah-based –Mindset of consumer debt is not in Islamic spirit –Investment and debt for productive use is allowed –Microfinance provides credit for the real economy  Microfinance fits need of Muslim communities –Muslim-countries in spectrum of poverty and underdeveloped social infrastructure –Islamic microfinance will attract under-banked and underserved “economically active” poor  Islamic finance provides interest-free solutions for job creation –Musharaka/Mudaraba PLS arrangements –Murabaha/Ijara commodity purchases Shariah-compliant products Shariah-based solutions Savings & Investments Indebtedness x  Income-sharing products  Shift from debt-based product offering  Letter of the law  Replicating conventional credit service offering

Financing the Poor: Towards an Islamic Microfinance | 10 –Assist in building Islamic microfinance institutions with Islamic finance products –Use charitable endowments as start-up, risk-free capital Industry can build commercial partnerships with Microfinance managers Islamic finance is a platform to build microfinance 3 PhilanthropicCommercial Partnership Organic 41 2 –Create charitable funding channels for Microfinance institution –Combine Islamic finance industry synergies and distribution assistance –Bring capital market access via Islamic finance industry and match with efficient institutions –Initiate joint ventures with successful, business-run enterprises –Build scale and reach of Islamic microfinance managers –Migrate successful models to other markets

Financing the Poor: Towards an Islamic Microfinance | 11 I.Islamic finance is an inclusive proposition II.Engaging the poor is not easy III.Industry has potential to lead and address the situation IV.Next stages

Financing the Poor: Towards an Islamic Microfinance | 12 Create successful partnership formula Islamic microfinance requires combined efforts Best-of-breed microfinance institutions Modest capital commitment Requires institutional will

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