MICROFINANCE IN ISLAMIC BANKING

PRESENTED BY AGIB

INTRODUCTION

What is Islamic Banking?

The prohibition of risk free return and permission of trading as stated in verse 2:275 of the Holy Quran makes the activities of Islamic financial institutions “ASSET BASE” and add value to economic activities.

Islamic Banking System is based on risk sharing (profit and loss sharing), owning and handling physical goods, trading and host of other activities.

Islamic Banking transactions are based on the commercial relationship which existed between the Prophet Muhammad (PBUH) and his first wife Haddija – Mudaraba (profit sharing) contracts.

COMMENCEMENT OF ISLAMIC BANKING

In the late 1960s experiments on Islamic Banking were carried out in Egypt.

In 1974 the Organisation of Islamic Conference Member Countries approved the establishment of the Islamic Development Bank with its head quarters situated in Jeddah, Kingdom of Saudi Arabia.

The IDB commenced operation as a multinational Islamic Bank in 1975/76 thus the beginning of Islamic Banking in the world.

IDB was then mandated to assist OIC member countries to establish and operate Islamic Banks.

As at the end of 2005, there were about 270 Islamic Financial Institutions worldwide. Their total asset was around US$300 billion the number of Islamic Banks and assets grow at the rate of 15% per annum.

Some multinational banks have opened Islamic Banking windows.

Iran, Pakistan and Sudan were the only countries operating on 100% Islamic Banking.

The establishment and operation of an Islamic Bank in UK was recently approved.

FACTORS OF PRODUCTION

CLASSICAL ECONOMIC> Land – rent
Labour – wages and salary
Capital – profit
Entrepreneur – profit



ISLAMIC ECONOMICS> Land – rent
Labour – wages and salary
Capital – profit
Entrepreneur and money – profit


Savings and Investment accounts are of a Mudaraba (profit sharing) agreement.

Islamic Banks are mostly Development Finance Institutions (DFI).

They operate on profit basis and not on interest.

Their modes of financing are asset based.

ISLAMIC BANKS’ MODES OF FINANCING

MUDARABA> Profit sharing

MURABAHA> Cost plus mark – sales on deferred payment basis

MUSHARAKA> Joint venture partnership base on capital contribution and profit sharing

ISTISNAA> (Deferred delivery sale contract) applicable to work in progress financing for capital projects

IJARAH> Operation and finance/lease purchase

TAWARUK> (Short term/cash facility)

PRIVATE-EQUITY INVESTMENT> Diminishing and permanent partnership

SUKUKS AL-SALAM> Short term Islamic Securities 3, 6 and 12 months

SUKUKS AL-IJARA> Medium to long term Islamic Securities up to 5 years

All these modes of financing are available to micro-finance enterprises.

LENDING/FINANCING CRITERIA

Character
Capital/capacity
Capability
Collateral
Connection

Limited business advisory service

(ii) BORROWED FUNDS

(a) Loans or financing facilities;
(b) Bank overdraft;
(c) Leasing agreements;
(d) Medium to long term finance etc.

FINANCING PLAN FOR MICROFINANCE ENTERPRISES

(i) Medium to long term sources of fund to march such financing needs;
(i) Owners’ equity to constitute at least 50% of required fund; and
(ii) Loan capital usually not more than 50% of total investment.

THE SCOPE AND SIGNIFICANCE OF MICROFINANCE ENTITIES

Microfinance as the name suggests are financial services that poor people desire and are willing to pay for. The term also refers to the practice of sustainable delivering of those services. More broadly, it refers to a movement that envisions “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers.” The importance of microfinance cannot be over emphasized as it evolved as a need-base policy and program to cater to the far neglected target groups (women, poor rural, deprived and so on). Development organizations and policy makers have included access to credit for poor people as a major aspect of many poverty alleviation activities as it creates economic and social development from below. It has been argued that once the poor have access to income there will be trickle-up effect of development as opposed to the trickle-down effect.

Microfinance is significant in national development as it enables the poor to increase their income level. It enables the poor to have access to financial services which were exclusively available to the upper and middle income population. Microfinance is the most effective intervention for economic empowerment of the poor.

The number of microfinance institution as at June 2005 was thirty-eight in the Gambia. There are mainly twenty microfinance practitioners/direct lenders, ten microfinance intermediaries, seven facilitators, two microfinance network institutions, various clients/beneficiaries and one regulator/supervisor (source A Study on The National Strategic Framework for Microfinance NSFM).

ISLAMIC BANKING AND MICROFINANCE

Islamic banking institutions are in operation ranging from pure Islamic banks to smaller Sharia banking units in conventional banks and investment houses. As one of the fastest growing segments of financial services market in the Islamic world for the past five years these institutions have attracted a lot of attention. Moreover the guiding principles of Islamic finances have drawn curiosity from Muslims and non-Muslims alike as they try to understand how a system that prohibited the receipt and payment of interest became so widespread.

Islam financial practices are founded on the core belief that money is not an earning asset of itself; there is more to the system's underlying tenets. Sharia emphasizes ethical, moral, social and religious factors to promote equality and fairness for the good of society as a whole.

The following basic instruments of Islamic financing can successfully be applicable to microfinance program:



A MUDARABA MODEL (trustee financing)

In a Mudaraba base transaction the microfinance program and the micro-enterprise are partners, with the program the microfinance invest in the money while the micro-entrepreneur investing the labor. The micro-entrepreneur is rewarded for his or her work and shares in the profit, the program only shares profit. The profit sharing rates are predetermined, but the profit is unknown. In effect, the microfinance program takes “equity” in the micro-enterprise.

A MURABAHA MODEL (cost plus markup)

The Murabaha contract is similar to trade finance in the context of working capital loans and to leasing in the context of fixed capital loans. Under such contract the microfinance program literally buys goods and resells them to the micro-enterprises for the cost of goods plus markup for administrative costs. The borrower often pays for goods in equal installments.

MUSHARAKA (Joint venture partnership)

Musharaka is an equity participation contract in which the bank is always the only provider of funds. The distinguishing features of this type of contract are the nature of the businesses activity and the duration of the gestation period for the business. Two or more partners contribute to the capital and expertise of an investment. Profits and losses are shared accordingly to the amounts of capital invested.

IJARAH WAL IQTINA (leasing)

This a contract under which the Islamic bank provides building or other assets to the clients against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rental as well as the purchase price is fixed in such manner that the bank gets back its principal sum along with the profit over the period of lease.

SOCIAL ROLE OF ISLAMIC BANKING

Eradication of poverty, socio-economic justice and equitable distribution of income are among the primary goals of Islam and should be unyielding features of an Islamic economic system. The philosophical basis of Islamic financial system lies in Adl (social justice) and Ihsan (benevolence). The implication of these concepts is taking care of those who cannot be taken care of by the market, who cannot play with economic forces or do not have access to economic means to enable them to exploit the economic opportunities around.
The social role of Islamic financial sectors is to provide finance to the poor so as to increase their income and wealth.

CONCLUSION

In conclusion, Islamic banking with its emphasis on risk sharing and for certain products, collateral free loans is compatible with the needs of micro-entrepreneurs. As it promotes entrepreneurship, expanding Islamic banking to the poor could foster development under the right application. Islamic law allows room for financial innovation, and several Islamic contractual arrangements can be combined to design a hybrid. Microfinance programs have extensive experience with character base lending, as most micro-entrepreneurs lack acceptable collateral. Thus there is compatibility between the needs of micro-entrepreneurs and the practice of Islamic banking. Islamic banking and micro credit program may complement one another in both ideological and practical terms.

Arab Gambian Islamic Bank Limited has been extending financing facilities all investors, more so to customers whose access to borrowed fund in limited.

It is the intention of the Bank to be more proactive in microfinance activities and contribute to poverty alleviation.

Sectors invested in by AGIB include:
Commerce
Industry
Agriculture
Construction
Fishing
Tourism
Energy etc

AGIB, like all other Islamic Banks and as a DFI, contributes to the socio economic development of The Gambia. This is by way of direct participation in the production and distribution of goods and rendering of services.