TENTATIVE PROGRAMME - Sudan University of Science...

REGULATORY AND SUPERVISORY FRAMEWORK

IN ISLAMIC MICROFINANCE

Edited by

Abdelrahman Elzahi

Abdul Ghafar Ismail

Mustafa Najm Albushari

Paper presented at the Roundtable Discussion on

Regulatory and Supervisory Frameworkin Islamic Microfinance,18 -19 March 2014,

Sudan University of Sciences and Technology, Khartoum, Sudan

ISLAMIC RESEARCH AND TRAINING INSTITUTE

ISLAMIC DEVELOPMENT BANK

i

©Islamic Development Bank, 2014King Fahd National Library Cataloging-in-Publication Data

King Fahd National Library Cataloguing-in-Publication DataElzahi, Abdelrahman

Proceedings of the roundtable discussion 2014 on Regulatory and Supervisory Framework in Islamic Microfinance. / Abdelrahaman Elzahi; Abdul Ghafar Ismail;Albushari. – Jeddah, 2014

346 p; …cm

ISBN: 978-9960-32-277-3

1-Microfinance 2- Islamic Development BankI- Abdelrahman Elzahi II- Abdul Ghafar Ismail III- Title

332.1 dc 1435/2195

L.D. no. 1435/2195ISBN: 978-9960-32-277-3

ii

PROCEEDINGS OFTHE ROUNDTABLE DISCUSSION PROGRAMME

REGULATORY AND SUPERVISORY FRAMEWORK IN ISLAMIC MICROFINANCE

Edited by Abdelrahman ElzahiAbdul Ghafar Ismail


Organized by

Sudan University of Sciences and Technology, Khartoum - Sudanand

Islamic Research and Training Institute (IRTI/ GIDB), Jeddah – Saudi Arabia

In collaboration with

Agricultural Bank of Sudan

Tuesday, March 18th – Wednesday, March 19th , 2014Sudan University of Sciences and Technology

Venue: Khartoum, Sudan

SUDAN UNIVERSITY OF SCIENCES AND TECHNOLOGYISLAMIC RESEARCH AND TRAINING INSTITUTE

2014

iii

PROCEEDINGS OFTHE ROUNDTABLE DISCUSSION PROGRAMME

REGULATORY AND SUPERVISORY FRAMEWORK IN ISLAMIC MICROFINANCE

Edited by Abdelrahman ElzahiAbdul Ghafar Ismail


Organized by

Sudan University of Sciences and Technology, Khartoum - Sudanand

Islamic Research and Training Institute (IRTI/ GIDB), Jeddah – Saudi Arabia

In collaboration with

Agricultural Bank of Sudan, Khartoum - Sudan

Tuesday, March 18th – Wednesday, March 19th , 2014Sudan University of Sciences and Technology

Venue: Khartoum, Sudan

SUDAN UNIVERSITY OF SCIENCES AND TECHNOLOGYISLAMIC RESEARCH AND TRAINING INSTITUTE

2014

v

TENTATIVE PROGRAMME

Assoc. Prof. Dr. Abdelrahman Elzahi Saaid AliIslamic Economic Research Division

IRTI/IsDBE-mail: [email protected]

Tel:+966 2 6466330

Prof. Dr. Abdul Ghafar IsmailIslamic Economic Research Division

IRTI/IsDBE-mail: [email protected]

Tel:+966 2 646 6330

Dr. Mustafa Najm AlbushariSudan University of Science and Technology

Khartoum SudanE-mail: [email protected]

Tel: +249916294031

ROUNDTABLE DISCUSSION PROGRAMMERegulatory and Supervisory Framework in Islamic Microfinance

Sudan University of Sciences and Technology Venue: Khartoum, Sudan

Tuesday, March 18th – Wednesday, March 19th , 2014http://www.sustech.edu/

PROGRAMME DAY 1 Tuesday, March 18th 2014 8:00 – 17:308:00 – 8:30Arrival, tea, coffee and registration

OPENING SESSION 8.30 – 9:30Chancellor, Sudan University of Science and TechnologyProf Dr Abdul Ghafar Ismail, Islamic Research and Training InstituteRepresentative, Agricultural Bank of SudanGovernment Official

vii

SESSION ONEMicrofinance in Sudan

Chaired by Abdelrahman Elzahi Saaid Ali

9:30-10:30-Islamic micro finance in Sudan weaknesses and opportunitiesBakhita Hamdow Gad Elkreem 01-For the development of the microfinance sector (in Arabic)General Federation of Trade Unions of Sudan 02

Break 10:30-10:45

SESSION TWO

Behavioral Economics can inform market regulation Chaired by Qosim al Fakiy ‘aliy Jadullah

10:45-12:30-A Framework for Regulating Islamic Microfinance InstitutionsAbdul Ghafar Ismail 03-Attaining Financial Inclusion through Regulating Islamic MicrofinanceBijay Kumar Swain 04Discussion

12:30-13:30 Buffet Lunch and Solat - Venue

SESSION THREEMicrofinance and Policymakers

Chaired by Mustafa Najm Albushari

13:30-15:00-The Role of State-Created Agencies in Supervising the Islamic Microfinance Institutions to Alleviate Poverty amongst Rural FarmersMuhammad Hakimi Mohd Shafiai and Abidullah 05-Experiences in Regulating and Supervising Islamic Microfinance InstitutionsMuhammad Zubair 06-Legal Framework for Crowdfunding in MicrofinanceDossa Maxime 07Discussion

Break 15:15-15:30

SESSION FOURExperiences in regulating and supervising Islamic Microfinance Institutions

Chaired by Khalid Al-bily

15:30-17:00-Moral and Ethics in Islamic Microfinance and Its Impact on Bangladeshi Rural Poor’s Livelihood: An Empirical Study

viii

M. Mizanur Rahman 08-Issues in Regulating and Supervising Islamic Micro Finance Institution in Indonesia: Its Policy Direction and Remedies under the New Regime. Akhmad Affandi Mahfudz 09Discussion

18:30 End20h30 Diners for Presenters

PROGRAMME DAY 2 Wednesday, 19th March 2014 8:00 – 17:008:00-8:30 Arrival, Tea, Coffee and registration

SESSION FIVEExperiences in regulating and supervising Islamic Microfinance Institutions

Chaired by Najmadin

8:30-10:30

-An Analysis of Islamic Microfinance InstitutionS (IMFS) In Indonesia: Regulation and Supervision PerspectiveYulizar D. Sanrego, Fikih Apriadi, Miftahussurur, Anita Priantina and Ries Wulandari 10-Regulatory Framework for Member-Owned Islamic Microfinance Institution (MIMI): Focus on Islamic Saving Groups and Cooperatives Sub-Saharan Africa (SSA)Muhammad-Bashir Owolabi Yusuf , Nasim Shah Shirazi and Moha Asri Abdullah 11-The Impact of Regulatory and Supervision framework on Microfinance in KenyaAbd elrahman Elzahi Saaid Ali and Wahida Mohamed Athman Ali 12-The effectiveness of Regulatory and Supervision framework of Microfinance in SudanAbdelrahman Elzahi Saaid Ali 13Discussion

Break 10:30-10:45

SESSION SIXExperiences in regulating and supervising Islamic Microfinance Institutions

Chaired by Mohamad Hammad

10:45-12:30

-Using Subsidy Dependence Index for Regulating and Supervising Microfinance Institutions: A Pakistan’s CaseHina Almas and Muhammad Mubashir Mukhtar 14-The effectiveness of microfinance projects run graduates. (Case study of business incubators at the University of Sudan for Science and Technology from 2010 to 2013) (in Arabic)Kassim al Fakiy ‘aliy Jadullah 15Discussion

ix

12:30-13:30 Buffet Lunch and Solat - Venue

SESSION SEVENPolicy related to regulation and supervision

Chaired by Abdul Azim?13:30-15:00

-Islamic Microfinance and Sukuk: A Propose Regulatory Framework for Liquidity issue in IndonesiaRaditya Sukmana 16-Capital Requirement and Financing Provision Regulation in Islamic Microfinance Institutions (IMFIs): Single and Double Mandate (s)Suhal Kusairi and Nur Azura Sanusi 1716:30 Discussion

Break 15:00-15:15

15.15 Conclusions – Proposals and recommendations:Abdelrahman Elzahi, Islamic Research and Training InstituteBijay Kumar Swain, National Institute of Rural DevelopmentAgricultural Bank of SudanMicrofinance Unit, Central Bank of Sudan

20h30 Diners for Presenters

x

CONTENTS

Tentative Programme...................................................................................................................viiContents..........................................................................................................................................xiList of Contributors ....................................................................................................................xiiiPreface............................................................................................................................................xv

Session One Microfinance in Sudan

Paper 1 Islamic Micro Finance in Sudan Weakness and Opportunities..............................1Bakhita Hamdow Gad Elkreem

Paper 2: For the Development of the Microfinance Sector..................................................3General Federation of Trade Unions of Sudan

Session Two Behavioral Economics can inform market regulation

Paper 3: A Framework for Regulating Islamic Microfinance Institutions..........................12Abdul Ghafar Ismail

Paper 4: Attaining Financial Inclusion through Regulating Islamic Microfinance............29Bijay Kumar Swain

Session Three Microfinance and Policymakers

Paper 5: The Role of State-Created Agencies in Supervising the Islamic Microfinance Institutions to Alleviate Poverty amongst Rural Farmers.....................................38Muhammad Hakimi Mohd Shafiai

Paper 6: Experiences in Regulating and Supervising Islamic Microfinance Institutions............................................................................................................56Muhammad Zubair

Paper 7: How African Diaspora Can Impact The Development Of Islamic Finance..................................................................................................................62Dossa Maxime

Session Four Experiences in regulating and supervising Islamic Microfinance Institutions

Paper 8: Moral and Ethics in Islamic Microfinance and Its Impact on Bangladeshi Rural Poor’s Livelihood: An Empirical Study.....................................................84M. Mizanur Rahman

Paper 9: Issues in Regulating and Supervising Islamic Micro Finance Institution in Indonesia: Its Policy Direction and Remedies under the New Regime..............109Akhmad Affandi Mahfudz

xi

Session Five Experiences in regulating and supervising Islamic Microfinance Institutions

Paper 10: An Analysis of Islamic Microfinance Institution (IMFs) In Indonesia: Regulation and Supervision Perspective.............................................................120Yulizar D. SanregoFikih ApriadiMiftahussurur Anita Priantina Ries Wulandari

Paper 11: Regulatory Framework for Member-Owned Islamic Microfinance Institution (MIMI): Focus on Islamic Saving Groups and Cooperatives Sub-Saharan Africa (SSA)..................................................................................140Muhammad-Bashir OwolabiYusufNasim Shah ShiraziMoha Asri Abdullah

Paper 12: The Impact of Regulatory and Supervision framework on Microfinance in Kenya ............................................................................................................156Abd elrahman Elzahi Saaid AliWahida Mohamed Athman Ali

Paper 13: The Effectiveness of Regulatory and Supervision Framework of Islamic Microfinance in Sudan.......................................................................178Abd elrahman Elzahi Saaid Ali

Session Six Experiences in regulating and supervising Islamic Microfinance Institutions

Paper 14: Using Subsidy Dependence Index for Regulating and SupervisingMicrofinance Institutions: A Pakistan’s Case..................................184Hina AlmasMuhammad Mubashir Mukhtar

Paper 15: The Effectiveness of Microfinance Projects Run Graduates..............................197Kassim Al Fakiy ‘aliy Jadullah

Session Seven Policy related to regulation and supervision

Paper 16: Islamic Microfinance and Sukuk:A Propose Regulatory Framework for Liquidity Issue in Indonesia..........................................................................214Raditya Sukmana

Paper 17: Capital Requirement and Financing Provision Regulation inIslamic Microfinance Institutions (IMFIs):Single and Double Mandate (s)...................229Suhal KusairiNur Azura Sanusi

xii

LIST OF CONTRIBUTORS

Abd elrahman Elzahi Saaid Ali, Islamic Research and Training Institute (IRTI/IDB)

Abdul Ghafar Ismail, Head of research division and Professor of Banking and Financial Economics,Islamic Research and Training Institute, Islamic Development Bank, P.O. Box 9201, Jeddah 21413 Kingdom of Saudi Arabia. e-mail:[email protected]

Abidullah, Graduate School of Business, University Kebangsaan Malasyia, 43750 Bangi, Selangor. Email: [email protected]

Akhmad Affandi Mahfudz, Visiting Scholar, Islamic Business School, School of Business Universiti Utara Malaysia. E-mail: [email protected]

Anita Priantina, Institute for Research and Community Empowerment (IRTI), Tazkia University, College of Islamic Economics, Jl. Ir. H. Djuanda, Sentul City, Bogor – Indonesia. E-mail: . www.lppm.tazkia.ac.id

Bakhita Hamdow Gad Elkreem, Assistant Professor, Banking Department, Faculty of Commerce, Kordofan University. Phone No :0122508117. E-mail: [email protected]

Bijay Kumar Swain, Professor & Head Centre for Rural Credit & Development Banking, National Institute of Rural Development, Rajendranagar, Hyderabad - 500 030, INDIA. Cell No. + 09550881770. Office No. 040-24008489. E-mail: [email protected]

Dossa Maxime, E-mail: .

Fikih Apriadi, Institute for Research and Community Empowerment (IRTI), Tazkia University, College of Islamic Economics, Jl. Ir. H. Djuanda, Sentul City, Bogor – Indonesia. E-mail: . www.lppm.tazkia.ac.id

Hina Almas, Research Scholar, MS Economics & Finance, International Institute of Islamic Economics (IIIE), International Islamic University Islamabad (IIUI), Pakistan. E-mail:

Kassim Al Fakiy ‘aliy Jadullah, Lecturer in Economics, Faculty of Business, Sudan University of Sciences and Technology. E-mail:

M. Mizanur Rahman, Director Research, Islamic Bank Training and Research Academy, IBBL, Bangladesh, Presently working on deputation as Head of Training in Jaiz Bank Plc., Abuja, Nigeria. Email: [email protected]

Miftahussurur, Institute for Research and Community Empowerment (IRTI), Tazkia University, College of Islamic Economics, Jl. Ir. H. Djuanda, Sentul City, Bogor – Indonesia. E-mail: . www.lppm.tazkia.ac.id

Moha Asri Abdullah, Professor of Economics, Department of Economics, International Islamic University Malaysia. E-mail:

Muhammad Hakimi Bin Mohd Shafiai, Senior Lecturer, School of Economics, Faculty of Economics & Management, Institut Islam Hadhari, Universiti Kebangsaan Malaysia (UKM), 43600 Bangi, Selangor. E-mail: [email protected]

xiii

Muhammad Mubashir Mukhtar, Research Assistant, Center for Entrepreneurial Development (CED), Institute of Business Administration (IBA), Karachi, Pakistan. Tel: +92-333-3147454; E-mail: [email protected]

Muhammad Zubair, Chief Executive Officer - AlHuda Centre of Islamic Banking and Economics (CIBE). [email protected]

Muhammad-Bashir OwolabiYusuf, Post-Doctoral Researcher, Department of Economics, International Islamic University Malaysia. E-mail:

Nasim Shah Shirazi, Senior Economist, Islamic Research and Training Institute (IRTI), Jeddah, Saudi Arabia. E-mail:

Nur Azura Sanusi, PhD, Associate Professor, School of Social and Economic Development, Universiti Malaysia Terengganu, Tel: +6096684541; Fax: +6096684237. Email: [email protected]

Paper 2 no name, in Arabic and no name, General Federation of Trade Unions of Sudan.

Raditya Sukmana, PhD. Lecturer in Islamic Economic, Faculty of Economics and Business, Universitas Airlangga, Surabaya, Indonesia. E-mail:

Ries Wulandari, Institute for Research and Community Empowerment (IRTI), Tazkia University, College of Islamic Economics, Jl. Ir. H. Djuanda, Sentul City, Bogor – Indonesia. E-mail:. www.lppm.tazkia.ac.id

Suhal Kusairi, Ph.D. Lecturer, School of Social and Economic Development, Universiti Malaysia Terengganu, Tel: +6096684541; Fax: +6096684237. Email: [email protected]

Wahida Mohamed Athman Ali, Maseno University

Yulizar D. Sanrego, Institute for Research and Community Empowerment (IRTI), Tazkia University, College of Islamic Economics, Jl. Ir. H. Djuanda, Sentul City, Bogor – Indonesia. E-mail: . www.lppm.tazkia.ac.id

xiv

PREFACE

xv

Paper 1

ISLAMIC MICRO FINANCE IN SUDAN WEAKNESS AND OPPORTUNITIES

Bakhita Hamdow Gad ElkreemAssistant Professor, Banking Department, Faculty of Commerce

Kordofan UniversityPhone No :0122508117

Email : [email protected]

Introduction:

Since the Grameen Bank and its founder Muhammad Yunus won a Nobel Peace Prize in 2006 for

their innovations in poverty alleviation through microfinance, the world has witnessed a virtual

“microfinance revolution.” Microcredit is the most common form of microfinance. Microcredit

provides small (often group-based) loans to those who are impoverished and lack collateral. It has

been credited for alleviating poverty and raising the incomes of millions of people in developing

countries. Beginning with Yunus’s Grameen Bank in Bangladesh, micro financing as both a

development tool and a means for bringing social change has spread to other developing countries and

has been adapted for use in impoverished areas in developed, high-income nations including the

United States.

Microfinance include microcredit with other financial tools such as micro insurance and

micro savings as well as the possibility of combining microfinance with other non-financial aspects

such as healthcare, education, and environmental issues.

In this paper I focus on micro credit in Sudan as one developing country applied micro

finance. so that to discover whether this micro credit led to achievement of micro finance objective or

not .also to investigate whether micro credit in Sudan accommodated to Islamic finance principle.

Moreover to discover any opportunity may improve micro credit to be appropriate tool for alleviation

poverty in Sudan.

The Purpose of paper:

The purpose of this paper is to investigate Islamic micro credit weakness which should be eliminate,

and to discover opportunities for gain in. This paper will begin by describing the historical roots of

microfinance and the basic, economic principles behind this unique form of credit rationing, and

hence overview similarities between micro finance and Islamic finance.

1

mailto:[email protected]

Methodology:

This paper follows a descriptive method to get empirical findings from questionnaire .and

argumentative method may be follow to analyze collected data from lenders.

Data Collection:

There are several stages for the data collection as follows.

First: structure interview to the lender institutions consist of some questions about the size

of micro loans as percentage of funds available to credit , and borrowers 'title, so that todistribute

questionnaire to them , also that interview will include questions about micro credit model which is

followed by lenders ,clauses of borrowing ,repayment conditions ,collaterals .also question about

whether gender effects on repayment or not will be included in interview.

Second: Structure questionnaire form consisting of two parts will be constructed to collect the

necessary data. The first part focuses on Demographic information of the respondents which include

gender, income, religious beliefs and practices, age, and occupation. The second parts deals with

respondents beliefs and attitudes toward the Islamic micro finance ,and their point of views about

whether micro finance has affect positively on their Income and living standard, also this part will

include respondents suggestions about improving micro credit to be appropriate tool for alleviation

poverty.

Third: secondary data about GDP will be collected from annul reports which have published

by the central bank of Sudan.

Important of the study:

This study will discuss Islamic microfinance behavior in Sudan, and recommend how can micro credit

accommodated with Islamic finance principle and micro finance objective.

2

Paper 2

For the Development of the Microfinance Sector

المقدمة : أصبح التمويل االص��غر يش��مل قط��اع واس��ع من الخ��دمات ولكن بعض الفئ��ات ال يمنكه��ا الوص��ول لمؤسس��ات التموي��ل الرسمية لذلك يحتاجون الى تشكيل متنوع من االدوات المالية . لذا فأننا نرىان عملية توسيع مفهوم التمويل االصغر والتحدى الحالى الموجود امامنا هو ايجاد طريق��ة كف��ؤه يمكن االعتم��اد عليه��ا لتق��ديم قائم��ة غني��ة من منتج��ات التموي��ل االص��غر . فالتمويل االصغر يلعب دورا هاما فى محاربة الفقر ويمكن ان يك��ون اداة قوي��ة للتمكين ال��ذاتى عن طري��ق تمكين الفق��راء امكاني��ة الحص��ول التموي��ل .فه��و اليس��اعد فق��ط فى نش��اط المش��روع للتوس��ع ولكن يس��اعد فى زي��ادة دخ��ل األس��ر وحص��ولهم على أمن غ��ذائى وتعليم االطف��ال واتاح��ة الف��رص للنس��اء الآلتى ال يعملن على مس��توى الم��دن واالري��اف فق��ط نحتاج الى تطوير اساليب الدراسات اإلقتص��ادية للوص��ول الى

استراتيجيات مالئمة .

:الرؤية بن��اء على الدراس��ة المقدم��ة من مجلس ال��وزراء لتط��وير قط��اع التموي��ل االص��غر ي��رى االتح��اد الع��ام لنقاب��ات عم��ال السودان ضرورة قيام مؤسسة تموي��ل أص��غر تع��نى بالتموي��ل فى شك��ل مجموع��ات عمالي��ة ) التموي��ل الجم��اعى ( فهى أفضل وسيلة للضمانات الجماعية والبعد عن القرض المباش��ر ق��در المس��تطاع بحيث ته��دف المؤسس��ة لتش��جيع وتط��وير المنتجات الغذائية والزراعية والبئيية التى ي��ذخر به��ا الس��ودان

3

السودان عمال لنقابات العام االتحاداألصغر التمويل قطـــاع لتطوير

لس��د الفج�وة بين الع�رض والطلب وإح��داث ح��راك اقتص�ادى واسع وتطوير البدائل الوطنية التى تمتلك البالد إمكانية إنتاجها

محليا . تتم ترجمة رسالة المؤسس��ة الى األه��داف من خالل تعميم نظم تش��غيلية للتوص��ل الى مجموع��ات العم��ال المس��تهدفين بتعميم وتقديم الخ��دمات وتلبي��ة متطلب��اهم مم��ا ي��ؤدى ب��دوره للتغيير المطلوب . ولبدء المسيرة البد من انتهاج هيكلية تكون افضل وضعا واكثر تركيزا على العمال وذلك من خالل مفاهيم واختصاص��ات جدي��دة ، دراس��ة الس��وق وتط��وير المنتج��ات ودراس��ة متابع��ة تحدي��د االتجاه��ات والمش��روعات ال��تى يتم تسليط الضوء عليها وذلك يتطلب استراتيجية مدروسة وجهود

واعية . س��يقوم االتح��اد الع��ام لنقاب��ات عم��ال الس��ودان برب��ط مؤسس��ة التموي��ل االص��غر ببن��ك العم��ال فى جمي��ع م�ا يختص بإجراءت التمويل ويترك المتابعة للمنظم��ات النقابي��ة ومن ثم توفير مستلزمات ومدخالت االنتاج والتقني��ة الحديث��ة واالرش��اد والتدريب والتأهي��ل لترقي��ة التوعي��ة وكف��اءة االنت��اج واالنتاجي��ة لتمكين��ه من المنافس��ة وذل��ك ع��بر االكاديمي��ة العمالي��ة ك��أكبر وع��اء ت��دريبى للحرك��ة النقابي��ة وتفعي��ل دور النقاب��ات للعم��ل كوسطاء اجتماعيين لتقديم الخدمات غير المالي��ة م��ع مق��دمى

الخدمات المالية مما يعزز آليات التنفيذ لتكون : بنك العمال الوطنى ) تجميع لمحفظة يشارك فيها بن��ك.1

السودان ومؤسساته ( .االكاديمية العمالية. .2شركة باسقات ..3النقابات العامة ..4االتحادات الوالئية ..5

الش��ك ان التح�دى كب��ير فى الوص��ول لتخفي��ف ح��دة الفق��ر والتنمية المجتمعي��ة ورفاهي��ة االس��رة والمس��اهمة فى ال��دخل

القومى و هذه التحديات : 4

تحديات السيولة ..1 تحديات مؤسساتية القدرة التشغيلية للمؤسسة والتدريب.2

.التخطيط للطوارى ء..3ارتفاع التكاليف المالية والتشغلية ..4

ولكن لدى اتحاد نقابات عم��ال الس��ودان معطي��ات مم��يزة وهى القدرة على تكوين قاعدة نفوذ عريضة من ذوى العالق��ة بالمجال ومقدموا الدعم الفنى والخدمات االخرى ذات الص��لة عالوة على االيدى العاملة والخ��برات والمؤسس��ات التمويلي��ة ممثلة فى بن��ك العم��ال الوط��نى وش��ركة باس��قات كم��ا يمكن

توفير بيئة تحتضن اهداف االداء الجماعى . ام��ا وس��ائل التنفي��ذ ف��ذلك يتطلب مجلس ادارة بخ��برات متنوعة تشارك فيه النقابات واالتحادات الوالئي��ة وال��تى تمث��ل الجهة التنسيقية بأن تط��رح ك��ل النقاب��ات العام�ة واالتح��ادات الوالئية مشاريع نموذجية بدراسة جدوى فى شكل مجموع��ات وفردية وفق التخصص�ات المختلف�ة واالمكان�ات المتاح�ة لك�ل والية وعلى يد فرق عمل م��زودة بالمه��ارات المتخصص��ة م��ع تحديد االحتياجات المحلية لكل منطقة واختيار الطريقة االك��ثر مالئمة خاصة مناطق انتاج الصادر من المحصوالت الزراعي��ة . مع التحديد الزمنى لكل مش��روع وفق��ا للخارط��ة االس��تثمارية العامة والمجازة فى الخطة االستراتيجية العامة للدولة .والب��د من البداية بحمالت توعي��ة من خالل التثقي��ف والت��دريب ح��تى نتمكن من احداث التغي��ير للنظ��رة التقليدي��ة للتموي��ل االص��غر مما يس��اعد على تقلي��ل المخ��اطر وض��مان االس��تدامة طويل��ة االج��ل للمش��روعات خدم��ة لمص��لحة الف��رد والجماع��ة على

مستوى قومى . ( والتى قامتBARACيمكننا االستفادة من تجربة بنقالديش )

اللجنة بدراستها وعرضها بتصوير كامل بواس��طة اس��طوانة )CDوهى تتمثل فى قيمة تعميق االنتشار بتملي��ك مش��روعات )

فى ش��كل ح��زم متكامل��ة وتوظي��ف المت��اح لفهم االحتياج��ات5

المعق��دة ألك��ثر الفئ��ات فق��را وعلى م��دار ع��دد من الس��نوات حيث تضم برامج التمويل االصغر برامج تثقيف سكنية وصحية بدءا بالروضة والمدرسة والمراكز الصحية حيث وفر البرن��امج جمي��ع مقوم��ات الحي��اة من الص��حة وال��دخل والتعليم ول��ذلك نجحت فى تط��وير مب��ادرات جدي��دة مص��ممة بحيث تفى باحتياجات هؤالء الفقراء من برامج التموي��ل االص��غر الس��ائدة ممثلة فى شبكة أمان إجتماعى لمساعدة االسر الفق��يرة مم��ا

ينتج عنها تطوير المساهمة فى الدخل القومى . ولتحقيق الوصول السهل للتمويل مع تقديم الجودة النوعية يمكننا توفير مجموع��ة من المص��ادر لجم��ع المعلوم��ات ال��تى نحتاجها والتى تتضمن المعلومات االساسية حول حالة العم��ال والمش��روعات لتك��ون ل��دينا معلوم��ات كافي��ة تتس��م بالكف��اءة

للوفاء بالمتطلبات .

وبذلك يمكننا ان نتوقع . دخل اكثر ثباتا. زيادة االيدى العاملة داخل االسرة .زيادة الشعور باألمان االقتصادى. زيادة دخل االسر

ولتق��وم المش��روعات الص��غيرة ب��دورها المنش��ود فى تحقي��ق التنمي��ة االقتص��ادية واالجتماعي��ة الب��د من الق��اء الض��وء على

بعض المحاور الهامة :

المشروعات : محور إنشاء كيان قومى يختص بتنمية وتطوير االعمال والمنش��أت

الصغيرة يعمل على :

6

توف��ير األط��ر القانوني��ة والتش��ريعية للمش��روعات.1 الص��غيرة ومنح االعف��اءات التش��جيعية من الض��رائب والرسوم المحلية ال��تى تمث��ل زي��ادة تكلف��ة على ه��ذه

المشروعات . تط��وير الهياك��ل والنظم االداري��ة ال��تى تكف��ل الحماي��ة.2

للمشروعات الص��غيرة ومنحه��ا االمتي��ازات االس��ثمارية بتخصيص االراضى والمواقع المناسبة والمالئمة لالنتاج

والتوزيع المباشر لجمهور المستهلكين . التنظيم والتجمي��ع النش��طة التموي��ل االص��غر المتمثل��ة.3

فى وح��دات كب��يرة ذات حجم اقتص��ادى كالتعاوني��ات ومراكز الخدمات المشتركة لالس��تفادة من اقتص��اديات الحجم الكبير وفرص التمويل واستخدام التقنية الحديثة

. تطوير هياكل التمويل المصرفى بالق��در ال��ذى يجعله��ا.4

قادرة على تلبية خدمات االئتمان . تقديم تسهيالت مناسبة لولوج مجال الصادر من االنتاج.5

العمالى ووارد مدخالت االنتاج وآلياته وقطع غيارها . تموي��ل االحتياج��ات التالي��ة بج��انب تموي��ل االص��ول.6

الرأسمالية : أ/ تمويل مصروفات التأسيس .

ب/تمويل رأس المال التشغيلى . تخصيص نسبة كبيرة من التمويل لبنك العمال الوط��نى.7

وذلك لخصوصيته فى التعام��ل م��ع التنظيم��ات النقابي��ةوالقطاع العمالى العريض.

تاس��يس ص��ندوق ض��مان او ص��ندوق كف��االت م��ع.8شركات التأمين بهامش ربح مناسب .

تفعيل دور الضمان الصامت ..9 تعزي��ز دور الض��مانات غ��ير التقليدي��ة فى تنمي��ة قط��اع.10

التمويل االصغر وتوسيع دائرة التغطية واالنتشار خاصة

7

الض��مانات المجتمعي��ة وذل��ك من خالل أى منالضمانات التالية :

أ/ حفز نظم الضمانات المتعاضدة متعددة االطراف . ب/ اعتم��اد اق��رارات وتعه��دات االق��ارب من الدرج��ة االولى

ضمن الضمانات المقبولة للمصارف ج/ اعتم�اد ش�يك العمي��ل من حس��ابه المع�زز بش�يكات س�داد

االقساط كضمان مقبول لدى المصارف. د/ معالج��ة أم��ر تق��ييم اوزان الض��مانات ض��من تق��ييم أص��ول المصارف ألغراض التقويم وذل��ك بإيج��اد مع��ايير بديل��ه لتق��ييم

اوزان الضمانات غير التقليدية ه��/تعزي��ز ف��رص قب��ول ال��راتب والمع��اش الش��هرى كض��مان

لسداد االقساط والتعسر كعنصر أساسى للضمان .التسويق : محور

ان تنتب��ه الدراس��ات المس��تقبلية ح��ول م��يزات المنتج الى استراتيجية الترويج وان تدمج االستراتيجية الترويجية كج��زء ال

يتجزأ من اى دراسة فصياغة العرض تتحكم فى النتائج . القي��ام بأبح��اث تتعل��ق بالس��وق وتأس��يس أنظم��ة للتوزي��ع والمحافظ��ة على إس��تمراريتها والعم��ل على تص��ميم م��واد ترويجية وتق��ديم توص��يات إلس��تراتيجيات االس��تثمار لمج��الس

إدارات مؤسسات التمويل ألصغر العمالية .

التمويل : صيغ محور حف��ز المص��ارف ومؤسس��ات التموي��ل االص��غر للتوس��ع فى

استخدام صيغ التمويل االسالمى المختلفة وذلك من خالل : تحرير هامش االرباح على عملي��ات التموي��ل االص��غر م��ع.1

وج��وب ال��تزام المص��ارف ومؤسس��ات التموي��ل االص��غر8

بحساب االرباح على اساس القسط المتن��اقص فى حال��ةالتمويل بصيغة المرابحة .

تحديد اس��قف ملزم��ة تش��جع )ت��دريجيا( اس��تخدام الص��يغ.2 االسالمية فى عمليات التمويل االص��غر مثال تغي��ير س��قف

% لمؤسسات التموي��ل20% للمصارف 4التمويل بنسبة االصغر من جهة محفظة التمويل .

تمويل مؤسسة التمويل االصغر العمالية بسقف اكبر م��ع.3فترة سماح أطول.

ال��زام المص��ارف ومؤسس��ات التموي��ل االص��غر بتعميم.4 مرش��د فقهى يض��اف لل��دليل االج��رائى لتنفي��ذ الص��يغ االسالمية فى عمليات التموي��ل االص��غر واعتم��اده ض��من

شروط التصديق لممارسة النشاط خاصة صيغ : أ/المضاربة المقيدة .

ب/ االيجاره ) ايجارة المنفعة – االيجارة المتبقية بالتمليك ( .ج/ السلم والسلم الموازى .

د/ رب��ط مؤسس��ات التموي��ل االص��غر ب��إدارة المخ��اطر اس��وةبالمصارف فيما يلى االستعالم االئتمانى .

: التدريب محور االس��تفادة من الف��رص المتاح��ة من بن��ك الس��ودان فى.1

تدريب الكوادر العمالية . اع��داد ب��رامج لرف��ع كف��اءة الق��درات وتعزي��ز المه��ارات.2

لتأهيل المشروعات الصغيرة . تضمين البرامج التدريبي��ة لنم��اذج المش��اريع الناجح��ة فى.3

السودان وعرض مقومات النجاح اعتم��اد م��ادة ثابت��ة فى ب��رامج االكاديمي��ة العمالي��ة لمنهج.4

كفاءة التمويل االصغر.

9

الحرفى : الحر القطاع محور دعم القط��اع الح��ر الح��رفى ب��برامج لتحس��ين المس��توى.1

الثقافى والوعى الفكرى بأهمية الح��رف وتقب��ل المجتم��ع لهذه الح��رف ودعمه��ا ويمكن ان تب��دا بت��دريب الم��دربين للص��ناعات الحرفي��ة لمواكب��ة التط��ورات والتغ��يرات المتس��ارعة المترتب��ة على التح��والت اإلجتماعي��ة واإلقتصادية لتكون على تواصل مع العلوم والمهارات فى

هذا المجال . المنتجات الحرفية عبارة عن فن واب��داع يه��دف الى منتج.2

يفى بغ��رض معين ل��ذلك الب��د من تط��وير الص��ناعات الحرفية المتخصصة لتحقيق الهدف المرجو منه��ا وتعزي��ز

قدرتها على المنافسة واالستمرارية . يك��ون تط��وير الحرف��يين والمنتج��ات الحرفي��ة من خالل.3

دراس��ة الس��وق واالحتي��اج الفعلى للمنتج��ات الحرفي��ة المختلفة واظهار المنتجات بشكل متطور م��ع المحافظ��ة على أص��التها والتط��وير من حيث االس��تخدام والخام��ات واكساب المنتج الحرفى سمة الج��ودة من حيث النظاف��ة واالتق��ان والس��عى نح��و االب��داع ورف��د الس��وق المحلى

بمنتجات حرفية متطورة ومن ثم المنافسة فى الصادر توظيف خامات البيئة بإقامة مشاريع بعد دراسات لمواقع.4

المواد الخام االولية خاصة الص��ناعات الحرفي��ة المرتبط��ةبالقطاع الزراعى .

تنظيم العالقة بين الحرفيين ومؤسسات التموي��ل االص��غر.5 التى تعنى بشؤونهم عبر الئحة تنظيمية تتضمن التعريفات وان��واع الح��رف وت��راخيص مزاولته��ا واه��دافها ومزاياه��ا

ضمانا لحقوق الحرفى وحماية المنتج وجودته . توسيع قاعدة التعامل بين الحرفيين ومؤسسات التموي��ل.6

االصغر وتحديد الضوابط ) لالفراد والمش��اريع ( وتس��جيل وتب��ويب معلوم��ات الحرف��يين وتوثيقه��ا وتح��ديث قاع��دة

10

البيانات وادراج شريحة الحرف��يين فى الخ��دمات وال��دعمالفنى .

تذليل كاف��ة الص��عوبات ألص��حاب المش��روعات الص��غيرة.7 والمتوسطة من الحرفيين والسعى مع جهات االختص��اص لتخص��يص محالت ل��بيع المنتج��ات الحرفي��ة فى االس��واق

العامة لتشجيع االستثمار فى مجال الصناعات الحرفية .

عامة : توصياتإستهداف السلع االنتاجية لزيادة الدخل القومى . .1 ض��رورة التوس��ع عم��ل التح��ويالت االلكتروني��ة وال��تى من.2

شانها تحقيق االنتشار باالضافة لتقليل تكلفة التمويل . إنشاء فروع متخصصة اضافية للبنوك خاص��ة بن��ك العم��ال.3

الوط��نى م��ع مراع��اة التغطي��ة الجغرافي��ة المتوازن��ة وذل��ك مث��ال لتجرب��ة الف��روع الحرفي��ة المتخصص��ة وال��تى اثبت

نجاحها فى مرحلة من المراحل .تقديم خدمات مصرفية متجولة ..4 التق��ارب والتنس��يق والتكاف��ل االس��تراتيجىبين مؤسس��ات.5

التمويل وقطاع التمويالالصغر . اقامةمنت��ديات فكري��ة لتلقى االفك��ار والمعلوماتالص��حيحة.6

والحقيقيةعن التمويل االصغر . دعوة النقابات العامة واالتحادات الوالئية للقاء ج��امع ح��ول.7

المشروع واالستفادة المتبادلة من االمكانات المتاح��ة ل��دىكل القطاعات لصالح الجماعة .

تكليف االمانات المتخصصة فى النقابات العامة واالتحادات.8 الوالئية لوضع دراسة جدوى نموذجية لكافة االمكانات ال��تى

تتوفر لديهم لتكون نواة لبداية المشروعات . يمكن االس��تفادة من بعض المص��انع المتوقف��ة ودراس��ة.9

إمكاني��ة تش��غيلها ) المملوك��ة للدول��ة او القط��اع الخ��اص (

11

والس��عى المتالكه��ا خدم��ة لمش��اريع التموي��ل االص��غرالعمالية .

إقامة دورات تدريبية لمدربين ضمن برنامج الب��نى التحتي��ة.10لتقديم خدمات التدريب لضباط االئتمان فى كل الواليات .

11. تث��بيت الت��أمين ع��بر اى ش��ركة من ش��ركات الت��أمين مثالشركة شيكان .

يجب ان تعنى مشروعات التموي�ل االص�غر بخ�دمات مالي�ة.12وعينية .

إقامة معرض منتجات للمشروعات الصغيرة ..13 التحف��يز بتق��ديم ج��وائز ومي��داليات للم��يزين من منف��ذى.14

المشروعات الناجحة .)إنشاء وحدة متخصصة لمنتجات ال.15

handmadeللمص��نوعات اليدوي��ة الس��ودانية فى موق��ع) متخصص باالتحاد العام .

والله الموفق

12

Paper 3

A Framework for Regulating Islamic Microfinance Institutions

Abdul Ghafar Ismail1

Islamic Research and Training InstituteIslamic Development Bank

P.O. Box 9201, Jeddah 21413 Kingdom of Saudi Arabiae-mail:[email protected]

AbstractRegulation is crucial for many reasons. More important than that is to produce an effective regulatory framework. In this paper, we will find that the first step in this framework is the philosophical foundation of Islamic microfinance institution’s establishment that is formulated in their operations and incentives. Second, the policy issues related to regulations need to be addressed, among others: Islamic microfinance institution activities and Islamic microfinance institution-philanthropy links; effectiveness and sustainability; shariah based business model; who are the regulators; and ownership. Finally, several guidelines will be introduced to produce environmentally effective regulations, among others aretheguideline on: the shariah advisory council, corporate governance, group lending policy, loan loss financing, minimum capital and micro-takaful scheme.

Keywords: regulation policy, Islamic microfinance institutions, regulatory philosophy, shariah JEL Classification:D03, G21, G23, G28, P40,

1He is head of research division and Professor of Banking and Financial Economics. He is currently on leave from School of Economics, Universiti Kebangsaan Malaysia. He is also principal research fellow, Institut Islam Hadhari, Universiti Kebangsaan Malaysia and AmBank Group Resident Fellow for Perdana Leadership Foundation.

13

1. Introduction

The sources of funds for Islamic microfinance institutions are typically provided by trustee and

depositors and managed by the managers. There are the entrepreneurs who need capital for their

microenterprise activities. The financial authority like central bank or ministry of finance or ministry

of cooperative is responsible for the supervision and regulation of Islamic microfinance institutions.

The philosophy behind the financial authority’s supervision and regulation of Islamic

microfinance institutions has three components. Firstly, the Islamic microfinance institution’s owners

should confine their activities to the management and control of Islamic microfinance institutions; and

Islamic microfinance institution should engage in activities related to shariah principles. They should

not affiliate with entrepreneurs engaged in activities that are not permitted. Secondly, the transactions

between an Islamic microfinance institution and its customers should be subjected to certain limits

and restrictions. Finally, there must be effective and efficient supervision of the financial status and

activities of Islamic microfinance institutions are to ensure their safety and soundness.

Behind this philosophical view, how could Islamic microfinance institutions be regulated?

This paper will first provide an overview of how the financial authority implements each of the

philosophical components. Then, it will be followed by the policy issues related to regulation and

several guidelines will be discussed to produce environmentally effective regulations.

2. Philosophical Foundation of Regulation

In discussing the philosophical foundation of regulation, we will take an approach of regulation where

it will reflect our view on the nature and purpose of Islamic microfinance institutions. We will

consider the theoretical foundations of Islamic microfinance which will be based on the interpretation

of shariah principles that is formulated in their operations and incentives. 2 More importantly than that

is not only that they comply the shariah, but also their roles in providing capital to un-bankable

society. They key is to design regulation so as to allow Islamic microfinance institutions to play their

role in the economy, especially in alleviating poverty. This approach involves a broader understanding

on the philosophical perspectives of regulation.

Epistemological Philosophy

As a branch of philosophy that concerns with the nature and scope of knowledge which is derived

from the belief of oneness of Good (or Al Tawhid) and the Al Tawhid affirms that the obedience to

God and fulfillment of His command are human being’s duty. It also serves the purpose of creating

2 We will refer to Smolo and Ismail (2011). The similar model was also proposed by Maamor et al (2014)

14

human being on earth, i.e., the vicegerent of God on earth.3 In addition, surah Al-Ahzab, God has

invested human being with His trust, a trust which heaven and earth were incapable of carrying and

from which for they shied away with terror.4 Here, the divine trust is the fulfillment of the ethical part

of the divine will, whose very nature requires that it will be realized in freedom, and human being is

the only create capable of doing so. It is this exercise of human freedom regarding obedience to God’s

commandment that makes fulfillment of the command moral.

It shows that al-tawhid tells us that God, being beneficent and purposive, does not create

human being in sport or in vain.5 He has endowed human being with the senses, with reason and

understanding, made them perfect – indeed, breathed into them of His spirit – to the end of preparing

them to perform their great duty. In performing their duty, their ethical striving and action will enter

the realm of space-time. Therefore, the earth (via the economic action) is the object of the human’s

endeavor, and all humankind is to be involved in its and their own nature. In this perspective, how the

economy via the Islamic microfinance institutions be operated? In particular, as mentioned by

Abdullah and Ismail (2014), we want to clarify the essential relation of al-tawhid to the economic

order of Islamic microfinance institutions.

The consensus process or shuratic in making the decision for providing loans to customers

should be reached. The micro entrepreneurs need shari’ah compliant models of microfinance which is

based on al-tawhid perspective. They cannot accept the practice of riba (as a proof in accepting al

tawhid) as normally done by the conventional microfinance institutions.

Islamic microfinance institutions should also maintain to observe the aims (maqasid shari’ah)

of providing the finance to the poor and needy. The Islamic microfinance institutions are not only

providing “money” for them to move up from poverty line but also to “change” their human

characters.

Ethical Philosophy

Ethic (or akhlak) is a branch of philosophy that deals with the human behavior or act in all aspects of

life. Ethic is also a set of Islamic moral values which has been prescribed fundamentally in the Quran

and implemented by Prophet Muhammad (saw) during his life.6 Principally, there are two types of

3 Refer to Al-Baqarah 2:30: And [mention, O Muhammad], when your Lord said to the angels, "Indeed, I will make upon the earth a successive authority." They said, "Will You place upon it one who causes corruption therein and sheds blood, while we declare Your praise and sanctify You?" Allah said, "Indeed, I know that which you do not know."4 Refer to Al-Ahzab 33:72: Indeed, we offered the Trust to the heavens and the earth and the mountains, and they declined to bear it and feared it; but man [undertook to] bear it. Indeed, he was unjust and ignorant.5 Refer to: Al-Qiyaamah75:3 (“Does man think that We will not assemble his bones?”); Al-Mu’minuun 23:115 (“Did ye then think that We had created you in jest, and that ye would not be brought back to Us (for account)?”) and Al-Anbiyaa’ 21:16 (“And We did not create the heaven and earth and that between them in play”).6 The Prophet (saw) said, “(I was sent to complement good morals) [Ahmad, Malik, Bazaar, Haithami and Ibn `Abd Al-Barr authenticated it. From Abu Hurairah]

15

akhlaq, good (or mahmudah)and bad (or mazmumah). Islam emphasizes the important of practicing

good akhlak in all aspect of human life and recognizes it as one of the purpose of sending His

messengers. Muslim is also encouraged to have good akhlak in all aspects which will bring the

business operates ethically.

Classical scholars such as Al-Ghazali in his encyclopedia Iḥya’ ‘Ulum al-Din (Revival of

Islamic Sciences) for instance, dedicated a chapter on the ethics of earning and living (Kitab al-Adab

al-Kasb wa al-Ma‘ash), which precedes the chapter on lawful and unlawful matters (Kitāb al-Ḥalāl wa

al-Ḥaram), indicating the importance of ethical behavior in earning a livelihood. Scrutinizing this

chapter of Iḥya’, al-Ghazzali identifies justice, truthfulness and benevolence as the main ethical values

that must be internalized by parties involved in business transactions. This view, as pointed by Ismail

and Zali (2014) showed general explanation of business ethics and ethics of relation.

Logical Philosophy

The last part is logical philosophy. It tries to investigate human thought and a fundamental to the

thinking straight, accurate and healthy. Learning about the rules of logic is expected to lay the

foundation so that it can make accurate conclusions. Any ethical action must have reasons and be able

to defend our actions if it is called upon to do so (Minja, 2009). In Islam, logic in business activities

can be determined by ijtihad that must obey to the Shariah rules. In the logic behind it, the Muslim

will be classified as a man who disobeys Allah. In this perspective, we can refer to Al-Ghazali’s major

works like (Mizaan al-'Amal (The Criterion or Logic of Action), one of the early works on ethics.7 Al-

Qaraḍāwi (1995) also observes that only in recent years Islamic business has been given due attention

by Muslim scholars and researchers. He describes Islamic business as being Godly, ethical, humane

and balanced, and is of the opinion that it is the responsibility of the state (i.e., financial authority) to

ensure that the theories of Islamic economics are implemented through the legislation of laws to

uphold righteousness and ethics.

The financial authority should promote and maintain Islamic microfinance institutions and

their services for the public and foster higher standards of practices. Hence, traditionally, the financial

authority as a regulator has to keep a close watch on these aspects of the Islamic microfinance

institutions, i.e; safety,stability, structure, public confidence, market discipline and the basis for a

public policy. Think of safety in terms of acting as a custodian for customers and capital funds as

cushion or buffer protection. Stability is protecting the economy from the vibrations of the Islamic

microfinance institution or ensuring a safe and secure Islamic microfinance institution by preventing

financial panic or spillover effects.

7 See Ghazanfar and Islahi (1997) in Islamic Economics Research Series, King Abdulaziz University.

16

The objective of focusing on the Islamic microfinance institution is due to risk, or fear of

collapse of the microfinance system. In contrast, structure focuses on promoting competition and

efficiency and protecting Islamic microfinance institution customers from a monopolistic system of

microfinance institution.

Safety and Stability

The safety objective is to reduce the risk associated with Islamic microfinance institution businesses

(i.e., protecting Islamic microfinance institutions from being exposed to much to external factors and

making them a sustainable institution). Today the safety objective comes under the guise of subsidy

and micro-takaful services. The Islamic microfinance institution stability objective is closely linked

with the goal of poverty alleviation of the economy. The failure to address the outreach and help the

poor and micro-small enterprises dominates regulatory thinking in this area.

The safety and stability objectives build on some fundamental microeconomic and

macroeconomic ideas. One of the tasks of a macroeconomic poverty eradication policy is to reduce

the poverty through providing the capital and employment to the poor and micro-small enterprises.

Capital was perceived as having made the microfinance institution as “the pillars”. However, after

more than three decades of Islamic microfinance institution operations, it seems that customers prefer

to have a long relationship and on a wider scale.

Promoting Competition and Efficiency through Microfinance Institutional Structure

The structure objective is best viewed in terms of the degree of competitiveness and efficiency in the

Islamic microfinance industry. The linkage between structure and competition is provided by the

industrial organization model. This model links structure with conduct and then with performance.

Structure refers to the number of Islamic microfinance institutions in the market (i.e.,

sustainability), conduct refers to the behavior of the Islamic microfinance institutions in the market,

and performance refers to the quantity and quality of products and services (i.e., outreach) by Islamic

microfinance institutions in the market. The conclusion of the model is: the more Islamic

microfinance institutions that exist in the market, the smaller the chances of non-competitive behavior

and the greater the chances that high- quality products and services will be provided to customers.

Hence in the business of providing financing and outreaching customers, a larger number of

customers will mean low level of unemployment.

Public Confidence

17

In addition, to safety and stability as a prerequsite for public confidence. Microfinance institutions

who are managed in Islamic ways could also create public confidence and the shariah compliant

framework is very much needed here. Building confidence at the microeconomic level focuses on

limiting the risk exposure of individual Islamic microfinance institution and at the macroeconomic

level, isolating Islamic microfinance institution failures. The financial authority would try to see that

each Islamic microfinance institution operates in a safe and sound manner. By pursuing the

macroeconomic goal of limited failure prevention, the financial authority expects to maintain public

confidence in the Islamic microfinance system.

Market Discipline

Both, disclosure and market discipline complement formal supervision, and clearly market

participants (i.e., Islamic microfinance institution, customers, non-profit organizations) can play an

important role. In free and open markets, market participants can use their investment and financing

decisions to reward those Islamic microfinance institutions that are performing most effectively. Or

more accurately, reward those Islamic microfinance institutions that their project will be the most

effective performers as going forward.

How market participants make those projections is not always easy to determine. Even in a

system with sophisticated analysis by rating agencies and other market practitioners (for example,

Forbes provide the list of top microfinance institutions) that recognize the inherent strength or

weaknesses of particular microfinance institutions, it seems that the market focuses heavily on short-

term matters-for example, often seemingly unduly penalizing modest shortfalls from quarterly

earnings estimates.

These market reactions can be explained to some extent by the difficulty of projecting the

Islamic microfinance institutions’ performance based on available disclosures. For market discipline

to be a truly effective complement to formal supervision, market participants must be armed with

accurate and timely information, not just about current balance sheet and income statement elements,

but also with information that has a longer-term value such as qualitative and quantitative information

on the Islamic microfinance institutions’ business strategies, risk profiles, and risk appetites.

Basis for Public Policy

It is important for the financial authority to maintain a sound and stable Islamic microfinance

institution. The main objective of a public policy is to establish a relationship that involves three

major groups, i.e., capital providers, operators and customers. The capital providers are the

government, cooperative members, individuals or private and non-governmental organizations

(NGOs). Operators are those who operate businesses such as banks, cooperatives, and individual

18

entrepreneurs. The microfinance customers are the micro-small enterprises (MSEs), low-income

groups and mostly the poor.

The overall effectiveness of a public policy, however, will depend on the extent of its

contribution to: reduce poverty; empower women or other disadvantaged/marginalized population

groups; create employment; help existing businesses to grow or diversify their activities; and to

encourage the development of new businesses. In this case, the financial authority usually employs

two primary methods or instruments; utilization of public funds as sources of funds and providing

capital to targeted groups.

In practice, the operators look at the profitability of their businesses. Normally, to make their

businesses profitable, they will exclude the lower income group and the poor in extending their

microfinance. This is because the revenue received may not be enough to cover the cost of providing

financial services (sustainability). Since operators focus more on the profitability at the expense of the

outreach (social responsibility), capital providers have to think of a way on how to change the

operators’ objective. The capital providers (example, via zakat and waqf) are not only interested in the

profitability of Islamic microfinance institutions, but also must uphold their social responsibility. 8

This responsibility is translated by providing subsidized funds to be channeled to the operators. At

the same time, there are also other operators that operate their businesses unsubsidized. This creates

several Islamic microfinance institutions players in the market. Each of them competes in the market,

and this raises the issues of sustainability, efficiency and competition among players.

3. Policy Issues Related to Regulations

This section will discuss several policy issues related to regulations. These issues cover the

regulations on: Islamic microfinance institution activities and Islamic microfinance institution-

philanthropy links; effectiveness and sustainability; shariah based business model; who are the

regulators; and ownership.

Regulations on Islamic Microfinance institution Activities and Microfinance institution-philanthropy

Links

8 Social responsibility taken by donors in serving micro-credit means donors have to serve this financial service because the needy (low-income group and the poor) have no choice but to get loans from other formal financial institutions. Or else they will go to loan sharks to get loans and will have problems in paying back those loans.

19

Islamic microfinance institutions are synonym with the micro and small enterprise development.

Therefore, micro-enterprise development programs cover financings and/or give classes to poor

people to help them to start or to strengthen their businesses, building self-esteem and self-reliance,

encouraging autonomy and creating community atmosphere. In the last few years, micro-small-

enterprise development has become one of the most diverse and dynamic approaches to poverty

alleviation, with literally hundreds of programs implemented by a wide range of microfinance

institutions across the globe. Within the micro-small-enterprise field, micro-financing is the best

known approach to providing micro-small-enterprise services.

Therefore, the reasons for allowing the degree to which microfinance institutions can only

engage with micro-small enterprises are due to: first, Islamic microfinance institutions work with the

targeted group (example, micro and small enterprises); second, government micro-financing programs

and staff tend to be both paternalistic and distrustful of the targeted group; third, identifying and

reaching the targeted group is extremely time consuming; fourth, government policies (e.g., licensing

requirement) and an unstable economic climate (e.g., high inflation) counter business growth and

saving potential; fifth, the targeted group often reject micro-financing programs because they do not

want to assume the risks involved; and sixth, inflexible micro-financing criteria, such as group

borrowing, initial financing repayments or collateral requirements are beyond the means of the

poorest. Indeed, it is these regulations that help define what observers mean by the term

“microfinance institution”.

Traditionally people with capital invest their money for the purpose of gaining profit.

However, there are people who invest money not to get more money but to get rewards in the life

hereafter. Islam provides several mechanisms for Muslims to get the satisfaction at the same time

investing for the life hereafter. One of the ways is through waqf and sadaqah (or philanthropy). The

concern is how to make it fully utilized and continuously developed. And also the issue is how to

ensure that the trustee will manage the property according to the interests of the original owners who

endow it. This will require good governance and procedures.

Regulation on Effectiveness and Sustainability

The effectiveness of microfinance programs requires considerable attention so that the benefit of the

programs can really be enjoyed by micro-enterprises. So, they can improve their business and enhance

the quality of life. Sustainability of microfinance programs constitutes important component to

support the achievement of micro-enterprise development, since it constitutes long-term process in

which micro-enterprises require long-term access to financial institution. It indicates that the

measurement of effectiveness (to evaluate the benefit of the programs) and the prediction of

sustainability microfinance programs are required in developing micro-enterprises and Islamic

microfinance institutions. The expectation of micro-enterprise development is that micro-enterprises

20

can develop their business and Islamic microfinance institutions as an organizer of microfinance

programs do not suffer losses. Therefore, the benefit of the programs should have been greater than

the cost.

In general, microfinance programs concern about business and job creation, income

generation, and other outcomes. These variables are measurable at the level of the individual, the

business, the community, or the economy. Therefore, the measurement of effectiveness (success) of

microfinance becomes important to examine whether the microfinance programs have attained its

predetermined goals. This activity requires the determination on the method of measurement and the

indicators of effectiveness of microfinance programs.

Furthermore, the indicators of effectiveness are not only tried to connect the microfinance

programs with income and production enhancement, but also the repayment rate and outreach

indicators such as: income of participants; the value and number of financing; saving accounts and the

type of financial services offered; the number of branches; and the annual growth of assets over recent

years. Therefore, the policy should be in place to select the customers to help making better allocation

for sustainability and effectiveness of the financing as they will be a vehicle for economic

development.

The effectiveness of microfinance is also related to the sustainability of the program, because

achieving the success, micro-enterprises need long-term access to financial services. Therefore,

financial sustainability or self-sufficiency is a prerequisite for making micro-financial services

permanent as well as widely available. Sustainability is about creating institutions that can provide a

positive flow of benefit for as long as they are needed. An Islamic microfinance institution can be said

to be self-sustainable if, without the use of subsidies, grant or other concession resources, can

profitably provide finance to micro-enterprises on an acceptable scale. Self-sustainability can be

achieved via financial self-sufficiency and profitability. It reveals that, to continue growth, Islamic

microfinance institutions are required to generate profit, balance the social objectives of reaching low-

income entrepreneurs with generating a return for its investors. It has dual missions that are balancing

a social agenda or social impact with its financial objective.

From the perspective of micro-enterprise development, we can conclude that the effectiveness

of microfinance can be indicated by the success of business, income enhancement, rate of repayment

and the benefit of the program to community, and the sustainability of the financing programs

constituting important component to achieve the goal of programs. Profitability is necessary to

achieve self-sustainability. Therefore, analyzing the ability of Islamic microfinance institutions profit

generation is needed.

To achieve the profitability, financial resources should be allocated efficiently. Efficiency has

important role related to profitability and sustainability. Increasing efficiency enables the Islamic

microfinance institutions generates higher profit and this condition will create two benefits. First, the

profit for savers and investors will increase; therefore, they are still interested in saving and investing

21

their money in Islamic microfinance institutions. Second, the return earning of Islamic microfinance

institutions will increase and can be used to add the capital that enable the Islamic microfinance

institutions to operate in longer time, to reach more micro-enterprises so that eventually the

sustainability can be achieved. Therefore, measuring and improving efficiency become important to

encourage progress of Islamic microfinance institutions to achieve sustainability.

Regulation on Shariah Based Business Model

As part of an effort to help the struggle of the poor people, micro-enterprise development should be

undertaken by giving loans at low charges. Giving loans at high charges causes the wealth of the poor

precisely flows to the rich (capitalist) and it contradicts with the value of justice. The prohibition of

interest (riba) in Islam constitutes the form of way out to avoid injustice.

Socio-economic justice is one of the most important characteristics of an ideal society.

Among the most important teachings of Islam for establishing justice and eliminating exploitation in

business transaction is the prohibition of all sources of unjustified enrichment. According to Chapra

(1985) one of the important sources of unjustified earning is receiving any monetary advantage in a

business transaction without giving a just counter value. Riba represents the prominent source of

unjustified advantage. To achieve the socio-economic justice, Islam offers shariah based business

model via different types of financing such qard, musharakah and mudharabah. Hence, there are

different business models that can be offered for the establishment of Islamic microfinance institution.

Who are the Regulators?

Many regulators encourage private monitoring of Islamic microfinance institutions. For instance,

regulators may require Islamic microfinance institutions to obtain certified audits and/or ratings from

rating agencies. Regulators may also make Islamic microfinance institution directors legally liable if

information is erroneous or misleading. Regulators may also compel Islamic microfinance institutions

to produce accurate, comprehensive and consolidated information on the full range of Islamic

microfinance institution activities and risk-management procedures. Furthermore, a country credibly

imposes a “no deposit insurance” policy to stimulate private monitoring of microfinance institutions.

Some economists have advocated greater reliance on the private sector and expressed

misgivings with official regulation of Islamic microfinance institutions. For instance, the “grabbing-

hand” view of government regulations holds that Islamic microfinance institutions will pressure

politicians who, in turn, can unduly influence regulators. Furthermore, in some countries, regulators

are not well compensated and hence quickly move into Islamic microfinance institution, resulting in a

situation in which regulators may have mixed objectives when it comes to strict adherence to the

rules. Also, since regulators do not have their own wealth invested in Islamic microfinance

22

institutions, they have different incentives from that of private owners or rabbul mal when it comes to

monitoring and disciplining Islamic microfinance institutions. For example, the rabbul mal who act as

capital contributors, via restricted deposits, are in a better position to monitor and discipline Islamic

microfinance institutions

However, questions are raised about placing excessive trust in private-sector monitoring,

especially in a system with poorly-developed capital markets, accounting standards, and legal

systems. A system with a weak institutional environment will benefit more from regulators containing

excessive risk-taking behavior Islamic microfinance institution and thereby instilling more confidence

in customers than would exist with private-sector monitoring. This view argues that, in weak

institutional settings, increased reliance on private monitoring leads to exploitation of small savers

and hence less Islamic microfinance institution development.

Ownership of Islamic Microfinance institutions

Economists hold sharply different views about the impact of government ownership of Islamic

microfinance institutions on financial and economic development. The argument is that government

ownership of Islamic microfinance institutions would facilitate the mobilization of funds and the

allocation of those funds toward strategic projects with long-term benefits on an economy. According

to this view, governments have adequate information and sufficient incentives to ensure socially

desirable investments. Consequently, government ownership of Islamic microfinance institutions

helps economies overcome private capital-market failures, exploit externalities, and invest in strategic

sectors. The government ownership of Islamic microfinance institutions to promote economic and

financial development may be relevant in an underdeveloped financial system.

However, governments do not have sufficient incentives to ensure socially desirable

investments. Government ownership tends to politicize resource allocation, soften budget constraints,

and otherwise hinder economic efficiency. Thus, government ownership of Islamic microfinance

institutions facilitates the financing of politically attractive projects, but not necessarily economically

efficient projects.

4. Regulatory Environments

The policy-related issues mentioned earlier are important for an effective regulatory framework.

Hence, several guidelines shall be introduced to produce environmentally effective regulations,

23

among others theguideline on: the shariah advisory council, corporate governance, group lending

policy, loan loss financing, minimum capital and micro-takaful scheme.

Guideline on Shariah Advisory Council

According to the discussion in section three, Islamic microfinance institutions need to comply the

shariah. Hence, Islamic microfinance institution is required to set up a Shariah Advisory Council

(SAC) to supervise its operations to ensure that those operations comply with the rules of shariah. The

SAC advises the directors about matters pertaining to the operational issues of the Islamic

microfinance institution. The SAC also takes the views of the Shariah Committees of relevant

authorities such as National Shariah Advisory Council on issues relating to the industry.

Guideline on Corporate Governance

The operation of an Islamic microfinance institution embodies a number of features such as equity

participation; and risk and profit-loss sharing arrangements and as trustee. On the one side, an Islamic

microfinance institution is essentially a partner with its trustees, and also a partner with entrepreneurs,

on the other side, when employing trustees' funds in productive direct investment. The trustee also

shares in the profits according to a predetermined ratio, and is rewarded with profit returns for

assuming risks.

These financial arrangements imply quite different stockholder relationships, and by corollary

governance structures, from the conventional model since trustees have a direct financial stake in the

microfinance institution's investment and equity participations and the benefits of investment should

be restricted or unrestricted depending on the types of philanthropy. As discussed above, the Islamic

microfinance institution is subject to an additional layer of governance since the suitability of its

investment and financing must be in strict conformity with Islamic law and the expectations of the

Muslim community. For this purpose, Islamic microfinance institutions should form the Shariah

Advisory Council.

Therefore, the governance structures are quite different because the Islamic microfinance

institution must obey a different set of rules - those of the Holy Qur'an - and meet the expectations of

the Muslim community by providing Islamically-acceptable financing modes. There are two major

differences from the conventional framework. First, and foremost, an Islamic microfinance institution

must serve God. It must develop a distinctive ethics and culture, the main purpose of which is to

create a collective morality and spirituality which, when combined with the production of goods and

services, sustains the growth and advancement of the Islamic way of life.

24

Secondly, Islamic microfinance institutions are formed based on the Islamic legal concepts of

shirkah (partnership) and mudarabah (profit-sharing). An Islamic microfinance institution is

conceived as financial intermediary mobilizing funds from the public on mudarabah and trust basis

and advancing capital to entrepreneurs.

Guideline on Group Lending Policy

The joint-liability lending (also known as group lending policy) practice, see for example Attanasio

et al (2011) has been introduced since the establishment of Grameen bank in the 1970s. The practice

has been widely adopted in microfinance programs in many developing countries as an important tool

to provide credit to the poor. This practice has produced many positive results, likes the expansion of

the number of microfinance institutions and improvement of repayment rates.

This practice also benefits the poor, because most of whom do not have any collateral; it is

very risky to lend them money. This lack of collateral, in addition to a severe lack of financial and

personal information about each potential client, puts an Islamic microfinance institution in the

impossible situation of guessing who is going to pay them back, and who is going to default or run off

with their money.

Group lending, as mentioned in Ismail and Wan Yussof (2014), solves both of these

problems. If one member of the group is unable to pay back their loan, the other members of the

group must pay back that person’s share for them. This provides a form of insurance for the Islamic

microfinance institutions, as they know they will get paid back, even if one person defaults on their

loan or is unable to make a payment. Group lending also addresses an Islamic microfinance

institution’s lack of information by making the members of a community form their own groups.

Since each member of the community has a more in-depth knowledge of who is likely to repay on

time and who is more risky, all of the less risky people will group together leaving all of the risky

people together. This means that the more responsible groups will very rarely have to pay for each

other, whereas the more risky groups will have to pay for someone else more often, thus effectively

creating a higher interest rate for those riskier people. The group-lending model is an ingenious way

of overcoming some of the challenges that lending to the poor entails.

However, it also creates a negative result on the commitment to repayment meetings and can

create social pressure for borrowers. A potential downside to group lending policy is that it often

involves time-consuming weekly repayment meetings and exerts strong social pressure, making it

potentially onerous for borrowers. This is one of the main reasons why Islamic microfinance

institutions started to move from joint to individual lending.

It is also often argued that the high transaction costs faced by Islamic microfinance

institutions in identifying and screening their clients, processing applications and collecting

25

repayments keep prevent Islamic microfinance institution from reaching new clients and expanding

their operations.

Understanding the factors affecting repayment performance, which may vary by (unobserved)

group types, are thus of great policy relevance. In particular, more accurate risk scoring tools can help

to overcome information asymmetries by aiding Islamic microfinance institutions to better classify

their potential clients and understand the factors driving their behavior, further promoting the

development and sustainability of microfinance programs.

Guideline on Loan Loss Financing

Islamic microfinance institutions may self-classify each of their financing assets within one of the five

categories set forth below. In making the decision to classify a financing asset within one of the five

classification categories listed, an Islamic microfinance institution may use its informed judgment but

may be guided by the standards and components set forth below with respect to each category. Self-

classifications of financing assets by Islamic microfinance institution may be subjected to

classification decisions of the regulators. Differences between classification decisions of regulators

with respect to any financing and that of the classifying Islamic microfinance institution may be

subject to negotiation between them but the classification decision of regulators shall be deemed final

for all purposes.

Standard - An asset classified as Standard is paid in a current manner and is supported by

sound net worth and the paying capability of the buyer. The financing was made with sound standards

of credit analysis. Standard assets are sufficiently secured with respect to both the principal amount

and profit, and only a general provision shall be formed for standard assets in the amount of 1%.

Watch-List – An asset classified as Watch List is adequately protected, but is potentially

weak. Such an asset constitutes an unwarranted credit risk, but not to the point of requiring a

classification of Substandard. The credit risk may be minor, and in most instances, Islamic

microfinance institution managements can correct the noted deficiencies with increased attention. Yet

such risk is consideredundue and unwarranted in light of the particular circumstancessurrounding the

asset.

Examples of Watch-List assets are those which may, if not corrected, become weakened by

imprudent financing practices including but not limited to the Islamic microfinance institution

financing officer’s inability to properly supervise them due to lack of expertise; the financing was not

made in compliance with the Islamic microfinance institution’s internal policies; failure to maintain

adequate and enforceable documentation; or poor control over collateral. Watch-List assets require a

minimum financing provision of, say, 1.5%. Under no circumstances should a Watch List category be

utilized as a compromise between the classification categories of Standard and Substandard.

26

Substandard – An asset classified as Substandard is inadequately protected by current sound

net worth and paying capacity of the buyer or by the collateral, if any, supporting it. Such an asset has

at least one well-defined weakness that jeopardizes the full repayment of the financing. It is

characterized by the distinct possibility that the Islamic microfinance institution will sustain some loss

if the deficiencies are not corrected. Assets that are past due 61-90 days for principal or profit

payments must be classified as substandard at a minimum. Substandard assets require a minimum

financing provision of 25%. Examples of substandard assets include the following: (i) primary

sources of repayment are insufficient to service the financing and the Islamic microfinance institution

must look to secondary sources of repayment, including collateral; (ii) the buyer’s current financial

capability or cash flow is not sufficient to meet currently maturing financing; and (iii) the buyer’s

business is significantly undercapitalized.

Doubtful – An asset classified as Doubtful has all the weaknesses inherent in one classified as

Substandard with the added characteristic that these weaknesses make collection or liquidation in full,

on the basis of current circumstances and values, highly questionable and improbable. Although the

possibility of loss is thus extremely high, because of significant pending factors, reasonably specific,

which could be expected to work to the advantage and strengthening of the asset, its classification as

an estimated loss is deferred until its more exact status may be determined. Examples of such pending

factors include but are not limited to mergers, acquisitions, capital restructuring, and the furnishing of

new collateral or realistic refinancing plans. Assets that are past due 91-180 days for principal or

profit payments (or deferred payment amounts) must be classified as doubtful at a minimum.

Doubtful assets require a minimum financing provision of 50%.

Loss -An asset classified as a loss is considered not collectible and of such little value that its

continuance as an asset is not warranted. A loss classification does not mean that the asset has

absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing

off this basically worthless asset even though partial recovery may be affected in the future. An asset

that is past due over 180 days for principal or profit payments must be classified as loss. Loss assets

require a financing provision of 100%.

Guidelines on Minimum Capital

Traditional approaches to Islamic microfinance institutions emphasize the positive features of capital

adequacy requirements. Capital, or net worth, serves as a buffer against losses and failure. When

faced with limited liability, Islamic microfinance institutions owners will avoid higher risk activities

considering the amount of capital at risk relative to assets. With deposit insurance the regulatory

capital requirements play a crucial role in aligning the incentives of Islamic microfinance institutions

owners with fund owners and other financiers. However, disagreement may exist over whether the

imposition of capital requirements actually reduces risk-taking incentives. Moreover, it is difficult - if

27

not impossible - for regulators and supervisors to set capital standards that mimic those that would be

demanded by well-informed, undistorted private-market participants.

For instance, actual capital requirements may increase risk-taking behavior. At the same time,

capital requirement may also induce credit rationing, that produce a negative implications for

economic growth.

Higher capital requirements may induce customers to shift to capital markets and in the

process impair capital allocation, while raising capital requirements can increase the cost of capital.

Thus, these provide conflicting predictions on whether capital requirements curtail or promote Islamic

microfinance institutions performance and stability.

Therefore, at a time when existing regulatory capital requirements are widely viewed as being

arbitrary and inadequate, it seems especially important to examine whether they even matter since

capital adequacy standards might be introduced.

Guidelines on Micro-Takaful

One of the strategies to maintain the sustainability of Islamic microfinance institutions is to create a

guarantee mechanism. It can be done through micro-takaful scheme. It is crucial to arrange micro-

takaful mechanism for Islamic microfinance institutions’ financing operation. The practice of takaful

for Islamic microfinance institutions as implemented by Indonesia Association for BMT (PBMTI)

through Ta’awuni Model can be considered as a good one. The Ta’awuni Model tries to mitigate risk

of financing, by providing guarantee for repayment of financing if the customers fail to do so due to

unexpected incidence prevails.

This guideline may include the coverage against defaults on financing to micro-enterprises.

For example, it can provide the facility such as 3 percent premium for 3-5-year financing and risk

sharing (a guarantee for 75 percent of each financing). Furthermore, by doing this, it will contribute to

a low arrears and default rate for Islamic microfinance institutions.

5. Conclusion

The aim of this paper is to provide a framework for addressing regulatory issues which impact Islamic

microfinance institution operations and institutional development. The first step in regulating Islamic

microfinance institutions is the philosophical foundation of its establishment that the interpretation of

shariah principles that is formulated in their operations and incentives. However, before the

introduction of regulations, several policy issues related to regulations need to be addressed, among

others: Islamic microfinance institution activities and Islamic microfinance institution-philanthropy

links; effectiveness and sustainability; shariah based business model; who are the regulators; and

28

ownership. These policy related issues are important for an effective regulatory framework. Several

guidelines have been introduced to produce environmentally effective regulations, among others

aretheguideline on: the shariah advisory council, corporate governance, group lending policy, loan

loss financing, minimum capital and micro-takaful scheme.

References

Abdulllah, R. and A.G. Ismail (2014) Al Tawhid in Relation to the Economic Order of Microfinance Institutions. Humanomics (forthcoming)

Attanasio, O., B. Augsburg, R De Haas, E Fitzsimons, and H Harmgart (2011) Group lending or individual lending? Evidence from a randomised field experiment in Mongolia. EBRD Working Paper No. 136.

Basel Committee on Banking Supervision (2010) Microfinance activities and Core Principles for Effective Banking Supervision, Consultative document February.

Chapra, M.U. (1985). Toward a Just Monetary System. Markfield: The Islamic Foundation.Ghazanfar, S. M. and A.A., Islahi (1997), Economic Thought of al-Ghazali, Jeddah Saudi Arabia:

Islamic Economic Research Series, King Abdul Aziz University.Imam al-Ghazali (2005) IHYA ULUM AL-DIN ((Revival of the Religious Sciences).Translated by

Muhammad Mahdi al-Sharif 4 Volumes Beirut: Dar al-Kutob al-IlmiyyahIsmail, A.G. and Wan Yussof, W.N.A (2014) Group Lending Policy and Repayment Rate in Islamic

Microfinance Institutions. IRTI Policy Papers no. PP-1435-01Ismail, A.G. and N.A., Zali (2014) Ethics in Relation to Islamic Finance Activities.Paper presented at

Seminar on Ethics and Religions for a Fair Economy, Singer-Polignac Foundation, Paris 23-24 January 2014

Maamor, S., A.G. Ismail and W. Mislan (2014) Islamic Microfinance Institutions: Study on Efficiency and Sustainability. Bangi: UKM Press

Minja, D. (2009). Ethical Practices for Effective Leadership: Fact or Fallacy-The Kenyan Experience. Journal of Business Management 2(1): 1-15.

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Paper 4

Attaining Financial Inclusion throughRegulating Islamic Microfinance

Dr.Bijay Kumar SwainProfessor & Head Centre for Rural Credit & Development Banking,

National Institute of Rural Development,Rajendranagar,Hyderabad - 500 030, INDIA

Cell No. + 09550881770Office No. 040-24008489

[email protected]

Introduction

The main aim of this article is to assess the potential for attaining financial inclusion through

regulating Islamic microfinance as an alternative to the conventional microfinance. This paper argues

that Islamic microfinance can play an important role in the eradication of poverty, the socio-economic

development of the poor and small entrepreneurs without charging any interest or riba. In addition, it

generates ethical and moral attributes and creates a new motivation among the micro entrepreneurs.

Its profit and loss sharing feature, which is different to conventional microfinance, allows it to reach

the poorest of the poor; allows equitable distribution of wealth; optimal utilization of resources and

control over inflation and in this way leads to socio-economic justice. Indeed, this article aims to

examine the possibility of narrowing the gaps between haves and have-nots, while bearing in mind the

present financial inclusion policies as the main agenda for developing economies.

Why Islamic Microfinance Over Conventional Finance?

Microfinance has undoubtedly yielded favourable results to a certain extent and microfinance

institutions have grown rapidly to meet the rising demand, but their outreach is still small compared

with the need for such finance. It has been found that even among those who have some access to

basic banking services, there is evidence of significant credit constraints. This problem has been

primarily identified in the Middle East, where Muslims are now showing an inclination to avoid

borrowing from interest based financial institutions. This is because, under Shariah principles, they

are prohibited from being involved in any financial instruments involving interest. A large section of

the Muslim population, therefore, rejects this interest based financing, which in turn leads to

increasing poverty among Muslim populations.

Researchers from the Islamic Development Bank estimated that in the six countries with the

largest Muslim populations like Indonesia, India, Pakistan, Bangladesh, Egypt and Nigeria, the

number of people living on less than $2 per day far exceeds half a billion. Recent studies have also

30


shown that Muslims are excluded from access to banking products and services to a significant extent,

with exclusion rates as high as 80% in India. Finally, for Muslims with access to microloans, the

Consultative Group to Assist the Poor has suggested that up to 40% reject loans on religious grounds.

This means that there is huge potential for interest free microfinance that is yet to be tapped.

Interest free financing is based on profit and loss sharing and is therefore a form of

partnership, where the partners share profits and losses on the basis of their capital share and effort,

but where there is no guaranteed rate of return. It is also consistent with the requirement that Muslims

do not act as nominal creditors in any investment, but are actual partners in the business. It is, in

effect, equity-based financing and does not involve any kind of interest. It may prove to be a

productive approach to the eradication of poverty in the future, but financial services alone cannot be

sufficient to solve the problems of poverty. It is essential, therefore, for microfinance to be

complemented by education in order to enhance economic growth and development.

Islamic finance is growing rapidly, but it has largely failed to engage the Muslim poor, who

comprise almost half of all the Muslims in the world. This issue needs to be addressed and Islamic

microfinance would appear to be a potential solution. The target group for microfinance is not,

however, constituted by the poorest of the poor, who need other interventions such as food aid and

health security, but those poor who live at the border of the so called poverty line; those who could

reasonably attain a decent quality of life and who have entrepreneurial ideas, but lack access to formal

finance. However, microfinance is a very flexible tool that can be adapted to every environment,

based on local needs and the economic and financial situation. Following this logic, microfinance can

also easily be adapted to cultural environments, such as those existing in countries with majority

Muslim populations.

Regulating Islamic Microfinance

The ultimate goal of Islamic finance is the maximization of social benefits as opposed to profit

maximization, through the creation of healthier financial institutions that can provide effective

financial services at a grass roots level, an alternative to the Western system that has created the

current socio–economic crisis. This suggests that Islamic microfinance possesses a tremendous

potential that needs to be recognized efficiently and effectively. In fact, the current, worldwide

economic crisis and the problems that have occurred with conventional microfinance in various

countries like Bangladesh and India compel us to look seriously at alternatives. That alternative may

be interest free financing. Islamic microfinance is a new area of interest within both the Islamic

finance and microfinance fields of study and they appear to share many common characteristics such

as risk sharing, promoting entrepreneurship and striving for economic justice. Interest free financing

is based on profit and loss sharing and is therefore a form of partnership, where the partners share

profits and losses on the basis of their capital share and effort, but where there is no guaranteed rate of

return. It is also consistent with the requirement that Muslims do not act as nominal creditors in any

31

investment, but are actual partners in the business. It is, in effect, equity-based financing and does not

involve any kind of interest. It may prove to be a productive approach to the eradication of poverty in

the future, but financial services alone cannot be sufficient to solve the problems of poverty. It is

essential, therefore, for regulating microfinance to be complemented by effective education in order to

enhance economic growth and development.

In all Muslim countries, Islamic microfinance accounts for a very small portion of the

country’s total microfinance outreach, never exceeding 3% of the outstanding loans. Conventional

microfinance products command in the same countries a market share of around 44%. Of the

conservatively estimated 77 million microcredit clients worldwide, only 380,000 adhere to Islamic

microfinance, 300,000 are reached by 126 institutions operating in 14 countries and 80,000 by a

network of Indonesian cooperatives. Its supply is concentrated within a few players, with Indonesia,

Bangladesh and Afghanistan accounting for 80% of global outreach. In all other countries, Islamic

microfinance is still in its infancy. No scalable institutions are reaching clients on a regional and

national level. The average outreach of the 126 institutions is 2,400 clients, none has more than

50,000 clients and the average Islamic micro loan is similar to a conventional micro loan. Efficiency

lags behind its conventional cousin. A loan-to-deposit ratio of more than 110% indicates the need to

improve the deposit-gathering process. The average operational efficiency ratio at 20% compares with

the more affordable 15% of conventional Asian institutions and shows the need to work on the

average loan size, cost structure and staff productivity. The average portfolio at risk at 30 days of

approximately 9% is well above the 5% as reported by the 1,200 conventional microfinance

institutions surveyed by the Microfinance Information Exchange. This lack of efficiency translates

into an average return on assets at 1.5% below the 2.2% of conventional institutions.

In spite of this low penetration and efficiency, studies suggest that a sizeable pent-up demand

for Shariah-compliant microfinance products does exist. In Jordan, 25% and 32% respectively of

those interviewed by USAID and FINCA cited religious reasons for not seeking conventional loans.

In Algeria, a 2006 study conducted by the Frankfurt School of Finance and Management revealed that

21% of microenterprise owners did not apply for loans, primarily because of religious reasons. In

Yemen, an estimated 40% of the poor demanded Islamic financial services, regardless of price. In

Syria, an International Finance Corporation survey revealed that 43% of respondents considered

religious reasons to be the largest obstacle to obtaining microcredit. In the West Bank and Gaza, more

than 60% of low income respondents to a survey conducted by Planet Finance in 2007 claimed a

preference for Islamic products over conventional products. A 2000 Bank Indonesia report indicated

that 49% of the rural population of East Java considers interest prohibition and would prefer to bank

with Shariah-compliant financial institutions.

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Business Model:

To take advantage of this opportunity, expand access to finance throughout the Muslim world and

ease financial exclusion exacerbated by the abhorrence to interest-based products, Islamic

microfinance needs to develop an original business model based on its authentic principles of equity

financing. Islamic microfinance also needs to adopt a performance-minded culture with a clear

separation between the roles of donors and capital providers and introduce proper risk management

techniques and benchmarking methodologies.

The industry still lacks product diversification to serve the financial needs of the micro

entrepreneur. Access, rather than cost, should be the main focus in designing and implementing an

Islamic microfinance programme. The dentition of microfinance needs to broaden from microcredit to

the provision of a variety of financial services, such as savings, insurance and remittance.

Equity-based products through musharakah are unique to Islamic microfinance and may

account for its superiority over conventional microfinance on the grounds of ethics, efficiency and

resiliency of the cost of capital. But the present Islamic microfinance industry mimics the

conventional version and relies for more than 70% of its products offering on asset financing through

Shariah-compliant debt or murabahah. Although the creation of debt does not require the client to

maintain written records and reduce the opportunity for abuse through inaccurate recordkeeping, the

implementation of murabahah is costly. The checks and balances of adequate documentation showing

ownership and constructive possession are extremely difficult, as microfinance involves the

disbursement of small amounts in large frequencies. The costs associated with purchasing,

maintaining, selling or leasing a commodity are also expensive and are often passed on to clients.

Another problem associated with debt-financing involves the possibility of willful default by

clients, because Islamic modes do not admit the possibility to sanction this behaviour with payments

in excess of the original amount of debt. A growing number of Shariah scholars do not approve of it,

especially in the tawarruq structure, on the basis that it is merely disguised lending, where the

participants have no interest in acquiring the underlying commodities. This particularly applies to

providing microfinance to start-ups and small companies whose businesses do not involve the sale and

purchase of commodities and do not have sufficient surplus funds to be credibly investing in

commodities.

Criticisms:

If, in spite of all these shortcomings, the Islamic micro-finance industry still focuses on debt-

financing, it exposes itself to the criticism that murabahah products are offered with the sole intent of

disguising interest as a cost mark-up or administration fee and that Islamic finance is simply a

rebranding of conventional finance and not truly reflective of Islamic principles. Consequently, low-

income populations, who often rely on financially uneducated local religious leaders to address

questions of religion, will tend to shy away from Islamic microfinancial products. As for musharakah,

33

agency problems with profit-loss-sharing are cited as the key reason behind the preference for debt-

based products. Reporting and transparency requirements surrounding the profit loss-sharing

mechanisms need long-term involvement by microfinance institutions in the form of technical and

business assistance. This in turn raises the cost of implementation and can result, at least at the

beginning, in substantial operating burdens and costs on small enterprises unaccustomed to formal

accounting. The uncertainty about profit is a major drawback of profit-loss-sharing models. To

address these issues, a group financing methodology can be used to fix the principal-agent problem.

Each member monitors other members’ businesses and the profit reporting and profit-sharing

payments are made available to the other group members, the latter may then report them to the

microfinance institution if they systematically understate profit.

Performance Based Culture:

In contrast with its conventional cousin, Islamic micro-finance is permeated by a not-for-profit culture

that relies on donor funds and focuses mainly on social goals. In Asia, non-government organizations

are the dominant players, with 14 institutions reaching 42% of clients and just two commercial banks

reaching 29%. In the Gulf, donor institutions are the key players. The Arab Fund for Economic and

Social Development, a US$2bn fund, includes a microfinance programme. The Arab Gulf Fund for

United Nations Development Organizations supports the establishment of banks for the poor across

several Arab countries, including the Republic of Yemen, Jordan and Lebanon. In Saudi Arabia, the

Abdul Latif Jameel Community Service Programme aims, through an interest-free loans micro retail

strategy, to empower low-income women. Its Bab Rizq Jameel Centre focuses on job creation and

offers interest-free loans to owners of new or existing projects of a service, industrial or production

nature.

Commercial banks are now timidly downscaling and offering Islamic microfinance services.

The Saudi Credit Bank extends interest-free loans for marriage, home repair, vocational pursuits and

other social endeavors, including family loans. The most well-known venture is the Noor Islamic

Bank and Emirates Post Holding Group plan, with aims to establish a company providing an array of

Islamic microfinance products, including microcredit and insurance, to the low income and unbanked

segment of the UAE population.

To expand and be sustainable, the industry should shift from a charity-based donor-dependent

approach to one that reflects the mechanics of the free market. It should emphasize systemic

efficiency and transparency and restrict the use of donor funds to capacity building, the key bottleneck

being the shortage of strong institutions and managers. Donor subsidies should be temporary start-up

supports designed to get an institution to the point where it can tap private funding sources. They

should complement private capital, not compete with it.

Capacity building is needed at all levels to realize the full potential of Islamic microfinance.

At the macro level, the Islamic Development Bank and Islamic financial standard setters, should

34

consider developing global financial reporting standards adapted to microfinance to build the

infrastructure for transparency in the global Islamic microfinance sector. This infrastructure would

entail comprehensive disclosure guidelines on Islamic microfinance accounting principles, pricing

methodologies, financial audits and, eventually, rating services.

At the micro and institutional levels, international donor agencies can play a major role by

helping existing institutions reach scale, and funding pilot projects testing various business models.

More effort should be made to train Islamic microfinance institutions managers and staff through, for

example, the development of operational tools and manuals for use in Indonesia. Governments should

set a supporting policy environment and legal and regulatory framework to enable financial services.

As for private funding, this should finance Islamic microfinance initially as an alternative business

model in which participants might like to engage, and subsequently as an alternative asset class in

which participants might like to invest.

Sources of Funds:

But where does one find the necessary funds? The UN Capital Development Fund estimates that there

is potential for seven million borrowers and 19 million savers. It appears that the availability of micro

savings products may be more important than microfinancing. The lack of fund mobilization and high

administrative cost means that most Islamic microfinance institutions are not economically viable and

their growth and sustainability largely depend on the availability of external funds and efficiency of

operations. External funds are needed, particularly during the initial stages of operation, members’

savings are small but as savings of beneficiaries accumulate and get recycled, the dependence on

external funds should reduce.

Risk Management Techniques:

This for-profit approach should help to address the issues related to the implementation of

musharakah and enable the industry to provide affordable financial services in a cost-effective manner

with the introduction of risk management techniques. As the conventional microfinance industry has

developed a set of good practices to manage credit risk and boasts an excellent portfolio quality,

Islamic microfinance should take peer pressure and strict discipline into account for collection in

accordance with principles embedded in Islam. For example, pressure from the religious community

and appeals to a sense of religious duty should complement reliance on peer pressure. A number of

ready instruments in Shariah are available to address the extra-financial issues.

One example is the kafalah, where the group members are guarantors for repayment.

Members in the group can agree to help each other in case any are unable to pay the installment. One

way to do this is to provide qard-hasan or interest-free loans to the person facing problems in paying

the installments. The Islamic social development programme builds the social capital, such as a

feeling of brotherhood and comradeship and obligation to repay debt, which helps the regular

35

repayment of installments. This approach will foster the establishment of benchmarks with Islamic

microfinance institutions, producing accurate and comparable reporting on financial performance, for

example, loan repayment and cost recovery, as well as social performance, such as number and

poverty level of clients being served.

Reporting not only helps stakeholders’ judge costs and benefits but also improves

performance. Islamic microfinance can pay for itself, and must do so if it is to reach large numbers of

people. Unless microfinance institutions are not economically viable and their growth and

sustainability largely depend on the availability of external funds and efficiency of operations,

external funds are needed, particularly during the initial stages of operation. Members’ savings are

small but as savings of beneficiaries accumulate and get recycled, the dependence on external funds

should reduce. The Islamic social development programme builds the social capital, such as a feeling

of brotherhood and comradeship and obligation to repay debt, which helps the regular repayment of

installments.

Future Potential:

The emergence of microfinance, conventional and Islamic alike, is a testimony to the fact that all is

not well with our world. There are a number of known and unknown lacunas with prevailing systems

of commercial banking, financing and resource allocation. Among the known lacunas, there are

problems of adverse selection and moral hazards like interest rates. As for conventional microfinance,

it is already structurally aligned to applying Islamic equity financing structures. Microfinance

programmes are based on group sharing of risk and personal guarantee, while maintenance of trust

and honesty is tied to the availability of future funds. This should allow for the inclusion of a

musharakah-based model or at least a model of collective guarantee.

Microfinance institutions looking to implement Islamic finance in their programmes can

develop mudarabah-based programmes. Microfinance institutions can find Islamic finance a natural

fit in their programmes, both debt and equity-based. Interest rates, high or low, are rejected by

Muslims as tantamount to riba, something that is prohibited in no uncertain terms by Shariah. Islamic

microfinance has the potential to respond not only to unmet demand but also to combine the Islamic

social principle of caring for the less fortunate with microfinance’s power to provide financial access

to the poor.

Microfinance and Islamic finance have much in common. Both emphasize the good of society

as a whole. Both advocate entrepreneurship and risk sharing and believe that the poor should take part

in such activities. Both focus on developmental and social goals and advocate financial inclusion and

both involve participation by the poor. Unlocking this potential could be the key to providing

financial access to millions of poor Muslims who currently reject microfinance products that do not

comply with Islamic law. It has been estimated that it would require only US$21bn to provide

microfinance facilities to the world’s poorest 100 million families.

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Benefits of Islamic Microfinance:

There are undoubtedly lessons to be learned from the experiences with microfinance in many

developing countries which may hasten the development of an interest free Islamic microfinance

system. In addition Islamic microfinance could be beneficial in other ways better recovery rates and

increased organizational and borrower sustainability, as well as more effectively meeting

microfinance’s core objective of poverty alleviation, increased production and job creation.

Simultaneously, Islamic microfinance can also offer an alternative paradigm for millions of poor

people who are currently not served by conventional microfinance.

It has been suggested that Islamic microfinance could be a critical enabler of wealth creation

and its equitable distribution, but the challenge of poverty alleviation through microfinance needs to

be achieved through a comprehensive approach to the issue. Innovations in Islamic microfinance must

be set within a background that includes financial instruments yielding stable income flows, cover or

security to deal with penalties on payment defaults and formulae for pricing Islamic financial

products. Innovations should be firmly based in the application of a new product or a technology to

specific market opportunities, for example, lifestyle or explicit socio-economic problems. Combining

the Islamic social principle of caring for the less fortunate with microfinance’s power to provide

financial access for the poor has the potential to reach out to millions more people, many of whom

have now started to prefer Islamic products over conventional ones. It also demands the development

of financial reporting standards to build the infrastructure for transparency in the global Islamic

microfinance sector.

Concluding Remarks:

It is time for the industry to adopt innovative and sound practices and prove that the model works

quite efficiently; that micro entrepreneurs with an appropriate business idea can be helped and thence

find a way out of poverty. In this way Islamic microfinance can be a fruitful initiative towards

microenterprise development and prove to be a positive accelerator of economic growth. Islamic

microfinance is, however, a new concept, still in its infancy and demands further introspection

through market research to identify market segments and to enable products to be customized

appropriately. It also demands the development of training courses so that micro entrepreneurs are

well equipped to take advantage of the opportunities they are being offered. Simultaneously, effective

regulation of Islamic Microfinance from the beginning will lead to the successful growth and

development of the sector benefitting the genuine borrowers who can change their standard of living

for ever.

37

References:

Farhat Abbas Shah – ‘Revitalizing the World Economy through Islamic Micro Finance’, Published by

the Farz Foundation, 2012

Brugnoni, A. – ‘Islamic Microfinance Models Needs Changing’, Published by Consultative Group to

Assist the Poor, 2011.

Shebrawy, A. – ‘Innovation in Micro entrepreneurship and Islamic Microfinance’, Published by

Islamic Economy & Finance Pedia, 2011.

Alasrag, H. – ‘Global Financial Crisis and Islamic Finance’, Published by Munich Personal Archive,

2010.

Khnifer, M & Baig, A. – ‘Design, Implementation and Risk Aspects of Islamic Financial Products

and Services’, Published by Reading University, 2010.

Ahmed, M, Masood, T. – ‘Problems and Prospects of Islamic Banking’, Published by Aligarh Muslim

University, 2010.

Ashraf, M. – ‘The Effectiveness of Microcredit Programme and Prospects of Islamic Microfinance

Institutes’, Islamic Bank Training and Research Academy, 2010.

Karim, N and Tarazi, - ‘Islamic Microfinance: An Emerging Market Niche’, Published by

Consultative Group to Assist the Poor, 2008.

Khan, A. – ‘Islamic Microfinance Theory, Policy and Practice’, Published by Islamic Relief

Worldwide, 2008.

Obaidullah, M – ‘Introduction to Islamic Microfinance’, Published by The Islamic Business and

Finance Network, 2008.

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Paper 5

The Role of State-Created Agencies in Supervising the Islamic Microfinance Institutions to Alleviate Poverty amongst Rural Farmers

Muhammad Hakimi Bin Mohd ShafiaiSenior Lecturer

School of Economics, Faculty of Economics & Management &Institut Islam Hadhari

Universiti Kebangsaan Malaysia (UKM)43600 Bangi, Selangor

e-mail: [email protected]

AbidullahGraduate School of Business

University Kebangsaan Malasyia43750 Bangi, Selangor.

Email: [email protected]

AbstractRural poverty is considered as a major challenge for the today’s economies. The people of rural areas have less access to education and health facility and hence linked with agriculture for earning their livelihood. Due inconsistent availability of the land from the landlord and less experience in input utilization, the farmers are left with small portion of earnings that are less than average. Hence, Islamic Microfinance Institutions (IMFIs) with the frequent supervision and assistance can play an important role in alleviating poverty amongst the rural farmers. The IMFIs with the introduction of Islamic sharecropping based on al-muzāraʻa and al-musāqāt contracts can help the farmers to earn the average incomes that they would need to have. In this paper through qualitative means we have investigated the role of agriculture department and IMFIs in poverty alleviation. Secondly, we have tried to develop an Islamic sharecropping contract the would address the issues sorted out by previous scholars. In the end we have developed a mechanism by which IMFIs can help in poverty alleviation amongst rural farmers with the application of sharecropping and with the assistance of agriculture department created by the Government.

Keywords: Poverty, Sharecropping, Al-muzāraʻa and al-musāqāt, Islamic Sharecropping, Islamic Microfinance Institutes, Department of Agriculture

39



1. Introduction:

The earnings of the people in developing countries are mostly linked with agriculture. These people

mostly reside in rural areas with less education and health facilities. It has been observed that the

poverty ratio is also higher in the rural areas with about 80% of the poor are living there and about

70% of the workforce depends their livelihood on the income from agriculture, fisheries, forestry and

livestock sectors. The agriculture intensification is on top as the governments are putting more focus

on it nowadays. But efficient output cannot be seen in most of the areas because of the fact that

farmers fails in applying appropriate farming system which led to erosion of soil and depletion of soil

fertility and ultimately results in less output (Polman, 2002).

In such case the role of government become vital to provide solution to the agriculture related

problems. Hence most of the governments have established a separate department that deals with the

issues regarding agriculture. The responsibilities that agriculture departments hold are mostly related

to policy development and implementation. The policies are regarding enabling agriculture industry to

adapt its self to compete in a fast-changing international and economic environment, assisting to

improve market access and market performance for agriculture sector, helping the industry in

adopting new technology and practices and also assisting the primary producers to develop marketing

and business skills to be financially self-reliant. But performing such kind of activities are quite

challenging for the agriculture department to perform efficiently.

Hence, the role of Islamic microfinance institutions (IMFIs) becomes vital in such kind of

situation. The mutual cooperation of both Agriculture Department and IMFI would help the farmers in

financing for performing the agriculture activities as well as the proper guidance and supervision from

the agriculture department.

Islamic microfinance institutions with the introduction of ‘Islamic sharecropping’ contract

can help the farmers to raise their living standards. Sharecropping is an agriculture contract according

to which the farmer and the landlord works in partnership to produce an adequate amount of output

and then share the output with pre specified ratio.

In this paper we have discussed about the sharecropping and the issues exist in it. We have

tried to provide the solution to those issues with the help Islamic sharecropping. Secondly we have

identified the role of government departments in economy and specifically the role of agriculture

department in poverty alleviation. Thirdly, we discussed about the Islamic Microfinance Institutions

and their role in agriculture sector in order to alleviate poverty amongst the rural farmers. In the end,

we came up with a workable mechanism that how IMFIs and Department of agriculture would help

the farmer to get sufficient earnings from the agriculture activities.

40

In order to come up with the workable mechanism we have used qualitative research

technique. Hence the research is based on the theory that is sorted out via secondary data collection

methods. We have mostly focused on journal articles, books, proceedings and article on websites.

2. Theories of State Created Agencies and Islamic Microfinance Institutes in Agriculture

Development & Poverty Alleviation:

2.1 Sharecropping:

Usually, in agriculture farming, three types of contracts are used such as rental based, wage based and

sharecropping. Sharecropping is widely used contract in agriculture in most of the poor countries

(Eswaran & Kotwal, 1985). Rental based contract which is known as Ijarah, is a contract in which the

tenant rents the land from the landlord for cropping. In wage-based contract the tenant is hired by the

landlord and is being paid on daily or weekly basis. While, in sharecropping contract the tenant and

landlord work on the land in partnership and then divide the output on pre-specified ratio. It is

believed this contract was developed in order to discriminate the tenant. This contract has received

severe criticism from the famous authors such as Adam Smith and Alfred Marshall. According to

Alfred Marshall (1920), sharecropping is an inefficient contract because tenant is paid in a percentage

rather than all, of their entire marginal product of the labor which will reduce their work effort. Hence

the contract was declared as inefficient contract. But this theory is contradicted by Cheung and his

follower. He further explained that the degree of risk aversion between landlord and tenant varies

hence it can make possible for them the advantage of risk sharing to offset the transaction cost

element. Garrett and Zhenhui (2003), found sharecropping as more efficient contract as compare to

other tenure systems in postbellum south. The question arise that why sharecropping contract still

exists while fix rent contract is considered as superior. According to Stiglitz (1974), sharecropping

may not be productively efficient (the effective land and labour ratio may vary on different plots) but

we can’t apply this inefficiency on the system as a whole. He further argued that sharecropping

system is adopted because of it risk sharing feature because in case of rental system worker or tenant

is forced to bear all the risks whereas the wage system push landlord to bear all the risks. Eswaran and

Kotwal (1985), mentioned that sharecropping is a partnership contract in which both landlord and

tenant provides some un-marketed factors in which they have expertise. For example, landlord may be

expert in managing the resources whereas the tenant can have expertise in supervising the labour.

Canjels and Volz (2001) argued that when the tenant’s efforts and skills are unobservable then the

monopolist landowner will offer sharecropping contract to the tenant.

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2.1.1 Issues in Supervision:

Supervision of the tenant is a main factor in sharecropping as it is the way to keep an eye on tenant to

produce the output in efficient way. The issue of supervision has been discussed by many economists

and they have provided their alternatives for supervision. It is considered as one of the vital factor to

be mentioned in the contract that whether the landlord can efficiently monitor the tenant (Steinmetz,

2004). According to Braverman and Stiglitz (1986), monitoring the level of tenant’s inputs cannot be

perfectly monitored but it is known that increase in efforts can increase the landlord profit. Hence, if

the inputs are complementary to the tenant’s effort then increase in the level of inputs (e.g. fertilizers)

by the landlord will decrease the cost share of the tenant.

The empirical evidence to this issue is provided by Jacoby and Mansuri (2008) by conducting

study in the rural areas of Pakistan. According to them, if the tenant is unsupervised, it will result in

low productivity and vice versa. But this supervision becomes costly for landlord (hiring people to

supervise tenant). Hence, this type of sharing contract depends on the cost of supervision. It is sure

that monitoring directly affects the choice of inputs used by the tenant. If tenant is not supervised

properly, he may use low quality of seeds or fertilizers. To overcome such issue, the landlord should

only be concerned with the output rather than tenant’s efforts. In this way the tenant will be induced to

work hard and honestly to produce optimal output (Prescott, 2005). But in such case, if the tenant only

focused on the optimal level of output then it can raise the issue of land fertility. According to Dubois

(2001), soil quality is an important factor in selecting the tenancy agreement because choice of crops

and level of production can affect the land fertility. Bhandari (2007) mentioned that the intensity of

monitoring the tenant depends on the social distance (the landlord and tenant are closer to each other),

if the social distance between the landlord and tenant is less, then the supervision costs will be low as

less effort will be needed to supervise the tenant’s actions.

2.2.2 Input and Output Sharing

Normally in sharecropping the output is shared with the ratio of 50:50 ignoring the capabilities of

tenant that has been provided as input for production (Bell and Zusman, 1979). According to them,

the tenant use hired labour for harvesting operations. Hence the cost of this operation falls on the

tenant. Moreover, acquiring labour for work are from different areas, hence contacting and acquiring

them incurs some transaction cost that are also passed to the tenant by the landlord. Also, some other

input factors such as choice of crops, timeliness of operation and good husbandry skills are also

needed to be considered. The tenant also needs to have bullocks, the cost of which is also bear by him.

Hence, the theory of 50:50 sharing is invalid in such case. The tenant should be compensated for his

efforts that he put for the production of specific crops. Roumasset (1995) classified the inputs that

each party provides. According to him, the landlord carries out land and asset management as well as

decision regarding production, where the tenant is mostly concerned with controlling the labour and to

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make routine production decisions in sharecropped land. The landowner manage his assets (e.g. land,

fertilizers, anti-pesticides etc) since he want to benefit from any increase in the productivity.

The efforts that tenant and landlord put in the form of different skill in quest of better output cannot be

measured; hence the cost of such inputs cannot be calculated. As Roumasset mentioned that the inputs

provided by landlord are in the shape of asset management and decision regarding production whereas

the tenant’s inputs are supervising the labour. It is better to offset such efforts with each other. The

inputs costs that are measureable such as fertilizers, bullocks or tractors and anti-pesticides etc. should

only be considered.

2.2 ‘Islamic Sharecropping’ Contract in Islamic Jurisprudence:

In Islamic Jurisprudence there are some contracts that are related with the concept of sharecropping,

namely al-muzāraʻa and al-musāqāt. Although, a lot of arguments have been seen on its validity from

different scholars but the later scholars do approved its validity based on their arguments. Basically

these are the contracts between the landlord and the tenants according to which the output from the

land will be shared between the landlord and the tenant based on the managerial skills provided by the

tenant and the land and seeds provided by the landlord.

There is no proof in the Quran which the primary source of law for all the Muslims. Neither

any proof can be found in the Sunnah, the secondary source of law, has given a clear idea about

whether or not sharecropping is permissible for the Muslims. There is only one Hadith on which the

al-muzāraʻa and al-musāqāt are based. According to that Hadith, the Prophet Muhammad S.A.W.

said to the Jews on the day of conquest of Khaybar that “I keep you on the land on which the God has

kept you, on the condition that the fruit will be equally shared between you and us”. To deal with the

problems regarding al-muzāraʻa and al-musāqāt, the jurists put some conditions and restriction to

make the contract valid (Muslim 2000: no. 3939).

The theory of al-muzāraʻa has prompted more criticism amongst the legal school as compare

to al-musāqāt. Al-muzāraʻa (derived from the word zar’ which means sowing or cultivation though

not necessarily with grain) is a sharecropping contract between two parties i.e. the landowner and the

tenant whereby the landowner provide the land and the tenant or farmer cultivates the land against the

specified ratio of the output share (Donaldson, 2000).

Imam Abu Hanifah acknowledged the contract of al-ijara but invalidate the contract of al-

muzāraʻa and al-musāqāt. According to him, the land cannot be the basis of the entitlement of the

profit and it is not liable for loss too, whereas partnership is founded on the notion of profit and loss

sharing. Imam Mālik and Imam Shāfiʻī validate the contract of al-musāqāt while they rejected the al-

muzāraʻa contract. According to their argument this contract involves uncertainty regarding the sale

of commodity at yet unknown future values (Imam Malik).

A major element of gharar (uncertainty) can be found in al-muzāraʻa contract because such

contracts is frequently regarded as ijārah contract and ultimately the contract of al-muzāraʻa contract

43

will be consider as either fāsid (defective) or bātil (invalid) due to the strict interpretation of the rules

for ijārah contract. According to ijārah contract, the date of payment cannot be specified since the

time and date of the harvest cannot be exactly known. Secondly, the exact value of the rent cannot be

determined as the output (harvested crop) is not available at the time of contract is made (Donaldson,

2000).

Imam Abu Yusuf and Muhammad al-Shaybani were the followers of Imam Abu Ḥanīfa. But

their views regarding al-muzāraʻa and al-musāqāt were opposed to Imam Abu Ḥanīfa. Based on their

view, these contracts are considered to be the partnership between property and work, which is

permissible under analogy of Mudarabah. According to them, the seed contiributed by the landowner

can be considered as capital whereas the land is to be considered as real estate because of which the

profit will be generated with the help of labour input (Nyazee, 2002). The view of these two has been

accepted by the later Hanafite jurists and declared al-muzāraʻa as a valid contract.

The contract of al-muzāraʻa and al-musāqāt are validated by the scholars as a legal contract

of financing operations. The input sharing in al-muzāraʻa can be in many forms such as the land and

other physical factors of production will be provided by one party whereas, the labour will be

provided by the other party. Alternatively, the land will be provided by one party while the other

factors of production and labour will be provided by the second party. According to the third

alternative for input sharing the land is provided by one party whereas the other factors may be

provided by all the other parties in the contract (Kāsānī, 1968).

For al-musāqāt all the forms that have been applied for the al-muzāraʻa contract will apply

for this contract as well. The farmer is obliged to provide the labour whereas the landlord is

responsible for providing a full access to the trees or orchards.

The primary responsibilities such as sowing, cultivating falls upon the tenant while the other

works such as harvesting and transportation is a joint liability of both the parties. In case, if the land

does not produce the output, then neither party is entitled for the profits. The landlord cannot claim

the rent and the labour is not entitled for the wages for his work (Aziz & Jamali, 2008).

Furthermore, the responsibility of farmer regarding the crops is like a trustee, he is not responsible for

the damage or loss to the crops except in case of excessive authority provided to farmer, default or

violation of al-muzāraʻa contract conditions (Hakimi, 2011).

On the other hand, in case of al-musāqāt, full authority should be given to the farmer

regarding all major decisions about maintenance, watering and protection of the trees etc. whereas, the

landlord has the authority to force the farmer to perform in case he is delaying or avoiding to work

(Kāsānī, 1968).

It is an obvious condition for al-muzāraʻa that the output should be share in percentage e.g.

one third, one fourth of the output etc. None of the party can be paid with the money instead of output

share, otherwise the contract will be considered as void (Aziz & Jamali, 2008). The same ruling goes

for al-musāqā.

44

2.3 The role of Government Agencies in Economic Development:

The role of government agencies has been realized after the World War II when almost all the

countries were destroyed and there was a need of rebuilding process. In such a situation the

government ordered to form agencies that should cooperate in the rebuilding process. Hence the

economic development was carried out by different government owned agencies and they played a

significant role in the development process. The economic development can be viewed as a growth

process that needs the systematic reallocation of factors of productions from low-productivity,

traditional technology, decreasing returns to a high-productivity, modern, increasing returns, mostly

industrial sector (Adelman, 1999).

In the capitalist economy, the role of government is to provide the public goods that are

required by the society, issuance of currency, levy taxes, money borrowing & investments, and

maintaining economic order and stability & growth (Gorman, 2003). The agencies that are involved in

public goods are mostly zakat and waqf organizations, police departments etc. The government tends

to maintain the economic growth in the country. Disorder in the economy prevail unrest and chaos

with in the economy. For example when the unemployment ratio is increased, the government

savings tend to decrease leading the investment to decrease which can put a significant effect on the

economic growth. Unemployment gives rise to poverty, and hence the government channel funds in

order to alleviate poverty.

Nowadays, the state economic development organizations or agencies are the backbone of the

government. The economic development cannot be achieved without the existence of such agencies.

The government is the main fund provider to such agencies. The major responsibilities of such

agencies are taxing, setting unemployment insurance, reducing poverty ratio, funding major

infrastructures, and transportation projects. Such state owned agencies also involved in technology

development, education, workforce development and enhancement as well as special funding for

business development etc. (Mountford, 2009).

2.3.1 Rural Poverty and Food Insecurity:

The day by day increase in the rural poverty amongst the developing countries is the major concern

for the governments. Developing countries within Asia-Pacific region represent more than half of the

world population today. Government policies towards poverty alleviation in the populated countries

like china and smaller countries like Thailand, worked successfully. But still majority of the poor do

exists in this region with in average wage of just a dollar per day (Polman, 2002). In the Asia-Pacific

region, about 80% of the poor and hungry lives in rural area and about 70% among them are linked

with agriculture, fisheries, fisheries, forestry and livestock sectors (Wan & Sebastian, 2011).

45

The World Bank’s report1 revealed that Rural East-Asia has improved its technological and

economic transformation which lead to the improvement in the food security and reduced the poverty

by raising the income in rural areas. But despite of such efforts the most unemployed people reside in

rural areas. The people in such areas are linked with agriculture and fishery and due to increase in the

population the unemployment rate is escalating. According to the report, the most poor people lives in

South Asia. About 500 million people are still in the state of deprivation, lack of sufficient access to

nutrition, health etc. Poverty in South Asia mostly lies in rural areas. The reason for poverty and

insecurity that are mentioned by the farmers include crop failures, natural disasters, domestic

violence, market fluctuations and non-accessibility to the market.

Hence the role of government in poverty alleviation in such regions is an important factor that

should be considered. As most of the people in such areas are linked with agricultural farming, hence,

the govt. owned agriculture departments should play an important role in providing solution for

improvement as well to provide support to the farmers in rural areas.

2.3.2 The Role of Agriculture Department in Agriculture Development and Poverty

Alleviation:

The responsibilities that agriculture departments hold are mostly related to policy development and

implementation. The policies are regarding enabling agriculture industry to adapt its self to compete

in a fast-changing international and economic environment, assisting to improve market access and

market performance for agriculture sector, helping the industry in adopting new technology and

practices and also assisting the primary producers to develop marketing and business skills to be

financially self-reliant. But performing such kind of activities are quite challenging for the agriculture

department to perform efficiently. In such situation, the collaboration of this government organization

with the NGOs is provided as solution as it will help in reducing the burden of agriculture department

and assists in rural development (Enyioko, 2012).

Although democratization has helped in the smooth operations of NGOs in different parts of

the world but the fact cannot be neglected that NGOs have faced harassment from democratic

government rather than autocratic regimes. Such situation has led the morale of the NGOs down in

order negotiate with the governments. Secondly, the resentment regarding the operations of NGOs

from the political parties has worsened the situation even more (Bebbington & Farrington, 1993). In

most of the Asian countries where the operation of foreign organizations face more resistance from

the people and political parties would lead the NGOs to shut down the operations.

Hence the role of Islamic Microfinance Institutions (IMFI) becomes vital in such kind of

situation. The mutual cooperation of both Agriculture Department and IMFI would help the farmers in

borrowing the loans for performing activities as well as the proper guidance and supervision from the

agriculture department. As till now, the role of IMFIs is neither criticized by the political parties nor

1 Agriculture for Development, 2008, accessed from: http://go.worldbank.org/H999NAVXG0

46

http://go.worldbank.org/H999NAVXG0

by the people, hence it could be a good opportunity for the Government to cooperate with IMFIs to

alleviate poverty and improve agricultural production.

2.4 Islam Microfinance Institutions and its Comparison with Conventional Counterparts:

Although the aim of both the Islamic and conventional microfinance institution looks the same i.e.

helping the poor via financing but in practice the Islamic MFIs are different than conventional

counterparts because of the interest factor that is not allowed in Islam. Hence, it is not allowed for

IMFIs to deal in interest based transactions. The source of funds for both the Institutions remains the

same but the factor of interest is not acceptable for Islamic MFIs hence these Institutions get financing

from non-interested based parties.

Items Conventional MFI Islamic MFI

Liabilities(Source of Fund)

External Funds, Saving ofClient

External Funds, Saving ofClients, Islamic CharitableSources(zakat, waqf)

Asset(Mode of Financing)

Interest-Based Islamic Financial Instrument

Financing the Poorest Poorest are left out Poorest can be included byintegrating with microfinance

Funds Transfer Cash Given Goods Transferred

Deduction at Inception ofContract

Part of the Funds Deducted asInception

No deduction at inception

Target Group Women Family

Objective of Targeting Women Empowerment of Women Ease of Availability

Liability of the Loan(Which given to Women)

Recipient Recipient and Spouse

Work Incentive of Employees Monetary Monetary and Religious

Dealing with Default Group/Center pressure andthreat

Guarantee, and Islamic Ethic

Social Development Program S e c u l a r ( n o n I s l a m i c)behavioral, ethical, and socialdevelopment

Religious (includes behavior,ethics and social)

Table 1: Differences between Conventional and Islamic Microfinance Source: (Rahman, 2007)

The other thing that is included in Islamic MFI is zakat and waqf. This can increase the

participation of poor in Islamic MFIs According to Rehman (2007), Islamic MFIs should exploit more

sources of fund that are not interest-based in order to get pool of funds. It has been also mentioned

that conventional MFIs provide financing via loan whereas in Islamic MFIs good are transferred and

the loan is in the shape of Qardul Hassan in which no interest is charged on the loan. The objective of

47

Islamic MFIs is not to only focus on women but also focus on other poor who are in need of financial

assistance. Hence the aim of the Islamic MFIs is not to only gain monetary benefits but also to follow

the Islamic ethics as opposed to the conventional counterpart which only focus on monetary benefits.

2.5 Monitoring in IMFIs:

Micro financing is the provision of funds to the poor and low income households without access to

the formal financial institutions (Conroy, 2003). Microfinance is described as “Banking for the Poor”

as the main target segment for such financial services is poor people. Loan is provided to the poor

without any strict conditions to start their business or an economic activity that can generate profit for

him and he repays the loan to the microfinance institution in installments. However Hulme (2003)

argued that microfinance is not a cure for poverty but it is a mean to alleviate poverty via broad range

of micro financial support that would support the poor in the effort to improve their living standards.

The purpose of both conventional and Islamic Micro financing is the same but the difference lies in

the prohibition of riba that is observed in IMFIs. The conventional microfinance institutes start

collecting the loans as the loans are sanctioned and disbursed. The repayments also include a portion

of interest that is charged by the Microfinance Institute (MFI). But for IMFI, as riba is illegal or

haram hence they use financing instruments that are allowed by the Shariah. The financing

instruments that can be used by the microfinance institutes include Mudarabah, Musharaka,

Murabahah, Ijarah, Tawaruq and Qard Hassan (Wilson, 2007).

2.5.1 Modes of Financing

There are several Islamic contracts through which Islamic microfinance institutes can provide

financing to the poor. Although some of the contracts are not preferred by the Islamic banks due to

existence of high risk of default, hence the mostly preferred Murabahah contract because in such

contract the loss will be borne by the borrower rather than capital provider. But such banks least

prefer the partnership contracts such as Mudarabah and Musharaka because of the risk of loss to be

borne by the bank (Rahman, 2007). Anyhow, IMFIs can use the given below financing contracts by

developing risk mitigation techniques.

2.5.1.1 Musharaka:

Musharaka contract can be used by IMFIs where it will enter in a partnership with the entrepreneur or

borrower. The profit and loss will be shared by both the parties on the pre-agreed ratio. According to

Akhtar (1997), a specific percentage of profit should be granted to the client as management fee and

after that the profit derived from the project should be distributed between both the parties as well as

the loss should also be borne by both the parties according to their share of investment. Rahan,

(2007), mentioned that the most suitable technique of Musharaka for IMFIs could be the concept of

Musharaka Mutanaqisah. According to this concept, the share of the IMFI would diminish with the

48

gradual installments paid by the borrower. When all the installments are paid by the borrower, the

ownership would be transferred to the borrower.

2.5.1.2 Mudarabah:

IMFIs can also use Mudarabah as a mode of financing. The IMFI would play the role of rab ul maal

(capital provider), whereas the borrower would be mudarib (entrepreneur). In such case the profit

would be divided by both the parties on pre-specified ratio whereas the loss would only be borne by

the capital provider. As the loss is only borne by the capital provider, it may create the probability of

capital erosion. Secondly, the IMFI is exposed to potential credit risk as it cannot ask for collateral in

Mudarabah contract.

2.5.1.3 Murabahah:

This sort of contract is more suitable for buying business equipment. In such contract, the

microfinance institute would buy an asset for the client, and then add the profit on the asset and sell it

to the client on installment basis. Dhumale and Sapcanin (1999), conducted a study on the feasibility

of Islamic Microfinance, they evaluated qardul hassan, Mudarabah and Murabahah as potentially

suitable instruments for financing. They come up with conclusion that Murabahah is the best

financing tool for IMFIs as less monitoring is involved in such contract.

2.5.1.4 Ijarah:

Under such contract the IMFI handover the asset to the lessee on the rental basis. The lessor i.e. IMFI

takes the responsibility of monitoring the use of an asset while discharge its responsibility for

maintenance and repair. Ijarah Muntahia Bitamleek, the elaborated concept of Ijarah can be used by

the lessor according to which the asset would be handover to the lessee after the complete payments

of the installments. The asset may be handover as a gift, pre-determined price at the time of agreement

or through gradual transfer of ownership.

In this contract the IMFI can be exposed to the settlement risk when the lessee is unable to

pay the rentals and when it fall due. In such scenario, the IMFI can request urboun from the lessee as

the advance payment of the lease rental. The lessor can claim the rental asset back if the lessee

defaults on the rental payments (Iqabl & Mirakhor, 1987).

2.5.1.4 Qardul Hassan:

Some borrower needs money instead of an asset. In such case, Qardul Hassan contract would be

suitable. According to this contract the loan is provided to the borrower who wants to start up a small

business. The IMFI can only charge service fee while the loan can be settled in installments on an

agreed period. But in this case the IMFI is exposed to credit risk as the borrower may default on the

49

loan. Hence the IMFI needs a proper risk mitigation technique to cope with such kind of risk

(Rahman, 2007).

2.5.2 Monitoring the Borrower

The main challenge arises when the loan is disbursed. There is need of proper monitoring from the

MFI to overlook the activities of the borrower that may lead to the default. The monitoring is essential

element for MFIs in order to increase the repayments frequencies and increase profits and

sustainability to the Institute. There are certain issues due to which the monitoring becomes necessary.

2.5.2.1Information Asymmetry:

Mostly these MFIs operate in least developed countries, hence the information regarding the people

and the area is vague. In order to dig out such kind of information, the MFIs incurs expenses that may

be too costly. Although, collateral or security can be a safeguard against such problem but due to the

nature of the borrower it is very difficult to attain the assets to be pledged (Godquin, 2004).

2.5.2.2Avoiding Adverse Selection:

Adverse selection arises when a borrower is chosen with undesirable characteristics. The information

regarding borrower is difficult to obtain hence this information asymmetry give rise to adverse

selection. There are borrowers with high risk profiles and those with inability to take benefit of the

credit. Hence the role of monitoring becomes necessary in such case (Rehman, 2010).

2.5.2.3Avoiding Moral Hazard:

Moral hazard relates to the unexpected act or behavior from the agent or borrower. This term can

mostly be seen in principle-agent theory. In Microfinance, moral hazard is of severe importance

because in case if borrower acts in an unexpected manner e.g. the borrower use the fund immorally

and used less efforts to generate profits, would lead to loss for MFIs as well the abandonment of the

contract (Rehman, 2010).

To overcome such issues and reduce the pressure of monitoring on MFIs, a concept of group

lending was introduced by Dr. Muhammad Yunus, the founder of Grameen Bank, Bangladesh.

According to him, credit is the fundamental right of every human. The banks provided the loans to the

poor where 95% of the borrowers were women. To overcome the issue of moral hazard and adverse

selection, the bank introduced a concept according to which a group of certain borrowers have to

apply for loan rather than an individual. A single borrower out of the group would get the loan, upon

successful payment of the first installment; the others in the group would get the loan. Hence it would

create a monitoring cycle within the group as each member has to keep a check on the others because

default of one member would lead to termination of contract with all the members (Chowdhury,

2005).

50

As in Shariah, it would be unethical if the other members are held liable for the losses

incurred by one of the member of the group. In such case, shariah principles should be developed that

should be compliant with group lending. But due to the non-availability of such principles, in Islamic

Microfinance the loan is provided to individual via three modes. One alternative is continuous

repayment according to which the initial small amount is provided to the borrower if he succeed to

pay back then a slightly higher amount of loan is sanctioned and so on. Another for is installment

based which means that full loan amount is sanctioned at the start and then it is recollected via

installments. Third form loan is provided in small installments that should be paid back i.e. return in

full at a certain period of time (Rehman, 2010). But due to provision of loan to individuals, the

monetary costs of IMFIs would be high because the IMFI has to monitor the individual in order to

avoid moral hazard and adverse selection and create sustainability in loan payment. But the IMFIs are

more preferred as compare to MFIs because of prohibition of riba element.

3. Findings and discussion:

3.1 Resolving the Issues under ‘Islamic Sharecropping’ Contract:

From the literature, it has been observed that although a lot of criticism has been seen on the

sharecropping and al-muzāraʻa contracts but the later researchers and the Islamic jurists have

approved the contract of al-muzāraʻa as well as the contract of sharecropping has been approved by

Cheung (1969) and the followers. But the issue of monitoring and input and output sharing has not

been answered satisfactorily. In this section, we will try to resolve these issues based on the previous

literature of al-muzāraʻa and sharecropping that has already been discussed in this paper. If the given

below suggestions are put into the al-muzāraʻa contract then we can get a modified and more

comprehensive form of the Islamic sharecropping contract.

3.1.1 Monitoring and Supervision:

In the literature of sharecropping it has been discussed that the farmer or tenant activities cannot be

monitored perfectly and supervising the tenant will cost the landlord extensively. But according to our

opinion, this issue can be resolved if the landlord convey to the farmer that he is only concerned with

the adequate output that should be produce and in the urge of attaining this objective the fertility of

the land should not be damaged extensively. This will save the cost of supervision for the landlord

and it will also reduce the change of work avoidance and using of low quality of seeds by the tenant to

the great extent. On the other hand each party should know their managerial responsibilities i.e.

monitoring activities involved in the sharecropping. Hence the monitoring of primary activities that

has already been acknowledged by Aziz & Ismail (2008) includes the sowing and cultivation etc. will

fall upon the tenant whereas the monitoring of secondary activities such as harvesting and

transportation will be the joint responsibility of both the parties. It should also be known to the

51

landlord that the role of tenant is like a trustee; hence he is not responsible for any damage caused to

the crops except in case of the negligence form the tenant side. Regarding the power of landlord, it

should be acknowledged that he has the authority to force the farmer in case he is delaying or

avoiding doing certain works that has already been mentioned in the contract.

3.1.2 Input and Output Sharing:

For the Islamic sharecropping contract to be valid, it is necessary that the output should be shared on

the basis of percentage. It has been argued that the work effort and the skill of farmer that he holds are

not compensated at the time of output sharing. On the other hand it is also acknowledge that the

managerial capabilities of landlord are also avoided at the time of output sharing. As these skills are

the intangible and their value cannot be calculated, hence it is better to offset the skill of each party

with the other. Hence at the time of output sharing only the tangible inputs should be considered. For

example if the seeds and technology is provided by the landlord and the labour is provided by tenant,

then the output should be shared on the basis of these inputs e.g. the more inputs provided by a party

can hold a higher share of output.

3.2 The role of ‘Department of Agriculture’ and ‘IMFIs’ in Poverty Alleviation amongst

Rural Farmers via Sharecropping Contract:

As mentioned earlier that the sources of fund for IMFI could be government, external funds such as

NGOs etc., savings of the clients and charity organizations such as waqf and zakat. Hence in our

model as shown in Figure 1, the source of land for IMFIs would be waqf, where the waqf organization

would hold the land from public and family waqf. The capital would be used from government funds,

external funds and savings of the client. This would be enough for the IMFI to act as a landlord in the

sharecropping contract. So, for the sharecropping contract, the landlord and the farmer should enter

into the sharecropping contract where the decisions regarding supervision, input and output sharing

are made. Once the contract is settled, then the input would be provided for the sharecropping project

based on the terms of the contract. Mostly, each party would provide specific inputs. As it is discussed

earlier that the cost of supervision can be decreased if the landlord convey his intentions to the farmer

that he is only concern with the adequate output with less damage to the soil fertility. In such case, the

cost of supervision would decrease and less effort would be required to monitor the farmer. On the

other hand, the farmer would also supervise his labour for the sake of producing efficient level of

output with less damage to land fertility. Hence, the supervision would become the joint responsibility

of both the parties. On the other hand, in the process of sharecropping (from the initiation of the

contract till the output is shared), the department of agriculture would play the role of supervisor and

consultant. It would help the farmer in contract formulation, providing assistance in input selection

and techniques to get maximum outputs, as well as training for the farmers. On the other hand it

would also help the IMFI in certain ways, such as contract formulation, selection of the right inputs,

52

providing with the pricing policies etc. The issue that is raised by Rahman (2007), that this contract

would put IMFI or Islamic banks on risk because of less or no experience in the farming sector, can

be overcome by the introduction of department of agriculture in the model.

Figure 1: The model regarding the role of ‘Department of Agriculture’ and ‘IMFIs’ in

Poverty Alleviation amongst Rural Farmers via sharecropping contract

53

WAQF (Source of Land)

External Funds, Govt. Funds Saving of Clients(Captial Providers)

ISLAMIC MICRO FINANCE INSTITUTE

Sharecropping ContractSupervision DecisionInput-sharing DecisionsOutput-sharing Decisions

FARMER OR TENANT

Sharecropping Project

Output sharing

supe

rvis

ion

supe

rvis

ion

The DOA General legislation Land Tenure Infrastructure Public utilities Pricing Policies Field Selection Technical Input Contract Formulas Contract Formats

The DOA

Project Components Crop schedules Pricing policies Contract formulas Contract formats Farmer selection Field selection Technical inputs Farmer advances Farmer training Farmer forums

3. Conclusion:

Poverty has been mostly observed in rural areas because the people in such areas don’t have access to

quality education and health facilities. The people in these areas earn their livelihood from the

agriculture activities. But due non availability of the land and less awareness about the technical

know-how regarding production of efficient output these farmers earn below than average. The

government owned agriculture department plays an important role in such case. It can provide

assistance to the farmer in using the inputs appropriately and maintaining the soil fertility. However it

is a difficult task for the agriculture department to provide financing facility to the farmers due less

resource availability with the department.

Islamic Microfinance Institution with the help of Islamic Sharecropping contract can provide

a better solution to the problems of rural farmers. We have tried to provide a better solution to the

issue of conventional sharecropping by developing an Islamic sharecropping contract.

To play the role of landlord, IMFI must hold the land. This land can be provided by the waqf

organizations. The capital would be taken from the investment parties such as government, and

client’s savings for input sharing and supervision etc. By doing so, IMFI can enter in the contract of

Islamic sharecropping with the farmer. On the other hand the role of agriculture department would be

as supervisor and advisor, and would provide suggestions regarding the inputs application,

supervision and contract formulation etc.

In short, the IMFIs and agriculture department mutually can play and important role in

poverty alleviation amongst the rural farmers. The courage and good intentions of both the parties in

working together would be an important factor in providing a relief to the rural farmers in the shape of

good earnings. The IMFIs need to develop models for sharecropping and also to develop risk

mitigation tools that can help in from the potential risks that can arise from the contract.

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al-Muzāraʻa & al-Musāqāt. Kyoto Bulletin of Islamic Area Studies, 4(1), 190-209.

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of Development Economics, 88, 232–241.

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contentId=446

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Press.

Polman, W. (2002). Role of government institutions for promotion of agricultural and rural

development in Asia and the Pacific Region-Dimensions & Issues. Food and Agricultural

Organization UN.

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Rahman, A. R. (2007). Islamic Microfinance: A Missing Component in Islamic Banking. Kyoto

Bulletin of Islamic Area Studies, 1(2), 38-53.

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Lap Lambert Publishing.

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Paper 6

Experiences in Regulating and Supervising Islamic Microfinance Institutions

Muhammad ZubairChief Executive Officer - AlHuda Centre of Islamic Banking and Economics (CIBE)

[email protected]

Abstract

Islamic Microfinance is a sub-set of the Islamic Economic & Financial System. The demand for Shari’ah complaint financial products and services is increasing with the progress of the Islamic finance industry. It is widely accepted that microfinance is the most effective tool for the alleviation of poverty and to uplift the living standards of the poor through generating real economic activities in society. However, market studies have shown that the conventional micro financial system could not serve this purpose as expected due to some deficiencies in the system. Therefore, there is an immediate need to develop substitute financial products for microfinance institutions. During the latest research on the microfinance sector, it was determined that the Islamic financial system provides the best solutions for Poverty alleviation and Social sustainability. This is due to the fact that it is not only providing an opportunity to utilize a sustainable system, but also offers a good rate of return with better and ideal performance in comparison to the conventional microfinance system.A number of institutions have been established as focal points on major issues in Islamic finance including the Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI), the International Islamic Rating Agency (IIRA), the Islamic Financial Services Board (IFSB), and the Liquidity Management Centre (LMC). Sudan, Indonesia, and Bangladesh are unlocking their potential for Islamic finance in their respective regions. Although Islamic banking regime is broad and encompassing, Islamic microfinance is in its nascent stages and still needs more attention in the realm of regulations for prudent practices and possible services to the deserving segment of community in a transparent way. As per industry preferences, conventional microfinance has the full attention of a microfinance regulatory regime, but Islamic microfinance has some challenges in acceptability, practices, and adaptability by conventional microfinance institutions. Lack of donors’ interest and absence of Shari’ah compliant sources of Funds, unavailability of Quality HR, and lack of a uniform regulatory/ legal framework for Islamic Microfinance institutions are the major challenges faced by Islamic Microfinance Institutions today.

State Bank of Pakistan presented a case study and issued certain guidelines for the Islamic microfinance business in Pakistan to be done by full-fledge IMFBs. This included instructions for conducting Islamic microfinance by full-fledged Islamic banks, Islamic microfinance by conventional banks, and Islamic microfinance services by conventional microfinance banks with the required formalities to prudently offer Islamic microfinance.

Keywords: Islamic Microfinance, Islamic Micro Finance Regulatory, Islamic Microfinance Models

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1. INTRODUCTION

Islam is not only a religion, but a complete code of life. Islam is a practical religion to be

implemented in our daily life since it covers all aspects of human life. As such, when implemented

honestly and correctly, Islam provides solutions to all problems that are faced by humanity. One of

the most widespread and dangerous problems faced by humanity is that of poverty, hunger, and

starvation. Millions of human beings on this planet are living under severe poverty and very brutal

conditions.

The issue of poverty has been the focus of the international community for quite some time.

Everybody is talking about poverty reduction and different measures are being suggested for this

purpose. Different instruments are being tried with different levels of success, however, the situation

has not improved to such a level where it can be claimed that this anti- poverty drive has paid its

dividends. It is widely accepted that microfinance is the most effective tool for alleviation of poverty

and uplifting the living standards of the poor through real economic activities in society. As per

market research, the conventional micro financial system could not serve this purpose as was expected

due to a few deficiencies in the system. So, there is an immediate need to develop substitute financial

products for microfinance institutions.

Islam always encourages asset- based financing. We have seen the recent international

financial crises and learned a lesson that financing without asset backing is always risky. Although

Islamic Microfinance is a system and not a Religion, it can be utilized & practiced by both Muslim

and Non-Muslim Communities for Poverty Alleviation, Social & Economic Development. Islamic

Microfinance is very much compatible with the all the models, which are being utilized in

conventional microfinance like the Grameen Model, Village Bank Model, Credit Union Model,

Cooperative Model, and Self-Help Group etc.

Interest is forbidden in all the divine religions, but Islam has a strict verdict on it. Therefore,

Muslims hesitate to utilize the conventional financial system and remain excluded from financial

access. Approximately 44% of conventional microfinance clients worldwide reside in Muslim

countries and almost one-half of the 56 IDB member countries in Asia and Africa are classed as

United Nations Least Developed Countries (LDCs), so there is an immediate need to focus Islamic

Microfinance institutions and regulation as well as in Muslim Majority countries for financial

inclusion. Right now, there are more than 250 Islamic Microfinance Institutions working globally in

32 countries. Islamic Microfinance has a proven track record, which deals with long lasting &

ultimate solutions for Sustainability, which can be strengthened further with strong regulatory

foundations.

Islamic finance is the broader term and it encompasses the diversified approaches such as

Islamic banking, Islamic Microfinance, Sukuk (Islamic Funds), and Takaful. Islamic financial

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institutions are guided by AAOIFI, IFSB and somehow by LMC and IIRA to improve the efficiency

in services around the globe although these said working bodies may be helpful for prudence in the

overall performance of Islamic microfinance institutions.

As per the latest research on the conventional and Shari’ah compliant Microfinance sector, it

is evaluated that the Islamic financial system provides the best solutions for Poverty alleviation and

Social sustainability. It is not only providing opportunity to utilize a sustainable system, but also

offers a good rate of return with ideal and better performance than he conventional microfinance

system. Islamic Microfinance is a sub-set of the Islamic Economic & Financial System. The Islamic

microfinance needs more attention in regulatory grounds for strong branches and proper

implementations.

“Islamic microfinance basically refers to a system of localized finance arrangements set up as

an alternative source of funds for small, low-income Islamic clients. Typically, users of Islamic

microfinance have little or no collateral, as they do not possess significant assets, and would therefore

be excluded from other forms of financing, including Islamic bank financing. Thus, Islamic

microfinance provides a means of accessing funds for those who are unlikely to qualify for other

forms of finance, yet are still seeking full compliance with Islamic law and the Islamic way of life.”

1.1 Sources of Islamic Microfinance

Islamic Microfinance products are basically derived from the four main sources of Fiqah. The first

source is Quran-e-Pak, which is the Holy Book of Muslims. It is the constitution of the Muslims from

which they derive the teachings to organize both of their religious and everyday affairs. Many Islamic

Microfinance products like Ijarah, Bai etc. have been derived from Quran-e-Pak. The Second source

of Islamic Microfinance is Sunnah, the sayings and practices of the Holy Prophet Hazrat Muhammad

(SAWW). Many Islamic Microfinance Products such as Mudarabah, Istisna, Wakalah, etc. have been

derived from Sunnah. The third source of Islamic microfinance is Ijma’a which is the consensus

among Jurists. Some Microfinance Products derived from Ijma’a like late payments and the charity

mechanism etc. are being utilized in the Islamic Microfinance Sector. The last source is Ijtihad &

Qiyas (Analogy). Ijtihad refers to making a decision in Shari’ah by personal effort, independent from

any school of jurisprudence as opposed to taklid, copying or obeying without question whereas Qiyas

is the process of deductive analogy in which the teachings of the Hadiths are compared and contrasted

with those of the Qur’an, in order to apply a known injunction to a new circumstance and create a new

injunction. Takaful or Micro Takaful is an example of Ijtihad.

1.2 Islamic Microfinance Products Mechanism

Islamic Microfinance products can be segregated into four categories: the partnership Mode, Trade

based Mode, Rental based mode and other Models like, Qard-e-Hasan, Waqf & Zakah, and Islamic

Cooperatives etc. In partnership Mode, MFIs & their clients enter into a Partnership agreement for a

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business venture on profit and Loss sharing mechanism. We have two Products in Partnership based

mode, Musharakah & Mudarabah. In Trade based Mode, MFIs & their Clients enter into trading

agreements. The products of Trade based Modes are Murabaha, Musawamah, Salam and Istisna.

There are two products in Rental based mechanism; Ijarah (a Shari’ah Compliant mode of leasing)

and Diminishing Musharakah. Qard e hasana is an Islamic financing, a loan, which under Islamic law

is always free of profit. Zakah is one of the five Pillars of Islam which is the giving of a fixed portion

of one's wealth to charity, generally to the poor and needy.

1.3 Basic Principle of Shari’ah Based Microfinance

Shari’ah based Micro financing is based upon several principles like the Prohibition of Interest and

Gharar (Speculative Behavior), Asset Based Financing, Risk Sharing, Sanctity of contracts, and

financing in Halal/ Shari’ah Complaint activities.

Prohibition of interest is an important principle of Islamic Microfinance. Interest is forbidden

in all the divine religions but Islam has a strict verdict on it. Therefore, Muslims hesitate to utilize the

Conventional financial system and remain excluded from financial access. Islam also prohibits

speculative behaviours (Gharar) because in Islamic finance, any transaction entered into should be

free from excessive uncertainty and speculation.

Care for the poor and poverty alleviation are religious obligations in Islam. In Islam, Zakah,

Sadqa (Donation), Tabbrumm, Fitrana, Usher etc. are dedicated for financial well being of Poor

people. Islam always encourages asset based financing. We have seen the recent international

financial crisis and learned a lesson that financing without the backing of assets is always risky. One

of the fundamental principles of Islamic Microfinance is Risk Sharing. Risk is shared in order to

compensate the loss occurred. Islamic Microfinance emphasizes the sanctity of Contracts. Micro

Takaful is a Shari’ah Compliant System of Risk Mitigation.

2. ISLAMIC MICROFINANCE WORLDWIDE

Islamic Microfinance is an emerging Market worldwide. Approximately 44% of conventional

microfinance clients worldwide reside in Muslim countries. Research shows that almost one-half of

the 56 IDB member countries in Asia and Africa are classed as United Nations Least Developed

Countries (LDCs). Islamic Asset-based Financing can prevent diversion of funds for consumption.

For Muslim majority countries, a great need for Islamic Microfinance exists as a large target segment

is averse to the interest based microfinance products. Islamic Microfinance has a proven track record

and its deals with long lasting & Complete solutions for Sustainability.

When we look for need assessment of Islamic Microfinance in Central Asia, the Caucasus and

South Asia, we see a great demand. The total Population of South Asia, Central Asia, West Africa,

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and the MENA Region & Caucasus are 2.4 Billion and out of them 1.12 Billion are Muslims, which

are 47.3%. This shows a big Demand of Islamic Microfinance Products for Financial Inclusion

because Muslims are reluctant to move towards the Interest based MF System. IMF is beneficial for

Muslims as well as for Non-Muslims. According to the World Bank, South Asia is home to half of the

world's poor, where the Muslim population is 33.2% of the total population, which shows the

immediate need of Islamic Microfinance there and shows a great potential and demand for Islamic

Microfinance in these regions.

There are about 250 Islamic Microfinance Institutions, which are working globally in 32

countries. There are 14 Islamic Microfinance Institutions in Pakistan whereas Yemen Sudan,

Bangladesh, Afghanistan, UK, and Malaysia have 11, 13, 9, 9, 5 and 11 Islamic Microfinance

Institutions respectively. This shows that Islamic Microfinance Institutions exist worldwide not only

in Muslim Countries, but also in Non-Muslim Countries.

Table 1 shows the names of the countries along with the institutions providing Islamic Microfinance.

Countries Islamic Microfinance Institutions

Indonesia BPRS, Islamic Financial Cooperatives referred as Bait ul Maal Wat Tamwil (BMT)

Bangladesh Islamic Bank Bangladesh, Social and Investment Bank Alfalah and Rescue

Afghanistan FINCA (Qard Hasan), WOCCU, Ariana Financial Services , IFIC, etc.

Pakistan Akhuwat , Farz Foundation, ASASAH, Muslim Aid, Islamic Relief, CWCD, ,HHRD , NRSP, NRDP, Naymet etc.

Malaysia Amina Iftikhar, Tabung Haji etc

India AICMEU, BASIX, Sahulat, Bait-un-Nasr , Al-Khair Co-operative, Marwar Shari’ah Credit

Azerbaijan Bait –un Nasr

Egypt Mit Ghamar Project

Syria Sanadiq project Jabal al Hoss

Lebanon Mu’assat Bayat Al-Mal

Yemen Hodeidah Microfinance Program, Al-Amal Microfinance Bank

South Africa Awqaf South Africa

U.K Faith Matters, Islamic Relief, Muslim Aid, HSBC Amanah

Jordan Jordan Islamic Bank

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Fig. 2 shows the demand of Islamic Microfinance in Central Asia, South Asia, Caucasus, West Africa

and MENA Region. [2]

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Fig. 1: A glimpse of Demand for Islamic Microfinance Worldwide

2.1 Challenges faced by Islamic Microfinance

Islamic Microfinance Institutions are facing some challenges, which need to be addressed. The

biggest challenge, which is now faced by the Islamic Microfinance Industry is the lack of Donors’

interest and non-availability of Shari’ah Compliant Sources of Funds, which is also a hurdle in the

way to scale it up. A Strong regulatory regime is the missing component in the Islamic microfinance

industry around the globe and IMF is being regulated, in reality as a component of conventional

microfinance, but the fact is opposite to it and Islamic microfinance institutions have their own norms

and practice. Therefore, there is a need to develop a uniform regulatory and legal framework for

Islamic Microfinance Institutions. Due to limited Islamic microfinance institutions, this sector is also

facing the shortage of quality HR. There is a big need to develop Shari’ah expertise towards the

growth of Islamic Microfinance. If we see the product mix of the Islamic Microfinance industry, it is

seen that Murabaha is covering almost 80% of the Microfinance Industry so there is an immediate

need of research on other Islamic Microfinance Products for product diversification. In short,

standardization of Islamic Microfinance Products is very much needed.

2.2 Opportunities for Islamic Microfinance

Many opportunities exist for the Islamic Microfinance sector. The International Islamic Microfinance

Network (IMFN) was established in 2009 by Islamic Microfinance institutions to strengthen and

support the Islamic Microfinance Institutions. It is an effective platform for coordination and harmony

among Islamic Microfinance Institutions. One should try to expand the market of Islamic

Microfinance where conventional Microfinance Institutions face limitations especially in Muslim

Majority Countries. AlHuda Centre of Islamic Banking and Economics, Pakistan has established a

Centre of Excellence in Islamic Microfinance (CEIMF) for advisory, trainings, and capacity building

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for Microfinance Institutions and to address the needs of the Islamic Microfinance industry. It

provides complete solutions in the field of Islamic Microfinance.

A perfectly sustainable system with the goal of poverty alleviation is needed to expand

Islamic Microfinance. Islamic Banking and Finance is emerging in South Asia and the MENA region,

which will strengthen the Islamic Microfinance effectively.

2.3 Islamic Microfinance Regulation

Islamic microfinance regulation has been the forefront of policy discussions among donors, investors,

and practitioners since the development of Islamic microfinance as an effective tool of poverty

alleviation. Islamic microfinance regulation is decisively needed to address the Shari’ah compliant

microfinance industry. Giving due consideration to the prevailing phenomenon in the microfinance

industry, it is concluded that somehow Islamic Microfinance is matched with conventional

microfinance in regulatory aspects but, in reality, most importantly there should be a separate Islamic

microfinance regulatory skeleton being followed by the policy makers and Islamic finance experts.

Apparently AAOIFI and IFSB, at their best, are filling the gaps in Islamic finance assistance

with a deep focus on the Shari’ah compliance of the microfinance industry through standardization for

Islamic finance industry around the globe, but Islamic microfinance is deprived of proper

consideration and structuring in its many potential areas in the world such as MENA Regions, Asia,

and Central Asia. Currently, there is no identical existence of regulations in the Islamic microfinance

industry working for it to provide rationale and Shari’ah compliant grounds.

Islamic microfinance should be kept separate in terms of regulatory ground as it has its own

Shari’ah requirements to target a selective segment of society to bring them into the financial

inclusion though diversified products. BMT (Baitul Mal Tamveel) initiatives taken by Indonesia

further strengthen the concept of Shari’ah compliant microfinance.

Although we did not see a handsome Islamic Microfinance Regulatory regime, we can take

some guidelines from the work, which has been done in Sudan, Indonesia & Pakistan. As Islamic

Banking and Finance is growing globally, it would be a supplementary to promote Islamic

Microfinance in all aspects including regulation & supervision alongside and complimentary to the

Islamic banking and finance industry.

3. ISLAMIC MICROFINANCE REGULATORIES GUIDELINES

With reference to the time to time research studies of CGAP and the situation a decade ago, most

policy makers, donors, and private investors involved in microfinance now appreciate that poor and

low-income people, like the rest of us, need a variety of basic financial services, not just credit. The

ability of the market to respond to this demand depends not only on providers developing sustainable,

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low-cost ways to provide such services, but also on having an enabling policy and regulatory

environment. Appropriate regulation and supervision of financial service providers is therefore

critically important in bringing to the poor and low-income people the financial services that they

need.

As per the guidelines of CGAP for financial inclusion of the poor in the Islamic microfinance

industry, different key approaches have been the need of time as explained further.

There is the need of increased attention to financial services beyond microcredit and reliance

only on the microcredit element, which may not generate the desired results. New financial services

providers should be encouraged with a compatible delivery mechanism. A Regulatory regime

evolution at a rapid pace will definitely satisfy the need of Islamic microfinance institutions.

Encouragement of public and private investors in the financial sector is mandatory in order to meet

the financing requirements of Islamic microfinance institutions. Most countries practicing Islamic

microfinance and potential target markets of Islamic microfinance should be connected with the new

comers of Islamic microfinance not only for financial inclusion, but also for regulatory aspects to

develop the most compatible environment and transparency with prudent norms and practices in the

Shari’ah compliant microfinance industry.

Transformation of microfinance institutions from non profit to for-profit shall ensure their

self- sufficiency, sustainability, and donors’ satisfaction with the long run position of microfinance

institutions. Microfinance integration of main players in the financial sector will cause the more

mature Shari’ah compliant microfinance industry. Yet international standard setting bodies are not

excluded from such job as they must contribute through proper supervision and appropriate guidance

with Shari’ah connection.

There are several factors, which should be considered while doing Islamic Microfinance.

There is a misconception that Islamic Microfinance is only for Muslims, but basically Islamic

Microfinance is a system not a Religion so it can be utilized & operated by both Muslim and Non-

Muslim Communities for Poverty Alleviation, Social & Economic Development.

As discussed earlier, Islamic Microfinance is Shari’ah compliant microfinance, which is free

from Riba and Gharar. It takes into consideration Shari’ah compliant funding as it is necessary for

Islamic Microfinance Institutions to have Shari’ah complaint funds in the Asset side & liability side.

Islamic Microfinance deals in Shari’ah vetted Products according to AAOIFI standards. There should

be trainings and Quality HR in this field and it is a very important element for Islamic Microfinance

Institutions. There should be qualified Shari’ah Advisors and Shari’ah Review etc. in MFIs. One of

the examples of Islamic Microfinance Products is Micro takaful, which is the mechanism of Shari’ah

compliant insurance.

65

3. 1 Establishing and Modelling the Islamic Microfinance

Islamic microfinance can be promoted by assisting Islamic commercial banks to establish units,

branches, or counters with Islamic microfinance products and by reassessing the challenges and

opportunities of Islamic rural banks and cooperatives through the following steps:

Commercial banks should learn about setting up branch networks of Islamic MFIs from the

experience of successful microfinance strategies and their successful experiences in consumer finance

services.

Islamic rural banks should be revamped in overcoming their deficiencies in overall operations

as they are the appropriate channel to be used for microfinance in financially deprived and excluded

areas, particularly in the regions having agriculture potential.

Islamic cooperatives and microfinance institutions need a system of prudential regulation,

mandatory auditing, and effective supervision by an appropriate financial authority to attain the trust

of investors and fund providers with the operational transparency and prudence in Shari'ah compliant

microfinance operations.

4. PAKISTAN’S ISLAMIC MICROFINANCE INDUSTRY

Pakistan is considered to be a leader of the Islamic Microfinance Industry. Islamic Microfinance

Institutions operating in Pakistan are Akhuwat, Centre for Women Co-operative Development

(CWCD), Narowal Rural Support Program (NRSP) – KPK, Farz Foundation, Islamic Relief, KKCB,

Helping Hand for Relief and Development, Muslim Aid, Deep Foundation, NGO World, Al-Noor

Foundation etc. Table 2 shows the product wise detail of Islamic Microfinance Institutions operating

in Pakistan.

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Table 2: Microfinance Institutions operating in Pakistan

Institution Mode of Finance

Akhuwat Qaraz-e-Hasna, MicroTakaful, Grants

CWCD Murabaha, Ijarah, Salam & Istisna MicroTakaful

NRSP – KPK Murabaha, Mudarabah with BOK for funding Source

Farz Foundation Murabaha, Musharakah, Livestock

IslamicRelief Murabaha and Qarz-e-Hassan

KKCB Murabaha and MicroTakaful

HelpingHandfor RD Murabaha, Mudarabah

MuslimAid Murabaha

NRDP, Deep Foundation, NGO world, Al Noor Foundation

5 MicroTakaful Co, 5 Full fledge Islamic Banks, 13 SAIBB

4.1 Experience in Regulation and Supervision - SBP’s guidelines for Islamic Microfinance

business – A Case Study

Since the development of Islamic microfinance as an effective tool for poverty alleviation, State Bank

of Pakistan has contributed greatly for the industry as it has published some guidelines for Islamic

microfinance business in Pakistan by financial institutions, which are presented here as a case study

covering all the material aspects related to Islamic microfinance practitioners. The purpose to publish

this document was to provide assistance in Shari’ah compliance for microfinance business and these

guidelines are in addition to the willing financial institutions for Islamic microfinance services rather

than replacing any already issued guidelines or directives. Islamic microfinance services and products

can be offered by various types of financial institutions, in different forms. Each type of financial

institution has been separately discussed under the following headings in these guidelines:

Full-fledge Islamic Microfinance Banks (IMFBs)

Islamic Microfinance Services by Full-fledge Islamic Banks

Islamic Microfinance Services by Conventional Banks

Islamic Microfinance Services by Conventional Microfinance Banks (MFBs)

Full-fledged Islamic Microfinance Banks, initially, are mandatory to be licensed by SBP

under Microfinance Institution Ordinance, 2001 for microfinance services on the national, provincial,

regional, and district level. Each full-fledged Islamic microfinance bank shall be mandatory to have

been appointed with a Shari’ah advisor after qualifying with the fit and proper criteria for the said job

67

and responsibility prescribed by SBP. As per the guidelines, all the asset and liability side products

are required to be vetted and properly modelled/sutured prior to launch in the supervision and

guidance of an independent Shari’ah advisor.

While Islamic microfinance can be offered by full-fledged Islamic banks, SBP requires that

the bank be licensed prior to launch. In a nutshell, SBP gave an opportunity to the financial sector to

perform in and for the microfinance industry in a Shari’ah compliant mode under actually supervised,

safe, and regulated environment, which builds donors’ and investors’ confidence.

Full-fledged Islamic banks can also offer Islamic microfinance for financial inclusion and

microfinance services, but the prerequisites, as stated earlier; to initiate Islamic microfinance shall

prevail. Islamic banks can offer Islamic microfinance products through four different ways prescribed

by SBP as:

Through established counters of Islamic microfinance at existing branches

Standalone Islamic microfinance branches and mobile banking

Establishing independent and subsidiary Islamic microfinance banks

Networking and developed linkages with existing IMFBs and MFIs

Islamic Microfinance services by conventional banks can be provided through different

institutional level models such as:

Islamic Microfinance counters at existing branches

Islamic Microfinance Standalone branches and mobile banking

Establishing independent Islamic microfinance banks as subsidiary of conventional banks

Networking and developed linkages with existing IMFBs and MFIs

Islamic Microfinance services by conventional microfinance banks, after getting license,

can offer Islamic microfinance products under the regulatory supervision of SBP in Pakistan. The

conventional microfinance bank is licensed for microfinance operations on financial strength, Net

capital (capital free from actual and potential losses), and adequacy of the capital, asset and liability

base with respective products, which are critically examined. The appointment of an independent

Shari’ah advisor after qualifying fit and proper criteria is the significant element, which is mandatory.

Further SBP has specific guidelines for internal control, audit, accounting, book keeping, minimum

capital requirement, and the establishment of an Islamic microfinance division. Most importantly, the

HR was also given due consideration regarding capacity, educational level, experience, and standing

of executives in the respective field.

In Pakistan, the Islamic microfinance regime is strong and strict in Shari’ah compliance,

which could have not been possible without the independent regulatory body of Islamic finance,

especially Islamic microfinance in Pakistan.

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5. REFERENCES

Central Asia. (2010). Retrieved January 2013, from Wikipedia:

http://en.wikipedia.org/wiki/Central_Asia

QFINANCE. (S.F.). Islamic Microfinance. Retrieved January 2013, from Q-Finance-The Ultimate

Financial Resource: http://www.qfinance.com/financing-checklists/islamic microfinance

South Asia. (2010). Retrieved January 2013, from The World Bank Group:

http://www.data.worldbank.org/region/SAS

South Asia. (2010). Retrieved January 2013, from Wikipedia:http://en.wikipedia.org/wiki/South_asia

State Bank of Pakistan guidelines for Islamic Microfinance Business (2013), website:

http://www.sbp.org.pk/ibd/2007/Annex-c5.pdf

CGAP – A guide to regulate and supervise Microfinance (2014), official

website:http://www.cgap.org/publications/guide-regulation-and-supervision-microfinance

MFTRANPARENCY, “Regulation in Microfinance” (Azish Filabi), Pub. September 4, 2013,

http://www.mftransparency.org/regulation-in-microfinance/

69

http://www.mftransparency.org/regulation-in-microfinance/

http://www.cgap.org/publications/guide-regulation-and-supervision-microfinance

http://www.sbp.org.pk/ibd/2007/Annex-c5.pdf

http://en.wikipedia.org/wiki/South_asia

http://www.data.worldbank.org/region/SAS

http://www.qfinance.com/financing-checklists/islamic%20microfinance

http://en.wikipedia.org/wiki/Central_Asia

Paper 7

HOW AFRICAN DIASPORA CAN IMPACT

THE DEVELOPMENT OF ISLAMIC FINANCE

Dossa Maxime

INTRODUCTION

Africa has recently witnessed considerable developments that have allowed Islamic finance to expand

in many parts of the continent. In fact, several African countries have proposed new legislative

initiatives and amended regulatory and legislative regimes in order to accommodate Islamic banking,

and to a lesser extent to attract Gulf funds into their own markets. Countries like Nigeria, Kenya,

South Africa, Morocco and Senegal really stand out from the other African countries and have

expressed much interest in Islamic finance and are acting to establish themselves as the African hub

for this industry.

Therefore, Islamic investors keep an eye on Africa because the continent features a great

potential and strong demand for Islamic financial services and products in the field of and

microfinance.However, there is still a long way to go and numerous challenges have to be

overcome.Among them, I think that an important component of resources known as Africa diaspora

and crowdfunding are not explored yet in order to ensure a great growth of the Islamic Microfinance

sector in Africa. This is the purpose of the current paper.In the following pages, I will stress on West

Africa Economic and Monetary Union

( WAEMU)

I. Crowdfunding: Alternative way to fund Islamic micro finance in Africa

Let’s focus on one of the region in Africa where some rules and legislation on micro finance already

exist. But the legislation have to change in order to incorporate Islamic micro finance and

crowdfunding principles.

A. State of the art

1. West African Economic and Monetary Union market

West African Economict and Monetary Union (WAEMU) are Eight French speaking countries:

Benin, Burkina Faso, Ivory Cost, Guinea-Bisau, Mali, Niger, Senegal and Togo.These countries are

working together so that to build a regional integration in economics and currency.The population in

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this area is mainly muslims with 60% muslims on an average and more than 90 % in some of the

countries…

Figure 1: Map of WAEMU countries

2. Legal framework of micro finance

a) The general concept of micro finance

Micro finance refers to financial services and products granted to people excluded from the financial

system due to the lack of guaranties they provide and little amounts of money concerned such as

micro credit, micro insurance, micro savings, money transfer, etc.

Microcredit is a very small loan, granted almost without guarantee to people excluded from

banking system and willing to develop a small activity allowing them to generate an income.

The loans are granted either to a group of persons or small businesses.

Sometimes it may be granted to an individual but with the solidarity of other members.

b) Micro finance definition in WAEMU

The legal framework of micro finance provision in WAEMU (West African Economic and Monetary

Union) is valid for the 8 countries: Benin, Burkina Faso, Ivory Coast, Guinea-Bissau, Senegal, Niger,

Togo and Mali.

All of them are French-speaking countries and share the same currency called FCFA. They

form a custom and currency union together.

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In this economical region, micro finance sector is regulated by a law called “Système

Financier Decentralisé” (Decentralised Financial System) which allow the following activities

- Deposit collection

Are considered as deposits, funds, other than participations and compulsory contributions collected by

the decentralized financial system from its members or clients with the right to use it with the

obligation to give back the money when needed by the clients in regard of the contract.

- Loans operations

A loan operation is any action undertaken by which a decentralized financial system gives funds for

value to a member or a client with obligation for him to pay the money back at maturity.

- Guarantees

This refers to any legal act by which a decentralized financial system takes some guarantees on behalf

of a member or a client.

3. Some characteristics of current microfinance sector

- Deficit of intervention of banks to fund small businesses

- The lack of collateral from the borrowers or micro entrepreneurs

- The majority of the population lives in rural region where there are less infrastructures, banks

and services

- The repayment rate are higher than in the banking sectors

- It contributes really to empower the women and rural population impact on the local region

The non-bankables could mostly not fit a sufficient credit scoring by banks because they have no

regular income or no good track record (bad credit history or no credit history, etc.)

4. Islamic finance in the WAEMU

a) The concept and Activities

This concerns all the financial system including banking activities and services, Takaful insurance,

fund management, financial services, micro finance based on Islamic rules and principles. These

principles are derived from the ethical values as described by Coran and Sunna among which the ban

of interest, forbidden activities, - profit and loss sharing, asset backing principle, solidarity, etc.

We can distinguish 2 types of contracts generally used in Islamic finance:

- Profit and loss sharing contracts commonly used which are Musharaka, Mudaraba

- Contract based on trade finance -buy and sell activities- commonly known as Murabaha,

Ijara, etc.

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In certain cases, the parties involved in these types of contracts may sign agency contracts.

As additional and alternative source of funding, Islamic finance could insure the effectiveness of

financial intermediation for economic activities. Its ethical principles have demonstrated robustness

and social responsibility throughout the recent financial crisis.

b) The lack of an effective Islamic microfinance framework in WAEMU

Article 56 of the Banking Law in WAEMU

“Central bank can decide particular rules in favor of companies with special status, namely companies

which don’t use interest rate and apply the principle of sharing of profits and losses.”1

This is the only one reference on non-conventional activities based on interest.

In consideration on this article of the financial system law, Islamic banking or financial activities are

possible in WAEMU area but needs to be strenghten.

B. Suggestions of micro finance contracts to develop in WAEMU area

We can notice that the law on Decentralised System in WAEMU does not consider the aspect of

Islamic finance namely the ban of interest by avoiding money to money operation.The loan operation

described as funds to be granted involve money to be given on conventional way of interest.

In Islamic finance, there are some alternatives of avoiding money to be given to the client.

The system has performed some product like Commodity Based Murabaha (CBM) by which the

financier sell goods to the client who has to sell it to a broker and get the equivalent money.

Even if the practice is criticized, it avoids the financier to give money directly to his client.

The margin or the commission is justified by the fact that the financier sells a good to his client.

Selling goods is a commercial activity and is allowed in Islamic finance.

“ God allows commercial activities but forbid interest ”, etc.

The law has to integrate the aspect that MFI can offer alternatives products apart from savings, loan,

and guarantees.The following contracts can be integrated in the microfinance law in WAEMU

1. Murabaha contract

2. Ijara contract

3. Salam contract

4. Musharaka contract

5. Micro insurance

1 Source:Portion of Article 56 of the Banking Law in WAEMU

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C. Justification for an alternative source of funding micro finance institutions

1. Finding additional / alternative source of funding

- There is a lack of funds and demand is going higher and higher in WAEMU the MFI are fund

by: 75% financing by banks and only 25% from specialized funds and international

organizations2.

The CGAP Cross-Border Funding Survey, 2010 shows that the loan granted by MFI comes mainly

from deposits of their clients.

But these deposits are very low and limited. So MFI have to face banks high credit rates.

Figure 2: Source of funding

Even in big economies, the smallest firms have difficulties in obtaining financing.

There is always a gap between the demand (entrepreneur) side and the supply side (financial

institutions) and this fact create difficulties especially to small enterprises and more for micro

entrepreneurs.

- The local banks are reluctant to develop micro finance activities

- The cost of fund is low by using IT processes

- According to Babyloan, crowdfunding platforms represent in 2012 only 0.15% of the overall

micro credit which is worldwide standing at USD 65 billions. But as a new market, the

platforms increase this niche market which by 400% in 2012.

2www.babyloan.fr

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http://www.babyloan.fr/

- The development of new technology for communication and services create new

opportunities for micro finance sectors.

The whole public is going to become a major player in financing micro projects by using the

crowdfunding mechanism in the word in general and particularly for developing countries projects.

One of the main target group to focus on as lender is the diaspora of the countries who

participate in the development of their country.

2. The cost of current funding

A report issued by CGAP 2009 Overview of Microfinance-Related Legal and Policy Reform in Sub-

Saharan Africa 2009 demonstrated that banking funding represents the majority of MFI source of

funding and this is expensive.

Figure 3: Institutional lenders of micro finance institutions in Africa

LENDERS PER REGION ( In USD Millions )

Private

Funds

Financial institutions

Public lenders

Source: Mix Database on financing structure, 2008

In 1997, the unusual rate of loan has been fixed by the banking and financial regulator in WAEMU at

18% and 27% respectively for banks and MFI.

The interest rate applied by MFI varies in accordance of many factors: the amount of the loan, the

geographic area, the MFI policy, the type of target, etc.

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Table 1: Cost of funding per type of lender

Type of lender Ass Central East South WestPublic lenders 8% 3% 9% 8% 5%Financial institutions 9% 7% 8% 13% 10%Funds 10% 8% 10% 11% 10%Private 3% 4% 3% 1% 5%Mixte 8% 5% 8% 9% 9%

Source: Mix Data base on financing structure, 2008

By using crowdfunding principles on Islamic way, the ethical principle meets a low cost of

funding to contribute to reduce poverty.

D. Recommandations of legal framework on crowdfunding

1. Definition and concepts

According to specialists, one of the key points in succeeding in micro finance strategy is the funding

mechanism of the lenders.

Crowdfunding provides a convenient access to a wide range of donators and investors.

Crowdfunding is a new concept of funding economical activities and businesses using internet

technology.

Some policymakers may be reluctant beause of the weekness of infrastructure and bad quality

of internet but, Africa has shown that it’s the continent where the internet, mobiles, mobiles banking

are booming.

The concept is improving and the legal approach also.According to the activity run by

crowdfunding operators, it may be considered as providing

Micro investment services

Providing micro financial titles

Banking operations

Payments services

Each of these activities is have to take account the legal framework in the countries.

But, the perspective of developing the tool for the enhancement of crowdfunding, the following

aspects should be considered for WAEMU or for Africa in general.

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2. Main factors to include in the regulatory perspective

Nowadays, there is no particular and specific regulation for crowdfunding operators in most of the

Africa countries.

To avoid that crowdfunding platform operators be considered as banks, a specific framework have to

be developed because these types of operators face particulars reality in there operations and risks

management.

It should forbid any entity running such activities without agreement from the local regulator. We

may distinguish 3 types of Islamic crowdfunding platforms for funding mico finance activities

Those collecting Zakat

This will be gift granted for a micro project selected by the donor in the platform

Those collecting Quard Hassan

This will be reserved for investors who want to support a project without any need of return in

the project

Those facilitating loss and profit sharing : Mudharaba, Musharaka..

These types of investors are risk takers.

The legal framework has to take account the protection and security of the investors and consider also

that some or most of the investors and donators and country diaspora members can grant a huge

amount of money.

The crowdfunding operators should not be considered as banks, or investment companies

because most of time they just create link between donors: investors and financial operators.

The minimum capital requirement to operators

A maximum amount of investment or donation per person

A maximum amount leveraged by the platform

The size of projects funded and the mechanism of funding are different from banking and

related sectors.

A specific status has to be developed for crowdfunding activities.

The status has to allow them to collect money, keep and transfer funds for the purpose and

financing participative projects.

A limitation of financing amount has to be defined for such activities per each person

They should not use the money for their one activity by any means.

They should act as an intermediary in financing small size activities.

They should provide some minimum report and statistics to the financial authority

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Some of the banking and financial prudential rules have to frame the activity (money

laundering, protection of investors, etc.)

As it’s done for micro finance sector, the corresponding legal framework on crowdfunding operators

have to consider some financial requirement in term of equity, limit in the amount collected by

project, by month, by year, per investor, door…so that banking and other financial services be

protected.

3. The main questions to ask while deciding to participate as investor in a

crowdfunding platform:

- The experience of the platform in financing micro credit ( how long it takes, which amount)

- The regulatory framework under which the platform is operating ( authorization, gift, loan, equity…)

- Analyzing the whole costs of funding even, cost of services provided, money transfer costs, foreign

exchange costs …

-What are the additional costs of monitoring from the platform requirements?

- How the platform keeps their lender loyal?

- Do the platform respect the law against money laundering and terrorist financing ( on of the

principle of Islamic finance- transparency and ban of forbidden activities…)?

In regards of the fundamental principles of Islamic finance, micro finance institutions have to:

- Develop transparency

- Enhance the portfolio quality

- Improve financial sustainability of their operations …

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II. Implementation of Crowfunding platform in Islamic finance way

A. Presentation of the model

Figure 4: Crowfunding platform in Islamic finance way

Contractual relationship

Monetary flow

B. Explanation of the model

The projects are published in the platform after selection by the IMFI

The platform operator deploys the community management strategies to attract investors but also

contact it’s basis potential investors so that they can invest in the project.

For marketing reasons, the projects have to stay on line for a limited period of time during which

potential investors can grant funding.

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PLATEFORME

IMFI

RECIPIENTS

Moudaraba 1

Representation infrastructure Disposal of fund fees

Wakala 2

Moudaraba 2

X% M = N

Y% N = P

POTENTIAL INVESTORRepresentation

and infrastructures fees

Wakala 1

After this limited period, if the project doesn’t reach the funding objectives it has to be removed

because it means a lack of interest from investors.

1. Differents types of contrats to be used

a) Wakala contract: The platforms way of earning money

According to AAOIFI, “Wakala is a mandate given by a person to another for all of activities needing

mandate….”

The approval, the subject and two parties are the elements of a Wakala.

Regarding the paid Wakala, the compensation has to be defined as a fixed amount for a package of

services provided or as a percentage of a certain amount.

Between the investor and the platform

Here, the investor commit the platform to represent him in all his operational actions with the IMFI

and the recipient.

The platform operator provides IT infrastructure to the investors.

For this services provided, the investor grant a% of the loan to the platform operator.

Between the platform and the IMFI

The platform provides it infrastructure to the IMFI so that they publish their clients micro projects.

The platform represents the IMFI in the transactions with the investors

The platform operator transfers money to the IMFI

For all these services provided, the IMFI pays some fees to the platform operator.

b) Mudharaba contracts

The money provider Rab Al Mal commit a Mudarib who is the entrepreneur to manage the business

Between the Investor and the IMFI

The investor commits IMFI to grant money to a selective project in accordance of some specific

criteria to be agreed together.

The selected criteria will lead to a selection of projects that can provide a profit of M

The IMFI will be committed to pay back Y% of N to the investor.

We can imagine that when the total budget of a specific project is not reached, a suggestion is maid

with the funder so that his money be affected to a similar project.

This rule will be specified in the contract.

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Between the IMFI and the Recipients

The recipient is committed by the IMFI to run the project in accordance to a binding specifications

and to make a profit for amount of M.

X % of M comes to the IMFI as his profit share : Mudharaba fee1 = N

When the financing target – money collection- is not reached, either the money is returned back to

the investor minus the Wakala fees or with the support of the IMFI it may be directed to another

project.

Possibility to offer profit and loss sharing contracts (compliant to Islamic law) to recipients.

The principle of profit and lost sharing

In order to make the loan Sharia compliant and back the compensation attractive to investors/ money

providers who are sensitive to Islamic ethics, the main objective is to suggest a non guaranteed

compensation, that will be based on the outcome of the IMFI recipients activities.

We will therefore target the money providers not as philanthropists but as investors in need of

Returns.

- If M is the profit earned by the recipient,

- The target rate of the income paid on the investment will be X% = N

- N is the profit to be shared by the IMFI and the investor

- Y% = P is the sharing part of that profit for the investor and the balance belongs to the IMFI (

1-Y%)x N

The state of the needs to develop such a model

The infrastructure : crowdfunding platform such as de www.babyloan.org

Potential investors data base

Strong marketing strategy with communication (community management, advertising …)

Wide partners network ( in marketing, IMFI, associations, institutional partners, states, local

councils…)

Trainings on Islamic micro finance and crowdfunding

Some Challenges to Overcome

- Regulation update in term of crowdfunding

- Regulation aspect of the model

- The sharing of profits and losses

- Supervisions, monitoring, reporting to manage with IMFI

- Legal structuring cost including Sharia Board cost ( in case of Mousharaka, they could be

additional cost)

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- Governance issue, transparency in under developed countries

- Basic training to recipients

III. How African migrants in Western countries can boost the environment of Islamic

microfinance

We can target 2 types of investors

A. The African Diaspora of the WAEMU, working in Western countries ( Europe, USA…)

According to Africa Union definition, african diaspora are considered as the sixth region of Africa.

For this category of potential investors, there is a need to participate to the development of their

countries.

According to Word Bank report « Migration and Remittances Facebook 2011 » money sent

by migrants in developing countries is estimated to USD

325 billion, including USD 56,9 billion sent in Africa and Middle East.

A recent study published by the Central Bank of West African States in WAEMU area show

that the Africans migrants of WAEMU remittances have been multiplied by 4 from 2000 to 2011.

The report also concludes that the remittances are higher than Development Aid.

This means that the Diasporas can contribute to the development of their countries if they are

more framed and some activities are organized to better master these crucial resources.

Figure 5: Remittances received in WAEMU countries

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The study reveals that almost 54.6% of the money sent by the migrants are used for

consumption goods and only 5.5% goes to investment.

One of the objectives of our suggestion is to redirect this source of funding in productive

investment.

B. Investors without any link with the project or the region

As a part of African Diaspora, some investors without any link with a country are just focused on the

type of the project and the ethical aspect of Islamic finance.

They are Muslims and non-Muslims who can be sensitive of the projects and contracts suggested by

the model.

A market study has to be realized and community management principles can lead to identify

this segment of investors.

A success of crowdfunding comes when the investors have a kind of emotional link with the

recipient.

With marketing, this link can be created between the recipients and those of investors who are

sensitive to the local development, to the ethical approach, to Muslim communities, to cities inter

cooperation…

Most of the African diaspora are involved in migrants associations, have social development

link with their resident countries and locals councils.

In France for example, the government grant fund to these migrants associations so that they

impact their countries.

This example can be generalized to attract other funds in reach muslims countries for the

development of Islamic micro fiancé in Africa.

IV. The Precious support of the IDB

As it is said in the web site of IDB:

“The purpose of the Bank is to foster the economic development and social progress of member

countries and Muslim communities individually as well as jointly in accordance with the principles of

Sharia”

IDB as one of its objective is to promote the Islamic finance activities overall the world, it’s technical

and financial assistance is needed in this field of micro finance.

.

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In conclusion, I’m convinced that the development of Islamic microfinance could help a lot of African

countries to strengthen their economic situation and thus reduce poverty.

The articles 4,6 and 60 in the law called Decentralized Financial Systèm have to be reviewed

so that to allow some alternative products and services to be provided by Decentralized Financial

systems (micro finance institutions).

Therefore, an appropriate regulatory framework is to be suggested to take in consideration

new approaches such as crowdfunding so that the industry catch additional money and reduce the cost

of funding.

An other potential player in this industry is african diasporas who have financial power to

participate in funding Islamic micro projects.

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Paper 8

Moral and Ethics in Islamic Microfinance and Its Impact on Bangladeshi Rural Poor’s Livelihood: An Empirical Study

M. Mizanur RahmanDirector Research, Islamic Bank Training and Research Academy, IBBL, Bangladesh, Curently working on deputation as Head of Training in Jaiz Bank Plc., Abuja, Nigeria.


1. Introduction

The charismatic words of Muhammad Yunus, pioneer of the Grameen is “that we can create a

poverty-free world, if we want to…in that kind of world, [the] only place you can see poverty is in the

museum.”

The Grameen Bank, founded in 1983, offered poor communities an alternative to the rich

moneylenders and traders that charged usurious interest rates. By achieving 98% repayment rates

from the very poor in Bangladesh Yunus showed the world that the poor are “bankable” and set a

trend in the international development community.

Based on his assumption the term microfinance is developed which refers to the provision of

financial services, most commonly microcredit, to poor individuals around the world with the primary

goal of poverty alleviation. The microcredit movement operates under the presumption that the poor

lack access to formal financial services and the current alternatives are loan sharks that charge

usurious rates. Two potential strategies by which MFIs alleviate poverty are financial inclusion and

the development of income-generating activities. The former strategy emphasizes the benefit to poor

people of having an alternative to the abusive moneylenders that charge exorbitant interest rates. The

latter strategy emphasizes generation of additional sources of income that permit individuals to

permanently escape the trap of poverty.

The Grameen Bank’s success in Bangladesh became the face of microfinance, and the Bank

served as a role model to other MFIs. Microcredit is now a well-established poverty alleviating

programme which is being implemented in many parts of the world to address different development

activities. This is especially so in Bangladesh the birthplace of the well-known initiative by Nobel

laureate Professor Rahman. Besides providing credit facilities, all such institutions also provide

training for skill development and self-employment of the poor.

But, unfortunately, all these institutions provide interest based credits and the rate of interest

is often exorbitantly high to commensurate with the risk in micro-finance lending. The interest rates

for institutional sources vary from 15-20%, while those for the non-institutional sources range from

33 to 120 per cent (Mahmood, 2006). Sometimes the interest rates of non-institutional sources may

even be 120-140%. Mahmood also mentioned that the poor do not have any surplus production hence

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accumulation of capital is very difficult and sometimes impossible for them. On the contrary, owing

to the absence of access to productive assets, lack of skills, low-level literacy, malnutrition and

absence of an organization of their own, the rural poor fall into the poverty trap (Jaim, 1986). Besides,

these microcredit institutions do not care about the ethical development of the rural poor to change

their behaviour consistent with a disciplined approach to economic activity. Business behaviour and

ethics are interrelated since the disciplined approach needed for good economic management is also

seen as founded in ethically consistent behaviour.

Considering the above mentioned factors, Islami Bank Bangladesh Limited (IBBL) launched the

Islamic microfinance program in the name of Rural Development Scheme (RDS) in 1995. This

scheme is completely interest free and the main objective of this scheme is to alleviate rural poverty

by providing Sariah based small capital micro investment finance to the agricultural and rural sector

for generating employment and raising income of the rural poor. The scheme also provides welfare,

moral and ethical services to the rural people of the country. Presently, the scheme is operating in

more than 13,000 villages in 60 districts. Some 0.67 million group members of around 22,206 centres

of the country covering 94% are females. As on 31st December 2012 the total ddisbursement is USD

618 million and the recovery rate is 99.58%

In the year 2007, a study was conducted to assess the impact of said microfinance scheme in and

found positive impact on income and livelihood of the rural poor’s of Bangladesh (Rahman, 2008,

2009). Based on that study findings some of the activities was revised and the scheme was further

expanded to the new areas. A further study was conducted to assess the impact on rural poor’s

livelihood especially the ethical and moral development of microfinance clients, which is one of the

major objectives of the scheme, and its impact on clients’ livelihood. It may be mentioned here that

although there are thousands of conventional microcredit programs are functioning in Bangladesh

with a view to alleviating poverty but the rural poor are still in the vicious circle of poverty and they

have little hope of getting out of poverty in the near future. Besides, none of them care about ethical

and moral development of the clients but IBBL micro-finance is giving especial emphasis to changing

behaviour, which aspect is its distinctive difference. Therefore, this study has especially assessed the

moral and ethical changes of the clients and its impact of on their income and livelihood.

2. Literature Review of Micro-finance Impact Studies

In Bangladesh, Islamic and conventional microfinance has a positive impact on rural poverty-as

shown by empirical studies which concluded that households’ income, wheat and cattle productivity,

and levels of expenditure and labour have all increased due to microloans programs, especially in

rural areas. The study concluded that the various loans program alone were not enough to alleviate

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poverty, unless they were in an environment with material and social capital sufficient to achieve the

goals of said programs (Rahman, 2005).

A 2007 survey by CGAP on Islamic microfinance revealed that total global coverage is only

an estimated 380,000 customers, which is half of one per cent of total microfinance coverage.

Furthermore, over 80 per cent of this small amount of borrowers is concentrated in Indonesia,

Bangladesh and Afghanistan. Although Muslim majority countries encompass approximately 44 per

cent of total conventional microfinance clients worldwide, the growth of Islamic microfinance has

been incredibly slow. In Bangladesh the largest MFI that provides Islamic products has a reach of

only 100,000 compared to the 22 million active borrowers reached by the MFIs Grameen Bank,

BRAC and ASA.

PKSF (2005) studied the impact of micro-credit on the members of partner organizations of

PKSF and found that absolute poverty was reduced by 9% during 1991 to 2000; moderate poverty

declined by 5% during 2000 to 2004. Chowdhury and Bhuiya (2004) examined the impact of credit

programme on the Bangladeshi borrowers under the BRAC projects and found positive impacts on

human well-being, survival rate and schooling of children. Amin, Rai and Ropa (2003) conducted a

study on the microcredit clients of Grameen Bank, BRAC and ASA. They observed that the micro-

credit programme was more successful to reach the poor, but less successful to reach the vulnerable

poor. Zaman (2001) assessed the impact of microcredit on poverty alleviation and women

empowerment. He found positive impact on income, decision making ability and in reducing gender

disparity.

Bangladesh Institute of Development Studies (BIDS) conducted impact study on the

microcredit borrowers under the partner organizations of PKSF. This study showed positive impact on

the income of microcredit participants in comparison to non-program participants (BIDS, 2001).

Khandker (2000) assessed the impact of microcredit on saving and found that microcredit increased

voluntary saving, which was more pronounced in the cases of women than men.

However, all of these studies simply assessed the impact of interest based microcredit

programmes which are interest based and which did not consider Sariah (Islamic rules and

regulations) related lending in investment. Islamizing the idea of conventional microcredit program

Islamic microfinance programs are functioning in different countries of the world. In the following

sub-section this study also reviewed the impact of some of the mentionable Islamic microfinance

programs functioning across the country.

Islamic Microfinance Overview

Islamic microfinance attempts to provide observant, poor Muslims with access to financial capital

through the use of tools from both microfinance and Islamic finance. The development of Islamic

microfinance has faced many obstacles and remains in its early stages; as a result, millions of poor

Muslims remain excluded from the financial sector.

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A review of recent studied on the impact of Microfinance on poverty shows that most

researchers agree that Islamic microfinance is highly effective in poverty alleviation. Most studies

contented that microfinance is an adequate instrument for preventing the spread of poverty at low

costs. This applies to countries of different development level like Turkey, India, Bangladesh and

Ethiopia and others. Microfinance provides the poor with self-employment opportunities and enables

them to overcome the obstacle of not owning any material assets that can be converted to banking

collaterals. Empirical studies present statistical evidence proving that these loans have led to an

increase in productivity in a number of countries and augmented the poor’s ability to achieve gains,

providing them with health care. These loans also had a great impact on the poor’s economic

independence. (Fadlallah, 2012)

In Pakistan, 86.8 per cent of surveyed people said that microloans were quite useful in

achieving prosperity and increasing the purchasing power of beneficiaries. A study in Islamic

microfinance in the Middle-east and North Africa found that this type of finance was the most able to

achieve social and economic development goals. In the Arab world, there are some successful

experiences such as: Jabal Al-Hoss Funds Project in Syria, Al-Hasida Project in Yemen, and Al-Qard

Al-Hassan Association in Lebanon. (Fadlallah, 2012)

The Iranian experience is considered pioneer in the field of Islamic Micro-finance that is

devoted to fund basic needs. Iran has nearly 3000 Qard Hasan funds in the urban and rural areas.

Islamic microloans are also popular in non-Islamic countries.

The lack of availability in Islamic microfinance products coincides with passionate demand

by individuals in Muslim majority countries. A 2006 study in Algeria revealed that 20.7 per cent of

microenterprise owners do not apply for loans primarily for religious reasons.27 Furthermore, a 2007

study shows that 60 per cent of low-income survey respondents in Palestine prefer Sharia-compliant

loans and products to conventional ones, and over half of these respondents claim they would even

pay a higher price for such products.28 The strong demand for Islamic microfinance products remains

unmet despite a vibrant conventional microfinance industry in those areas. The lack of growth of

Islamic MFIs, despite the strong demand reported, could be the result of an over-exaggerated demand

or a lack of supply, as discussed below.

Anecdotal evidence suggests that individuals may claim a preference for Sariah-compliant

loans when surveyed in an attempt to appear more pious. Alternatively, potential borrowers may have

a true desire to only use Sharia loans, but practical limitations, such as higher rates, may inhibit them

from selecting Islamic loans.

Notwithstanding likely exaggeration, however, the surveys referenced above indicate

potential for growth in the Islamic microfinance industry.

Another explanation for the slow growth is that Islamic microfinance is used as a general term, and

there is a lack of distinction between its financial products. Currently 70 per cent of Islamic

microfinance loans, an overwhelming majority, are Murabaha based.

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A study on Islamic microfinance in the Middle-east and North Africa found that this type of

finance was the most able to achieve social and economic development goals.

The Iranian experience is considered pioneer in the field of Islamic MF that is devoted to fund basic

needs. Iran has nearly 3000 Qard Hasan funds in the urban and rural areas.

Rahman (2008, 2009) conducted an empirical study on impact on Islamic microfinance and

found it had a positive impact on rural poverty alleviation especially on households’ income, crop

productivity, and level of expenditure and labour have all increased due to microloans programs,

especially rural areas. The study concluded that microfinance along cannot alleviate poverty, unless

they were government effort to develop infrastructure development and Zakat and Awqaf for touching

ultra-poor.

Literature review shows that the conventional microcredit does not care about ethics and

morality rather cares about poverty alleviation. While, Islamic microfinance care about ethical and

moral development of the clients but none of them assessed the ethical development of neither the

clients nor even its impact on poverty alleviation. Previous studies on the impact assessment of

microcredit programmes in Bangladesh have also been narrow in their focus. Therefore, unlike other

microcredit programmes, the main objective of this study was to examine the linkage between clients

moral and ethical behavioural changes as well as their income and demographic and investment

factors, using modern econometric techniques.

Another point is that the size of the rural households in Bangladesh is generally large and they

have a low level of literacy. Rural development is hampered due to lack of credits, lack of training,

weak infrastructure and poor transport systems. The weak resource base coupled with a faster growing

population is aggravating the poverty level of the country. This study will also determine if the above

factors which are most relevant in explaining poverty alleviation will have important implications for

refining micro-finance policy.

3. Theoretical Concept about the Role of Morality and Ethics in Islam

The term Islam is commonly defined as the full submission to God; therefore all actions can be

considered religious practices such that morality plays a central role in all actions of a Muslim,

including economic decisions. Perspectives on Morality and Human Well-Being by Syed Naqvi lists

five elements of Islam’s ethical system that he argues are universally believed by Muslims and

significantly influence their economic behaviour: (i) Islam is a complete way of life; (ii) Allah is

omnipresent; (iii) Allah owns all wealth; (iv) Individuals must be committed; and (v) the poor have a

right to the wealth of the rich.

With the support of the Qur’an and Hadith, these five principles are explained below.

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a. Islam is a complete way of life

The full submission to God required of all Muslims encompasses every component of an individual’s

life. Islam sets rules and expectations for a wide range of activities to guide this full submission.

Almost every action can be an act of worship if it carries the appropriate intention. The following

verse from the Qur’an demonstrates the holistic definition that is given to “righteousness”:

It is not righteousness that ye turn your faces Towards east or West; but it is righteousness to

believe in God and the Last Day, and the Angels, and the Book, and the Messengers; to spend of your

substance, out of love for Him, for your kin, for orphans, for the needy, for the wayfarer, for those

who ask, and for the ransom of slaves; to be steadfast in prayer, and practice regular charity; to fulfil

the contracts which ye have made; and to be firm and patient, in pain (or suffering) and adversity, and

throughout all periods of panic. Such are the people of truth, the God-fearing. [2:177]

The reference to turning to the East or West is for the physical act of prayer. This verse

reminds Muslims that worshipping God is not limited to religious activity in the narrow sense. There

is no “checklist” of actions that would ensure admittance to heaven for Muslims. God is believed to

be the most just of judges, and also the most merciful.

Muslims strive for a “righteous” character that demonstrates itself in all aspects of life.

b. Allah is omnipresent

Muslims believe that God knows every action, and every intention behind that action. The concept of

taqwa commonly translates to God-consciousness and involves the remembrance of God’s

overarching presence in the universe. The following two verses illustrate the omnipresence of God in

each individual’s life.

It was We Who created man, and We know what dark suggestions his soul makes to him: for

We are nearer to him than (his) jugular vein. [50:16]

He it is Who created the heavens and the earth in Six Days, and is moreover firmly

established on the Throne (of Authority). He knows what enters within the earth and what comes forth

out of it, what comes down from heaven and what mounts up to it. And He is with you whosesoever

ye may be. And Allah sees well all that ye do. [57:4]

The active presence of God in all aspects of a Muslim’s life has a clear effect on his/her

individual behaviours, both in public and in private, serving as an additional source of due diligence

in financial contracts.

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c. Allah owns all wealth

Man is an agent of God’s wealth during his time in this life; ultimately all wealth belongs to God, and

wealth serves as a test of character. It is clear in many verses that God is the creator of the universe

and all things will return to Him. The following verse directly poses the questions to Muslims:

And what causes have ye why ye should not spend in the cause of Allah? - For to Allah belongs the

heritage of the heavens and the earth. [57:10]

“The cause of Allah” is a common phrase in the Qur’an, and one interpretation of it is caring

for the poor in society. In the following phrase, it is commanded that a Muslim care for her/her

relatives (kindred), the needy, and travellers:

And render to the kindred their due rights, as (also) to those in want, and to the wayfarer: But

squander not (your wealth) in the manner of a spendthrift. Verily spendthrifts are brothers of the Evil

Ones; and the Evil One is to his Lord (himself) ungrateful. [17:26-27]

This verse also emphasizes the importance of not spending money wastefully. At the same

time, Islam strongly condemns the hoarding of wealth. This careful balance of saving and spending is

an important concept for any successful economic system. The verse below illustrates the serious

tones in which God condemns hoarding and announces a grave punishment for doing so.

And let not those who covetously withhold of the gifts which Allah Hath given them of His

Grace, think that it is good for them: Nay, it will be the worse for them: soon shall the things which

they covetously withheld be tied to their necks Like a twisted collar, on the Day of Judgment. To

Allah belongs the heritage of the heavens and the earth; and Allah is well-acquainted with all that ye

do. [3:180]

Wealth is considered the means to an end in Islam. Islam emphasizes the spending of wealth

in moderation, and the fact that all wealth belongs to God means that such wealth should be spent in

His cause.

d. Individuals must be committed

Islam rejects the concept of pure self-interest, and strongly promotes a commitment to the welfare of

others. An individual carries great responsibility for his/her community. While Islam does recognize

the inherent self-interest of man, it expects Muslims to overcome this and care for their community.

Islam places the responsibility of the community upon its very members. If an individual in a

community goes hungry, the blame is placed upon the community, and it is not the job of the

community to judge the worthiness of a poor person’s need. The Qur’an states that such actions will

directly affect an individual’s prosperity on the Day of Judgment, linking the giving of charity to

one’s own self-interest. The verse below promises a return for wealth given in the cause of God:

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Whatever of good ye give benefits your own souls, and ye shall only do so seeking the “Face”

of Allah. Whatever good ye give, shall be rendered back to you, and ye shall not Be dealt with

unjustly. [2:272].

Islam recognizes self-interest of all men. However, rather than selfishly loving worldly

possessions, Muslims should be willing to sacrifice things they love most for the hereafter. Through a

detachment from worldly possessions, an individual can truly share the things he/she loves most with

the community. The following verse illustrates the fact that Muslims are expected to give from that

which they love most:

By no means shall ye attain righteousness unless ye give (freely) of that which ye love; and whatever

ye give, of a truth Allah knoweth it well. [3:92]

The commitment to the well-being of society must play a central role in the life of a Muslim,

and this commitment requires that Muslims give freely and are detached from the material

possessions of this life.

e. The poor have a right to the wealth of the rich

The paying of zakat, or alms, is one of the five pillars of Islam, and continuously referenced in the

Qur’an and Hadith. Charity is not a gift, but instead a right of the poor:

And in their wealth and possessions (was remembered) the right of the (needy,) him who

asked, and him who (for some reason) was prevented (from asking). [51:19]

In this verse, the Qur’an references both the needy that ask, and the needy that do not ask.

Helping the latter group requires that Muslims play a proactive role in the aid of others. These five

moral principles operate in tandem to shape the economic life of Muslims and encourage the

advancement of a just economic system. The acceptance of these moral ethics is expected to advance

a Muslim society’s economic system. Today, no society unanimously embraces these principles;

however, that does not restrict an individual from pursuing them. Doing so does not require the

unanimous cooperation of an entire society, and the principles can be successfully implemented at the

individual or grassroots level. Muslims commonly believe that the economic ills in their society are a

result of the failure to embrace these principles. The five principles presented above describe the

moral responsibility of Muslims in a general framework, and the following section discusses other

concepts relevant to economics.

f. The Work of Ethics in Islam

“It is work that Islam sanctifies; making work the primary ground of possession and profit; and it does

not permit wealth to grow through idleness, nor will it allow wealth to beget wealth. Only effort can

beget wealth, otherwise wealth is unlawful.”

—Syed Qutb

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Both the Qur’an and the Hadith extol the work of an honest businessman. A society can be

neither productive nor successful if its citizens are idle. Islam thus promotes a strong work ethic

among its believers. Individuals are permitted to profit from their work, as long as the profits are

extracted in a just, transparent and honest manner. The Hadith below extols the role of an honest

businessman, raising him to the level of the most esteemed individuals in Islam:

A producer or a businessman whose behaviour complies with Islamic rules is said to be like

the prophets, martyrs, and the truthful friends of Allah (swt). He is ranked with the prophets because

he, like the prophets, follows the path of justice; like martyrs because they both fight with heavy odds

in the path of honesty and virtue; and like the truthful because both are steadfast in their resolves.

Islam forbids dishonest dealings in business. Profits are permitted, and work is strongly encouraged

when done in a lawful and honest manner. There are expectations for people when engaging in

commercial transactions and the Qur’an warns against any unjust behaviour in trade:

Give full measure when ye measure, and weigh with a balance that is straight: that is the most

fitting and the most advantageous in the final determination. [17:35]

Individuals are expected to deal justly in all matters, especially regarding trade. God’s omnipresence

serves as a constant reminder for Muslims to deal honestly in their trade.

g. Ethical finance underpinned in the monotheistic scriptures

Christianity:Being in debt is equivalent to servitude because of the immense burden to

repay. Hence, “The rich rule over the poor and the borrower is slave of the lender” (Proverbs

22:7).

Judaism: "The first question an individual is asked in the afterlife at the final judgment is:

“Did you conduct your business affairs honestly?” (Babylonian Talmud, Shabbos 31a).

h. Economic Concepts in Islam

Ibn al-Qayyim emphasizes the role of economic activity and its need to fulfil man’s needs and

requirements. He writes:

When it is preordained that grains will be obtained only after performing a certain chain of

activities, it means that the produce cannot be obtained without the sowing of the seeds and the

cultivation of the land. Likewise, quenching the thirst or satisfying the appetite depends on drinking

water or taking food. Neither of these objectives can be achieved without the specific action it

demands. The same is true of all affairs in this life and affairs pertaining to the life hereafter.

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4. Methodology and Data

A. Conceptual Framework

The microfinance has been recognized as a powerful and an effective tool for combating poverty, the

poor access to credit has been rapidly expanding over the past few decades in the area of hopeless and

helpless hunger society over the world (Bhuiyan, Siwar, Islam, and Rashid, 2012; Mirghani et al.,

2011).

An early study of Grameen Bank noted its support for the poor, to alleviate poverty especially

women, through empowerment and income generation and empowerment in social indicator

microfinance has been recognized as a powerful and effective tool for combating poverty, the poor

access to cred it has been rapidly expanding over the past few decades in the area of hopeless and

helpless hunger society over the world (Basher, 2010; Mohammad Hossain, 1988a; Kabir Hassan and

Tufte, 2001; Morduch, 1999; Schreiner, 1999).

In this study, it was observed that the beneficiaries are mainly rural poor having very limited

access to education and institutional credit and they also have low command over productive

resources Due to their inability to meet the collateral requirement, the rural poor cannot start up

productive activities even though they may have the adequate skills for pursuing income-generating

activities.

Because of their low level of income, they cannot even fulfil their consumption needs

properly and ultimately they have to lead a lower quality of life. In such circumstances, microcredit

programme may support the poor in reducing their poverty by creating both direct and indirect

benefits.

Under microcredit programmes, borrowers can take investment without providing collateral

from the microcredit providers. The amount of investment they receive from the providers increases

their financial ability to invest more into income generating activities. Microcredit programmes also

provides opportunity to generate employment for the poor in the locality.

By participating in income generating activities under microcredit, rural poor may have more

earnings from activities that directly add to their income. This increased income would ultimately

increase their purchasing ability. More purchasing ability would enable them to spend more on food,

thus, leading them to higher quality of living. The conceptual framework of microcredit in alleviating

poverty is shown in Figure 1.

Besides income, there are other factors which are related to well-being of the borrowers. It is

imperative to enhance human capital as it is deeply related to the well-being of the borrowers.

Therefore, the programme provides training and non-formal education to the borrowers, hoping that

training and education will enhance their level of skills in performing income-generating activities.

Therefore, borrowers’ age, education and experiences need to be considered carefully in choosing

participants because decision-making ability may largely be influenced by such factors. Factors like

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household’s asset will increase the ability of the borrowers to invest in income generating activities.

Household asset also helps in increasing income earnings for them. In addition, it is difficult for the

poor households to hire labour for operating income generating activities.

Thus, they largely depend on family labour for pursuing income-generating activities. Due to

the microcredit programme, they have the opportunity to utilize their manpower for productive

purposes. Inadequacy of rural infrastructure is one of the major obstacles for development of

Bangladesh. Rural poor have very limited access to infrastructural facility and this hampers their

economic activities. Initiative to establish rural infrastructures (such as rural markets, roads etc.)

under the microcredit programme may help them to accelerate their economic activity. Access to

infrastructure facility and its proper utilisation will increase the ability of rural poor in pursuing their

income generating activities (IGAs). Training and non-formal education of borrowers can enhance

their level of skills in performing income generating activities. Therefore, the RDS programme also

provides training and non-formal education to the clients.

Ethics and moral development is an important factor for developing human capital which is

deeply related to the well-being of the clients. As RDS investment is collateral free, therefore, clients

with good ethics and moral behaviour as determined by the field officer would indirectly act as

collateral to get their investment back and also to invest the borrowed money to the proper income

generating activities.

Bangladesh is the one of the most growing up developing countries as well as most density of

population in terms of the number of the population living and land area in the world (Bhuiyan, Siwar,

and Talib, 2012). Last three decades the Bangladesh economy could not able to achieve a rapid

macro-economic development and strong track record of tackling poverty due to Natural disasters as

like as floods, cyclone, river bank erosion and as well as the political unrest and misused or unused of

national resources the economic development of Bangladesh is not most remarkable but impressive

(Bhuiyan, Siwar, Islam, et al., 2012; Bhuiyan, Siwar, Ismail, and Talib, 2011a; Bhuiyan, Siwar,

andTalib, 2012).

In the above circumstances the microcredit came with the revolutionary approach by providing

the poor accessibility for the credit to increase their total family through different approaches of

Income Generating Activities (IGAs) and thus, sufficient income provides a hope to the poor to

ensure livelihood development by improving good health, access of children's education, achieved

skill, acquiring assets, take part social activities. After those achievements they acknowledge

themselves as important parts of family members that means other family members honour about their

opinion at the time of decision making. Furthermore, at the end above successive factors microcredit

borrowers able to ensure the opportunity of sustainable livelihood if all other livelihood assets remain

constant.

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B. Model Specification

Literature shows that different techniques such as Descriptive Analysis, Ordinary Least Square

(OLS), Weighted Least Square (WLS), Linear Programming (LP), and Simultaneous Equation

Systems (SES) had been used by researchers in order to estimate the effect of microcredit on the

various outcomes such as income, consumption and saving etc. Khandker (2000) estimated a

conditional demand equation to assess the effect of microcredit on the economic outcomes, such as

saving. The researcher used OLS estimation technique, using log in both sides, for this study which is

as follows:

Y=a0+❑i∑j=1

n

X ij+ Iij+❑ij

Where,I = amount of credit taken by the borrower,Y = household income,Xij = a vector of exogenous characteristics (such as age or education of household head)α, and unknown parameters, and❑ij error component in the equation.In this study, Ordinary Least Square (OLS) regression was used to assess the effect of microcredit on the dependent

C. Households Income Model

Y=a0+∑i=1

n

❑i X i+ I+µi

n = 1,……., 5

where,Y = amount change2 of annual income of the household,I = amount of investment taken by the borrowers in 2006,X1 = total land size,X2 = age of the borrowers dummy (above 40 years of age is 1 and 0 otherwise),X3 = education dummy (up to 5 years of schooling is 1 and 0 otherwise),X4 = number of family members engaged in income generating activities,X5 = ethics and moral of the clients,❑i and are the coefficients of the variables to be estimated, andα constant for the equation and µ error term for the equation.

D. Estimation of Well-being Based on the Clients’ Opinion

The Logit model was applied to find out the probability level that the clients would be well-off due to

the influence of particular explanatory variable. In the Logit model, dependent variable “clients’ well-

being” had two categories such as “borrowers were well-off” under the programme coded as one and

otherwise coded as zero.

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Researchers who had used the logit model to assess the effect of microcredit programmes on

loan utilization, awareness towards living-standard, and women empowerment had found positive

effects of microcredit (Begum, 1998; and Zaman, 2001). Different studies used different dichotomous

dependent variables in the logit model for example; Begum (1998) used awareness of the borrowers;

Zaman (2001) used women’s empowerment. In this study, the researcher used "borrowers’ well-

being" as the dependent variable which was divided into two categories: (i) borrowers were well-off,

and (ii) borrowers were not well-off.

ln [ P i

1−Pi ]=❑0+❑1 EDU+❑2 FMIG+❑3 DOM +❑4 SFE+❑5 EHC+❑6 EAMC+µ

where,Pi = probability that borrowers were well-off,1- Pi = probability that borrowers were not well-off,EDU = education dummy for the clients (up to 5 years of schooling is 1, 0 otherwise),FMIG= no of family members involved in income generating activities,DOM = duration of membership (Years),SFE = share of food expenditure to the total expenditure (%),EHC = expenditure on health care (taka),EAMC= ethics and moral4 of the clients. and❑0 = constant, ❑i = coefficient to be estimated and µ= error term.

E. Estimation of Ethical and Moral Change Based on the Clients’ Opinion

The Logit model was selected in this study to find out the probability level that the clients could be

better off due to the influence of particular explanatory variable. In the logit model, the dependent

variable (clients’ ethical and moral development) had two categories such as clients being “ethically

and morally become well-off” under the programme coded as one and otherwise coded as zero.

Specifically model can be written as:

ln [ P i

1−Pi ]=α0+❑1 EDU+❑2 AGE+❑3 DOM+µ

where,

Pi = probability that borrowers were well-off,1- Pi = probability that borrowers were not well-off,EDU = education dummy for the clients (up to 5 years of schooling is 1, 0 otherwise),DOM = duration of membership (Years),AGE= age of the borrowers dummy (above 40 years of age is 1 and 0 otherwise). and

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❑0 = constant, ❑i = coefficient to be estimated and µ= error term.

F. Estimation of Ethics and Moral of the Clients

Opinions were sought from the clients about their awareness and practice of 10 different religious

activities. Table 1 shows the different religious activities of the clients. A four-point Likert scale was

used to evaluate the borrowers, moral and ethical development i.e. each statement had four options,

which were regular, very often, very rare and not at all.

The points were summed up from each 10 statements and the total score obtained by each

borrower were divided by the highest score of seventy- five in order to create an index of acceptability

towards effectiveness of the microcredit programme. The borrowers who received scores less than

70% per cent were coded as zero otherwise coded as one. Borrowers performance was considered

satisfactory when they scored 70% or above. Therefore, in this study, borrowers’ moral and ethics

was evaluated based on the score of 70% or above. Mahmud (1999) created an acceptability index

towards effectiveness of ADIP programme and the borrower who received scores 70% or above was

coded as one to indicate that they were well-off under the ADIP’s microcredit programme, otherwise

coded as zero. Begum (1998) created an awareness index and the borrowers who received a score

50% was coded as one in order to indicate that awareness level increased toward their living-standard

otherwise coded as zero.

Logit model was chosen in this study to find out the probability level that the borrowers

would be morally and ethically well off due to the influence of particular explanatory variable. In the

logit model, dependent variable ‘clients moral and ethical development’ had two categories such as

‘clients morally and ethically well-off’ coded as one and otherwise coded as zero.

Table 1: Religious Activities Perform by the ClientsStatements Regular Very often Very rare Not at allScore (no.) 10 (0) 6 (4) 4 (6) 0 (10)Saying prayer 57 23 29 26Know how to recite Holy Quran 113 - - 32Reciting Holly Quran 31 47 39 28Fasting 109 21 17 08Inviting towards Islamic activities 48 29 37 31Involvement with dowry 11 - - 134Maintain Parda 57 33 30 25Involve with interest 31 23 19 72Misunderstanding with husband 21 19 07 98Involvement with social activities 03 49 51 42Note: Figures in the parentheses are the score for dowry, interest and misunderstanding with husband

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G. Justification of Retaining Variables in the StudyThe factors which are responsible for the impact of microcredit on the rural poor have been reviewed.

Girish and Mehta (2003) and Asanoy (2004) observed that age of the family head and family size

were an important factor for economic decision such as production and consumption. Latif (2002)

also observed that family size had influence on consumption and calorie intake of rural Bangladeshi

households. Shrestha and Shivakoti (2003) mentioned that family labour was one of the important

human capitals. Therefore, rural farmers are largely depended on their family labour for pursuing

economic activities. Khandker (2000) reported that microcredit programmes had increased

production, consumption, and employment opportunity and reduced informal borrowing among the

borrowers and it had also increased the ability of the poor borrowers to save regularly for building

financial and physical capital. Asanoy (2004) indicated that educated borrowers had higher level of

knowledge and skills as compared to less educated borrowers in case of performing their economic

activities.

Latif (2002) observed that the establishment of rural infrastructure had reduced production

cost, transportation cost and it had created easy access to markets for inputs and outputs. Shrestha and

Shivakoti (2003) mentioned that physical infrastructure facilities helped in distributing inputs and

output, adding value and enhancing production.

It is hypothesized that all of these variables would influence households’ livelihood,

therefore, age, education, family size, financial capital, savings and asset base has been considered in

this study as important factors of livelihood.

H. Sources of dataThe primary data were directly collected from the field in Early 2013, through interviewing 150

clients from some selected areas, namely Amin Bazar, Savar and Manikgonj. The impact of

investment on ethics and moral of the microfinance (RDS) clients were our major interest therefore

assessment was made comparing clients’ present position (31 December 2012) with their base

information (at the time of becoming member).

The study areas were purposively selected based on the convenience of researcher’s data

collection. From the clients lists of the study areas a second list was prepared from all three areas

consisting the clients having minimum membership. It was because it was assumed that without

having minimum five years involvement with microfinance activities impact assessment would not be

feasible. From the said lists 150 clients (50 from each area) were randomly selected.

The data were collected from the clients using a set of semi-structured pre-tested questionnaire

prepared for the purpose. A total of 3 enumerators (one for branch), have collected the data under the

supervision of the researcher. The data were coded and entered into the SPSS (Statistical Package for

Social Scientist).

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I. Analytical Frame Work

The major concern of this study was to assess the impact of Microfinance investment client. So,

comparison was made between the status at present (up to December 2012) and at joining (joining

time of the individual clients) on a cross sectional basis. In total 150 clients were interviewed. Five of

them were incomplete and hence were dropped from the analysis. The rest of the sample (145) were

analysed and the conventional tabular method was used in describing and comparing the performance

of the Microfinance clients. The responses were expressed in terms of percentage/frequencies.

Besides, in order to meet up the objectives the collected data were analysed economically, statistically

and econometrically.

4. Results and Discussion

The study was intended to explore the true picture of ethical and moral development of the clients’

livelihood and its impact on poverty alleviation through micro-investment of the Islamic Microfinance

Scheme of IBBL. The results are presented below:

A. Impact of Microfinance on Clients Religious Activities

In addition to the poverty alleviation the micro-investment program has taken initiative to increase the

clients’ awareness on religious activities. Therefore, in this study attempt was made to assess the

influence of microfinance on clients’ awareness on religious activities. Table 2 shows that a

significant number of clients (33%) have started praying after joining RDS programme. About 57

percentage clients have learned reciting Holly Quran after joining the Microfinance program. Besides,

a significant number of clients have started practicing some other religious activities like, reciting

Holly Quran, inviting others to follow Islamic activities and avoid taking interest.

Table 2: Microfinance Clients Religious ActivitiesIndicators At present At Joining Change Status

Frequency Frequency Frequency PercentageRegular prayer 57 38 19 33.34Know how to recite Holy Quran 113 49 64 56.64Reciting Holly Quran 31 19 12 38.71Fasting 109 56 53 48.62Inviting towards Islamic activities 48 29 19 39.58Involvement with dowry 11 11 0 0Maintain Parda 57 31 26 45.61Not Involve with interest 31 71 -40 -129.03Misunderstanding with husband 21 43 -22 -104.76Involvement with social activities 03 0 2 66.66

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B. Changes in Family Income

Effort was taken under this micro-investment programme to increase clients’ family income by

investing their borrowed money to different income generating activities. Table 3 shows that on

average clients’ income have increased by more than 32% from joining in the microfinance program

to until 2012. The highest income change (US$108/year) was observed for small business which was

followed by income from crops (US$82 /year). The service sector income has also significantly

increased but highest change was observed for small business which implied that clients preferred

investing money into the business sector.

Table 3: Income Generation of the Households by SourcesSource of Income Household income

(US$/year)Change of income Level of

significancePresent Joining US$ Per cent t-value Sig.

Off FarmSmall Business 496 388 108 27.83 4.150 0.000Labour Selling 212 182 30 16.48 3.210 0.003Service Income 228 153 75 49.02 6.502 0.000On FarmCrops 231 149 82 55.03 4.890 0.000Fruits 22 18 4 22.22 2.501 0.021Vegetables 47 39 8 20.51 2.242 0.012Livestock 51 42 9 21.42 20291 0.022Poultry 23 18 5 27.78 2.284 0.019Fish 31 23 8 34.78 3.571 0.004Others 210 145 65 44.83 5.432 0.000Total 1551 1157 394 31.99

C. Results of Ordinary Least Square (OLS) Estimation of the Model

One of the prime objectives of the study was to assess the factors influencing households’ income,

expenditures, well-being and ethical and morals of the clients. The Ordinary Least Square (OLS)

technique was used to estimate the model for assuming the effect of different factors of the model. If

the regression equation estimation of similar functions involves more variables, the model would have

suffered from low degrees of freedom and multicollinearity problems resulting in inefficient

estimates. Therefore, multicollinearity was tested and the outcome of some independent variables not

being significant could be the effect of multicollinearity. The regression model was re-estimated;

dropping some variables whose level of significance was very low. The results were significantly

improved and hence have been interpreted.

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D. OLS Results for the Household Income Model

It was expected that the amount of investment taken by the borrowers would increase their household

income. Therefore, this study examined the influence of micro-investment on the households’ income.

However, household income does not depend on only one factor like amount of investment. It also

depends on the other socioeconomic factors. That is why, variables like borrower’s age, borrower’s

educational background, involvement of family members in farming, total land size of the households,

distance to branch from the borrowers’ place and ethics and moral of the clients were considered as

independent variables.

Table 4 shows the results of OLS for the households’ income. As can be seen from the

statistics, the sign of all the variables are plausible but only four of them namely, borrowers’ age,

amount of investment taken by the borrowers, number of family members involved in earning and

clients’ ethics and morals had positive and significant influence on the household income. The value

of R-square was 0.612. It indicates that about 61% of the total variation of the dependent variable was

explained by the independent variables.

It was found that the amount of investment taken by the borrowers had a positive and

significant influence on the household income. This collateral free investment-money had increased

their opportunity to start up income generating activities. It had also increased their ability to invest

more on the existing economic activities resulting in more earnings from their investment. All these

reasons had assisted them in increasing their household income. Household income would increase by

1.01 point because of receiving additional one unit of investment by the borrower from the micro-

investment providers.

The study showed that the borrowers’ age variable was positively and significantly related

with household income. As age increases, borrowers acquire more experiences which would

ultimately assist them to increase their household income level. Many researchers used age as

independent variable in their regression analysis in order to assess its influence on borrowers saving,

agricultural production, household income and consumption (Khandker, 2000; Amin et al., 2003) and

found significant influence.

This study shows that the number of earning family members’ had positive and significant

influence on their households’ income. This result implied that higher the number of earning family

members, the higher the family income.

This expected result is also supported by Mahmood (2006). Education did not show any significant

influence on household income as there was small variation of education among the clients. Result

showed that more than 90% of the borrowers had schooling of less than five years. However, the

variable had a positive sign. This indicates that education might influence their income level but it

required more time and more educational facilities for the borrowers to realize the effect of education

on income.

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Finally, the ethics and morality variables, which were the main objective of the study, had

significantly positive contribution on household income. This result is not unlikely as it is assumed

that the clients who are bearing good moral and ethical characters are honest and sincere enough, so

they did not divert their borrowed money to any unproductive sector. Besides, they are sincere enough

in their activities and hence may have generated more income.

Table 4: OLS Results of Household Income ModelVariables Coefficient t-value Sig.Constant 3.189 23.314 0.000**Log of Investment taken in 2012 1.010 2.402 0.020**Log of total land size 0.121 0.518 0.693Log Number of earning family members 1.210 2.110 0.028**Borrower’s age dummy (above 40 years 0.322 2.726 0.019**Education dummy (up to 5 years schooling is 1 and 0 otherwise)

0.220 0.7183 0.470

Ethics and Moral (Dummy) 0.090 2.847 0.045*R-squared: 0.612Note: **Significant at 1% level, and *Significant at 5% level.

E. Results of the Logit Model for Clients’ Well Being

The Logit model was selected in this study to find out the probability level that the clients would be

well-off due to the influence of particular explanatory variable.

In the Logit model, dependent variable “clients’ well-being” had two categories such as

“borrowers were well-off” under the program coded as one otherwise coded as zero. The rural poor

had to lead a low quality of life. It is expected that the microfinance programme would bring a

positive change in the overall living-standard of the borrowers by improving their economic activities.

Therefore, an attempt was made to investigate the influence of socioeconomic variables on the

dependent variable "borrowers’ welfare". Based on the borrowers’ perceptions, the dependent variable

was coded as one if the borrowers had answered well-off under the micro-investment programme,

otherwise, it was coded as zero. The logit model was used in order to find out the probability level

that the borrowers would be well-off due to the influence of a particular independent variable.

Table 5 shows that the duration of microfinance clients membership, number of income

generating family members, share of food expenditure to total expenditure, households health

expenditure and clients ethics and morals had positive and significant contribution on clients well-

being.

Table 5 shows that the Wald statistic for the variable "expenditure on health" was 3.13 and it

was positively and significantly related to the dependent variable. This indicates that more

expenditure on health care would increase the likelihood for the borrowers to be well-off.

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Due to the low level of purchasing ability, borrowers had to maintain a low level of

expenditure indicating a lower quality of living. They had to struggle even to meet their expenditure

on food items. The microfinance programme takes the effort to increase borrowers’ ability to spend

more on food items for better living. Table 5 shows that wald statistic for the independent variable

"share of food expenditure to the total expenditure" was 4.946, and it was found significantly and

positively related with the dependent variable.

It may be mentioned here that ethics and moral had significantly positive contribution on

clients’ well-being. This result is not was likely as the clients bearing good moral and ethical

characters are honest enough so they did not divert their borrowed money to any unproductive sectors.

Besides, they are sincere enough to their activities hence were better-off.

Table 5: Logit Model Results of Clients Well-beingVariable (B) Standard

errorWalld Statistics

Sig. Odd ratioEXP (B)

Constant -0.756 0.723 1.432 0.251 0.343Duration of membership 0.242 0.071 14.44 0.000** 0.713Education dummy (up to 5 yrs of 0.020 0.251 0.211 0.986 0.987Income generating family members 0.211 0.067 13.59 0.00** 0.787Age of the clients dummy (up to 40yrs of age is 1 and 0 otherwise)

-0.070 0.656 0.012 0.906 0.931

Share of food expenditure to thetotal expenditure (%)

0.011 0.008 4.946 0.018 1.021

Health expenditure (taka) 0.018 0.021 3.131 0.051* 0.810Ethics and morals 0.154 0.213 3.416 0.050* 0.816Cox and Snell R square: 0.198-2log likelihood: 667.280Overall accuracy: 82.8Note: **Significant at 1% level and *significant at 5% level.

F. Results of the Logit Model for Assessing Clients Ethics and Moral

It is expected that Micro-finance program would bring a positive change in the ethical and moral

development of the clients. Therefore, an attempt was made to investigate the influence of

socioeconomic variables on the dependent variable "moral and ethical development".

Based on the borrowers’ perceptions, the dependent variable coded as one if the borrowers

were morally and ethically well-off under the micro-investment program and otherwise it was coded

as zero. The logit model was used in order to find out the probability level that the borrowers would

be morally and ethically well-off due to the influence of a particular independent variable.

Table 6 shows that the educational level, age and membership duration had positive and

significant contribution on clients’ ethics and moral development. This result implies that elderly and

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educated clients who have several years’ involvement with this microfinance programme have

ethically and morally been more developed than the young and illiterate new clients.

Table 6: Logit Models Results of Clients Ethics and MoralVariable (B) Standard

errorWalld Statistics

Sig. Odd ratioEXP (B)

Constant 1.21 0.451 6.110 0.014** 3.008Education dummy (up to 5 yrs of schooling is 1 and 0 otherwise

0.672 0.161 13.016 0.000** 0.511

Age of the clients dummy (up to 40yrs of age is 1 and 0 otherwise)

1.411 0.316 14.126 0.000** 0.243

Membership Duration (years) 0.112 0.032 11.021 0.003** 1.118Cox and Snell R square: 0.198-2log likelihood: 667.280Overall accuracy: 82.8

G. Clients’ Opinion towards Micro-investment Programmes

Clients’ opinion about the benefit of micro-investment programmes on their skill, social and

economic condition was assessed.

The clients opined that that micro-investment programme had brought positive changes in

their skill and socioeconomic status. It had also brought positive changes in self-confidence

development, economic solvency, communication skill, and knowledge on business and religion

practices are mentionable.

H. Major Problems and Suggestions Stated by the Clients

Like other credit programs, Islamic micro investment clients also face problems participating in the

microfinance program. Their problems are diverse in nature and vary depending on time, space,

socioeconomic aspects, and nature of the program. Success of the programs largely depends on

identifying and solving the problems on time. Therefore, in order to improve the operations of the

program, it is important to identify clearly the borrowers’ problems.

Islamic microfinance still has very small markets and still suffers sometimes from a decline in

demand, as Islamic financial products are still less flexible than the usury-based, than conventional

counterparts.

In most of the microfinance programs across the world use mostly Bai modes. This limited

approach to Islamic microfinance inhibits the industry’s ability to leverage Islam’s emphasis on

economic justice and discover innovative means that can achieve poverty alleviation. Paradoxically,

however, the prohibition of interest in Islam provides the microfinance industry with an opportunity

to experiment with the financial product offered to the poor to better meet the industry’s goal of

poverty alleviation, mainly through a new emphasis on profit-generating activities. Profit-loss sharing

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contracts provide an alternative to conventional microfinance and a more acceptable financial product

for conservative Muslims.

Assessing the social and development performance of Islamic microfinance is not possible

before the sector of Islamic microfinance reaches the maturity phase that it has not attained yet.

The positive relation between Islamic microfinance and poverty alleviation is often limited to the

benefiting categories and households without having considerable impact on the economy as a whole,

for the size of this finance has not exceeded 0.04 per cent of the total credits granted to the private

sector in the Arab countries in 2011, knowing that this percentage goes up to 0-05 per cent if the

balance of conventional microfinance is added.

Table 7 shows that majority (93.55%) of the borrowers had problems with investment size.

They mentioned that the amount of investment they had received from the micro-investment providers

was inadequate for them to pursue their income generating activities (IGAs) smoothly.

Lack of training facilities to upgrade their skills and technical and Islamic knowledge is also an

important problem mentioned by 82% clients. About 87% respondents mentioned that a delay in

receiving investment is also a problem which was followed by very short gestation period for

repaying investment.

Some respondents (91%) mentioned that sometimes they needed to start repaying their

borrowed money even before investing the money. Some clients (33.65 %) had to produce false

voucher which is a clear violation of Sariah.

Although small percentages of clients (30 %) mentioned that having no Islamic school under

this scheme, which can teach Islamic knowledge to their children, is a problem but to the researchers

it is a major issue. Because, in most of the study village, there is school operates by the conventional

micro-credit institution like, BRAC, where some of the educations contradict with the Islamic ethics.

This issue needs to be considered as it can cause severe ideological problem in the long run.

Lack of proper sanitation facilities, poor infrastructure, and power shortage absence of rural market is

also problem mentioned by the clients, which researchers also observed.

The most important issue, from the researcher’s point of view, is that this microfinance does

not touch ultra-poor. Rather it deals with the clients having certain level assets. Therefore, to alleviate

the poverty of ultra-poor an integrated approach, including zakat, awqaf and Government initiative

can truly alleviate the poverty of Bangladeshi rural poor.

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Table 7: Major Problems Clients’ Face in the Study AreasProblems Per centAmount of investment is very small 93.55Do not have any training programme 82.50Investment getting period is very long 87.29Gestation period for repaying investment is too short 91.50Insufficient time for meeting 49.55There is no place for organizing meeting 57.85Need to produce fake buying and selling voucher 29.52No Islamic school for their children 29.58Woman has no control on their borrowed money 19.55

5. Conclusion

Microcredit is now a well-established poverty alleviating programme which is being implemented

across the world. But, the conventional micro-credit institutions working in Bangladesh and some

other countries of the world provide interest based credit which is straightway a violation of Shariah.

These institutions also do not care about the ethical aspects of the rural poor, although it is obligatory,

not only in business sector but also in all aspects of life. Business and ethics should be interrelated.

However, the Islamic micro-investment programme, which objectives is to uplift the overall

socioeconomic plight of the rural poor, which, in this case, cares about developing ethics and morals

development of the clients as it can play a crucial role in alleviating poverty.

This assessment highlighted the achievement of ethics and morals of the clients and its

contribution on poor people’s livelihood and summary of the study findings along with the some

major policy implications are presented below:

Although, level of participation in religious activities by the clients has greatly been improved

after joining Islamic Micro-finance programme, there is still room to improve these activities,

especially knowledge about interest, its consequence, and how to get rid of it. Therefore, a

weekly meeting or frequent lectures may be organized regarding these issues, which can

assist building clients’ ethics and morality.

Results showed that most of the clients utilized their borrowed money but the reality is that

not all clients invested their borrowed money to income generating activities. Instead, some of

them utilised their investment in house repairing, children’s marriage ceremony and furniture

purchase etc. Therefore, proper monitoring and supervision should be done to develop their

morals and ethics so that they use their money in income generating activities.

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It was observed that some field supervisors do not properly practice the Murabaha mode;

which is a clear violation of Shariah so, necessary measures have to be taken to develop their

moral and ethics so that they do not violate Shariah.

Musharaka mode of investment may be practised with some selective good clients, even if in

some cases this mode does not bring any profit for the scheme so that the clients and person

concerned would find the difference between conventional (interest based) and Islamic

microfinance. Incorporating this mode along-with of Murabaha mode may reduce Shariah

violation. Besides, this Musharaka mode will make clients’ clearly understand the difference

between conventional and Islamic Microfinance.

Besides, some of the benevolent mechanism can also be practiced here which can bring

welfare for the clients, although Qard is practiced to provide sanitation and pure drinking

water to the clients but the areas and amount can be widen. In addition, to touch the ultra-poor

an integrated approach including zakat and awqaf is needed to alleviate ultra-poor.

Government efforts to develop infrastructure, supplying electricity can also contribute

alleviating ultra-poor’s’ poverty.

Poor borrowers are not aware of the modern technology. They depend much on the traditional

method of farming resulting in low production, which is a severe issue in the study areas.

Therefore, provision should be made to provide demand-led and effective training on

different aspects of on-farm and off-farm activities, credit management, environmental

pollution, nutrition, health care and ethical development.

It was observed that field supervisors are not well trained up and hence they found it difficult

to motivate the rural people toward Islamic Microfinance activities. Frequent training should

therefore, be organised for improving the field supervisors’ knowledge, skill, moral and

ethical values.

The number of microfinance clients is sharply increasing over the time, although the average

rate of dropout is also alarming. The reason for dropout is not yet known therefore, proper

selection of clients is very important and monitoring should be increased to reduce the rate of

dropout.

References

Amin S., Rai A.S. and Ropa G. (2003) Does microcredit reach the poor and vulnerable? Evidence from Northern Bangladesh. Journal of Development Economics, 70, 59-82.

Asanoy, A. (2004). Effects of agricultural credit and microfinance on expenditure patterns in Yemen (Unpublished doctoral dissertation). University Putra Malaysia, Selangor, Malaysia.

Bangladesh Institute of Development Studies (BIDS). (2001, October). Final Report on BIDS Study on PKSF’s Monitoring and Evaluation System (MES), Dhaka.

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Begum, R.A. (1998). A comparative study on the status of awareness and potential of credit receiver and credit non-receiver rural women in selected areas of Dinazpur district of Bangladesh (Unpublished master’ thesis). Agricultural University, Mymensingh, Bangladesh.

Bhuiyan, A. B., Chamhuri, S, Abdul, G. I., and Basri, T. (2011), “Islamic Microcredit is the Way of Alternative Approach for Eradicating Poverty in Bangladesh: A Review of Islami Bank Microcredit Scheme,” Australian Journal of Basic and Applied Sciences vol. 5, no 5: 221–230.

Bhuiyan, A. B., Abdul, G. I., and Mamunur, R. (2011). “Islamic microcredit in Bangladesh: performance analysis of rural development scheme (RDS) of Islami Bank Bangladesh Limited (1996–2009),” The Global Journal of Finance and Economics vol. 8, no. 1: 1–21.

Chowdhury, A. M. R., and Bhuiya, A. (2004). The wider impacts of BRAC poverty alleviation programme in Bangladesh. Journal of International Development 16(3), 369-386.

Girish, M., and Mehta, P. (2003). Crop diversification: An empirical analysis on Kangra farms of Himachal Pradesh, India. Asia-Paci c Journal of Rural Development, 13 (2).

Latif, M.A. (2002). Income, consumption and poverty impact of infrastructure development. The Quarterly Journal of the Bangladesh Institute of Development Studies, 28 (3), 1-36.

Mahmood, T. (2006). Effectiveness of microcredit for poverty alleviation under agricultural intensi cation projects in Bangladesh. (Unpublished doctoral dissertation). School of Graduate Studies, University Putra Malaysia, Malaysia.

Mahmud, K. T. (1999). Impact of credit on income and employment of women members of Savar Thana under world vision project (Unpulished master’s thesis). Bangabandhu Sheikh Mujibur Rahman Agricultural University, Gazipur, Bangladesh.

Mirghani, M., M. Mohammed, A.B. Bhuiyan and C. Siwar, (2011). Islamic microcredit and poverty alleviation in the Muslim World: Prospects and challenges. Australian Journal of Basic and Applied Sciences, 5(9): 620-626.

PKSF (2005). Follow up monitoring and evaluation system (MES). HB Consultant Limited.Rahman, M. Mizanur (2010). “Islamic Micro-finance Programme and its Impact on Rural Poverty

Alleviation,” International Journal of Banking and Finance vol. 7, no. 1: 119–138.Rahman, M. Mizanur., M. Jafrullah, and Anm Tawhidul Islam (2008). “Rural Development Scheme

of Islami Bank Bangladesh Limited (IBBL): Assessment and Challenges,” IIUM Journal of Economic and Management vol. 16, no. 2: 139–163.

Rahman, M., (2005). Microcredit in Poverty Eradication Achievement of MDGs”: Bangladesh Experience.

Shrestha, S. G. and Shivakoti, G. P. (2003). Prominent livelihood asset Pentagon within the analytical framework of irrigation system performance assessment. Asia-Pacific Journal of Rural Development, 13(1), 60-88.

Zaman, H. (2001). Assessing the poverty and vulnerability impact of micro-credit in Bangladesh: A case study of BRAC. (World Bank Policy Research Working Paper No-2445). Washington D.C.: World Bank.

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Paper 9

Issues in Regulating and Supervising Islamic Micro Finance Institution in Indonesia: Its Policy Direction and Remedies under the New Regime

Dr. Akhmad Affandi MahfudzVisiting Scholar

Islamic Business SchoolSchool of Business

Universiti Utara [email protected]

Abstract

Amid remarkable growth of Islamic micro finance industry (IMFI) in Indonesia, the vast compendium on regulation and supervision remain unresolved issues although their operation to be transferred to new government body, i.e., financial services authority (FSA) in 2015. This paper aims to unveil those issues whilst exploring some essential notes on better policy direction and remedies on existing problems since the operation of all Islamic financial institutions now under the auspices and responsibility of FSA. This paper found that in terms of regulation, IMFI has no specific and strong legal entities in its operation while government policy treated IMFI as the same with that of other financial institutions in deposit protection and capital adequacy. This paper also produced some essential notes on idiosyncratic strategies to wreak remarkable growth of IMFI in Indonesia whilst deliberately explores its policy direction.

1. Introduction

The emergence of Islamic micro finance in Indonesia is considered as an infant industry whilst its

existence undeniable to be considerable focus of interest for many Indonesians today since it is an

integral part of financial industry that can boost national economy particularly the economy of poor

and the poorest. The main function of this institution is to empower the life of destitute while

upgrading the economic wellbeing of low income families. The history of Islamic micro finance can

be traced through discovering the history of establishing Bank Rakyat Indonesia (BRI) who

proclaimed to be the largest bank of small and micro financing in the country. BRI is the first bank

operating in Indonesia and in fact the pioneer of Islamic micro finance and cooperative in the country.

BRI initially was established through a mosque-based association, which function was to manage and

disburse trusted fund to community of that mosque in a very simple scheme (Affandi, 2011).

It is no doubt that financial institutions are needed to support capitalization of the real sector

where IMFIs are involved. This function has long been experienced by Indonesia through the concept

of banking, either in the form of conventional (by capitalist and socialist) or the Islamic principle

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(Sunyikno, 2008). However, banks are technically found not connected its intermediary function to

the small micro businesses (SMEs) particularly among street traders1 who are in traditional markets

due to the limited types of businesses and assets owned by these traders. In fact, it is undeniable that

they are contributing much larger percentage of businesses in Indonesia and only IMFI can bridge

financial need of low income enterprises, i.e., street traders. Hence, if that capital not fulfilling the

demand of street traders to enhance their business capacity would result simultaneous loss and market

imbalances in the economy that will surely create a new havoc that can wreak unemployment in

Indonesia.

On the other hand, in the microfinance sector, there are actually individual activities of people

who have noticed it that they are providing the necessary capital for SMEs. These individuals are

often known in the public as loan sharks. It is no doubt that micro financial institution plays

significant role whilst boosting real sector as strong foundation that is proven to be resistant from

uncertain financial atmosphere. Indonesia with more than 220 million populations where majority of

them relying their survival on the micro small and medium enterprises recently encountering the

problem of capital injection from financial institutions. In addition, small and medium enterprises

(SME) sector played significant role in boosting Indonesian economy. According to the Bureau of

National Statistic, the number of SME in 2010 approaching 99,99% out of total 49.845 enterprises in

Indonesia where 97,3% of workforce absorbed by this sector. It is predicted that there will be swelling

number of SMEs in the years to come as the impact of global financial crisis in the early 2008 that

brought corporate sector in a declining scale (Asrin, 2008). Unfortunately, this magnitude potential

has not been captured a serious attention from financial institutions, banking and non-banking,

particularly in the field of capital. It is proved that the rapid growth of banking industry in Indonesia

hitherto not able to create strong banking industry after the financial crisis.2

On the other side,no government agency that is strong enough to take on broader policy scope

and focused for the benefit of the development of IMFI. State Ministry and department office possess

different capacity in their operation to produce law. That is why, the operation of IMFI undertaking

the regulation of cooperatives considered as an emergency action to be amended. This issue is in line

with the principle of Islamic jurisprudence “mâ lâ yudraku kulluh lâ yutraku kulluh”which means

anything that could not be fully obtained, not to be abandoned altogether.

Prior to the establishment of Financial Authority Services, over two decades of IMFI

operating in Indonesia, the regulation has been progressing quite fast and responsive. At the start of

recognition of Islamic banks operating in Law No. 10 of 1998 on banking, Bank Indonesia and then

being allowed to conduct monetary policy based on the Sharia Law No. 23 of 1999 concerning Bank

Indonesia until approved and the enactment of Law No. 21 of 2008 concerning Islamic Bank by

1 Street traders known in Indonesia as “Pedagang Kaki Lima (PKL)”, the traders who sell merchandise along the roads2 Financial crisis that occurred in 1997 whilst adopting dual monetary system

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Parliament. All the legal foundation also supported by a number of Bank Indonesia regulations related

to operations of Islamic banks such as Bank Indonesia Regulation (PBI) and Bank Indonesia Circular

Letter. All legal basis and regulations that have been issued by the government, Bank Indonesia, and

the House have supported the development of Islamic banks.

Indonesia's Islamic financial system was implemented in the early 1990s that started from

Islamic banking institutions and then followed by insurance, capital markets, pawn shops, and Islamic

finance. The Government supports the desire of Muslims to implement Islamic financial system by

making laws and implement policies related to Islamic financial institutions. However, such support

had not been optimum so that it needs to be improved, especially in terms of drafting legislation for

each type of Islamic financial services in accordance with Sharia and policies that wreak to growth

and development of Islamic financial services in Indonesia.

Meanwhile, the new regime of Islamic financial services started by establishing Financial

Services Authority (FSA), the Indonesian government agency that regulates and supervises the

financial services sector. With the Law No. 21 Year 2011 on the Financial Services Authority (FSA),

the regulatory and supervisory functions of all activities in the financial services sector is under the

authority of the Financial Services Authority where the main function of FSA is to promote and

organize a system of regulations and supervisions that is integrated into the overall activities in the

financial services sector. Effective as of 31 December 2013, the agreement has been made between

Bank Indonesia and the Financial Service Authority, where the duties on banking regulation and

supervision are to be transferred from Bank Indonesia to FSA.

Since the regulation and supervision of IMFI under FSA will commence in 2015, some

unresolved issues which are promptly to be considered by all parties particularly government

agencies. The attention of this matter must be preceded by political will of the government and

cooperation of all related parties since majority of Indonesian population are involved in micro

finance institution whilst relying their financial need on this institution to empower their economic

well-being.

This paper therefore attempts to unveil all issues related to IMFIs pertaining to its regulation,

supervision, policies and wreak an idiosyncratic strategies and remedies especially under new regime

of financial services authority that hitherto remain unresolved.

2. The Establishment of Financial Services Authority: New Regime of Regulation and

Supervision for IMFI

Reflecting on the experience of the financial crisis that occurred in 1997, the global financial crisis of

2008, and the Euro zone crisis that struck in 2010, the financial industry is predicted to experience a

very bad condition. Fiscal policy and monetary policies are needed to save the economy. Most

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http://en.wikipedia.org/wiki/Financial_sector

http://en.wikipedia.org/wiki/Financial_regulation

probably this would threaten the financial crisis in Indonesia. At the end of 2011, as efforts to reform

the financial sector, the government and the House of Representatives agreed to set up the Financial

Services Authority.

Then, on 22 November 2012, Law No. 21 of the Financial Services Authority inaugurated.

This so-called independent institutions have been functioning from December 31, 2012 and which

replaces the functions, duties and powers of regulation that has been conducted by the Ministry of

Finance through the Capital Market Supervisory Agency and Financial Institution. On 31 December

2013, the turn of the functions, duties and powers of regulation and banking supervision by Bank

Indonesia also has been transferred to the Financial Services Authority (Badroen, 2005). Financial

Services Authority incorporated in the Financial Sector Stability Coordination Forum (FSSCF)

together with the Ministry of Finance, the central bank and the Deposit Insurance Agency. FSSCF a

coordination protocol to maintain the stability of the financial system. FSSCF also has the authority to

make policies for the prevention or handling a crisis,”

FSA is an agency authority formed from the integration of two large institutions, namely the

Directorate of Banking Regulatory and Supervision of Bank Indonesia and Capital Market

Supervisory Agency and Financial Institution, Ministry of Finance. In addition to the constraints of

time lags, the effectiveness of institutions, and the scope of the work area, the FSA facing problems in

achieving optimum integration model for the role and interests of each tend to be different, ie,

between the prudential principles of banking and financial institutions as well as the openness of the

capital market.

Pertaining to IMFI under this new regime, IMFI do not yet have the level of self-regulation

legislation. Sudarsono (2007) states that the absence of independent law makes clear the agency

position is not so exposed to other problems that inhibit the growth of IMFI. The existence of FSA

laws can provide a legal loophole to give birth insistence of FSA regulation of Islamic finance

services to strengthen the presence and operation of the IMFI. Some essential notes on the FSA act

that require attention, especially related to the existence and sustainability of IMFI in Indonesia,

among others: (a) the financial services supervision function will switch from Ministry of

Cooperatives, Ministry of Finance and Bank Indonesia to Financial Services Authority, (b) Function

including licensing of establishment , and business activities of all Islamic financial institutions

including Islamic micro finance industry, and (c) investigation function of financial institution.

3. Issues in Regulatory Aspect of Islamic Micro Finance

In line with the growth of Islamic banks in Indonesia, followed by the development of other Islamic

financial institutions, Program linkage between Islamic banks and IMFI (IMFI) is among the policies

implemented by Bank Indonesia. These conditions provide a favorable situation for the growth of

IMFIs which are mostly operate under the cooperative legal entity.

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In terms of specific regulations for IMFI, it is the urgent need for the presence of legal and regulatory

framework that supports the growth and development of IMFI as an institution that focus on specific

access for the small micro-business practitioners. Furthermore, the existing law not sufficient to

undertake further practice of IMFI in years to come particularly to convert IMFI into credible

institutions like other financial institution such as a bank. In line with these phenomenon, there are a

few reasons that promptly to explain the weakness of the regulatory aspects in the development IMFI

in Indonesia, namely;

3.1. The Legal Framework of IMFI

Concerning the legal status, the main foundation for operation of IMFI is Islamic Cooperative

Financial Services based on regulation of Ministry of Cooperative 20043 on Islamic financial services

cooperatives possess legal status even though under new Decree but it is equal to the legal status of

cooperatives subject to the law No. 25 Year 1992 on Cooperatives. However, this legal status is not

sufficient and strong when compared to Law No. 10 Year 2004 on the Establishment of legislation,

the Decree of Ministry of Cooperative is no longer exists due to the change in the Constitution of

1945.

Meanwhile, the Law no. 25 of 1992 on Cooperatives is no longer relevant to anchor the law

since it does not accommodate the need of change in development of law. The existing Cooperative

Act does not incorporate the aspects of "shari'a" in its operation, accounting standard, performance

indicators and even fail to accommodate the development of regional autonomy. The regional

autonomy has broad authority for local governments to undertake such policy for the sake of local

development, particularly to foster efforts to boost local government revenue (Djumiarti, 2005).

The absence of legal protection in the form of an Act to specifically regulating microfinance

institutions both conventional and Islamic institutions has led to get less full attention from the

government. In practice, there is difference in operation for both cooperatives and IMFI. IMFI

regarded as a financial institution that collect funds from the public and distribute it to the people who

have a small business micro. Legal entities of cooperatives Islamic financial services is only used for

the legality alone but in substance majority of them do not practice as cooperative.

The function of IMFI has the same sharia principle with that of Islamic banks that correspond

to the regulation of Islamic Bank in Law No. 21 out of 2008. However, to some extent, IMFI differs

with that of cooperatives. Therefore, the regulation for both could not be treated the same. According

to PINBUK (Center for Incubating Small Business), in 2006 there are more than 3000 units and 1302

units of IMFI according to Ministry of Cooperatives that has been operating for a long time but have

not been accommodated in the existing regulation. Ministerial Decree on Islamic cooperative financial

service is not strong enough to acknowledge the position of IMFI.

3Kepmenegkop 91/Kep/M.KUKM/IX/2004

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The absence of law makes other aspects related to the development IMFI not been prepared

because it is not a priority. Cooperative legislation and related Ministerial Decision seem merely to

bind IMFI since it has been incorporated cooperative law, while many IMFI that have not been

incorporated or in the form of micro finance institutions such as the District Credit Institutions and

Development Financing Institutions Micro, Small and Medium Enterprises which is a microfinance

institution as developed by the banking system following the rural areas that extend credit to people

without collateral is not enclosed by this rule. In future there will be emerging microfinance

institutions in various forms. Framework of regional autonomy gives ample scope to support the

emergence of the microfinance institutions.

3.2. Government Policy

The absence of a government policy lead the institutions to have a duty to regulate IMFI in various

aspects just like Bank Indonesia in supervising and regulating the operations of commercial banks and

rural banks in Indonesia. The existence of IMFI is essential in order to provide rules for the operation

of technical standards of IMFI, its restructuring, risk management, rating agencies, IMFI financial

performance and of course IMFI sustainability. Today most of the roles performed by the Ministry of

Cooperatives and SMEs who have the technical functions for setting this field but still much more that

has not been done. Currently, Standard Operating Procedures, Standard Operations Management and

Standardization Agreement have been prepared. In addition, implementation of regulation and

supervision have not been consistently implemented as Bank Indonesia supervise Islamic Bank

including Islamic rural banks (Irawan, 2007).

3.3. Regulation Related to Customer’s Deposit

The lack of protection of deposits for customers in the form of deposit insurance agency for MFIs

need to be regulated. Cooperative Law No. 25 of 1992 on Cooperatives a Legal Entity, State Minister

of Cooperatives and SMEs No. 91/Kep/M.KUKM/IX/2004 on Implementation Guidelines

Cooperative Operations of Islamic Financial Services, and the Regulation of the Minister

Cooperatives and SMEs No. 10/Per/M.KUKM/VI/2006 on Technical Guidelines Program Financing

Productive Cooperatives and Micro Enterprises have set up several issues related to customer

protection from possible abuse by managers of IMFI. However, these provisions are still far from

enough when many customers are still reluctant to keep their funds in these micro institutions for fear

of risk liquidity. Not to mention that in practice it does not work effectively due to the Ministry of

Cooperatives not actively supervising and monitoring the activities of IMFI. As a result, the operation

of IMFI do not comply with cooperative principles and even utilize it as a protection of illegal

operation. There are even some cases regarding the lack of sanctions but did not get anything. IMFI

incorporated cooperative is supposed to obey the basic principles and provisions of the cooperative

operations and must also comply with sharia. IMFI as non-bank financial institutions still required to

115

maintain the principle of prudence in running operations but the existing system is not strong enough

to maintain this principle.

3.4. Capital Adequacy

Pertaining to the lack of access to capital Insurance Agency. Financing for MFIs , among others have

been regulated in the government regulation no 44 of 1997 concerning the Partnership, Cooperative

and SME PERMENEG No. 10/Per/M.KUKM/VI/2006 on Technical Guidelines Program Financing

Productive Cooperatives and Micro (P3KUM), SOE PERMENEG PER/MBU/2007 about Partnership

Program State Owned Enterprises with Small and Community Development Program. People

Business Credit (PBC) is a financing facility that can be accessed by SMEs and cooperatives

especially those who have a viable business (feasible) but not bankable. This business usually has

good business prospects but does not have adequate collateral.

The existence of Islamic micro finance institutions as a provider of funds for capital facilities

for SMEs is clearly undeniable. The absence of law constitutes the agency position not so exposed to

other problems that inhibit the growth of these institutions function for financing Small Micro

Business. The existence of this law should not be intended to strictly limit the operation but

implemented within the framework of legal safeguards for the existence of institutions and the

protection of those who use the services of the IMFI.

4. Policy Direction and Remedies under the New Regime

4.1. Policy Direction

Based on the various problems encountered by the IMFI, it can be formulated some policy direction

as follow:

a. Definition of independent legal entities for IMFI. This calls to increase public confidence in

investing money in IMFI because the guaranty is legally clear.

b. Establishment of IMFI as the main IMFI of all IMFI in Indonesia where the elements of

regulation should be inherent. In other words, there must be specific legislation for IMFI. The

main IMFI should be regarded as reference and the laws are decentralized through IMFI

center of each region, while the parent national IMFI serves as a general policy determination.

Thus will facilitate in setting policy and determining the potential for the development and

expansion of IMFI network throughout Indonesia.

c. Supervision of the IMFI conducted by an independent monitoring agency. The supervisory

board has the primary duty under the supervision of IMFI primarily related to the Islamic

system. The cornerstone of this work is based on a fatwa council of the National Sharia

Board. The main functions of the council include: as advisors and providers of advice or

116

fatwa to administrators and managers on matters related to the establishment of sharia as a

product, as a mediator between the IMFI and National Sharia Council, representing the

members of the Shariah supervision.

4.2. Strategies and Remedies towards Existing Problems

Taking into account the direction of policy development IMFI and problems facing by IMFI and in

order to achieve the desired strategies and remedies on the existing problem, this paper has produced

several notes as follow:

a. The need for a clear long term strategy for the development of both IMFI institutional

blueprint or architecture as a strategy that has been applied in the banking industry.

b. The law on Microfinance Institutions should be structured as an umbrella both for business

practitioners and providers of funds.

c. The government should have a database of Microfinance Institutions in Indonesia

d. Integration of social approach to business development and finance with charity

organizations for productive financing and risk management

e. Systematic mentoring through collaboration with various stakeholders such as universities to

conduct technical assistance, business assistance, marketing strategy, financial management

and spiritual enhancement for SMEs.

f. Improving the quality of human resources through appropriate education and training.

g. The existence of strategic knowledge in business. It is necessary to improve IMFI

professionalism in service.

h. Paradigmatic aspects of development, the necessary knowledge about aspects of Islamic

business

i. Expanding the network of cooperation among IMFI, Islamic rural banks and Islamic banks.

Horizontal network is a network among IMFI and vertical networks is between IMFI with

another larger institution. Networking is important because it allows IMFI obtain the

information needed, access to funds, as well as the transfer of knowledge and technology.

j. Intensive supervision, as this is very important as a means of control in the operational

implementation of IMFI. Intensive supervision is important to ensure that there are no

irregularities in the operation of IMFI.

k. Increase the number of IMFI to set it up in every village. This is because today, IMFI in

Indonesia are generally located in sub rural areas, such as districts and sub-districts.

l. The needs to be a joint evaluation in order to provide opportunities for IMFI to be

competitive. This evaluation can be done by establishing evaluation agencies IMFI or

certified institutions IMFI. It aims specifically to provide a report quarterly or annual

performance rating IMFI in Indonesia

117

5. Conclusion

There are many IMFI in Indonesia who encounters critical condition. It is due to various problem in

operation. Theoretically, IMFI existence is needed by the community, but in terms of its application is

deemed not able to function optimally. Human resources is largely owned by IMFI in Indonesia but

still low . This greatly affects the operations and competitiveness IMFI with other agencies working in

the same field. The lack of public confidence in the IMFI because the agency does not yet have a clear

legal basis. Besides, the doubts of the people to the products offered, as it is considered not in

accordance with Islamic principles. IMFI has been not able to address the real economic problems

facing society today.

The need for sharia-compliant product innovation offered to the public. Innovative product

development can be done through replication products that have proven successful. Orientation of

marketing strategies resulted in flaws IMFI efforts to promote products IMFI. In order to develop

IMFI, efforts to improve marketing techniques needs to be done, to introduce IMFI existence in the

midst of society. IMFI also need to grab the support from community and religious leaders in

disseminating the potential and the existence IMFI as financial institutions.

Islamic micro finance institution under the new regime characterized by some challenges,

problems and prospects. The most critical notes on regulation of IMFI that has no specific law

pertaining to the operation of IMFI. This lead to ambiguity of government and practitioners to expand

financial intermediaries to empower the economic well being of the poor. Although the operation of

IMFI will be under the auspices and responsibility of Financial Services Authority, the treatment of

IMFI should apply the same as other financial institution in all matters.

In terms of policy direction, this paper concludes that the establishment of main IMFI in

Indonesia is essential and urgent to oversee and monitor the performance of each IMFI just like the

bank. Supervision of the IMFI conducted by an independent monitoring agency and Fatwa. The

strategies adopted in order to reach policy direction whilst producing remedies towards existing

problem facing by IMFI has come up with an essential notes to be undertaken by related parties.

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120

Paper 10

AN ANALYSIS OF ISLAMIC MICROFINANCE INSTITUTION (IMFS) IN INDONESIA: REGULATION AND SUPERVISION PERSPECTIVE0

Yulizar D. SanregoFikih ApriadiMiftahussurur

Anita PriantinaRies Wulandari

Institute for Research and Community Empowerment (IRTI)Tazkia University, College of Islamic Economics

Jl. Ir. H. Djuanda, Sentul CityBogor – Indonesia

www.lppm.tazkia.ac.id

AbstractObjective - The purpose of this study is to obtain ideas about the concept of regulation and supervision for Islamic Microfinance (IMFS) industry.Design/Methodology - The method used is the analytic network process (ANP). This method begins with the problem decomposition through the study of literature and in-depth interview to IMFS practitioners and experts, followed by filling the questionnaire. The data will than running by Super Decision software resulting priorities with a particular rater agreement. The results are then analyzed and described which will be taken into consideration in formulating policy.Result – The overall results showed that the solution to IMFS regulation and its supervision model are ranging from the most important issue; the establishment of operation standards, the establishment of competition restriction regulation and the establishment of supporting regulation.

Keywords: Islamic Microfinance Institution (IMFS), Analytic Networking Process (ANP)

0 This research is sponsored by Division of Non-Bank Financial Industry (IKNB) – Financial Services Authority (FSA), Republic of Indonesia.

121

http://www.lppm.tazkia.ac.id/

I. Background

Non-Bank Financial Industry (IKNB) began to be demanded bythe public for investment

purposes. The evident could be seen from its high growth within the last decade. Based on Financial

Services Authority (FSA) data, during the first semester of 2013 Sharia Non-Bank Financial Industry

in the aggregate showed a positive development (FSA, 2013). Total assets Sharia IKNB increased

from Rp35, 8 trillion in the second half of 2012 to Rp42, 61 trillion in the first half of 2013.0

However, the market share of sharia is still far less than the total assets of IKNB Rp1.233, 63 trillion

that is 3.3%. It shows the market share of sharia IKNB still far less than the potential market that

could be working on. However, when it is compared with other countries in Asia, IKNB penetration

in Indonesia is still lagging behind the economic growth (FSA Consumer Education, 2013).

One of the IKNB sectors that showed a significant growth is Islamic Microfinance Institutions

(IMFS). The important role of IMFS is also prominent in the several views in some forums. LKMS

requested more act as intermediaries between banks and the public, for example Islamic Cooperative

Financial Services and BMT (Nugroho, 2012). In the D-8 Islamic Microfinance Workshop, in 2011,

assessed the role LKMS also still experiencing problems because of the concept and practice of

Islamic microfinance is still searching for the ideal shape to find the optimum result for the sake of

poverty alleviation and economic development (Alamsyah, H, 2011).

Given the strategic role of IMFS in the lack of its support situation, the study aims to identify

challenges in the development of IMFS in Indonesia. The development approach of IMFS can use

both demand and supply side. The challenge faced by regulators or the government as the parties who

have authority and power to formulate laws or regulations is a problem on the supply side. While the

challenges faced by the industry as the party requiring IMFS laws or regulations related to a problem

from the demand side.

In-depth study of the issues on the both two sides can then be used to formulate an appropriate

regulation and supervision model. The results of the study will be used as a reference in the

formulation of IMFS regulations and supervision development in 2014.

II. Methodology

In order to support the results of the study can be justified scientifically; all the activities of

this research will be undertaken within the framework of Analytic Network Process (ANP)

methodology. ANP is a new qualitative method approach, which is non-parametric and non-

Bayesian, to a decision-making process that provides a general framework in treating decisions

without making assumptions about the independence of the elements at a higher level than the

elements on the lower level and on the independence of the elements in a level (Ascarya, 2005).

0 Quarterly Report II 2013, www.ojk.go.id

122

http://www.ojk.go.id/

This method begins with the problem decomposition through literature study and in-depth

interview to some IMFS practitioners and experts by filling the questionnaire. The data will then be

running using Super Decision software in order to have priority scale with a particular rater

agreement. The results are then analyzed accordingly as a consideration for policy formulation.

Respondents were selected from IMFS experts and practitioners in Indonesia, which consist of 5

experts and 5 practitioners. ANP does not require the number of respondents. The most emphasized is

that the respondent must master in the field being studied.

123

DEVELOPMENT POLICY OF IMFS

Solution

Establishment of Competition Restriction Regulation

Establishment of Supporting Regulation

Establishment of Operation Standard

Operation Assistance

Financing Analisys and Risk Management Risk

Customer Companion and Capacity Building

Sharia Compliance Standard

Problem

Regulation of Competition Restriction

Supporting Regulation

Operation Standar Operation Assistance

Deposit Guarantee

Credit Guarantee

IMFS Healthy

Financing Ceiling

Customers’ Turnover

Service Coverage

Financial Assistance

IT Development Assistance

Management Capacity Building & HR Development

Figure 3.1. Conceptual Framework

124

III. The Result of Problem Decomposition

From literature study and some of the views that have been collected from practitioners and

academics through in-depth interviewsat the beginning of the study (preliminiery research), there are

some IMFS problems development of the regulations and institutions that can be seen in the above

conceptual framework (Figure 3.1).

The Result of Priority Scale and Rater Agreement

In the subsequent discussion will be presented some priority graphs and figures. There are

two scales that will be used, there are priority scale and deal scale. Priority scale is a scale that shows

how important an issue compared to other issues. The higher the priority number, the higher important

problem needs to be solved. In general, there is no specific standard numbers to see a significant

problem or not. However, particular issue could be considered important that needs to be resolved if

this particular issue gets the highest number compared to the other priority issues. The agreement

scale among rater agreement which symbolized by the letter W (W value) is the level of agreement

value among respondents in assessing the problem. For the criteria level of agreement value is as in

the following table.

Table 3.1 Rater Agreement Criteria

No W Value Rater Agreement1 0,063 Very Low2 0,118 Low3 0,235 Medium4 0,578 High5 1,000 Very High

Develop from Saaty, 2006

For more details, the following describes how the views of each party as well as its

comparison, both the views of experts and practitioners on the subject of the development of Islamic

microfinance institutions.

125

Figure 4.1. The Regulation of Competition Restriction

p1 p2 p3 p4 p5 a1 a2 a3 a4 a50

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

omsetplafonS-coveage

The priority values from practitioners’ side indicate that regulatory restrictions on competition

in the form of financing ceiling become the first priority with the priority value of 0.38 followed by s-

coverage with 0:34 and turn over of 0.28. This is because the regulation of competition is very

important so that the bank should not have to provide financing ceiling up to two million dollars

below. The government must have long term vision; build a strong economic foundation and support

IMFS which is owned by its own citizen. This mind set should be clearly understood. Foreign

microfinance institutions only pursue their own targets, bad credit, and guarantees execution resulting

in death of SMEs.0

While different views addressed by academicians. They declared that it is the turn over that

should be take priority into account in the regulation restriction of competition with the priority value

of 0.47, followed by ceiling finance of 0.39 and the last s-coverage with 0.24. Rater agreement value

among academicians is as high as 0.73. This indicates that there is an agreement of the scholars

regarding the determination of the priorities that have been mentioned above.

The overall calculation/result between practitioners and academicians indicate that the

restriction competition through the ceiling of funding is a top priority with its priority value of 0.39,

followed by restriction of competition through turnover with 0.37 and the last restriction of

competition is through the S-coverage 0.24. While the overall rater agreement of respondents both

academicians and practitioners is very low at 0.053. This number indicates the diversity views of the

respondents.

Regulatory on competition restrictions in the form of ceiling financing means that there

should be clear limits on competition between financial institutions to finance their potential

customers. Each type of the existing financial institutions must have clear boundaries that limit how

much should be given to each customer. If there is no clear limit on the ceiling financing of all

0 In line with what has been opined by Abdullah Yazid inindepth interview on Wednesday, 06 November 2013 at 12.15-13.15pm.

126

financial institutions (either in the form of bank, rural bank, cooperative, microfinance institution,

etc), they will go into all level of people and compete in an uncontrolled manner. This situation would

be very detrimental to relatively small financial institutions such as IMFS.0These findings are in line

with what has been produced by Jansson et . al (2004 ) in his research that shows that there are four

types of financial institutions that compete in the microfinance market ; 1 ) commercial banks and

non-bank financial institutions that provide microfinance services; 2 ) commercial banks and non-

bank financial institutions that specialized only provide microfinance services ; 3 ) cooperatives , and

4 ) BMT .

Similar results are also shown in the research of Masyita and Ahmed (2011) which states that

BMT (IMFS) faced unbalanced level of competition, whereby each of the institutions, especially

commercial banks, have much larger business scale so that their cost of funds arevery small. One of

the main obstacles faced by the managers in developing BMT is a matter of competition (Sakti, 2013).

BMT-performance among banking business competition is one of the factors that influence the

professionalism of BMT practitioners (Karsidi et al, 2011). It means that in general could be seen that

there has been unfairness competition within the IMFS operational so far. Therefore it’s urged to have

a strict regulations that govern the competition among the existing financial institutions.

Figure 4.2. Supporting Regulation

p1 p2 p3 p4 p5 a1 a2 a3 a4 a50

0.1

0.2

0.3

0.4

0.5

0.6

0.7

regulasi kesehatanregulasi penjamin kreditregulasi penjamin simpanan

The most important aspect that needs attention is the problem aspect with lack of regulation

regarding IMFS health assessment. Both views of experts/academicians and practitioners give the

highest priority to this problem.

The average priority value of practitioners indicates that support regulation in the form of

health assessment become the top priority with its priority value of 0.39. The second priority within

0In line with what has been opined by Aslihan (secretary general of PINBUK) in indepth-interview on Monday 3 November 2013 at 13.15 – 16.20pm.

127

support regulation is deposit guarantee with its priority value 0.32. The final priority is credit

guarantee with 0.29. With this close priority value, it is indicates that the three priorities within the

cluster of support regulation is not much different or relatively the same. However, rater agreement of

practitioners is high at 0.25. This value indicates that there exist agreements among the practitioners

about the issues that have been mentioned. In fact the health assessment for IMFS under cooperative

is already there, but the implementation remains constraint. The constraint is actually health in Islamic

perspective which is not well accommodated.0

The academician average priority value is slightly different with practitioners, where support

regulation in the form of health assessments primarily to be a top priority with its value of 0.5. The

second priority is deposit guarantee regulations with its priority value of 0.27 and finally credit

guarantee regulation priority value of 0.23. However, rater agreement among academicians is high at

0.31. This indicates that there exist an agreement among academicianss on issues that have been

mentioned.

The overall results show not much different between the sides of views. Support regulation in

the form of health assessment is at the top priority with priority value of 0.45. The second level of

priority is deposit guarantee regulations with its priority value of 0.29 and last but not least is credit

gguarantee regulation with priority value of 0.26. Total rater agreement is at the medium level with

0.12. This shows the diversity views of the respondents.

Health regulation in the context of developing IMFS is the existence legislation that mandated

the establishment of a special agency or entity that independently and continuously assessing and

overseeing the health of IMFS across Indonesia. This regulation must exist and be implemented

immediately to ensure IMFS able to walk with an adequate level of security. The health of IMFS

could become be the key that will make society more confident when interacting with IMFS. IMFS

health regulations will also be able to ensure or at least minimize business risk. Third party funds are

also becoming safer since IMFS considered as a healthy body with minimum standard that has been

standardized by the regulator.0

Meanwhile with regard to the supervision issue in order to ensure the healthy of IMFS and its

competitives in the future, it is best to be submitted to an independent and professional body which

can be established either by Ministry of Cooperative or Financial Services Authority (FSA).0 Similar

views were also expressed by other practitioners that in order to create professional IMFS and not

detrimental to the public, IMFS health supervision problem should be left entirely to the authorities so

0 In line with what has been opined by Abdullah Yazid inindepth interview on Wednesday 06 November 2013 at 12.15-13.15pm.

0In line with what has been opined byAsadullah and Mulyadih (Chairman and Deputy Chairman of Peramu Foundation that specifically work on incubation and development of BMT) in indepth-interview on friday 08 November 2013 at 13.00 – 16.15pm.

0In line with what has been opined by Saat Suharto in indepth-interview (Chairman of BMT Association) on Wednesday 5 November 2013 at 09.00am – 14.12pm.

128

as to create a fair and good climate of competition. With one roof supervision, it will create a healthy

and strong IMFS.0

Further supporting regulation is related to deposit guarantee and financing in IMFS. For these

particular purposes, there should be a formulation of fixed rule regarding the establishment of deposit

guarantee agency that ensures all customer deposits at IMFS and also ensure the financing which

channeled by IMFS to the public.

The emergence of new rules and regulations will support the development of IMFS in the

future; the new regulations that particularly related to how IMFS will guarantee the provision of

customers as what has been implemented in insurance as well as banking industry. Thus with

comprehensive instrument support, IMFS will participate and contribute Indonesia economic

development in the future. These results reinforce what is inferred by Soetrisno (2005) that the

existence of institutional guarantee that guarantee IMFS credit or financing is badly needed to

increase the range of IMFS services extensively. Kusmuljono (2009) also suggested to have Bank

Apex as a patron of the entire microfinance institutions.

In fact there is an optimism, particularly from the practitioners, that if the IMFS supporting

institutions/instruments are existed and well implemented as what has been experienced by banking

industry, it is no longer for IMFS to require regulation that subject to competition restriction with

other financial institutions. The reason is that, if there is no problem in security deposit and its

financing, IMFS has another advantage compared to banks. IMFS have better human resources that

very much understand conditions and character of the micro community spread over the territory of

Indonesia.0

However, the real practices show that the expected supporting institutions/instruments by

IMFS industries and managers are lack behind. According to practitioners, this condition is caused by

miss management and the ego of each department within the ministry level who feel more entitled to

take care of IMFS. Other practitioners further explained that the problem is more acute sincethe

financial roadmap and who will be responsible is not clear. The current situation is a logical

consequence of those obscurity.0

Referring to the above discussion, it can be concluded also that IMFS practitioners/experts

expect the regulations/legislationsthat govern specifically IMFS in order to support its future

development. These findings correspond to what has been observed previously by Seibel and Agung

(2008) which revealed that IMFS requires effective regulation and supervision. To avoid a loss to the

community as customers, there should only healthy IMFS and properly supervised that are allowed to

0Sesuai dengan hasil indepth-interview dengan Iwan Setiwan (Ketua Microfin BMT) yang dilakukan pada hari Ahad tanggal 10 November 2013 pada pukul 10.46 – 12.15 di Bogor.


0In line with what has been opined by Saat Suharto (ketua Perhimpunan BMT) in indepth-interview on Wednesday 05 November 2013 at 09.00am – 14.12pm.

129

raise funds from non-members. Similar results were presented by Hascaryani et al., (2011) that the

absence of a funds guarantee system has been an obstacle for BMT to optimize fund raising.

Figure 4.3. Operation Standard

p1 p2 p3 p4 p5 a1 a2 a3 a4 a50

0.1

0.2

0.3

0.4

0.5

0.6

0.7

standar analisa pembiayaan dan manajemen risikostandar kepatuhan syaiahstandar pembinaan dan pendampingan

The graphic above denotes that there exist similarity priority value between practitioners and

academicians in which the absence of standards sharia compliance issues becomes the most priority

among others. The second priority of the issues is lack of standard financial analysis and risk

management and final priority is the absence of mentoring and coaching standard.

The average priority value of practitioners indicate that the absence of sharia compliance is

the top priority with its priority value 0.41 . The second priority of the issues is lack of standard

financial analysis and risk management with its priority value 0.33. The last priority is no standard

mentoring and coaching with its priority value 0.26. However, rater agreement of practitioners is at a

low level with 0.09. This number indicates various views among practitioners about the issues that

have been mentioned . Sharia deviations in Islamic financial institutions including MFIS have been

quite remarkable. Sharia is only used as a “mask" to exploit customers by using jargon that is not

relevant such as "going in heaven should not be paid by cheap price" or " for the sake of Islam we

should be willing to pay in whatever price". It is a mere camouflage to cover the capitalist motives

under the guise of sharia.0 In this case there should be a sharia compliance standards, with gradually

0 In line with what has been opined byDian Masyita in in-depth interview on Monday, 11 November 2013 at 14.00 – 15.05pm.

130

implemented since most IMFS not have a deep understanding of sharia nature and its practices in

microfinance institutions.0

Compare to practitioners, the average priority value of academicians is slightly different,

where the absence of sharia compliance is the top priority with its priority value 0.37. The second

priority with slightly different is a problem that there are no financial analysis and risk management

standard with its priority value 0.36 and the last is the lack of mentoring and coaching standards with

its priority value 0.27. Those priority values with a small different indicates that the priority level of

the three operational standards are not much different or relatively the same. However, rater

agreement among academicians is high at 0.60. This figure indicates that there exist a consensus

among academicians on this particular issue.

The overall results show not much different. The absence of sharia compliance standards

becomes top priority with its priority value of 0.39. The second priority with slightly different is a

problem that there are no financial analysis and risk management standard with its priority value 0.35

and the final priority is credit guarantee regulation with its priority value 0.26. However, the total rater

agreement is at very low level with 0.12. This value shows the diversity of the views of the

respondents.

The problem of IMFS operational standardization is a classic problem due to the related

parties feels not responsible to provide such standards that actually mandatory. It is a sour fruit from

the obscurity of IMFS regulators as an organizers and due to mis-management so far.0

In terms of IMFS operational standardization, the first rule that should become the next

priority for Regulator is sharia compliance standards. Furthermore, the constraint violations of sharia

rules that has been happening in the real practices is because of lack knowledge and understanding of

IMFS managers. Though Shariah compliance is something that is absolute and can not be negotiable

in running IMFS.0

The above discussion is consistent with the research done by Kholim (2004) which revealed

the one that hamper the operations of IMFS is lacking understand of Islamic economic and concepts

and Islamic finance. Karsidi et al (2011) also found that there are practitioners who have not mastered

the concept of the Islamic finance well. Even Masyita (2013) claimed that on behalfof sharia, many

Islamic financial institutions including IMFS “exploitate”their clients.

Reinforcing the importance of this sharia compliance standards from the above discussion,

can be concluded that adherence to sharia is the IMFS existence spirit in Indonesia. Thus, the

0 In line with what has been opined byAbdullah yazid in in-depth interview on Wednesday, 06 November 2013 at 12.15-13.15pm.

0 In line with what has been opined by Iwan Setiawan in indepth-interview (Head of Microfin BMT) on Sunday, 10 November 2013 at 10.46am – 12.15pm. The opinion also in line with what has been addressed by Saat Suharto in indepth-interview (Head of BMT Association) on Wednesday, 5 November 2013 at 09.00am – 14.12pm.

0In line with what has been opined by Aslihan (Head of PINBUK)in in-depth interview on Monday, 3 November 2013 at 13.15pm – 16.20pm.

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regulation of sharia compliance standards should be devised and defined by the FSA together with the

National Sharia Board (DSN). This element is a special feature for MFI.0 In fact the lack of sharia

compliance standard rules agreed by LKMS is clear evidence of bias and lack of concern for the

government. It was started with the vagueness of financial institutions road map in Indonesia.0

On the other hand some have concluded that non-sharia compliance of IMFS is issues at the

regulator policy level, while the fact that a more prominent issue in the field is operation problems not

sharia compliance. This may be due to the lack of knowledge of the public or customers themselves to

the implementation of sharia concepts in finance even though sharia is the main reason of customers

to come and to have financial services from IMFS.0

Figure. 4.4. Operation Assistance

p1 p2 p3 p4 p5 a1 a2 a3 a4 a50

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

ITpermodalanSdm

From the data presented in the graph above, it can be said that the most important aspect that

needs attention is the lack of support to enhance and to empower the capacity of human

resources.Both view either experts and practitioners give the highest priority to the problems of lack

of human resources assistance empowerment.

The average priority value of practitioners indicates the problem the lack of support to

enhance and to empower the capacity of human resources is in the top priority with its priority value

0.46. The second priority is the lack of assistance in Information Technology (IT) with its priority

0In line with what has been opined by Iwan Setiawan in indepth-interview (Head of Microfin BMT) on Sunday, 10 November 2013 at 10.46am – 12.15pm.

0in line with what has been addressed by Saat Suharto in indepth-interview (Head of BMT Association) on Wednesday, 5 November 2013 at 09.00am – 14.12pm


132

value 0.32. While the last priority in the issue of operation assistance is limited funding assistance

with its priority value 0.22.

However, practitioners’ rater agreement is at the high level with 0.25. This number indicates

various views among practitioners about the issues that have been mentioned. The most important

operation assistance is setting up IMFS human resources. Human resources development and training

should become program and subsidized by the government. In order to run smoothly this development

and training program should be monitored closely since there were many cases in this particular

program does not run properly.0

The average priority value of academicians is slightly different with practitioners, where the

lack of support to empower human resources is in the top priority with it priority value 0.46. The

second priority with considerable difference is the problem of limited capital fund assistance with

0.32, while the last priority is the lack support of Information Technology (IT) with its priority value

0.22. The slightly difference in the priority values indicates that the priority level of the third

operation standards are not much different or relatively the same. Hence, rater agreement among

academicians is relatively high at 0.60. This indicates that there exist the consensus among

academicians on the issues that have been mentioned.

However, the overall showed slightly different results. The lack of support to empower

human resources is as the top priority with 0.39. The second and the third priority ranking with a very

thin margin is the lack of Information Technology (IT) support with 0.27 and limited funding

assistance with its priority value of 0.27. The total rater agreement is at very low level with 0.043.

This shows the diversity of the views of the respondents.

Another assistance that is badly needed by IMFS is capital. In order to operate properly, it is

necessary for IMFS to have sufficient capital to cover all operation expenses or even to make profit.

In this capital aspect, IMFS need of capital or bailout funds that could be used to resolve the liquidity

problem. This assistance is very important since there are still many IMFS that have not been able to

predict their liquidity needs properly and optimally.

Minimum level of IMFS human resource competence becomes a major issue in the future

development of IMFS particularly in the era of financial inclusion. In fact, this human resource

problem that has been causing a lot of IMFS failures LKMS; ranging from the inability in mapping

the risk, lack of financing analysis, inability to use technology effectively, and low level of

understanding on sharia aspect.0The similar view is also delivered by other practitioners that the real

problem of human resource is becoming the central issue to develop Indonesia IMFS in the future.

0In line with what has been opined byAbdullah yazid in in-depth interview on Wednesday, 06 November 2013 at 12.15-13.15pm.

0In line with what has been opined by Aslihan (Head of PINBUK)in in-depth interview on Monday, 3 November 2013 at 13.15pm – 16.20pm.

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Current IMFS limitations could be solved properly by having better competence of their human

resources/managers.0

There is even a belief that if IMFS human resources/managers are good people and

professional, IMFS will be able to compete with other financial institutions regardless limited

infrastructure and minimum regulations facing by IMFS.Therefore, IMFS manager certification

program should be immediately required by the regulator though the early stages should be facilitated

accordingly.0 The results of this study in accordance with the results of previous studies conducted by

Soetrisno (2005), Sakti (2013) and Hamzah (2013) which revealed that the most prominent problem

faced by BMT managers is the issue of human resources competency.

The Solution to Develop IMFS

From the data presented before, it is revealed that the most important solutions that need

critical attention are the establishment of operation standards. Both views either from the experts and

practitioners side give the highest priority to the establishment of operation standards as the solution

to develop IMFS in the future.

The slightly difference in prioritiy value ofthe four problem solutions as mentioned above

illustrates that these particular solutionsare havingrelatively the similar level of priority. In other

words, the establishment supporting regulation, operation standards, operation assistance, and

competition regulation are the similar important solutions that need to be resolved immediately.

The sequence of priority values between practitioners and academicians are different mainly

in the second, third and fourth. The average priority value of the practitioner for the second solution is

the establishment of supporting regulation with priority value of 0.27, followed by the third solution

that is the establishment of the operation standards with its priority value 0.23 and the final solution is

providing operation assistance with 0, 22. While academicians put the establishment of supporting

regulation in the second place with its priority value 0.24, followed by the provision of operation

assistancewith 0.21 and finallythe establishment of competition regulation with its priority value 0.20.

The overall results show that the average different of priority values is relatively small. It

indicates that all the mentioned solutions have almost the same priority value to be executed

immediately.

0In line with what has been opined by Iwan Setiawan in indepth-interview (Head of Microfin BMT) on Sunday, 10 November 2013 at 10.46am – 12.15pm.

0 In line with what has been opined byAsadullah and Mulyadih (Chairman and Deputy Chairman of Peramu Foundation that specifically work on incubation and development of BMT) in indepth-interview on friday 08 November 2013 at 13.00 – 16.15pm.

134

p1 p2 p3 p4 p5 a1 a2 a3 a4 a50

0.1

0.2

0.3

0.4

0.5

0.6

pembentukan regulasi penunjangpembentukan regulasi pembatasan persainganpembentukan standar operasionalpemberian bantuan operasional

Regulation Solution Related to Competition Restriction

The solutions that can be offered related to the above matter is to arrange and to issue the

regulations that govern and manage the distribution of market share among IMF (particularly IMFS)

with commercial bank that has microfinance services. This is similar to what has been expressed by

Sakti (2013) that ensuring financial services of BMT (IMFS) to reach the BMT is also important,

given the main common factor that support the development of BMT is its financial services which

affordable for the community (members). However, cooperative institution must sit down with the

ministry of cooperatives and the Financial Services Authority (FSA), determines what will be the

coverage between these two authority. Government must have long term vision to build the economic

foundation that really strong. IMFS which is owned by the citizen should be supported. This

philosophy should be clearly understood.0

The Solution for Supporting Regulation

One effort that can be done to handle the problem of capital is doing linkage with Islamic

banks. However, the current practice of such linkage program still facing a limitation. One of the

limitations is the unavailability of relevant information related to the soundness/healthy of BMT

(Sakti, 2013). Actually, the supervision on this issue is still lack behind. In some surveys revealed that

most respondents from BMT managers/officials stated that there exist regular

monitoring/supervision.0 However, it was found that this supervision has not been running regularly

and uniformly in all IMFS (BMT). Hence, when the supervision is undertaken, any indicators or

0 In line with what has been opined byAbdullah yazid in in-depth interview on Wednesday, 06 November 2013 at 12.15-13.15pm.

0 For example by Seibel and Agung (2008) and Sakti (2013)

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financial ratios used as benchmarks for the soundness health levels are still not uniform.0 Supervision

for example run conditionally upon the necessary information about the condition of the BMT in the

context of capital assistance programs, either from the government0 or from the private sector (Sakti,

2013).

Among the institutions that have been undertaken the supervision and health assessment role

are cooperative agency (Ministry of Cooperative), BMT associations such as Puskopsyah, BMT

builder institutions (such PINBUK, BMT Center and Inkopsyah). However, there is no one particular

institution that has formal supervisory functions. In order to achieve better industrial development of

IMFS, the governance improvements in this industry at the macro level is badly needed. In addition, it

is expected to have micro-guarantee institution or similar with micro-insurance institutions that can

manage risk mitigation for both BMT depositors and BMT themselves (Sakti, 2013).0 So far, some

efforts have been made to address this issue. It was agreed the cooperation between Sharia Indonesian

Credit Association (Askrindo)0 and Indonesian Association of Islamic Baitulmaal wat Tamwil

(Absindo).0

The Solution of Operation Standardization

In general, BMT regulation, reporting, and supervision are not effectively applied (Seibel &

Court, 2008). This is due to the absence of basic standard. The reports provided are not in the same

form, especially because there are no sanctions in this particular matter. In the worst case, there exist

BMT which doesn’t come up with their financial report. Thus, there are no standard procedures for

cooperative that decided not to continue their business (Seibel and Agung, 2008). Several BMT

studies provide recommendations for BMT to sit for the training; not only on BMT operatio, but also

in the form of mentoring and coaching clients including the concept of the Islamic finance (Kholim,

2004 and Karsidi, 2011).

The Solution for Operation Assistance

With a variety of limitations, there have been performed various training related to the

capabilities of BMT operation. Unfortunately, the training is not done effectively.Human resource

training of BMT was still concentrating on basic training (Sakti, 2011).0 Given the limited availability

0 Usually the minimum measurement being used is Non-Performing Financing (NPF), Return on Asset ( ROA)and Return on Equity(ROE)

0For example in 1998, government through certain departments create development program of microfinance institution in order to anticipate the declined of economic performance and the increase of unemployment rate due to crisis.

0See also Soetrisno, 2005.0 Askrindo is State-owned Enterprises (BUMN) which established 1971. It has holding company

Askrindo syariah which operated since Februari 2013.0 This particular cooperation agreement has been done 20 May 2013.0 In the survey conducted by Sakti (2013) it has been known that type of training mostly provided BMT

are related to BMT operation, accountant training, and BMT Marketing training.

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of funds, the assistance from the government is badly needed in order for BMT/IMFS toperform

training programs to enhance their human resource capacity particularly in term of BMT operation

and technology information.The completion of services problems that have not been computerized is

expected to improve the competitiveness of BMT (Karsidi, 2011).

If it is further explored, crucial functions in the Islamic microfinance industry especially that

carried out by BMT/IMFS are already exist; such as the functions of regulation and supervision,

advocacy and liquidity provider both for liquidity management as well as for a lender of last resort.

Regulation and licensing functions are performed by Ministry of Cooperatives and SMEs. However,

the execution its supervision functions is performed by Cooperative Agency Office under the

coordination of Local Government (Pemda), both at the provincial and district or municipality level.

The separation of the two entities that agencies have the authority function is a challenge, especially

in terms of synchronization policies and effective implementation of policies.

Figure4.5. The Relationship Inter-Institutions in IMFSSource: Sakti, 2013

Some of other BMT builder that serves as a companion and consultants who provide services

for capacity building, IT development and fund disbursement from donor agencies, among them are

Small Business Incubation Center (PINBUK), Induk of Islamic Cooperative (Inkopsyah), MicroFin

Indonesia, BMT CENTER , Indonesia Association of BMT (Absindo), and Center of Islamic

Cooperative (Puskopsyah). In addition, there is also the APEX institutions that provide liquidity

facilities for BMT, such as PT. Permodalan Nasional Madani (PNM) Limited and Permodalan BMT

Ventura (Sakti, 2013). The relationship among these institutions is as in the above figure.

Based on a survey conducted by Sakti (2013), BMT is expecting government to take the role

as lender of last resort for BMT liquidity needs. Another source fund that is expected by BMT is

linkage program that might be take place with Islamic banks.One of the solution that can be offered to

address the problem of capital and human resource development and IT is the linkage program with

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Islamic banking. There are three linkage scheme commonly used by Islamic banks, the patronage

BMT, local government, or other financial institutions; namely channeling scheme, executing or joint

financing. It should be made clear and practical policies in order to optimize it.

IV. Conclusion and Recommendation

Conclusion

Based on discussion and analysis of IMFS development issues from regulatory and institutional side,

the following are some conclusions:

1. In the cluster whereby regulatory restrictions is absence, restriction competition in the form

offinancing ceiling is at the top priority with its priority value 0.39, followed by restriction

competition in the form ofIMFS’ turnover with 0.37 and the last restriction competition is in

the form ofservice coverage with 0.24.

2. In the cluster whereby supporting regulation is absence, Supporting regulation in the form of

health assessments become the top priority with its priority value 0.45. The second one in this

cluster with considerable difference is deposit guarantee regulations with 0.29 and finally is

credit guarantee regulation with its priority value 0.26.

3. In the cluster whereby operation standard is absence, masalah tidak adanya standar kepatuhan

syariah menjadi prioritas utama denan nilai prioritas 0,39. Di peringkat prioritas kedua

dengan selisih yang tidak jauh yaitu masalah tidak adanya standar analisis pembiayaan dan

manajemen risiko dengan nilai prioritas 0,35 dan terakhir yaitu regulasi penjamin kredit

dengan nilai prioritas 0,26. the absence of sharia compliance standard issue is at the top

priority with its priority value of 0.39. The second priority with slightly difference is the

absence of financial analysis and risk management with 0.35 and finally is credit guarantee

regulation with 0.26.

4. In the cluster whereby operation assistance is minimum, minimum assistance for human resources empowerment is at the top priority with its priority value 0.39. In the second and third priority level with a slightly different, that is sequence minimum assistance of IT with its priority value 0.27 and limited funding assistance with 0.27.

5. The research results in this cluster suggests that the formation of operation standards become

the first priority with its priority value 0.31, followed by the establishment of competition

regulation with 0.24, supporting regulation with 0.23 and finally providing operation

assistance. In general, it can be seen that the average priority values are slightly different

which indicates that the all mentioned solutions have relatively the similar priority value to be

further executed.

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Recommendation

Based on the results of the discussion, there are some suggestions that can be recommended, among

others:

The government should immediately establish operation standards since it is urgent to be

implemented as a reference for IMFS. Both respondent practitioners and academicians are

agreed that the establishment of operation standards is the first priority followed by other

solutions that have been mentioned above.

REFERENCES

Hamzah, et al. 2013. Analysis Problem of Baitul Maal Wat Tamwil (BMT) Operation in Pekanbaru Indonesia Using Analytical Network Process (ANP) Approach. International Journal of Academic Research in Business and Social Sciences, Vol. 3, No. 8.

Hascaryani, Tyas D et al. 2011. Metafora Risk and Return sebagai Dasar Pengembangan Baitul Maal wa Tamwil (BMT) yang Mandiri. Journal of Indonesian Applied Economics, Vol. 5 No. 1 Mei 2011, hal. 93-109.

Jansson, T., et al. 2004. Principles and Pratices for Regulating and Supervising Microfinance. Washington: Inter-American Development Bank.

Karsidi et al., 2011. Strategi Peningkatan Profesionalisme Praktisi BAITUL MAAL WAT TAMWIL (BMT) di Kabupaten Banyumas. Performance, Vol. 14 No.2 September 2011, hal.13-34.

Kholim, Muhammad. 2004. Eksistensi Baitul Maal Wat Tamwildan Permasalahan dalam Operasionalisasinya: Studi di Provinsi Jawa Tengah. Tesis di Universitas Diponegoro. Tidak diterbitkan.

Kusmuljono, Bangun Sarwito. 2009. Menciptakan Kesempatan Rakyat Berusaha: Sebuah Konsep Baru tentang Hybrid Microfinancing. Bogor: IPB Press.

Masyita, Dian dan Ahmed, Habib. 2011. Why is Growth of Islamic Microfinance Lower than Conventional? A Comparative Study of the Preferences and Perceptions of the Clients of Islamic and Conventional Microfinance Institutions’ in Indonesia. Paper presented in 8th

International Conference on Islamic Economics and Finance, 19-21 December 2011, Qatar.

Nugroho, M.R. dan W. Untoro. 2012. Prosiding Forum Riset Ekonomi dan Keuangan Syariah Ke-1. BI dan DPP IAIE. UIN Suska, Riau.

Sakti, Ali. 2013. Pemetaan Kondisi dan Potensi BMT: Kemitraan dalam rangka Memperluas Pasar dan Jangkauan Pelayanan Bank Syariah kepada Usaha Mikro. Jurnal Al Muzara’ah, Vol.1 no.1 2013 hal.1-17.

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Seibel, Hans Dieter., Agung, Wahyu Dwi. 2008. Islamic Microfinance in Indonesia: The Challenge of Institutional Diversity, Regulation, and Supervision. Sojourn: Journal of Social Issues in Southeast Asia Vol. 23, No. 1, hal. 86-103.

Soetrisno, Noer. 2005. Ekonomi Rakyat Usaha Mikro dan UKM dalam Perekonomian Indonesia. Jakarta: STEKPI.

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Paper 11

REGULATORY FRAMEWORK FOR MEMBER-OWNED ISLAMIC MICROFINANCE INSTITUTION (MIMI): FOCUS ON ISLAMIC SAVING GROUPS AND COOPERATIVES

SUB-SAHARAN AFRICA (SSA)

Muhammad-Bashir OwolabiYusufPost-Doctoral Researcher,

Department of Economics, International Islamic University Malaysia.

Nasim Shah ShiraziSenior Economist

Islamic Research and Training Institute (IRTI), Jeddah, Saudi Arabia.

MohaAsri AbdullahProfessor of Economics

Department of Economics, International Islamic University Malaysia

AbstractMember-owned Islamic microfinance institutions have been toast to be the alternative means of financial inclusion among the Muslims who are voluntarily excluded from participating in the traditional member-owned microfinance institutions because of the interestthey charge. This novel idea is still new and few are known about its operations and regulations guiding its operations. This paper surveys the practices of the common member owned Islamic microfinance in Sub-Saharan Africa with a view of recommending regulatory framework for its operations based on these practices. This paper thus proposes a number of regulations for the operation of both Islamic Saving Groups and Financial Cooperative. It is hoped that these proposed regulations will assist the operators, policy makers and donor agencies to chat a way of improving the financial inclusiveness of the poor who are excluded from benefiting from the available member-owned microfinance institutions with a view to lift them out of poverty.

Keywords: Member-Owned Islamic Microfinance, Regulatory Framework, Financial Inclusiveness, Saving Group, Financial Cooperative.

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1. Introduction

The newness of member-owned Islamic microfinance institution, its peculiarity and the environment

in which it operates need some regulations to forestall spectacular bankruptcy in the nascent Islamic

financial institution. This is because when it performs badly, the investment of the poor members are

at risk. Experience from the conventional member-owned microfinance institutions have shown that a

saving-led institution does not guarantee the quality of loan and its repayment.

The importance of member-owned microfinance in Sub-Saharan Africa cannot be over

emphasised. More than 85 percent of people in this region are un-bankable with majority living in

rural areas where there are no financial services, be it formal or informal 0. Member-owned

microfinance is as major instrument to reach out to these people in order to facilitate financial

inclusion of all rural of the population. Saving group and financial cooperatives are two saving-led

and member-owned microfinance institutions common in this region of the world with over 27

million members. Saving group refers to an informal, self-selected group of between 10 and 30

individuals that own and manages it. It is widely distributed in both rural and urban area and thrives

well in the areas that lack the presence of microfinance institutions with women being the majority of

the members. Financial cooperatives are member owned microfinance institutions that is open to

people as long as they satisfied the laid down criteria. Member-owned Islamic microfinance

institution refers to either Saving Group or Financial Cooperatives that has resolved to use Islamic

principle in its operations. This institution operates similar to the conventional member-owned

microfinance institutions with additional shariah restrictions.

While member-owned microfinance institutions have a long history in Sub-Saharan Africa,

the operation of the Islamic member-owned microfinance institutions is still less than a decade in the

region where it is still struggling to have a firm grip. If this institution is expected to fill the gap of

financial exclusion of the poor Muslims who are voluntarily excluded from enjoying the financial

benefits of the conventional microfinance institutions, because of their beliefs, there is the need for a

sound regulatory framework to guide its operations in order to protect members meager saving,

facilitate government appropriate supervision and encourage donor assistance, especially those that

are interested in assisting the non-interest based member-owned microfinance institutions. This paper,

therefore, proposes a set of rules and regulations for member-owned Islamic to guide its operations to

safeguard its members and facilitates both government and donors involvements.

The rest of the paper is organized as follows. Section two presents the literature review, section

three is on the regulations proposed and section four concludes the work.

0FinScope Africa Brief, November 2007. MIX and CGAP analysis trends, February 2012. ‘2011 Sub-Saharan Regional Snapshot’.

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2. Literature Review

Microfinance Institutions

Microfinance refers to the provision of a wide range of financial services like, deposits, loans,

payment services, money transfers and insurance, to poor and low-income households and their

microenterprises. This is borne out of the concept that poor individuals have the abilities to lifting

themselves out of poverty if they have access to financial services0.A microfinance institution offers

financial services to the low income, poor and marginalised individual that would not be accepted

normally by traditional banks, and provides transaction services for amounts that may be smaller than

the average service fees charged by the traditional mainstream financial institutions 0. Poor people

encounter problems which impede their ability to move out of poverty. These problems include

inadequate funds which results from insufficient infrastructural and institutional provision (Alam,

2003). Coleman (2006) identifies perceived high risk and high cost of transaction related to the loans

and saving deposit as the reasons why the commercial banks could not provide the credit needs of the

poor. This is because commercial banks require security for their loan which the poor do not have; the

process of loan is complex and they prefer giving out big loans which is far more than what the poor

entrepreneurs need (Gofran, 1996).

This is where Microfinance institutions come in. They offer poor financial services that meet

their needs. These services include loans, savings, remittance, insurance and venture capital at their

level to overcome their financial shortages. This helps the poor micro enterprises to boost their

income and guarantee their economic wellbeing; create assets and reduce susceptibility; increase their

demands of other goods and services and promote local economies (Juwainiet al. 2010). Microfinance

is also a very flexible tool that can be adapted in every environment, based on the local needs and

economic and financial situation (Fouzia, 2012). Traditionally, three types of microfinance

institutions are in operation. These are: formal institutions - i.e. rural banks and cooperatives,

semiformal institutions - i.e. nongovernment organizations and informal sources - i.e. money lenders

and shopkeepers.

However, the facilities of the traditional micro financial services fall short of the needs of the

majority of Muslim population. This is because the conventional microfinance institutions operate on

riba which they charge on the loan they extend to the people. This is against the Islamic tenets, and as

such a large number of Muslim entrepreneurs abstain from benefitting from the traditional

microfinance services to do away with interest which is against the Sharī’ah (Obaidullah, 2008).

Islamic Micro Finance (IMF) was developed to fill this lacuna. Its goal is to extend shariah compliant

loans to the poor entrepreneurs that have been excluded from the capital provided by the banking

0http://www.adb.org/sectors/finance/microfinance0http://www.investorwords.com/17362/microfinance_institution.html

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sector, which target only the bigger players in the economy. Meanwhile, microfinance is not for the

poorest of the poor who are subjects of financial intervention, rather the fringe poor with

entrepreneurial ideas who could reach more easily a decent quality of life but lack access to formal

finance. In this circumstance, Islamic micro finance has a big role to play in Muslim countries as

alternative to conventional microfinance as a tool of enterprise creation and expansion that develop

human capital base to meet the financial requirement of Muslim community thereby play a great role

in their economic growth.

Islamic Microfinance

The Islamic financial system broadly denotes financial activities that comply with the teachings of the

Shari‘ah (Islamic law). The principle and laws of Islam demand some types of activities, risks or

rewards to either be forbidden or encouraged. Many Shari‘ah laws, rules and interpretations take into

account the subject of social justice, equity and fairness, as well as the implementation of commercial

transactions. Islamic microfinance fits into the asset-based economic paradigm and equity objective of

Islamic moral economy as well as fulfilling other social expectations. Thus it provides wide range of

financial resources such as small loans, insurance, and saving to low-income families in order to help

them build businesses and increase their income.

The conventional microfinance services exclude the majority of Muslim population. This is

because, though they have access, they refuse to utilize the conventional microfinance institutions as

they operate on Interest. Paying or charging interest is forbidden in Islam. Thus, a large number of

Muslim entrepreneurs abstain from benefitting from the traditional microfinance services to do away

with interest which is against the Sharī’ah (Obaidullah, 2008).

The success stories of Islamic microfinance in Muslim countries are still few. This is because

these institutions have not been fully incorporated in countries’ formal financial systems. With the

exception of few countries, Islamic microfinance in Muslim countries has been experimental projects

operated by foreign donor agencies, religious or political groups. The case becomes worse when we

consider the number of Islamic banks practicing microfinance. The first Islamic microfinance

initiative after the fall of Islamic caliphate was by MitGhamr in Egypt in 1950s. However, the

experiment was aborted shortly. This notwithstanding, the recent years have witnessed a few

successful experiment of Islamic microfinance throughout the world (Obaidullah, 2008).

Islamic microfinance begins in Malaysia in the early part of second half of the 20 th century

with the introduction of the Tabung Haji. This was borne out of the intention to finance the hajj cost

of poor Malaysian farmers. Started as a saving and investment institution, Tabung Haji has now

become a big specialized financial house, financing various projects within and outside Malaysia.

This good initiative has been followed by some other South East Asian countries (Obaidullah, 2008).

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Islamic Microfinance and Poverty Alleviation

A number of authors have discussed the role of Islamic micro finance as a means of poverty

reduction. According to Rahul and Sapcanin, the risk sharing component of Islamic microfinance is

compatible to the needs of the poor who have no collateral to obtain loans from the conventional

banks. This they said will make it possible for poor entrepreneurs to finance viable projects that have

been turned down by conventional institutions for lack of collateral to be financed by Islamic

microfinance through its risk sharing products. In his own submission on the role of Islamic finance in

poverty reduction, Chaudhri (quoting Mirakhor) described Islamic finance as a double prong approach

to poverty alleviation. This is because it empowers the poor by utilizing the idle capital which would

have been charged negative interest (Zakat) for lying fallow for a year round (Chaudhri, 2006). Thus

Islamic microfinance will provide fund for enterprising poor and generate additional income for the

owner of the fund.

Islamic microfinance has also been described as a safe haven for investors against credit

crisis. Frasca (2008) while looking at the competitiveness of Islamic microfinance, noted its ability to

protect the investors from the excessive speculator of the conventional thus protect them from

unwarranted financial crisis.

Characteristics of Member-Owned Microfinance Institutions in SSA

The importance of member-owned microfinance is obvious anywhere in the world and SSA is not an

exception. This is because saving led organization has more members compared to credit-led

providers. The two common saving-led organizations that are focus of this study are saving-group and

financial cooperatives. In SSA, membership of financial cooperatives is more than 20 million while

that of saving group is over 7 million. The characteristics of these two saving-led organizations are

summarized in the table 1 below.

Table 1:The key Characteristics of Saving-Led Organization

Subject Saving Groups (SG) Financial Cooperatives (FC)LEGAL SITUATION SGs are informal groups and

inmost countries do not need any registration or license.

SGs are time-bound and operate in cycles of approximately one year. At the end of the cycle, themembers receive their savings plus earnings and start the following cycle.

FCs are legal institutions that need to obtain legal recognition.They aim at sustainability.License requirements aredependent on the legislation and regulations for FCs and cooperatives in general, very different from one country to the next.FCs are usually under a kind of supervisory framework.

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MEMBER-OWNEDAND

MEMBER-MANAGED

SGs are member-owned and managed by its members. Group members are self-selected.

Management Committeeis elected from among themembers.

FCs are member-owned.Oversight and control are through representative bodies,membership of which is elected according to the ‘one member one vote’-principle. No externalparties can be appointed to positions in the regular organs/ committees.

Sometimes FCs are also –partly member-managed. In thatcase elected members perform-certain- operational tasks of aFC. This is usually the case for small or starting FCs.

There are also many FCs inwhich elected members are notat all engaged in operational daily tasks.

MEMBERSHIP Typically between 10 and 25 self-selected members. Tokeep the group manageableand ensure transparency oftransactions by witnessing, memorization and simple record keeping, the total number of members should be limited.

Membership is open to anyonethat meets certain criteria.These criteria vary per FC:• in the case of ‘employment-based’FC; people with the sameprofession/ employer;• In the case of ‘community-based’FCs: limited to a certain geographical area.

PROFILE OF MEMBERS

SG mostly promoted amongthe rural, remote and/or poor population, but also in urban environment, like city slums. Some promoters explicitly target women.

Membership profile of FCs is very diverse; rural and urban, poor and non-poor. Amongcooperative members, thereis often a difference in profile between savers and borrowers; borrowers are usually the better-off or salaried members.

SECURITY OF SAVINGS

Cash and records are kept in a box with multiple locks. Cash boxes rarely get lost. Sometimes groups open bank accounts.

Good governance, professionalmanagement, effective internalcontrol, external audit, and legislation and supervision have to ensure security of savings.

When these requirements arenot fulfilled there are higherrisks of fraud, abuse anddefault, with subsequent risks for depositors.

SOURCE OF LOAN SGs provide loans based on FCs are traditionally and legallyalso

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FUND theirsavings, sometimes linked for refinancing to MFI’s (mature groups).

saving-led (often 2x or 3x size of loan).

However a source of loan fundof the FC can also be contracted through external loan.

PRODUCTS Flexibility of savings products vary according to savings group methodology.Savings is the most preferred product.

Average loan size usually small.Both consumptive and productive loan uses.

Return on savings because ofinterest (or service fee) chargedon loans. Net earnings aredivided proportionally to savingsamong members at the share-outat the end of each cycle.

Social fund caters to emergencies.

Loan size is dependent onliquidity, loan policy, regulationand what products are developed. Individual loans can vary between 200 to 10.000 euro. If the FC has introducedsolidarity lending, the loan amounts are lower.

Consumption loans and lendingto salaried people may be favoured in view of less risks and operational costs.

Interest on loans is usually lower than in commercial banks or MFIs.

Interest given on savings is also usually quite low, and current savings accounts often dominate.

Depending on how much profitis made, dividend is distributed to members, based on their shares.

INTEGRATION IN WIDERSYSTEM

SGs operate independentlyafter an initial training andsupervision investment of 9to 12 months. Survival rate ofgroups is high; dropout rate of members is low.

FCs can be stand-alonecooperatives, not associatedor integrated into a wider cooperative system.

They can also be part of a(three- or two-tier) –nation orregion-wide-, integratedFC network, with degrees of autonomy for the primary society. Some FC networks have their own banks, full-fledged parts of the financial sector.

Source: Athmer and Bosch (2013)

Key Characteristics of Member-Owned Islamic Microfinance Institutions in SSA

Member-owned Islamic microfinance is relatively new and few in SSA. This section enumerates a

number of characteristic observed among the two types of member owned Islamic microfinance in

this region0. These characteristics are discussed separately for Islamic saving group and financial

cooperatives.

0This section draws heavily from the experience of member-owned Islamic microfinance organizations in operation in Nigeria.

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Islamic Saving Group (ISG)

There are different types of saving groups methodologies in operation, most especially when they

draw heavily from the experiences of the well-established conventional saving groups. However, the

following characteristics seem to cut across them:

i) Membership: Like its conventional counterparts, Islamic saving groups are typically self-

selected group between 10 to 30 members, single sex or mixed group within the same

locality. At times they are guaranteed by members of already existed saving group in that

locality that has already have the required number of members. This is to make sure that

members are not only known within the locality, there are actually others who could stand

for them. Members are expected to be active in attending meetings, paying their

contributions and returning the loan as at when due. Any member found wanting of their

responsibilities may be replaced after recovering their outstanding, through paying up or

the use of guarantor contributions to cover the shortfalls.

ii) Ownership and Management: It is normally owned and managed by members.

Management committee is chosen among the members to take charge. However, the

decision is taken jointly at the meeting which normally comes up once every month. All

the request of loan or issues that arise is tabled at the meeting and decisions taken

together. The committee members mostly comprise of chairperson, secretary and

treasurer. While the chairperson chairs the meeting, the secretary takes the minute and the

treasurer keeps the record of accounts. To ensure transparency, another members are also

encourage to take note of the group’s account and all the decision must be taken at the

monthly meeting where every member is in attendance and all the request must pass

through this process even if it is from the management committee.

iii) Profile of the member: Members are mostly Muslims who have come together to form

Islamic saving group in order to avoid interest pay and charged by the traditional saving

groups. They are common in the urban area or its suburb, mostly as self-help

organization. Members are not necessarily poor.

iv) Sources of loan fund and administration of the group: Members contribution forms the

bases of loan provided to the members. The affair of ISG is normally run by the

membership fees paid by members for joining the group. There is no other ways by which

ISG makes save through these two sources since they don’t charge interest and they do

not involve in other money making activities. Each member normal pledge certain

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amount of money as month contribution. This varies from member to member and group

to group based on the capability of the members.

v) Products: The main product of ISG is saving which serves as the main source of fund for

the other product which is loan. The average loan is usually small, for both consumptive

and productive. There is always an initial period of contributions before a member can be

entitled to loan (usually six months). The initial loan extend to the member is always

equal to initial contribution on the probation period which is guaranteed by other

members and payable over the period of between 3 to 10 months. Subsequent loan may

be up to maximum of 3 times the individual’s contribution. Member requests are tabled at

the meeting and request entertained based on the availability of fund, the needs of those

who applied and their performance on previous loan. Some amount is also reserved to

cater for emergency among the members

vi) Legal status: Islamic saving group, like other saving group in SSA are mostly informal

organizations that do not need registration or license. In some countries where they need

some form of registration under the local authorities, the inability of the group to satisfy

the registration requirement in terms of fees and documents often prevent them from

registering because they do not have the money and documents to meet this requirement.

However, in difference to other cooperatives, ISGs are not normally time bound, though

member can opt out anytime if they feel they could not meet the obligation of been an

ISG member.

vii) Security of Loan: Members contribution is kept in ISG bank account at the

community/microfinance bank. Members, who can do so, are encouraged to pay their

monthly contributions into the group account directly and provide their evidence of

payment to the treasurer for account reconciliation. The monthly contributions by

members are kept in the group account at the bank and record kept with the treasurer.

Where there is no presence of banks within the vicinity, cash contributions and record are

kept in a well secure box.

viii) Shariah components of ISG: The main shariah component of ISG is absence of interest in

their transactions. Because their main product is extension of loan, most of the well-

known shariah compliant products are not in demand by ISG.

ix) Integration in wider system: ISG operates independently though there may be informal

relationship with parent ISG (inform of guaranteeing members of new ISG). There is no

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initial training like the other SG. There is also no external support, either from the

government or donor agencies. ISG also lack access to continuous training and shariah

input at minimum level.

Islamic Financial Cooperatives (IFC)

The Islamic financial cooperatives in SSA, like its conventional counterparts, are of two types:

employment financial cooperatives and community cooperatives. An employment cooperative is a

workplace based financial cooperatives that provide services that share the same workplace,

employment or profession. These individuals are formally employed and on salary, either from

government or private organizations. These types of financial cooperatives are mostly common in the

urban areas where there is opportunity for white collar jobs. A community based cooperative on the

other hand is a financial cooperative whose membership is opened to every member of a particular

community or geographical location, no matter what is their economic activities. This type of

financial cooperative is found in both rural and urban centres (Athmer and Bosch, 2013). Employment

based Islamic financial cooperatives were the first set of IFC in SSA. These were formed by Muslim

professionals in their various places of work to promote members’ consumptions. Being professional

organizations, members usually have high education and ability to understand the fundamentals of

financial cooperative and even well versed in shariah principle or well placed to be able to obtain

shariah information about Islamic transaction from the experts. Another advantage enjoy by

employment based financial cooperatives is the guarantee provided by the employer to retain loan

repayment by gradual deduction from the salary of the borrower.

The case of community based cooperative is a bit different from what is obtainable in

employment based cooperative. The first difference is that members are mostly self-employed, with

jobs, reflecting the economics activities present in that particular location. The members are of

different education level, ranging from no formal education to post primary level. The loan obtained

could be for consumption, enterprise creation and/or expansion. The loan extend to members requires

collateral in form of solidarity lending which replaces physical guarantee. However, this is not

without its own cost as solidarity lending requires nearness and regular visits of highly trained and

supervised loan officers that constantly monitors the lender before and after obtaining the loan. This

makes the management of loan to be more demanding. Nonetheless, this type of cooperatives

organization provides financial access to women in developing nations because they are more active

in micro, small and medium enterprises in the informal sector0.

Key Characteristics of Islamic Financial Cooperatives in SSA0ibid

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i) Membership: Membership of cooperative is open to people that meets the criteria set by

the IFC. In the case of employment based IFC, membership is open to people having the

same profession or belonging to the same employer, mostly Muslims, because IFC always

have a religious undertone, though that is not an express condition. In case of the

community based IFC, members come from different profession or self-employed

individuals with different enterprises. Like the traditional FC, IFC is mostly limited to

people of a particular geographic location, but there are some IFC that have members

beyond a certain geographical location, even across different continent. This is possible as

some of the IFC operates online membership and have members from different

geographical location.

ii) Ownership and Management: Islamic Financial cooperatives in SSA are member owned.

The cooperative is run by executive committee that are elected by voting or selected

through the shura committee. This is a tenured position, with stipulated number of years,

ranging from one to three and is renewable only once. In most cases, the elected

members perform operational task of IFC. This is because most of the IFC are still not yet

in the position to employ people to perform the operational task of the cooperative. These

operational tasks include record keeping, evaluating and monitoring members.

iii) Profile of the Members: The members of employment cooperative are somewhat similar

as it is normally made up of people with similar profession or under the same employer.

However, community based cooperatives have diverse membership with different

employment portfolio and coming from the same or different geographical location as

long as they can meet the membership requirement. There is no limit to the membership

of the cooperative.

iv) Sources of Loan Fund and Administration of the Group: The loans giving to members

come from the saving by the members. The money use for running of the cooperative

affairs comes from membership charges and profit makes by the cooperatives in the

businesses it involves in. IFC also makes money from partnering members in their

business and setting up of cooperative owned businesses.

3. Regulatory Framework for Member-Owned Islamic Microfinance Sub-Saharan Africa

A regulatory framework refers to the law, regulations, guidelines, rules and code of conducts which

entities being regulated are expected to comply with, together with institutions or structure in place to

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enforce it. Regulation of financial institutions is as a result of need for the system to boost funds

mobilization and intermediation to promote efficiency in the distribution of capital and guarantee

correct risk management, and depositors’ protection. With reference to Member-owned Islamic

microfinance, it refers to set of laws, regulations, guidelines, rules and code of ethics that it must

comply with to safeguard the money of the members and comply with Islamic standards.

Reasons for Regulating Member-Owned Islamic microfinance institutions in SSA

There are a various reasons why member-owned Islamic microfinance institutions in SSA need sound

regulations, some of which are listed below:

i) For it to reach a large number of Muslims and others who are financially excluded

because of non-availability/lack of coverage of non-interest taking microfinance banks

and the charge of interest by traditional member-owned microfinance institution to be

able to attract government and/or donor support to boost private capital it has attracted

from member savings.

ii) To give room for properly and orderly development of the nascent institution.

iii) Most MIMI begin as self-help organizations to assist members and have to seek

alternative strategies to survival such as assessing donor fund.

iv) To be able to move from credit organization to more commercially oriented entities-

regulations lays the foundation for such transformation.

v) Ensure financial sector stability- though players in MIMI, like other microfinance sector

have little systemic impact, failure can have negative impact on the credibility of the

financial sector

vi) To render legitimacy and confidence to the sector in order to attract long-term funding to

the sector

vii) Investors and donors need to have confidence in the systems in which the recipient of the

funds operates in.

viii) Regulation sets minimum acceptable standards and gives confidence in MIMIs as a safe

destination of donor or investor funds

Proposed Regulatory Frameworks for Member-Owned Islamic Microfinance Institutions in

SSA.

Given that MIMI have evolved as self-help initiatives by members to ensure their financial

inclusiveness, there exists various regulatory structures that can be used to regulate it. These

regulatory structures may be one or combination of any/or all of the following depending on what is

obtainable in a particular country:

Primary Registrars

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Microfinance institutions are registered legal entities under different pieces of legislation in many

countries in SSA. These legislations include “The Money Lenders and Rates Interest Act”, “Banking

Act”, “Cooperative Society Act” and “Private Voluntary Act”. MIMI can come under any of these

legislations depending on which country and what is obtainable. However, most of these need special

provision to be able to cater for the non-interest component of MIMI as most of them are formulated

based on interest bearing activities.

Network of MIMIs

There exist different national and international networks that give support to MFIs. These networks

compose of both formal and MFIs. These networks serve a regulatory role as they develop

performance standard for best practices that member organization are persuaded to meet. Inability to

obey these laid down network norms by members mostly result in loss of benefits provided by the

network for its members. These benefits include capacity building opportunities, inform of training

and system implementations, and financial services such as grants and guarantees. MIMI can also

form local, national and international networks among similar organizations, both formal and

informal, and play a regulatory role by developing sets of performance standards and best practices

that member organizations should be encouraged to struggle to achieve. There should also be

incentives attached to these norms, failure to follow which should also attract loss of benefits, such as

training and systems implementation especially those relate to Shariah which MIMI are noted for, and

financial services like grant and guarantees as in the case of traditional MFIs.

Self-Regulatory Body

This refers to a body that is founded, owned and controlled by MIMI members to be supervised. This

can be an umbrella association of MIMIs in any of the countries. The duty of these self-regulatory

bodies will be to regulate the market conduct through the formulation of codes of conduct as well as

other norms for member organizations. The primary responsibility of the self-regulatory body will be

to monitor and enforce the agreed norms. However, experiences from MFIs show that this regulatory

structure is not suitable for prudential supervision as most of member institutions normally lack the

power to adequately sanction erring members.

Apex Institution

This is another body that can be used to regulate MIMIs. This involves having an apex institution or

national fund that will be giving wholesale lending to the local MIMIs. Because of its role as an

investor in MIMIs, that apex institution can naturally be used as a form of regulatory structure. This

institution will assess and monitor the soundness of the MIMIs it extends loan to. Any MIMIs that do

not meet the laid down standard can be sanction by denying it loans. This will make MIMIs to

struggle to conform to the terms and conditions of the loan. These conditions may include: Financial

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soundness (adequate capital); achieving and maintaining acceptable profitability (if need be); ability

to meet obligations as they fall due (liquidity); having a competent Board of Directors; having annual

audited financial statements, and conforming to appropriate Shariah standard.

Delegated Supervision

This is an arrangement whereby financial supervisory agency of the government delegates its role as

the direct supervisor of financial institution to an external body while it monitors and controls the

body. This role can be given to an apex regulatory structure, umbrella association of MIMIs religious

council (or Shariah board) or audit firms. However, there are some issues that need to be clarified for

proper implementation of delegated supervision. These, among others, include: who bear the cost of

the delegation; in case of the need to withdraw authority from the delegated supervisor, what will be a

realistic fallback option; and which authority will take charge to sanitize the system in case the

delegated authority fails. These are important issues that must be settled before engaging delegated

authority to supervise the activities of MIMI.

Financial Supervisory Agency

The central bank is the financial supervisory agency in most of the countries in SSA that is

responsible for supervising bank and other financial institutions including MFIs. However, the focus

of the central banks is more on deposit-taking MFIs and applies non-prudential supervision on credit

MFIs alone. Unfortunately, most of MIMIs only deal with members saving and do not take deposit

from the general populace. Some central banks are also using minimum start-up capital for MFIs as a

way of rationing prudential supervision. Sadly too, MIMIs do not meet this minimum start-up capital

for it to fall under the MFIs that will come under the supervision of the central bank. The result of

these is therefore the lack of financial and human resources to supervise MIMIs effectively. The

central banks could make special provision for this faith based financial institutions and other MFIs

that are not deposit-taking or meet the minimum start-up capital to be able to monitor their financial

activities.

ShariahAdisory Board

Shariah advisory board is a body that regulates the shariah activities of financial institutions. Where it

operates, it either comes under the central bank or operates as an independent body. This body advises

the central bank on the shariah issues regarding to Islamic financial activities. They look at the shariah

compliance of any financial products/activities under Islamic financial institutions and advice

appropriately. This body or similar one may be used to regulate the activities of MIMIs, especially in

the area that has to do with shariah compliance.

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4. Conclusion

Member-owned Islamic microfinance is a new self-help group by Muslims in SSA to ensure financial

inclusion of the members. The importance of this initiative is underscored by the fact that more than

85 percent of the people in this region are un-bankable, out of which a reasonable number are

Muslims who will not deal in interest. As laudable as the idea may look, leaving it unregulated may

be a time-bomb for the poor members, who put in their meager resources to assist themselves, if it

fails. This calls for a sound regulatory framework that will not only protect poor fund, but will also

ensure the continuity of the good idea.

This study has looked at the operations of the two commonly used member-owned

microfinance organizations by Muslims- saving groups and financial cooperatives, with a view to

understand their mode of operations. It has also discussed various regulatory frameworks that are

available to regulate this nascent financial institution. It is hope that this study will gear up the

stakeholder to do what is necessary and call the attention of researcher to research more in this area.

References

Alam M. N. (2003) ‘Institutionalization and Development of Saving Habits through Bai-Muajjal

Mode of Islamic Banking Finance (A unique means of mobilizing rural savings towards

productive sources).’, Managerial Finance, Selected Financial Institutional Structures and

Policy Perspective, Volume 29, Number 2/3, Barmarick Publications, England, January,

2003. pp. 3-22.

Coleman, B.E. (2006). Microfinance in Northeast Thailand: Who benefits and how much? World

Development, 34(9), 1612-1638.

Fouzia, J. (2012). Financing Microenterprises: Creating a Potential Value-Based Hybrid Model for

Islamic Microfinance, Proceedings of International Conference on Excellence in Business,

Sharjah, United Arab Emirate, May, 09-10.

Gofran, M. (1996). Loan Utilization and Repayment Behaviour of Women Members inBasanGazipur

Branch of Grameen Bank, MS Thesis, Institute of Post-graduate Studies in Agriculture,

Gazipur, Bangladesh.

Juwaini, A. Rambe, M. Mintarti, N. and Febrianto, R. (2010). BMT (BaitulwaTamwil) Islamic Micro

Financial Services for the Poor, ISO/COPOLCO WORKSHOP, Bali, Indonesia, May 26,

2010.

Obaidullah, M. (2008).Islamic Finance for Micro and Medium Enterprises (ed), IRTI, IDB.

Athmer, G. & Bosch, E. (2013).Policy Guidelines for Donor Support to Member-owned Financial

Institutions in RuralSub-SaharanAfrica.Access on 10/12/2014 from

http://www.microfinancegateway.org/p/site/m/template.rc/1.9.63399/.

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http://www.microfinancegateway.org/p/site/m/template.rc/1.9.63399/

Paper 12

The Impact of Regulatory and Supervision framework on Microfinance in Kenya

Abd elrahman Elzahi Saaid ALI, (PhD.)Islamic Research and Training Institute (IRTI/IDB)

Wahida Mohamed Athman ALI (MA )Maseno University

AbstractMicrofinance, through formal and informal means and institutions, is one of the very essential branches of lending that is used to mitigate the negative impact of high poverty and unemployment among the youth, mariginalised groups and the needy in Kenya.Therefore, in order for these services to be delivered to the targeted beneficaries effectively, a strong regulatory and supervisory system is rather essential. This research seeks to investigate and test the Kenyan microfinance regulatory system and pinpoint its positive and negative impacts on institutions and the targeted beneficiaries located in different parts of Kenya. This study is expected to give strong policy implications for both government and the public.

Key Words: Microfinance Institutions (MFIs), Development Financial Institutions(DFIs), Savings and Credit Cooperative Societies (SACCOS), Rotating Savings and Credit Societies(ROSCAS) ,Accumulating Savings and Credit Associations (ASCAS), Association of Microfinance Institutions –Kenya (AMFI-Kenya), DTMs-Deposit Taking Microfinance

Introduction:

The Central Bank of Kenya (CBK) defines a microfinance institution (MFI) as an institution that

offers financial services such as credit, savings, insurance, money transfer services to the poor, low

income households and Small and Micro Enterprises (SMEs) who do not qualify for, and therefore

lack access to, traditional formal financial institutions. CBK broadly categorises MFIs into credit non-

deposit taking (credit-only) and deposit-taking microfinance(DTM) institutions. The distinction

between the two is that DTMs are licensed and regulated by the Central Bank of Kenya and are

permitted to mobilize and intermediate (or lend) deposits from the general public. However unlike

commercial banks DTMs can only engage in a limited range of products. They are not allowed to

invest in enterprise capital; undertake wholesale or retail trade; underwrite or place of securities; and

purchase or otherwise acquire land except for expansion of deposit-taking business

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Non-deposit taking microfinance institutions, on the other hand are regulated by the Ministy

of Finance, and are not allowed to mobilize public funds and can only lend their own funds or

borrowed funds.

Both categories of MFIs support the economic activities of the youth, the marginalized, the

needy and SMEs contributing immensely towards poverty alleviation. Therefore the sound

development of a conducive regulatory and supervisory environment that takes into account the

different categories of MFIs and facilitates their rapid growth is vitally important.

Background

The potential of using institutional credit and other financial services for poverty alleviation in Kenya

is quite significant. About 22 million people, or 50% of the population, are poor and mostly out of the

scope of formal banking services. Yet, according to the Financial Sector Deepening Trust (FSD)

website, Kenyan banks serve no more than 4 million people leaving the rest of the economically

active population to depend on expensive informal and semi-formal sources of finance not subject to

the prudential regulations that apply to banks and other formal-sector institutions. This is because the

ability of most of these ‘less regulated’ microfinance institutions (MFIs) to leverage capital and

mobilize external resources is limited to borrowing expensively from formal financial institutions or

large institutional and individual investors, or the government or accepting limited and forced deposits

from the public.

Kenya’s MFI landscape

Figure 1: Kenya’s financial access strand

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Figure 2: Kenya’s Financial Sector Landscape

MFI business in Kenya is carried out by different institutions with varied institutional forms.

There are companies (including commercial banks), Co-operative Societies, Trusts, Non

Governmental Organisations (NGOs),State Corporations(Such as the Uwezo Fund and Women’s

Enterprise Fund) and Informal institutions such as ROSCAs, ASCAs & Moneylenders.The ROSCAs,

ASCAs and money lenders are user-owned and managed and offer products tailored to the needs of

their different communities.

According to AMFI Kenya’s 2012 annual report on MFI sector in kenya the total assets for

the sector report a steady growth averaging 30.4% and are worth over KES 220bn (USD 2.59bn) as of

Dec 2011, up from KES 129bn (USD 1.71bn) as of Dec 2009. However, Equity Bank alone accounts

for 80.4% of the sector’s total assets. In fact, the sector’s asset growth, excluding commercial banks,

is less strong, and relatively stagnant. In 2011, DTMs recording a negative growth despite the fact

that there was an increase in the number of granted DTM licenses.

Overall,the sector reaches out to nearly 1.5 million borrowers with the value of the

outstanding loan book standing at KES 138.4bn as of Dec 2011 (USD 1.6 bn), which shows positive

growth trends. Total liabilities amount to KES 178.4bn (USD 2.2bn) as of December 2011 and show

steady growth trends of 40% and 27.6% in 2010 and 2011 respectively .The sector largely funds itself

with deposits collected from the public, which account for 58.9% of total assets, while total equity

accounts for 18.2% of total assets, followed by borrowings accounting for 16.6%. compulsory savings

account for only 4.16% of the funding structure.

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Figure 3 Liabilities and Equities of Kenyan MFIs

Problem Statement

Despite, the ‘slow’ paced growth, Kenyan MFIs continue to evolve rapidly by creating new ways to

service the increasing demand for their services. This innovation and rapid development of many

localized efforts to provide financial services to the population outside of formal channels seems to

have generally overtaken taken policy formulation by the Kenyan government. The reaction to this,

by some quarters in government and multilateral agencies is to favor comprehensive regulation

through mandated standards of performance and risk-ratios based on the untested hypothesis that the

institutional and market impact of moving from an less regulated environment to one that is blanket

and as tightly regulated as the one for formal banks will have the same positive impact.But is this the

best available option?

With this in mind it is important to note that the MFI sectorin Kenya is quite unlike the formal

banking sector. MFIs face a number of constraints that need to be addressed to enable them to

improve outreach and sustainability. In Kenya, like in many other countries, approaches to the

regulation of MFIs are complicated because many institutions involved in providing microfinance

services exist under different legal structures. MFIs in Kenya can be registered under eight different

Acts of Parliament namely: The Non Governmental Organizations (NGO) Co-ordination Act, The

Building Societies Act, The Trustee Act, The Societies Act, The Co-operative Societies Act, The

Companies Act, The Banking Act and The Kenya Post Office Savings Bank (KPOSB) Act. Some of

these forms or registrations do not address issues regarding ownership, governance and management

capacities, unhealthy competition, access to funds and accountability simply because they lack the

appropriate regulatory oversight machinery that can enforce compliance to set performance standards.

This presents a challenge when it comes to identifying the appropriate overarching regulatory

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approach that is conducive to the development of the sector while providing adequate flexibility to

microfinance activities.

Many may also argue that the ‘reduced’ oversight mode has enabled the MFIs to innovate and

develop different techniques of providing micro finance services. Bearing in mind the risks involved

and the impact on the well being of the youth, marginalized groups and the needy when a majority of

the MFIs that serve them operate in an environment that doesn’t have the appropriate oversight and

set performance standards the debate then moves from whether or not to have regulation but to how

much regulation and what kind of regulatory framework is necessary.

Objectives

This general objective of this study is to examine how Kenya’s regulatory and supervisory framework

impacts on the clients, operations and institutional development of microfinance institutions (MFIs).

Specifically the study will

1. Examine the performance of the microfinance sector since the implementation of the

Microfinance regulatory and supervisory framework of 1996 to date;

2. Critically review, identify and analyze the basic regulatory and supervisory weaknesses,

constraints and challenges that are obstacles to the efficient performance of the microfinance

sector.

3. Suggest a course of action to enhance the regulatory and supervisory framework of MFIs in

Kenya.

Research Questions

1. What is the impact of the regulatory and supervisory framework on the performance of

Kenya’s microfinance sector since 1996?

2. What are the basic regulatory and supervisory weaknesses, constraints and challenges that are

obstacles to the efficient performance of Kenya’s microfinance sector?

3. What is the best course of action for enhancing the regulatory and supervisoryFramework for

MFIs in Kenya?

Methodology

The study will basically use secondary information and a questionnaire survey which will be

distributed through AMFI to MFIs and commercial banks.

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Scope

This study will seek to examine the impact of Kenya’s existing regulatory and supervisory framework

on MFIs. It will define its weakness, constraints and challenges and then suggest the best course of

action that can be taken to enhance the framework. This paper will only deal with external supervision

of MFIs that is usually performed by central bank or specialized supervisory agencies.

Justification for the study

This study is expected to contribute to the efforts of strengthening Kenya’s regulatory and

supervisory framework of microfinance institutions by pinpointing the weakness, constraints and

challenges as well as make suggestions for improvement.

This study seeks to use the Kenyan context to improve the understanding of the host of

challenges being proliferated by the regulatory and supervisory framework on MFIs existing outside

the formal regulatory framework.This will be of significant use to governments, funders,

implementers and practitioners who are seeking to develop a financial inclusion strategy that

leverages on these kinds of MFIs.

MFI service providers are continuously discovering innovative usages that their users are

inventing. They are seeing what works and what does not. Such lessons learned need to be

incorporated in regulatory and supervisory frameworks and shared widely and quickly. The

Innovators themselves cannot do this as fast as they should, as they already have enough to do in

terms of improving their services and fine-tuning their business model. This is why studies such as

this one need to be conducted in order to incorporate and disseminate lessons learnt quickly and

effectively. This paper is useful therefore in the development of up to date guidelines and strong

policy that lead towards the establishment of a regulatory environment that permits all MFIs to

progressively evolve into institutions capable of wider outreach and achieving critical mass in

operations.

Finally, it is envisioned that this study will add to the existing literature, provoke interest in

areas for further research in regulatory systems as well as be a valuable tool for students,

academicians, institutions, corporate managers and individuals.

Organization of the paper

This paper will start by discussing the need to regulate and supervise microfinance institutions. It will

then identify various principles, approaches and instruments of regulating and supervising MFIs from

various literatures, books and theoretical papers. The next section will assess Kenya’s financial

system, the historical development of microfinance and provide a review of the regulatory and

supervisory framework focusing on major weaknesses and challenges. The final section will

summarize the findings, present a conclusion and set out recommendations for a course of action

leading to the enhancement of Kenya’s regulatory system.

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Literature Review

Introduction

The current literature and actual practice tell us that the government and donor funds can supply only

a tiny fraction of global microfinance demand and hence financial intermediation by self sufficient

institutions is the only way that financial services can be supplied to lower-income people worldwide

(Marguerite S.Robinson , 2001). Only an MFI that is able to cover its costs can be able to continue its

operations in a sustainable way and generate benefits to its clients (H.Schmidt and Zeitinger, 2003).

This paper is based on the belief that the microfinance sector can reach its full potential in a regulated

environment. It must be able to enter the arena of licensed, prudentially supervised financial

intermediation. At the same time regulations must be crafted that allow effective and efficient

development of the MFIs (Peck Cristen and et.al, 2003).This section discusses the basic issues in

regulation and supervision of microfinance institutions. Effort is also made to present and learn from

Uganda and Tanzania’s experience.

Definitions

According to Peck Christen, R. Lyman and Rosenberg (2003) regulation refers to a set of enforceable

binding rules that govern the conduct of legal entities or individuals, whether they are adopted by a

legislative body (laws) or an executive body (regulations). PrudentialRegulation on the other hand

refers to the set of general principles or legal rules that aim to contribute to the stable and efficient

performance of financial institutions and markets (Chaves and Gonzalez_Vega, 1994). Therefore, the

purpose of prudential regulation is to ensure the financial soundness of financial intermediaries such

as MFIs and try to prevent financial system instability and loss of depositors’ money. Prudential

supervision refers to external oversight of the financial intermediaries though examination and

monitoring mechanisms to verify compliance with regulation.

Rationale of Regulation and Supervision of MFIs

The need and rationale for regulation of economic activities is often justified as a policy instrument to

minimize the effects of market failure, protect public deposits and small depositors, ensure integrity

and financial stability, promote efficient performance of the institutions has gained substantial

attention by governments of different countries recently, particularly in the course of reform measures

in developing countries (Armstrong and et.al cited in Thankom Arun, 2004). The regulatory

framework of any country should therefore have a clear rationale and objectives for regulating the

financial sector, otherwise it leads to wastage of scarce supervisory resources, unnecessary

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compliance burdens of licensed institutions and development of the financial sector will be

constrained.

Principles of Regulation of Financial Intermediaries

The current debate in relation to regulation and supervision of financial intermediaries is not about

whether there should be regulation or not but how much regulation and what kind of regulatory

framework to introduce for microfinance institutions. In order to appropriately design a regulatory

framework of the optimal type it should be very specific in terms of time, location, and institutional

structure of the organization to be regulated (Chaves and Gonzalez-Vega, 1994).

This paper presents the appropriate principles of regulation as:-

Regulation should accord competitive neutrality or fair competition among the MFIs;

Regulation should enhance efficiency (Chaves and Gonzalez-Vega, 1994). But it is important

to note here that measures such as high equity requirements to safeguard the soundness of

financial systems always affects competition and tend to impact efficiency.

All regulatory guidelines and supervisory methods should be subject to a cost-benefit analysis

because overregulation can hamper innovation. For example, while the number of MFIs in

Kenya is high, the cost of supervision tends to be high especially when compared to the actual

risk these MFIs impose on the financial system. This is one of the major challenges for

Kenya’s regulators and supervisors.

The regulatory framework should be dynamic and not static. It should be flexible enough to

fit into the environment in which the intermediaries operate, the market niches they serve, and

their institutional design. According to Chaves and Gonzalez-Vega, the idea is to allow for

diversity of organizations compatible with the diverse needs of the market, but at the same

time to assign the regulatory burden with maximum efficiency.

Prudential Regulation

Different countries apply different instruments of prudential regulation. Therefore, there is a variation

on type and scope of government regulation of depository financial intermediaries. The two

frequently adopted instruments of regulation are preventive and protective regulation.

Preventive Regulation

Preventive regulation is a pre-crisis measure that is taken by external supervisors in order to reduce

the probability of failure of depository financial institutions. Preventive regulation tries to control the

risk exposure of the system. External supervisors use entry and ongoing requirements as instruments

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of preventive regulation. Entry requirements ensure that only financially healthy institutions join the

market place. Generally these are institutions that do not have flawed governance and organizational

structures, have quality staff and portfolios. Otherwise they will negatively affect the financial system

and hence the economy as a whole (Michael Fiebig, 2001). Entry requirements are usually based on

minimum capital requirements, ownership criteria, feasibility studies and other ongoing requirements

such as capital to asset ratio. This is one of the most powerful actions that can be laid down by

external regulators and one of the most difficult for Kenyan MFIs from the less regulated sector to

overcome.

In terms of ownership, according to A. Chaves and Gonzalez-Vega (1994), since the MFIs in

the less regulated sector do not have owners in the traditional sense, this may suggest the need for a

different type of regulation for the microfinance institutions. In terms of capital adequacy, Michael

Fiebig (2001) proposes the idea that for developing countries a higher capital adequacy rate than 8%

to cushion the specific risks of narrow and volatile financial systems and for microfinance providers

in particular to buffer the danger of rapidly deteriorating short term credit portfolios. Stefan Staschen

(2003) recommends stricter capital adequacy requirements for MFIs than commercial banks.

Protective regulation

Protective regulation is a post crisis measure taken by external regulators so that to avoid run on

deposit by assuring the depositors that they will be the first to withdraw the funds from the financial

intermediary. Protective regulatory instruments include government as a lender of last resort, deposit

insurance and the formalized process of financial intermediaries restructuring and reform.

Prudential supervision

According to Chaves and Gonzalez vega (1994), prudential supervision refers to the process of

enforcing the regulatory framework. The financial intermediaries are monitored and directed to ensure

that they comply with the regulatory requirements so as not threaten the financial system. Efficient

regulatory policies are useless if they are not backed by enforcement mechanisms of efficient

supervision (Christen and Rosenberg, 2000).

The challenge here therefore is for a supervisory authority to design indicators for measuring

risks, monitoring and analyzing the impact external events that might have an impact on the

performance of the financial intermediaries. The prudential supervisory system must work as an early

warning system.

Offsite and On-site supervision

An adequate mechanism of the supervision of financial intermediaries has two components. These are

offsite and on-site supervision. The off-site component is the early warning system and is based on

the analysis of the data reported to the supervisory authority. The on-site component involves actual

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visits to the financial intermediaries to verify thatthe data fed to the off-site system are accurate. The

most commonly applied tools for on-site supervision include CAMEL and PEARLS however recent

development indicate that central banks are moving towards introducing risk based supervision

approach.

External and Internal audit for Supervision

It is a fact that the external auditors and internal audit departments of MFIs can besource of

information for supervisory work but the reliability of the information provided by them is determined

by the quality of the external and internal audit practice. The quality of audit negatively affects the

quality of data provided to regulators and hence impacts on the quality of off-site analysis which then

leads to the demand for increased need of on-site examination and hence higher cost of supervision.

East African experiences in regulating and supervising MFIs:

Tanzania case study

The microfinance sector in Tanzania is highly segmented and exists in the form of banks,

financial institutions, community banks, saving and credit societies and NGOs. There are three

commercial banks (National Microfinance Bank, CRDB Bank and Akiba Commercial Bank) that

provide microfinance services. The post bank also provides a variety of saving deposit services.

Saving and Credit Cooperatives (SACCOS) and foreign donor assisted NGOs are also providers of

microfinance services. The primary and legal functions of the microfinance companies in Tanzania

include accepting savings deposits, and fixed (time) deposits from the public, making microfinance

loans making remittances and domestic payment orders and transfers. There is no restriction on the

lending methodology to be used by MFIs. The microfinance institutions are allowed to provide loans

to individuals, groups, micro and small enterprises

The regulatory framework of Tanzania’s MFIs stipulates requirements for licensing such as

adequacy of capital, verification of ownership and manpower competency. Under this regulatory

framework branch opening is also subject to review process. The microfinance companies (MFC) and

microfinance activities law of 2004 also stipulates that the board of directors appoints the internal

auditor who then becomes accountable for them. A specialized directorate at the Bank of Tanzania

(BOT) regulates and supervises the MFIs.

The main regulatory requirements in Tanzania are summarized below:

Minimum Capital Required to establish MFC with nationwide branches TSHS 800,000,000

equivalent to (US$ 587,000)

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Minimum Capital Required to establish unit MFC Tshs 200,000,000 equivalent to (US$

147000)

Maximum Lending Limit .3% of core capital if granted against collateral and 1% of core

capital if secured by other than registered collateral

Capital Adequacy Ratio: Core capital of 10% of RWA or total capital of 15% RWA

No. of Days Past Due Classification ;0 days (Current) 2%,up to 15 days (Specially

mentioned) 25%, 16 – 30 days (substandard) 50%, 31 – 45 days (Doubtful)75% ,More than

45 days (Loss) 100%.

The more notable characteristics of Tanzania’s microfinance industry are (a) the existence ofthe

specialized directorate for microfinance at the country’s central bank, (b) the regulatory framework

for microfinance (which should inform the activities of the specialized directorate and govern the

operations of microfinance intermediaries), which still needs to be drafted by outside consultants,

and(c) a very thin and fragmented microfinance sector whose main players – the SACCOs and NGOs

(at least until NMB and the commercial banks with microfinance programs are able to reach critical

mass in their microfinance operations) – might not even fall within the ambit of the regulatory

authority, even though the BAFIA 1991 gives the Bank of Tanzania the discretion to subject SACCOs

to the same regulations as those [licensed deposit-taking] institutions of similar size and offering

similar activities in order to ensure a level playing field.

Challenges faced and lessons learned from Tanzania

The National Microfinance Policy is a clearly-articulated document, but it is not sufficient to

guide semi-formal and unregulated providers of microfinance services in assessing which institutional

transformation processes need to be considered until the appropriate microfinance regulatory

framework is put in place and becomes operational.

The gap between requirements for and the supply of manpower with financial skills for

banking and microfinance operations is becoming increasingly more apparent as a major constraint to

development of sustainable microfinance. Thus, capacity constraints are a major issue, not only for

providers of banking and microfinance services, but for the regulatory agencies (BOT and the

Cooperatives regulator) as well. A related obstacle arises from Tanzania’s labor laws, which make it

virtually impossible to terminate the employment status of an employee even for just cause such as

fraud.

While the relevant banking and financial laws and regulations clearly permit the

establishment of licensed specialized regional and community banks oriented to rural and micro

finance, there have only been three such institutions established. The reasons and factors underlying

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this need to be identified and better understood by policy makers, stakeholders and practitioners, to

make appropriate adjustments in the regulatory framework.

There is need for a clearly defined strategy on how to integrate SACCOs and NGOs into the

emerging microfinance regulatory framework, and what policy environment, resource and capacity

requirements will be required not only by the institutions but also by the regulatory bodies.

While not specific to the rural and micro finance sector only, the practical application of

accounting methods and standards appear to lag significantly behind the needs of a dynamic and

modern financial sector. Similarly, the tax regime’s treatment of loan loss provisions has an adverse

impact on the application of sound banking practice and compliance with prudential standards.

Two other areas that require attention and appropriate policy action because of their impact

on the growth of micro and small enterprises and of institutional providers of microfinance services

are

o The reporting requirements (and associated time and resource costs) for legalentities and

o The impact of the structure for business and local taxes and impositions thatmake the cost

of transactions much higher or impede the application of and compliance withprudential

banking standards.

Uganda case study

The formal financial institutions in Uganda are composed of Central Bank, commercial banks,

credit institutions and MDI (Microfinance Deposit taking Institution) (David D Kalyango, 2005).

Many other institutions like NGOs, SACCOs and unregistered microfinance institutions also provide

microfinance service. The regulatory and Supervisory framework in Uganda is based on tiered

approach. According to David D Kalyango (2005) the tired approach reflects microfinance as a line of

business and it is conducive to the development of a sound microfinance sector and it does not

constrain the microfinance activities in the country.

The tired approach identifies four categories of MFIs which are regulated using different

approaches that are compatible to their nature. They are allowed to graduate from the first tier to the

next when they meet the requirements of that tier.

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Table 1: The Tiered Regulatory Framework of Uganda

Criteria Level Deposit Taking

Initial capital required

Regulated and supervised by

Tier 1 - Banks which are licensed under the provision of Act 2004 by whichmicrofinance is considered as a new financial product in their lending portfolio.

Yes US$ 2 M Bank of Uganda

Tier 2 - Credit institutions are licensed under provision of the Financial Institutionsact 2004

Yes (but notallowed totake demanddeposits)

US$ 500,000 Bank of Uganda

Tier 3 - Microfinance Deposit taking Institutions (MDIs), which are regulatedunder microfinance deposit taking institutions Act. 2003

Yes US$ 250,000 Bank of Uganda

Tier 4 - Non deposit taking institutions or credit only institutions

No NA Under discussion withMinistry of Finance andumbrella body

Source: Adapted from: How to regulate and supervise microfinance (Kampala, 2000) and Kalyango (2004).

The Micro Finance Deposit - Taking Institutions regulation of 2004 dictates conditions for suitability

of shareholders, liquidity, capital adequacy and provisioning requirements to be complied with by

MFIs. While Uganda’s MDIs Act of 2003 covers issues such as procedures to be followed during

liquidation, management takeover ,receivership, deposit protection mechanisms, application of Credit

Information Bureau, and duties/responsibilities of external auditors.

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Table 2: Prudential Norms set for Uganda Deposit Taking Microfinance Institutions

No Item Requirement Frequency of reporting

1 Liquidity 15% of total deposits Weekly

2 Capital Adequacy Core capital not less than 15% of risk weighted assets.Total capital not less than 20%RWA

Monthly

3 ProvisioningSubstandard (Un paid for 30-60 days)Doubtful (un paid for 60-90 days)Loss (un paid for > 90 days)

25% of outstanding balance

50% of outstanding balance100% of outstanding balance

Monthly

Source: Extracted from Uganda's Micro Finance Deposit Taking Institutions Regulation Issued in 2004

Challenges and lessons learned from Uganda

On the practitioners’ side, smaller MFIs are advocating for a far smaller capital amount (USh 20m

[US$15,000]) compared to the Bank of Uganda(BOU) suggested requirelimit of (USh 700m [US$

388,000]). However, all parties agree in principal that the capital requirements for MFIs needed to be

smaller than those for the formal financial institutions even though it was evident that the bigger

MFIs, especially internationally based MFIs, did not have a problem with the USh 700m requirement.

The promulgation of the MDI Act 2003 has however set the minimum capital requirement at USh.

500m (US$ 250,000).

The key MFIs in Uganda are donor funded, which raises the issue of ownership. The key

question was how donor-funded institutions would become deposit-taking financial institutions and

what would be the appropriate ownership structure?

There is also the fear that BOU had limited experience with MFIs, which would results in

MFIs being subjected to the same rigorous regulations as those applicable to banks. However, through

consultations it has been able to successfully develop specially tailored regulations.

The original thinking at the BOU was that any form of deposit/savings, whether voluntary or

involuntary, had to be regulated and supervised by the Central Bank. To the practitioners, such

measures were too restrictive. They strongly believe that this would stifle innovation especially for

those MFIs that were not intending to mobilize voluntary deposits due to their own lack of capacity.

The practitioners urged that the future of unregulated MFIs was in allowing them to accept forced

savings as a form of collateral. Because, most microfinance loans are character-based and an

important way of securing their portfolios from default is to encourage forced savings from clients.

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Besides, such savings help the MFIs to develop a credit history of the clients. In a bid to promote the

industry and through the consultative process, it was agreed that forced savings would not trigger

licensing requirements as long as they were not intermediated.

The overview of Financial System and Development of Microfinance Sector in Kenya.

The earliest cases of micro-finance and microcredit development were church-based lending programs

that arose in the 1980s. Most were confined to specific church parishes that started with local

financing for members before they developed into institutions that could cover a wider number of

people in rural and suburban areas of Kenya. While these church-based lending programs served the

primary function of providing the credit to the members of their congregations, they were often very

small and operations limited to specific geographic locations hence with limited reach and financial

resources. However, they still served the function of providing limited credit facilities for their

members for use in specific purposes.

However in many cases, these organizations were overwhelmed by the demand for credit by

their membership. From the beginning, nongovernmental organizations (NGOs) began to fill this gap

by extending the credit services more widely. Due to this, in the 1990s, the NGOs developed

functioning systems to facilitate the administration of the credit delivery. The programs were funded

and were not necessarily considered as outright business ventures in spite of the success that most of

the schemes achieved. As the successes of the microcredit institutions grew, they received

considerable funding and began to turn into full commercial entities. This development was also aided

by the increased competence in administration, credit assessment and the organization of individuals

into groups to facilitate the collective guarantee of loans by individual members. As the micro-finance

industry in Kenya grew, the institutions assumed various formal structures and were registered under

different statutes.

Towards the end of the 1990s, many micro-finance institutions moved away from serving

closed groups and into more formalized institutions. This institutionalizationnecessarily required that

the micro-finance and micro-credit institutions also move away from subsidized institutions into more

commercial entities. Evidence of the growth and increasingly significant role played by the micro-

credit and micro-finance institutions is seen in the development of the K-Rep Bank. The K-Rep bank

is the first of the micro-finance institutions in Kenya to develop into a full commercial banking

enterprise. In order to formally conduct its business as banking institution, the K-Rep Bank in Kenya

is registered under the Banking Act (Cap 488).

The Kenyan banking sector has experienced a continued growth trajectory. It is developing

and deepening faster than the overall economy. It grew by 9% in 2010 and 7.8% in 2011, while the

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economy grew by 5.8% and 4.4% in 2010 and 2011 respectively. This development within the

financial sector is strongly guided by the medium-term objectives of the financial sector reform and

development strategy embedded in the economic development blueprint, ‘Vision 2030’, which covers

the period 2008-2030. The 2030 vision for financial services is to create a vibrant and competitive

financial sector that will create jobs and promote a high level of savings to finance Kenya’s overall

financial needs. It provides for the introduction of both legal and institutional reforms in the sector

that will enhance transparency in all transactions, build trust and make enforcement of justice more

efficient.

Some of the specific developments include continued expansion of the sector through

branches and other places of business across Kenya as well as the larger East African region; growth

of the deposit-taking microfinance sub-sector; increased permeation of mobile financial services, with

more financial service providers entering into partnership with mobile service providers to provide

financial services through mobile phone platforms; and greater usage of the agency banking model,

which was rolled out in May 2010, to allow commercial banks to engage third parties to offer

specified banking services on their behalf.

Kenya’s Regulatory architecture

The Microfinance Act 2006

The microfinance industry in Kenya is primarily governed by the Microfinance Act 2006 (Chapter 19,

Laws of Kenya) (the “Microfinance Act 2006”), and by the Central Bank of Kenya Act (Chapter 491,

Laws of Kenya) (the “CBK Act”). The main objective of the Microfinance Act is to provide the legal,

regulatory and supervisory framework for the DTMs. The Act categorises the Deposit Takings MFIs

as nationwide MFIs (operating countrywide) with a minimum core capital of KES 60M (USD

860,000) and Community MFIs (operating within a specific administrative region) whose minimum

core capital is KES 20M (USD 300,000). The Act makes provisions for MFI licensing issuance,

revocation and restriction, provides for MFI entry into regulated status, defines the minimum core

capital requirements and prohibited activities, provides limits for loans or credit facilities, defines

ownership and management structure, provides for supervision by CBK and stipulates the terms for

periodic reporting to the CBK.

The Microfinance (Amendment) Bill 2013 increased the range of financial services that the

DTMs can offer. It is now possible to differentiate regulated MFIs from other un-regulated lenders

because they are required by law to incorporate the term DTM into their names. Thereby enhancing

market confidence in Kenya’s MFI Sector. Section 14 of the Microfinance Bill was amended to

ensure that now the DTMs can issue third party cheques, operate current accounts and can perform

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foreign trade operations .It is argued that the transformation of DTMs into microfinance banks will

help in reducing their reliance on loans from local and international banks for lending.

The Deposit Taking Microfinance (DTM) Bill

The Deposit Taking Micro Finance Bill inter alia, specifies three different tiers of micro finance

institutions and who should regulate and supervise them:

First tier — Formally Constituted Deposit-taking MFIs: MFIs intending to take deposits from

members of the public regulated and supervised by CBK via the Deposit Taking Micro Finance Bill.

The Bill empowers the CBK to license, regulate and supervise formally constituted micro finance

institutions intending to take deposits from members of the public. Specific performance parameters

and appropriate guidelines will be developed to facilitate supervision of this group of MFIs. This

group of MFIs are members of the

Deposit Protection Fund Board (a deposit insurance scheme) that protects depositors’ deposit up to

KES. 100,000.

Second tier — Formally Constituted Credit-Only MFIs that do not take deposits from the

public but can accept cash collateral tied to loan contracts are regulated and supervised by the

envisaged Micro Finance Unit in the Ministry of Finance through regulations issued by the Minister

for Finance.

Third tier — Informally Constituted MFIs like ROSCAs, club pools, and financial services

associations (FSAs) are not be supervised by an external agency of the Government. Donors,

commercial banks, and government agencies from which they obtain funds or that support them are

obligated to carry out due diligence and make informed decisions about them.

Financial Institutions Department and Rural Finance Department

In the year 2000, CBK set up a microfinance division in the Bank Supervision Department (now

Financial Institutions Department) to participate in the drafting of the Microfinance Bill and to

develop prudential guidelines/regulations to be used once the Bill was in place. In 2004, the Central

Bank established a Rural Finance Department to address various policy issues concerning rural

finance, including microfinance. This department, in liaison with the Financial Institutions

Department is involved in developing capacity to regulate and supervise those microfinance

institutions that will be licensed under the DTM Bill.

Microfinance Units

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A Fully-fledged microfinance unit is envisaged at the Ministry of Finance (the Treasury) to formulate

policies and procedures to address the challenges facing microfinance institutions not supervised by

CBK, especially those in the rural areas, and to build a database to facilitate better regulation and

monitoring of their operations.

The Association of MFIs in Kenya

The Association of Microfinance Institutions (AMFI) is a member-based institution, registered in

1999 under the Societies Act by the leading MFIs in Kenya, with the aim to build the capacity of the

Kenyan microfinance industry. The main reasons for its establishment were the felt need for MFIs to

have a common voice; to lobby government for favorable policies; to share information and

experiences and to link up and network with both local and international actors.

AMFI currently has 59 member institutions serving more than 6,500,000 poor and middle

class families with financial services throughout the country. Membership ranges from banks such as

K-Rep and Equity to Deposit Taking Microfinance such as Faulu Kenya and KWFT smaller and rural

MFIs such as KADET and Aga Khan Foundation micro credit program as well as micro-insurance

providers such as Chartis and CIC insurance, wholesalers such as the government backed Women

Enterprise Fund, SACCOS such as Unaitas and development partners such as Swiss contact.

AMFI is governed by a General Assembly and is led by a Board of Directors who

experienced practitioners are running some of the leading microfinance Institutions in Kenya. AMFIs

mandate is to enhance collective action by MFIs and other stakeholders for a conducive policy and

regulatory environment for microfinance in Kenya;to strengthen the capacity of MFIs in delivering

appropriate and sustainable microfinance services to low income people, through organization and

coordination of workshops and training sessions and effective systems for information collection,

analysis and dissemination ;to develop and operationalize a Performance Monitoring System for MFIs

that will set standards and increase professionalism in the industry and to enhance collaboration,

linkages and partnerships between AMFI, its members and other development actors and

stakeholders, both locally and internationally.

Financial Reporting Centre

The Financial Reporting Centre (the “Centre”); established under the Proceeds of Crime and Anti-

Money Laundering Act, 2009 (the “AML Act”) became fully operational in 2012. The centre’s

principal role is to assist in the identification of the proceeds of crime and the combating of money

laundering. All banks, financial institutions, non-bank financial institutions, mortgage finance

companies and forex bureaux are obliged to monitor and report suspected money-laundering activities

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to the Centre, verify customer identity including that of existing customers, establish and maintain

customer records, and establish and maintain internal reporting procedures. With regard to cash

transactions, the reporting threshold for reporting institutions is set at US$10,000 or its equivalent in

any other currency, irrespective of whether or not such transactions are suspicious. This means that a

reporting institution would have to report to the Centre any cash transaction whose value is or exceeds

US$10,000 or its equivalent in any other currency. Banks and financial institutions have complained

that this is a relatively low threshold, and results in numerous transactions having to be reported.

The Prudential Guidelines

Prudential guidelines deal with a wide range of issues including licensing requirements, corporate

governance, board composition, remuneration of directors, capital adequacy requirements, liquidity

management, stress testing, foreign exchange exposure limits, prohibited business, anti-money

laundering, consumer protection, enforcement of banking laws and regulations, agent banking, and

representative offices.

The reason behind these new Prudential Guidelines is best summarized by reference to the

circular issued by the CBK which states that: “Pursuant to its mandate of fostering the liquidity,

solvency and proper functioning of a stable market-based financial system, the Central Bank of Kenya

has conducted a comprehensive review of the Prudential Guidelines and Risk Management Guidelines

currently in use. The review has been necessitated by developments in the national, regional and

global arenas and the need to proactively strengthen the regulatory framework for banks and other

institutions licensed pursuant to the Banking Act.”

Retail Transfers Regulation

As part of Kenya’s recent move to bring in adequate measures for consumer protection and to prevent

money laundering, the CBK has published the draft Retail Transfers Regulation, 2013 (the

“Regulation”) for provision and regulation of electronic retail transfers and e-money. Stakeholders

have been invited to review and comment on this draft Regulation before it is brought into force. The

Regulation will apply to all retail transfers utilizing an electronic payment method, and to all payment

service providers that are not licensed as banks or financial institutions. Such payment service

providers will be required to apply to CBK for authorization and, at the time of authorization, will be

required to hold a core capital of not less than KES 10m (approximately US$119,000). If the

Regulation is brought into force, service providers would need to report any suspicious transactions

which indicate possible money-laundering or terrorism financing to the Financial Reporting Centre.

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Islamic banking

There are currently two fully-fledged Shariah-compliant banks and a few conventional banks that

have an Islamic Banking arm but there are no fully fledged shariah compliant MFI in Kenya. A few

donor funded Islamic microcredit projects exist; none of which are regulated by CBK or are members

of AMFI. The challenge for offering Islamic financing has been the lack of a proper legal framework,

which prevents financial institutions from providing certain products. In addition, there is ambiguity

in respect of the tax treatment of Shariah-compliant financial instruments.

Recent regulatory themes and key regulatory developments that may impact MFI operations

A credit information-sharing mechanism was launched in July 2010 continues to be used by both

commercial banks and individuals. Through this mechanism, the CBK has ensured that banks have

strengthened credit appraisal standards by their incorporating credit reference reports in the credit risk

appraisal. However regulation has not yet been amended to allow MFIs to incorporate this process

into their credit appraisal system.

The Kenya Deposit Insurance Act, 2012 (the “KDI Act”), which has been assented to but is

yet to commence, provides for the establishment of an autonomous body called the Kenya Deposit

Insurance Corporation which will replace the current Deposit Protection Fund Board, a department of

the CBK. The KDI Act provides for the setting up of a deposit insurance system, and the receivership

and liquidation of deposit-taking institutions.

There is increased interest in Islamic MFI and non-deposit-taking microfinance business in

Kenya; areas not covered by specific legislation as yet.

Suggestions for further research

Further research needs to be done to determine the actual minimum capital requirements for every tier

of the regulatory and supervisory framework for MFIs.

It is also important to research into the exact number, size and suite of products offered by

MFIs in the less regulated sector so that it is then possible to design an appropriate regulatory and

supervisory framework.

Many MFI are moving towards the use of mobile phones for various transactions yet there is

no regulation in place to supervise these popular and globally acclaimed services. Urgent studies into

this arena are therefore very much required.

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Finally research into the definition of a proper legal framework and policies for Islamic finance needs

to be conducted if the Kenya expects to achieve significant growth in this sector.

Conclusion:

Most of the literature in the area of regulating and supervision MFIs confirms that themicrofinance

sector has to be regulated in order to have massive and sustainable delivery offinancial services to the

lower income section of the population. Therefore, the issue ofPrudential regulation and supervision

of MFIs is key to its success yet it is also a complex matter because it keeps evolving.

One of the objectives of this paper is to provide an appropriate model for tackling the

challenges and constraints of Kenya’s current regulatory and supervisory framework. In this regard

the paper will provide suggestions for a regulatory framework that will facilitate the transition of

MFIs from lower tier to the upper tier without creating problems of regulatory arbitrage. This will

involve the determining the impact of linking capital adequacy requirement not only to total capital as

well as the core capital of the MFI; the availing of special treatment by the regulators to Commercial

Banks, international MFIs and NGOs that have an interest in owning equity in MFIs; the review of

loan classification provisioning percentages; an improvement into the off-site reporting system.

References:

Albino Dak Othow, Micro-finance Unit, Bank of Southern Sudan, Microfinance n Sudan, Regulatory framework and Vision

Anne Pouchous The Regulation and Supervision of Microfinance: The International Institute for Sustainable Development September 2012

Bikki Randhawa, Joselito Gallardo, Microfinance Regulation in Tanzania: Implications for Development and Performance of the Industry Africa Region Working Paper Series No. 51 June 2003

Cassian J. Nyanjwa, Central Bank Of Kenya, The Status Of The Microfinance Industry In KenyaPresentation At The 5th Afraca Microfinance Forum 2nd - 4th July 2008 Cotonou, Benin

Chaves R. and C. Gonzalez-Vega, "Principles of Regulation and Prudential Supervision and Their Relevance for Microenterprise Finance Organizations 1994

David Kalyango, Bank Of Uganda, Uganda’s Experience With The Regulatory And Supervisory Framework For Microfinance Institutions, May 2005

177

David. L. Kalyango, Uganda’s Experience with Tiered Banking RegulationGeorge Omino, Central Bank Of Kenya, March 2005 Regulation And SupervisionOf Microfinance Institutions In Kenya

Hennie van Greuning Joselito Gallardo Bikki Randhawa A Framework for Regulating Microfinance Institutions, Financial Sector Development Department, The World Bank, December 1998

Marguerite S Robinson, The Microfinance revolution: Sustainable Finance for the poor, 2001 ISBN-10: 0821345249 | ISBN-13: 978-0821345245

Michael Fiebig, Prudential Regulation and Supervision for Agricultural Finance, Food and Agriculture Organization of the United Nations, 2001

Reinhard H. Schmidt and J.D von Pischke, Networks of Micro and Small enterprise banks:a contribution to financial sector development, Frankfurt and Washington issn 1434-3401

Robert Peck Christen, Timothy R. Lyman, Richard Rosenberg Microfinance Consensus Guidelines © 2003 by CGAP/The World Bank GroupJune 2003

Robert Peck Christen, Richard RosenbergThe Rush to Regulate: Legal Frameworks for Microfinance, Consultative group to assist the poorest (CGAP), 2000

Sonal Sejpal & Mona Doshi, Anjarwalla & Khanna, Banking Regulation: Kenya, Global Legal insights, 1st Edition

Stefan Staschen, Regulatory Requirements for Microfinance, A Comparison of Legal Frameworks in 11 Countries Worldwide Deutsche Gesellschaft fürTechnische Zusammenarbeit (GTZ) GmbH,2003

Special Issue, Kenya Gazette Supplement No. 169 (Acts No. 41) Acts, 2013 Nairobi, 2nd December, 2013 The Microfinance (Amendment) Act, 2013 page 1101

T G Arun, JD Turner, Corporate governance of banks in developing economies: concepts and issues 2004

Yigrem Kassa, National Bank Of Ethiopia, Regulation & Supervision Of Microfinance Business In Ethiopia: Achievements, Challenges & Prospects, presentation at the International Conference On Microfinance Regulation, March 15-17, 2010, Bangladesh, Dhaka

Websites

www.vision2030.go.ke

www.amfikenya.com

www.centralbank.go.ke

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Paper 13

The Effectiveness of Regulatory and Supervision Framework of Islamic Microfinance in Sudan

Abd elrahman Elzahi Saaid Ali, (PhD.)Islamic Research and Training Institute (IRTI/IDB)

AbstractIslamic microfinance is one of the essential unconventional branch of lending that uses by Islamic finacial institutions to mitigate the negative impact of the extreme poverty. Since finacing micro-borrowers and extremely poor projects are highly risk, the need for efficient and effective regulatory and supervision of microfinance frame work is very important. This research investigated Sudnese Islamic microfiance regulatory and supervisory framewark. The results of this research gives stromg policy implications for both government of Sudan to carry on some improvement in their experience of supervsion and the users of Islamic microfiance in and ouside for further improve thier dealing with Islamic microfinance institutions.

Key Words: Islamic microfinance, regulatory of Islamic microfinance

Introduction:

Recently Sudanese economic has weakened. The country economic growth was totally depending on

exporting crude oil since the beginning of this century particularly after 1999. The country used to

depend on mainly on agricultures and livestock before the oil. The game is over. Sudan loosed 75% of

its oil revenue due to the secession of the South in 2010. In addition to that the internal and regional

conflicts, heightened political tensions, are continuing to effect the economic growth which eventually

leads to the high unemployment and disadvantages among most of the citizens.

Sudan dominated the political instability from the independence in 1956. Since then the

country exposure to three military cops. All the civil governments that attempt to rule the used to be

the largest country in Africa were overthrown in an overnight by the military even before

implementing their agendas. Other factor contributed to the unemployment and poverty is longest

civil wars and the internal conflicts across the regions.

Civil wars had great imact on the economic growth and creates econoimical and political

disorder. Sudan has the longest civil wars in the continent between the North and the South since

1955 until 2005. In addition to the ongoing internal conflects between the North and Western Sudan

since 2003 fueling on the previous valnerable areas due to the huge immigrations of people

particulary from rural inhabitants. More people leaved thier farms and lost thier livestock to live as

refugees around the urban cities.

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The Sudan has a histrory of high inflations and strcutre economic disorder particularly during

the 1980th and the 1990th. The country also among the poor and low income and highly indebted

countries. Sudan economics growth was started to improve shortly after had started exporting the

crude oil in 1999. Unfortunately the economic prosperity was not complete due to the secession of the

south that lead to the lost of three quarter of the oil revenue.

The slowing economic growth following the secession of the south, the continuing US

economics sanction and boarders conflicts have exaggerated the high existing unemployment for the

country of more than 40 million population majority are Muslims. Moreover, the country faces the

challenges of economic diversification. Sudan is only Arab country that has most fertilize land and

huge livestock resources, faces high unemployment and more disadvantages people most of the in the

rural areas. Hence, the outgoing factors and other such as that related to the unrelevent jobs education

and skills mismatch training might lead to unfavorable economic conditions that caused the current

high unemployment and extreme poverty across the country.

Sudan government who aware of the dilemma has taken immediate policy priorities including

micro-financing business model as is an initiative to assist in restoring the confidence and create more

jobs for its people particularly among the youth, the graduates and skillful categories.

The country has complete transform the all the conomics into Islamic system since more than

twenty years. Being the majority are Muslims and more than 25 Islamic banks in addition to others

non- banks Islamic financinf providers, the country has become a suitable host for Islamic

microfiance. Islamic microfinance is one of the essential unconventional branches of lending that use

by Islamic financial institutions to mitigate the negative impact of the extreme poverty and

unemployment among the people in Muslim countries and Muslims minorties in non-Muslims

countries. Sudan is the pioneer country that adopts Islamic mirofinance among other Muslims

countires.

Islamic Microfinance in Sudan: Opportunities and Challenges:

Opportunities:

The Government of Sudan aware of the challenges of the chronic poverty that dominated the country

even before the National Revolution Salvation in 1989. Since then the government has attempted

many initiatives to reduce the bearding from the shoulders of the poor particularly in the rural areas.

The current Sudanese government supported the Islamic finance in general and Islamic microfinance

in particular from its inceptions.

Islamic financial infrastructure has witnessed tremendous growth and improvement since

1989. The government transformed the available dual economic system into Islamic financial system.

This initiative has improved Islamic financial infrastructures and made enabling environment for

Islamic microfinance and its supportive intuitions such as Waqf and Zakah to play their vital roles in

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helping the poor in Sudan. Due to that Islamic banks have increased from about four banks before the

Islamization of the economic to more than 28 commerical Islamic banks and financial institutions by

the end of the twenty century. In addition to the Islamic commercial banks, there are also at least more

than three specialized banks working effectively with its branches scatored all over the country.

Recently the country also witness the entrasnce of some foreign banks has joined the banking

operation particularly from Emirates. The new copital injected from the foreign banks, improve

banking technology in Sudan, enhence skills that might lead the good banking servies, improving

banking outreach and might help in getting better financial inclusion.

Moreover, for a better broading the economic and providing sustianable source of financiaing

for the Sudanese exportors, the Central Bank of Sudan and the Ministry of Finance and National

Economy were jointly established a National Agency for Insurance and Finance of Exports. The goal

of this agency is to provide and expands the financing the resources of for Sudanese exporters.

Hence, the establishment of National Agency shows an additional evidence for Sudanese government

in supporting financial infrastructure in general and the micro producers in particular.

Zakah collections and Waqf system was revived to play their designed role effectively as are

needed by the Maqasid Al-shari’ah. Zakah is very important tools for poverty alleviation. It is the

right of the poor on the wealth of the rich people. Islamic microfinance can better use Zakah fund to

provide the basic needs for the extremely poor. This will pave for better utilization of the

microfinance fund. Moreover, Zakah help in reducing the unemployment by recruiting considerable

number of people and helping them to have small projects specially the women. The strategic of the

Sudan government was also to revive the Waqf and to encourage all types of Sadaqah including Al-

Gardul Al-Hassan. Waqf either land or cash can play essential role to support microfinance and help

in uplifting the extremely poor in the community. Having reviving Waqf, Zakah and Sadaqah,

Sudanese government went further step to establish effective Islamic microfinance model that might

help in alleviating the poverty in the country.

Other very essential opportunities for Islamic microfinance in Sudan is that the availability of

the sound Islamic Micro-Finance infrastructure. The Islamic financial infrastructure in Sudan

represents an enabling environment for Islamic microfinance that created good opportunity for it to

grow and prosper. The establishment of the Islamic financial institutions followed adaptation of the

Shariah law all over the country in September 1984. The all ready existing Shariah law help the

central banks of Sudan to adopt regulations and supervisions guide lines to be extracted from Islamic

jurisdictions more easily compared to other country in the region. In addition to that the availability of

the natural resources such as agriculture land and livestock in the areas of disadvantages people in

Sudan has created another opportunity. Agricultures represent more than 36% from the national

income of Sudan. Most of the disadvantages people in Sudan are traditional farmers and livestock

producers. Hence the involvement of the Sudanese Islamic and Islamic microfinance intuitions along

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with the local and international ONGs under the guidance the supervision of the Sudanese Central

Banks provides effective services to reduce costs and expand outreach.

Despite of the favorable Islamic financial system development in Sudan, Islamic

microfinance is not risk-free. There are more challenges facing Islamic Microfinance particularly in

the very fragile areas such as western and eastern Sudan. Sudan is very big country in Africa with

more disadvantages people outside the main town. Similar to Sub-Sahara and other IDB member

countries, Islamic microfinance faces the challenges of poor quality basic infrastructures. Previous

studies showed that the quality and the development of the basic utilities such as energy, water,

transportations (land and marine), warehouses, rural infrastructure, and low cost technologies are very

essential for the Islamic micro finance . The weakness on basic infrastructure represents big challenge

which hinders Islamic microfinance institutions and their ONGs alliances to reach the poor in the very

remote areas. Moreover, putting in mind the nature of Islamic finance such as Al-salam and Istisna’a

in to consideration, the availability of warehouses and cheap in-land transportation are even more

essential.

Challenges:

Despite of the financial support of the Islamic development banks, UN, and Sudan governments,

accessing Shari’ah Compliant Sources of Funds is one of the most formidable challenges facing

Sudanese Islamic microfinance in the Sudan. Given the high rate of the poverty and the recent

separation of the rich South part of Sudan, Sudanese economic has encountered sever instability. This

is in addition to the high demand for Shari’ah fund due to the uprising civil wars that lead to more

disadvantages on the countryside areas. Hence the limited donors fund, inability of the government to

provide sustainable micro-financing support for the poor and the microfinance institutions, lead to the

severe shortage of Shari’ah Compliant Sources of Funds.

The nature of Sudanese Islamic microfinance model is involving more payers, need to co-

ordinate between them-selves. All these parties are supporting the development of Islamic

microfinance in the country. They are either providing the microfinance services directly to the

beneficiaries such as Islamic banks and non-banks microfinance institutions or supporting and

managing the Islamic microfinance system such as the Central Banks of Sudan and the Ministry of

Economic and Finance, Zakah and Waqf institutions in Sudan, internal and external donors and the

leaders of the Sudanese community in the disadvantages areas. Hence the absence of coordination

between micro-finance providers in term of data, information and exposure best practices, experiences

and other parties might represent one of the more challenges facing the successful of Islamic

microfinance in Sudan. Therefore, there is an argent need for establishing effective and electronic

networking among these contributors to Islamic microfinance in Sudan, particularly between banks

and non-banks sector, Ministries of Economic and Finance, the Central Bank of Sudan and the

donors.

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Microfinance outreach to the extremely poor people is one of the main goals of the

microfinance providers. Sudan is an extended country with wide and undeveloped country side areas

in which rural and farmers are reside. Considering the nature of Islamic financing that based on profit

sharing and Salam mode of finance, the poor communication, and the weakness of the Sudanese basic

infrastructures are represent one of the most challenges hindering Islamic microfinance services

deliverance to the disadvantages areas.

Another big challenges facing Islamic microfinance is the high tax. Sudan like any other less

development country depends on tax revenue in many aspects. There are more than 20 types of tax on

the income or the agricultures products. None the less more than authorities taxing the same product

particular when moving it from one area to another are for the recommended market. Human

development is one of the essential priorities for the successful of microfinance. To provide effective

and successful microfinance to poor the Islamic finance providers much give much attention to the

capacity building need of the beneficiaries. Most of the disadvantages people in Sudan they are lack

of expertise in many areas related to their microfinance project such as identifying the opportunities,

feasibility studies, cost evaluations and marketing their output to end users. Hence building capacity

apart of the other might represent one of the challenges need to solve for the successful of the Islamic

microfinance model.

Regulatory and Supervision Framework of Islamic Microfinance in Sudan:

The previous section shows that the Sudanese government exerted more efforts to build reseanable

Islamic financial infrastures through complete Islamization of the economic. This intiatve has created

reasonabling enabling environment for encubating Islamic microfinace. the government was aware of

the regulatory and supervision challenges that might face the implementation of Islamic microfinace.

hence, the Central Banks of Sudan was empowered to play the role of the regulatory and supervision

for the microfiance in addition to the orginal madated job.

Since the interest rate was completely abolished from the Sudanese financial systems, the

previous role of the Central Bank of Sudan on regulation, control, supervision, promotion and

development of the banking business and enhancement has modified or changed into Shari’ah based

tools. Based on the additional empowering to regulated Islamic microfinance, the CBOS role has

become not only limited to the designing of the monetary policies, and prudential regulation and

supervision and promoting the economic growth through these policies, but also encouraged to play

vital role in developing a comprehensive financial system that include Islamic microfinance business

model.

To expand the base of the banking services, prepare policies, control and supervision and

regulations for the development of inclusive financial system that cater for micro-finance producer,

the Banking Supervision Department of the CBOS together with a Sudanese consultancy firm, were a

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pointed to lead the team. in additional to that the Banking Supervision Department has a pointed to

prepare policies and regulation for licensing Islamic micro-finance. To achieve that purpose

effectively the Banking Supervision Department established Micro Finance Unit to cater for

promoting microfinance through banks and non-banks institutions. The Micro Finance Unit also

reuqired to play the role of facilitator bbetween Islamic microfiance providers and government and

non-government technical resources. the mian objectives of Micro-Finance Unit is to assist in

developing collaboration and coordination among microfiance providers and offering them whole sale

financing based on the Central Bank of Sudan guidences.

The central bank of Sudan played an instrumental role in alleivating poverty through

promoting Islamic microfinance as a part of financial sector development. Moreover, the central bank

dirct the the Sudanrse banks to allocate 12% out of thier total lending to the micro-fiance projects as

part of the Central Bank policy. The CBOS has also given more emphasis on reducing the extreme

poverty particularly in the rural sector-marginalized farmers, artesian-vendors, household sector and

other alike disadvantages groups in the community.

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Paper 14

Using Subsidy Dependence Index for Regulating and Supervising Microfinance Institutions: A Pakistan’s Case

Hina AlmasResearch Scholar, MS Economics & Finance,

International Institute of Islamic Economics (IIIE), International Islamic University Islamabad (IIUI), Pakistan.

Muhammad Mubashir MukhtarResearch Assistant, Center for Entrepreneurial Development (CED),

Institute of Business Administration (IBA), Karachi, Pakistan.Corresponding author: Tel: +92-333-3147454;


AbstractMicrofinance provides strength to boost the economic activities of low income group people and thus contributes to alleviate their poverty. Research has highlighted the role of microfinance institutions in reducing the sufferings of poor. Issue of Sustainability of microfinance institutions has received the attention of researchers in the last few decades. In Pakistan microfinance institutions have been facing challenge of trade-off between targeting the poor and achieving financial sustainability. This paper investigates the level of Subsidy Dependence of eight different microfinance institutions working in Islamabad and Rawalpindi. The sample institutes comprise of conventional and Islamic microfinance institutions. While numerous researches have been done in other countries on exploring this issue, no such study has yet been done in Pakistan especially in Rawalpindi/Islamabad. In measuring the subsidy dependence this paper uses Subsidy Dependence Index (SDI) model proposed by Yaron (1992). Data have been drawn from financial statements of MFIs from the year 2006 to 2012, available at mix market website and annual reports of MFIs. Findings of this study highlight the level of self-sufficiency and self- sustainability level of microfinance institutions and extent to which these MFI has reached its target clientele through achieving the social objectives it was set to achieve. SDI can play a vital role as a supervisor and regulatory tool for Islamic Microfinance Institutions.

Introduction

Microfinance sector has been considered as an effective tool for poverty reduction. However

microfinance sector has been currently facing many challenges specially mission drift. When

microfinance institutions focus their attention on social objectives like poverty reduction, they have to

face the risk of financial unsustainability. MFIs need to be economically viable and sustainable in the

long run but at the same time they must consider economic implications of long term sustainability,

which are not being considered, (Srinivasan et al., 2006).

The microfinance revolution and the remarkable development of the Microfinance industry in

scale and scope raise demands for increased justification on the utilization of scarce public funds. In

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order to allocate these resources in the most efficient way, performance evaluation should reveal an

accurate and meaningful picture of the performance of MFI in term of reaching the objectives desired

by society and the efficiency in developing products and services to the target recipients, (Yaron and

Manos 2008).

While a vast amount of literature exists on the trade-off between outreach depth and financial

sustainability, much less research has been done in the field of how successful MFIs designed their

institutions to bridge the trade-off, (Woller 2004).

MFIs must grow in both the outreach and financial sustainability dimensions if they are to

achieve their social objectives like poverty reduction. In case of Pakistan MFIs are facing the

challenge of tradeoff between achieving financial sustainability and targeting the poor. Empirical

evidence from other countries states that if MFIs have to serve the poor in remote rural areas, it may

be difficult for them to achieve financial self-sufficiency due to higher transaction costs. The

underlying research aims to investigate this issue in Pakistan context. In such a case, some level of

subsidy may be justified if they can be shown to be more effective than alternative strategies to reduce

poverty. Nonetheless, MFIs should strive to achieve financial sustainability by reducing operational

costs. The higher the degree of self-sufficiency, the greater the extent to which an MFI can leverage

donor and government funds to expand outreach.

This paper initially explains the background including detailed view of current methodologies

for measuring performance of MFIs in Pakistan as well as their objectives and limitations. Further on

it gives a description of SDI and overview of literature across the world related to this research. It then

develops and calculates SDI on a sample of eight MFIs working in Islamabad and Rawalpindi,

including both conventional as well as Islamic MFIs.

Setting the Context

Background: Detailed View of Current Methodologies

Below is a detailed view on some current methodologies for evaluating MFIs,

Techniques Objective Limitations

Difference-in-Difference (DID) To assess the impact of microfinance program on various outcomes.

Failure to take into account externalities and spillover effects, and the differencing nets out the effect of the comparison group.

Stochastic Frontier Analysis (SFA)

To estimate cost function for MFIs

This method inherently renders biased coefficients.

Operational Self Sufficiency To indicates whether enough OSS only covers operating

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Techniques Objective Limitations

(OSS) revenue has been earned to cover the MFI’s direct costs, excluding the cost of capital but including any actual financing costs

income and operating expenses along with a provision of loan loss. But it does not include cost of capital, which can depict a real picture of the financial sustainability of the MFIs.

Financial Self Sufficiency (FSS) To portray financial health of MFIs.

FSS measure tends to underestimate the subsidy dependence of the MFI

SDR To compare subsidy with revenue both from loans and from investments

The Break Even Condition In depth economic analysis of the institution.

Data Envelopment Analysis (DEA)

To measure cost efficiency of MFIs

It cannot control measurement errors and other random effects

The Return on Assets (ROA) and the return on equity (ROE)

To evaluate the performance of MFIs

They ignore the subsidies received by MFIs and opportunity cost of capital

Discounted Cash Flow (DCF) method

To measure performance of MFIs

It requires the implementation of a different data collection system to that which the organization uses to generate its financial statements

Economic Value Added (EVA) To measure the amount by which the profit made by the firm exceeds the return required by the suppliers of capital

It requires accounting figures are adjusted so that profit is measured more accurately

SDI To measure the self-sustainability level of the MFI

SDI compares subsidy only with revenue from lending even though MFIs also get revenue from investments in non-loan assets such as treasury bills.

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General Overview of SDI:

Subsidy Dependence Index (SDI) was initially proposed by Yaron (1992). It assesses and quantifies

subsidy dependence with a single number and also measures the extent to which the lending interest

rate or profit rate would have to be raised in order to cover all operating costs if any subsidies the

MFIs receive were to be uncovered (Hulme and Mosley 1996: 43). SDI highlights the cost to society

of subsidizing the MFI, relative to the interest plus fees or profit plus fees paid by the target clientele

to the MFI. According to Yaron (1992), SDI is calculated as ratio of subsidy and loan portfolio

multiplied by lending rate of interest. SDI = S / (LP * i)

where:

SDI = Index of subsidy dependence of the MFI

S = Annual subsidy received by the MFI (see below)

LP = Average annual outstanding loan portfolio of the MFI

i = Weighted average yield earned on the loan portfolio of the MFI.

The amount of the annual subsidy received by the MFI is defined as:

S = A(m - c) + [(E * m) - P] + K

where:

S = Annual subsidy received by the MFI

A = MFI concessionary borrowed funds outstanding (annual average)

m = The assumed interest rate that the MFI would have to pay for borrowed funds if

access to concessionary borrowing was eliminated.

c = Weighted average annual concessionary rate of interest actually paid by the MFI on

its annual average concessionary borrowed funds outstanding

E = Average annual equity

P = Reported annual profit before tax (adjusted, when necessary, for loan loss provisions,

inflation, and so on)

K = The sum of all other annual subsidies received by the MFI (such as partial or

complete coverage by the state of operational costs of the MFI).

Literature Review

Social objectives of microfinance are defined as “the effective translation of an institution's social

goals into practice in line with accepted social values; these include sustainably serving increasing

number of poor people, improving the quality and appropriateness of financial services and improving

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the economic and social conditions of clients”0 . With these two objectives microfinance can be an

effective way for poverty alleviation and for achieving social and economic impact. Social

performance is being measured by using some variables as proxies like number of borrowers, average

loan size, percentage of female borrowers etc.

The microfinance industry is characterized by a “schism” (Murdoch 2000) which spurs debate

between two streams of thought. On the one hand are institutionalisms who focus on achieving

financial self-sufficiency by outreach in scale (targeting more the marginally poor), while on the other

hand, welfarists emphasize outreach in depth and social impact and attribute an important role to

subsidies. While institutionalists regard "subsidized" institutions as inherently inefficient (Murdoch

1999, Hollis 1998), welfarists argue that all crucial microfinance innovations came from flag-ship

institutions such as Grameen Bank, ACCION and FINCA which were heavily dependent on donor

funding at the time of innovation (Woller, Dunford, Woodworth 1999).

Despite the fact that there is a common understanding on the importance of financial

performance and gradual strive towards sustainability (Tucker 2001), the debate goes on with regard

to fulfilling the promise of microfinance in reaching out to the “poorest” of the poor. Various surveys

such as the one conducted in Bolivia (Navajas 2000) show that the majority of households reached by

MFIs were near the poverty line. That means that they rather reached the marginally poor than the

very or rural poor.

This opened the debate on the depth of outreach and Schreiner (1999) aided discussions by

proposing a framework which defines the six dimensions of outreach such as worth, cost, depth,

breadth, length, and scope. Depth of outreach he argues is the preference of society towards recipients

of funds. As direct measurement through income or wealth is difficult, Schreiner (1999) proposes

indirect proxies for depth such as gender (women are preferred) and location (rural is preferred).

Deepening outreach accordingly means to extend services to women and to remote rural

areas. Rural finance however usually triggers high transaction costs and increased risk due to

dispersion (Mayer and Buchenau 2007). High transaction cost and risk thus often serve as argument

by those focusing on sustainability against reaching out to remote rural areas. During the past ten

years considerable concern arose over the increasing emphasis on financial performance as this often

served as legitimization for drifting from the original social mission in servicing the very poor.

The significant development of the Microfinance industry resulted in a broad spectrum of

“Microfinance institutions” ranging from organizations who regard social objectives only as

byproducts to those who focus on translating their missions into practice (Dunford, 2000).

Measurement of success of microfinance institutions accordingly depends on the intent (mission) and

design of the MFI, the selection of specific target segments and the responsiveness of products and

services to the needs of the client segments selected by the MFI. The design of appropriate

0 http://www.microfinancegateway.org/p/site/m/template.rc/1.11.48260

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methodologies to translate mission into practice while gradually achieving cost recovery and subsidy

independence accordingly is of utmost importance (Ledgerwood, 1999; Nitin, 2001).

MFIs must grow in both the outreach and financial sustainability dimensions if they are to

achieve their social objectives like poverty reduction. In case of Pakistan MFIs are facing the

challenge of tradeoff between achieving financial sustainability and targeting the poor. Empirical

evidence from other countries states that if MFIs have to serve the poor in remote rural areas, it may

be difficult for them to achieve financial self-sufficiency due to higher transaction costs. In such a

case, some level of subsidy may be justified if they can be shown to be more effective than alternative

strategies to reduce poverty. Nonetheless, MFIs should strive to achieve financial sustainability by

reducing operational costs. The higher the degree of self-sufficiency, the greater the extent to which

an MFI can leverage donor and government funds to expand outreach.

O’Brien (2006) suggests that in the face of the commercialization of the microfinance

industry, MFIs should adopt the valuation method used by the for-profit sector, the discounted cash

flow (DCF) method. The advantage of the DCF method over traditional accounting measures is that it

recognizes and focuses on the opportunity cost of capital. However, as it is based on cash flows and

not on accounting data, the DCF method requires the implementation of a different data collection

system to that which the organization uses to generate its financial statements. Alternatively, the

economic profit approach, a concept well-familiar to sophisticated managers, also considers the

opportunity cost of capital, while utilizing existing accounting data to calculate profit.

The most popular performance measure, which is based on the economic profit approach, is

the economic value added (EVA) suggested by Stewart (1991). EVA is calculated as the adjusted

capital employed multiplied by the difference between the adjusted return on capital and the weighted

average cost of capital for the firm. It measures the amount by which the profit made by the firm

exceeds the return required by the suppliers of capital. EVA also requires that accounting figures are

adjusted so that profit is measured more accurately. Indeed, Tully (1993) notes that unlike traditional

accounting measures of performance, EVA is not distorted by accounting rules.

Financial sustainability indicates that income from the microfinance services should be

greater than the cost of providing services. Therefore, self-sufficiency is an indication for the financial

sustainability of the MFIs. As the microfinance industry matures, the definition of the self-sufficiency

has commenced to slender and currently sustainability refers only two levels of sustainability by the

most of the people associated with this industry (Ledgerwood 1999: 216-17). These are Operational

Self Sufficiency (OSS) and Financial Self Sufficiency (FSS).

OSS indicates whether enough revenue has been earned to cover the MFI’s direct costs,

excluding the cost of capital but including any actual financing costs. Since all MFIs do not incur

financial cost equally, hence for the sake of simplicity, financing cost excluded. FSS on the other hand

portray the actual financial health of MFIs. It is clear from the definition that OSS only covers

operating income and operating expenses along with a provision of loan loss. But it does not include

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cost of capital, which can depict a real picture of the financial sustainability of the MFIs. Thus, FSS

includes cost of capital (adjusted) apart from the components in OSS. Vinelli (2002) defines FSS as

income derived from operations divided by the operating expenses incurred, thus excluding revenue

from subsidies. On the other hand Pollinger et al (2007) refers self-sufficiency as to organizations that

can survive and add to their asset base wholly on the basis of income derived from their lending and

related operations

It is useful to analyze the break even condition for a financial institution in general and MFIs

in particular. The reason behind adoption of breakeven condition is that without analysis of breakeven

it is difficult to have an in-depth economic analysis of the institution. It thus demands for estimation

of expected level of price of financial products. A break even condition for any financial institution

over a period of time simply indicates that income of the institution should be at least equal to the

expenditure. For analysis of the same, the method as adopted by Hulme and Mosley is considered

(Hulme and Mosley 1996: 17-26).

Subsidy is a crucial factor in analyzing sustainability of microfinance in general and MFIs in

particular. Majority of microfinance programs in the world are subsidized in different ways,

sustainability of the programs poses a question in the mind of academics and researchers. Even front

line institution like Grameen Bank of Bangladesh may experience a high repayment rate, but also

depends on subsidies due to higher value towards social sector (Morduch 1999). It is observed from

the experience of the Philippines that although replication of Grameen type MFIs can be sustainable

with substantial increase in outreach, but it is at the cost of subsidy (Seibel and Torres 1999). Subsidy

syndrome thus considered attention from very beginning by researchers like Yaron, Hulme and

Mosely, Khandker, etc. who constructed index to examine the subsidy dependence of the MFIs. The

rationality of this index is to examine the social cost associated with such subsidies and to highlight

the harmful effects of subsidies to credit (Yaron 1992).

Subsidy Dependence Index (SDI) as first developed by Yaron assesses and quantifies subsidy

dependence and also measures the extent to which the lending interest rate would have to be raised in

order to cover all operating costs if any subsidies the MFIs receive were to be uncovered (Hulme and

Mosley 1996: 43). Consequently the notion of a subsidy free break-even rate for MFIs provides the

argument for the upward revision in interest rates to poor borrowers. SDI as calculated by Yaron is a

fraction of subsidy and loan portfolio multiplied by lending rate of interest. The most interesting

calculation part of the index is subsidy where it comprises of a number of cost revenue and cost

components. A modified version of the formula was devised in by Hulme and Mosley (1996) where

they used new notations and simpler to calculate.

SDI shows subsidy dependence of an MFI and in calculating the index from the earning point

of view only income from loan portfolio is considered. But in reality sources of earning of a MFI is

not confined only to interest or profit income but it considers income from investment. Moreover,

since cost component involves in case of all these segments of earning, thus SDI seems to be narrow

191

in calculating subsidies. Khandker therefore proposes Subsidy Dependence Ratio to have a better

understanding on the financial health of the institution. The basic rationality for taking this ratio is

based on the argument of Kahndakar and Khalily (1995), which stated that as the SDI compares

subsidy only with revenue from lending even though MFIs also get revenue from investments in non-

loan assets such as treasury bills.

Measurement Models: Results and Findings

In measuring the magnitude of subsidy dependence of respective microfinance institutions, this paper

uses subsidy dependence index model developed by Yaron (1992). For calculation of SDI, it is

necessary to aggregate all subsidies received by all MFIs and compare it to total loan revenues, being

the product of the bank’s on lending interest rate or profit rate (I) and the average annual loan

portfolio (LP). This can be mathematically expressed as:

SDI = S/LP*i

Where SDI is the index of subsidy dependence; LP is the average outstanding loan portfolio and i is

the weighted average on lending rate paid on loan portfolio.

The amount of the annual subsidy received by the MFI is defined as:

S = A(m - c) + [(E * m) - P] + K

where:

S = Annual subsidy received by the MFI

A = MFI concessionary borrowed funds outstanding (annual average)

m = The assumed interest rate that the MFI would have to pay for borrowed funds if

access to concessionary borrowing was eliminated.

c = Weighted average annual concessionary rate of interest actually paid by the MFI on its

annual average concessionary borrowed funds outstanding

E = Average annual equity

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Data was collected from microfinance institutions financial statements available online at Mix Market

website and from the annual reports. SDI for different MFIs from year 2006 to 2012 was calculated.

The sample contained seven conventional microfinance banks and one Islamic microfinance institute.

The SDI results are given below:

KASHF Bank

NRSPBank

Khushali Bank

First Microfinance Bank

Pak Oman Micofinance Bank

KASHF Foundation

BRAC-AK

Akhuwat (Islamic)

2006 - 0.0181 -0.0047 0.0102 -0.01740 - 0

2007 - - 0.0137 0.0073 0.0127 -0.05838 - 02008 0.01165 - -0.050 0.0123 0.0962 0.059511 0.00056 0.03682009 0.06086 - 1.1070 0.0051 1.6412 0.342643 -2.6395 0.02442010 0.20818 0 0.78179 0.0424 -0.023 0.000629 -0.02006 0.04002011 0.12055 0.095 0.1837 0.0276 1.6458 -0.17589 0.04568 0.000122012 0.04487 -0.091 0.0714 0.0006 2.6923 -0.14432 0.04681 0.00012

2004 2006 2008 2010 2012 20140

0.050.1

0.150.2

0.25

KASHAF BANK

year

SDI

2004 2006 2008 2010 2012 2014

-0.15-0.1

-0.050

0.050.1

0.15

NRSP

YEARS

SDI

INCREASING TREND DECRESING TREND

2004 2006 2008 2010 2012 2014-0.5

0

0.5

1

1.5

KHUSHALI BANK

YEARS

SDI

2004 2006 2008 2010 2012 2014-0.02

0

0.02

0.04

0.06

FMF BANK

YEARS

SDI

INCREASING TREND INCREASING TREND

193

2004 2006 2008 2010 2012 2014-1

0

1

2

3

POMF BANK

YEARS

SDI

2004 2006 2008 2010 2012 2014

-0.3-0.2-0.1

00.10.20.30.4

KASHAF FOUNDATION

YEARS

SDI

INCREASING TREND DECREASING TREND

2004 2006 2008 2010 2012 2014

-3

-2

-1

0

BRAC-AK

YEARS

SDI

2008 2009 2010 2011 2012 20130

0.02

0.04

0.06

AKUWAT BANK

YEARS

SDI

INCREASING TREND DECREASING TREND

Results show that subsidy dependence of most MFIs increased from 2006 to 2012 except NRSP,

Kashaf Foundation and Akuwat Bank. The value of SDI near zero shows a bank is performing well

and utilizing the subsidy received in optimal way. The trends for other MFIs have fluctuated and held

an increasing line showing a not so well performance in SDI context. To keep the value near zero the

banks have to increase the interest or profit rate.

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Conclusion

Subsidy Dependence Index gives another dimension of measuring the performance of MFIs by

focusing on optimal usage of public funding. As a preliminary study in this line, SDI has immense

potential to be incorporated in Islamic MFIs and base the regulation and supervision in it. Further on

another measuring tool such as ‘Outreach Index’ should be calculated in parallel to SDI, in order to

give a more comprehensive picture of attainment of social objectives of IMFIs.

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Paper 15

The Effectiveness of Microfinance Projects Run Graduates

Dr. Kassim Al Fakiy ‘aliy JadullahLescturer in Economics

Faculty of BusinessSudan University of Sciences and Technology

الخريجين تشغيل لمشروعات األصغر التمويل فاعلية

( للعلوم السودان بجامعة األعمال حاضنات حالة دراسةم2013-2010والتكنولوجيا )

الله. جاد علي الفكي قاسم د

المقدمة : أوال السودان كغيره من الدول النامية يواجه بكثير من الصعوبات

والتحديات االقتصادية والتي انعكست في معدالت متزايدة من التضخم ، أفضت إلى نسب عالية من البطالة ليس فقط من حيث المقارنة

بالمتاح من فرص العمل ، بل أيضا من خالل تزايد أعداد الراغبين والقادرين على العمل خاصة وسط الشباب والخريجين والذين تتزايد

31م فقط 1945أعدادهم عاما بعد عام ، حيث كان عددهم في العام ألف خريج ، كل150م أكثر من 2012خريجا وبلغ هذا العدد في العام

ذلك في اقتصاد اتجه نحو الخصخصة بتطبيق سياسة التحرير حيث فتح المجال واسعا للقطاع الخاص(1)م1992اإلقتصادي منذ العام

وتسارعت وتيرة التخلص من وحدات اإلنتاج في القطاع العام بالبيع لبعضها ودمج بعضها في بعض والتخلص من فائض العمالة فيها ، عليه

فإن المشكلة التي تسعى هذه الورقة المقدمة إلى تسليط الضوء عليها مفادها التزايد المضطرد في اعداد الخريجين وطالبي العمل في

ظل قلة فرص العمل المتاحة، وذلك بسبب عدم توسيع مواعين االقتصاد في المجالين العام والخاص بالقدر الذي يستوعب الكم الكبير

من الخريجين مما ترك فجوة مستمرة من البطالة إنداحت بآثارها السالبة على المجاالت االقتصادية واالجتماعية والسياسية مما استدعى

تقديم معالجات عاجلة وفاعلة لها عن طريق التمويل األصغر لمشروعات الخريجين. وتهدف الورقة إلى مناقشة هذا الموضوع من

198

خالل دراسة حالة لحاضنات األعمال بجامعة السودان للعلوموالتكنولوجيا، وذلك من خالل التركيز على األهداف اآلتية:-

تقييم مدى فاعلية التمويل األصغر لمشروعات تشغيل الخريجين-1.

التعرف على تجربة جامعة السودان في حاضنات األعمال لتحديد-2 مدى فاعليتها وتحقيقها ألهدافها الرامية إلى المساهمة في

التشغيل الذاتي للخريجين. تقديم مقترحات لمعالجة المشكالت المتعلقة بالتمويل األصغر-1

الموجه نحو مشروعات تشغيل الخريجين. وتسعى الورقة أيضا إلى اختبار فرضية مفادها أن عدم سهولة

إجراءات وضمانات منح التمويل األصغر وتركيز البنوك على استرداد األموال المقترضة باالضافة لإلرباح اضعف األستفادة من األموال المخصصة مقارنة بالمقترضة فعليا مما أنعكس سلبا في

تحقيق التمويل األصغر لغاياته. لتحقيق األهداف أعاله واختبار الفرضية إتبعت الورقة المنهج

واإلستنباطي ألكتناف غموض الحقائق واستخالص النتائج وصفيا مدعمة بالمؤشرات الكمية والكيفية المتاحة، حيث بدأت الورقة بإستعراض اإلطار المفاهيمي للتمويل األصغر ثم تاله ذلك دور

المشروعات الصغير في التنمية بالتركيز على حاضنات األعمال ودراسة حالة لحاضنة األعمال بجامعة السودان وأختتمت الورقةباستخالص وعرض النتائج التي وضعت على أساسها التوصيات .

األصغر: للتمويل العملية والممارسة المفاهيمي اإلطار : ثانيا يعد التمويل أحد فروع النظرية اإلقتصادية وهو يركز على وصف

وتحليل أساليب التمويل المتعددة ، ويعرف التمويل بأنه )فن أو علم أو نظام معالجة القضايا المالية في الدولة أو الشركة وتدبير األموال

يعتبر التمويل األصغر من الخدمات المالية(2)( والقروض وتنظيم إدارته التي تقدم للفقراء الناشطين اقتصاديا والمحتاجين لرؤوس األموال

الصغيرة رغبة منهم في اإلعتماد على أنفسهم بعد الله بتأسيس العمل الحر لتحقيق الكسب المشروع والحالل ، هذا المفهوم يؤكد على أن

التمويل األصغر بمثابة مجموعة من الخدمات المالية )وليس تقديم اإلئتمان فقط(وذلك من اجل تفعيل انشطة األعمال التجارية وخدمات االدخار بجانب إن التمويل األصغر يساعد على زيادة الدخل وتخفيض

نسبة البطالة وزيادة الطلب على السلع والخدمات .199

يعد التمويل األصغر توسطا ماليا على المستوى المحلي ويشمل التسليف وودائع االدخار وكل أشكال الخدمات المالية ، ويعرف بأنه

نظام لتوفير اإلئتمان واإلدخار والتمويالت والخدمات المالية مثل خدمات الودائع والقروض والدفعيات والتأمين للفقراءالناشطين

اقتصاديا وزيادة دخولهم وتحسين مستوى معيشتهم وتقديم المشورة الفنية لهم لزيادة النشاط االستثماري ومساعدة األفراد على توزيع

دخولهم ما بين االستهالك واالستثمار وإختيارهم لفرص االستثمارالمناسبة لهم من بين العديد من الفرص المتاحة أمامهم .

األصغر / التمويل أهمية : ثالثا تعتبر المشروعات الصغيرة الممولة عبر التمويل األصغر وسيلة

رئيسية من وسائل مواجهة المشكالت اإلقتصادية واالجتماعية وقد لعبت دورا فاعال في الطفرة اإلقتصادية لدول شرق أسيا كما لعبت

دورا كبيرا في تحقيق النهضة الصناعية في دول أوروبا وذلك لقدرتها على زيادة اإلنتاجية في اإلقتصاد القومي نسبة إلرتباطها الوثيق مع

مختلف القطاعات اإلنتاجية والخدمية في المجتمع، وبما أن اإلقتصاد يواجه بكثير من التحديات والمعوقات في حراكه المتصل’ السوداني

صوب بلوغ غايات النهضة الشاملة ، فإن توجيه التمويل األصغر نحو المشروعات الصغيرة والمتوسطة يمكن أن تكون من أكثر الوسائل

فاعلية في تحقيق التنمية الشاملة بأبعادها اإلجتماعية واإلقتصادية م والذي أشار إلى أن2005ويؤكد ذلك نتائج المسح الصناعي للعام

% من مجموع المنشآت93المنشأت الصغيرة في السودان تمثل العاملة وهذا القدر الكبير من المنشآت الصغيرة تنتج بالطبع قيمة

مضافة ال يستهان بها للدخل القومي بجانب مساهمتها في توفير فرص العمل لعدد كبير من السكان الناشطين اقتصاديا ويسهم التمويل

االصغر بذلك في معالجة مشكلة البطالة . إلتبار ذلك عمليا نقف على تجربة واقعية للتمويل االصغر للتأكد من فاعليتة وذلك من خالل

التركيز على تجربة جامعة السودان في حاضنات االعمال لتحديد نقاط الضعف والقوة فيها، وصوال إلبراز المنافع التى حققتها

التجربة.لتقويمها للتأكد عن مدي تحقيقها الهدافها الرامية الى توسيع فالحاضنة هى’فرص العمل للخرجين من خالل حاضنات األعمال

مؤسسات تعمل على دعم المبادرين الذين تتوافر لهم األفكار الطموحة والدراسة اإلقتصادية السليمة ، وبعض الموارد الالزمة

لتحقيق طموحاتهم ، بحيث توفر لهم بيئة عمل مناسبة خالل السنة األولى من عمر المشروع لزيادة فرصة النجاح من خالل إستكمال النواحي الفنية واإلدارية بتكلفة رمزية ودفع صاحب المشروع إلى

200

التركيز على جوهر العمل ، وذلك إلى فترة محددة تتضاءل بعدهاالعالقة لتتحول إلى مبادرة جديدة.

ويمكن تعريف حاضنة األعمال بأنها المشروع الذي يقدم الخبرة ، والمعدات ، والدعم التوجيهي ورأس المال لألعمال الجديدة التي هى

على وشك البدء ومن هذا التعريف يمكن أن نالحظ أن حاضنات األعمال تختص باألعمال والمشروعات الصغيرة التي تسمىبالحاضنات لتقديم أنواع المساندة لألعمال الصغيرة مثل :-

كله أو بعضه.المالالقروض واإلعانات : رأس -التسهيالت: اآلالت والمعدات ، واألجهزة ، واألدوات الضرورية .- الخدمات : تأخذ شكل شبكة الفرص ، واإلستشارات الفنية-

.( 3)والقانونية واإلقتصادية والتسويقية بدأت الفكرة بتمويل المنتجين في المصارف السودانية من خالل البنك

م، ثم تاله بنك االدخار1959الزراعي السوداني وذلك في العام م وبنك الشعب التعاوني وبعدها إنداحت1974السوداني في العام

الفكرة على باقي البنوك السودانية وتم تدعيم وتقنين الفكرة من خالل السياسات النقدية والتمويلية لبنك السودان ، والتي تشير إلى توظيف نسبة من الموارد المالية للمصارف للتمويل األصغر خاصة لألسر المنتجة ، ويتضح ذلك جليا في صياق السياسة حيث جاء في

بندها الثالث : تمشيا مع سياسة الدولة لمحاربة الفقر وتخفيض معدالته ينبه بنك السودان المركزي المصارف إلى أهمية التمويل

األصغر ، ويشجعها في تقديم التمويل لتنمية الشرائح الضعيفة وذلك %من إجمالي محفظة التمويل في كل وقت( ، أما في10في حدود

م فقد طرأ تغيير في النسبة حيث جاء في البند الثالث2007العام ايضا أن بنك السودان المركزي يشجع المصارف اإلسالمية والتقليدية

% كحد أدنى من محفظة التمويل في أي وقت12على تخصيص نسبة لقطاع التمويل األصغر والحرفيين ، وذلك في إطار توجيه المزيد من

الموارد للتخفيف من حدة الفقر ، هذا التطور في المدلول والمصطلح نتاج إلستراتيجية التمويل األصغر التي تبناها البنك المركزي منذ تلك

م خصص بنك2010- 2006في الفترة من الفترة وحتى تاريخه ، مليون جنيه سوداني لتنفيذ البرنامج التجريبي350السودان مبلغ

مليون دوالر تقريبا وتم إختيار عدد168للتمويل االصغر أى يعادل ثمانية بنوك هي البنك الزراعي السودانى ، مصرف اإلدخار والتنمية

اإلجتماعية ، مصرف المزراع التجاري ، بنك الثروة الحيوانية ، مصرف التنمية الصناعية ، بنك التنمية التعاوني اإلسالمي ، بنك العمال

الوطني والبنك العقاري السوداني ومؤسستين ماليتين هما مؤسسة التنمية اإلجتماعية والية الخرطوم ومؤسسة التنمية اإلجتماعية والية

كسال بجانب مؤسسة الشباب للتمويل االصغر ومؤسسة الجزيرة201

مليون162للتمويل االصغر وبلغ إجمالى التمويل لهذه المؤسسات .(4) مليون دوالر60جنيه أي يعادل

بلغ إجمالى مبلغ محفظة التمويل االصغر التراكمي للبنوك حتي عام مليون دوالر، وفي146 مليون جنيه أي ما يعادل 395م مبلغ 2010 200م تم تكوين محفظة أمان للتمويل االصغر برأس مال 2011العام

مليون دوالر وهي مساهمة بين المصارف75مليون جنيه أي ما يعادل % ، قدرت محفظة25وديوان الزكاة حيث ساهم فيها بما يعادل

م وفق النسبة المحددة من بنك2012التمويل األصغر للمصارف للعام مليون297 مليون جنيه أي مايعادل 832%( مبلغ 12السودان )

.(5)دوالر رغم األموال الكبيرة المتاحة للتمويل األصغر إال أن الممارسة الفعلية للتمويل األصغر تشير إلى أن التجاوب مع هذه السياسة على

االرض يبدو ضعيفا عمليا من خالل االستخدام لهذه الموارد والذي دعم هذا اإلتجاه(6)%( 12% من السقف المتاح)4-1يتراوح ما بين

اإلنتقاد الذي وجهه السيد/ النائب األول لرئيس الجمهورية حينها األستاذ على عثمان محمد طه على التطبيق العملي لتجربة التمويل األصغر

على أرض الواقع وإعتبر بأنها أصبحت توظف في اإلنتاج الذي ال يحمل القيمة المضافة وذلك لدى مخاطبته اجتماع وزراء الشئون اإلجتماعية بالوالية ، حيث ذكر أن اإلنطباع السائد هو أننا نسمع ضجيجا وال نرى

مليار جنيه تم تخصيصها لمشروعات20طحينا وأضاف بأن أكثر من التمويل األصغر بالبنوك ، البد أن يكون فيها نسبة وتناسب بين التمويل والنشاط حتى ال يهدرالمال ، ووجه بإيجاد معالجات عاجلة حتى يحقق

التمويل األصغر أهداف البرنامج وينزل على أرض الواقع ، فالتمويل األصغر ينبغي أن يوظف التوظيف األمثل من خالل المشروعات

ويعزى ضعف التطبيق العملي(7)اإلنتاجية التي تحقق القيمة المضافة لتجربة التمويل األصغر إلى تخوف المصارف من التعثر بجانب التكلفة

فالتمويل’ اإلدارية العالية والعوائق اإلجتماعية واإلقتصادية والثقافية األصغر هزم من قبل المصارف من خالل تمسكها بالضمانات من

طالبي التمويل فضال عن أن بعض البنوك لم تسهم بصورة كبيرة في توفير التسهيالت بل ركزت في منح التمويل للقادرين على السداد من

، وبالنظر(8)شرائح المجتمع المختلفة ولم تهتم بالشرائح الضعيفة للرؤية التقويمية لتجربة التمويل األصغر في اإلتجاه اآلخر تحدث المدير

التنفيذي لصندوق تشغيل الخريجين بوالية الخرطوم السيد/ الكامل محمد إبراهيم قائال : رغم تعثر تجربة التمويل األصغر الخاصة

بالخريجين في بدايتها ولكن واقع الحال يشير إلى نجاح العديد من. (9)مشاريع التمويل األصغر

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لها / العملي والتطبيق األعمال حاضنات فكرة :رابعااالعمال/ حاضنات مفهوم أ

الحاضنة هى المكان الذي يوفر للشباب وبالخصوص الخريجين الراغبين في إقامة مشروعات جديدة، وتقوم الحاضنة بتقديم خدمة

كاملة من المساعدات تتمثل في المكان المناسب لبدء المشروع وتقديم الدعم الفني واإلداري ألصحاب المشروعات سواء في مرحلة

بدء النشاط أو في أثناء المزاولة والمتابعة والتسويق كما تساعد الحاضنة أيضا في اإلسراع ببدء النشاط للمشروع وزيادة فرص نجاح أصحاب المشروعات الصغيرة وتأهيلهم للدخول في سوق العمل بعد

إكسابهم المهارات الفنية واإلدارية الالزمة بعد فترة تخرجهم من.(10)الحاضنة

ويشير مفهوم حاضنات األعمال إلى نوع من التنظيمات اإلدارية التي تهدف إلى تنمية وتدعيم مشروعات األعمال الصغيرة خالل

الفترات األولى لبدء نشاط هذه المشروعات والتي تعتبر من أكثر الفترات صعوبة في حياة المشروع ، وعادة ما يتم إنشاء حاضنة

األعمال بهدف تقليل التكاليف المرتبطة بإقامة مشروعات األعمال مع زيادة فرص هذه المشروعات في تحقيق النجاح باإلضافة إلى تحقيق

الترابط واإلتصال بين المشروع الناشئ و المشروعات القائمة والجامعات ومراكز البحث والخبراء العاملين في نفس المجال . يتبين

من ذلك أن حاضنة األعمال ما هى إال مكان محدد يعمل على إستضافة المشروعات الجديدة حتى تصل إلى مرحلة النضوج واإلستقرار ، هذا المكان وفر مجموعة من التسهيالت واإلمكانات والخدمات المختلفة

بأقل تكلفة ممكنة وفي نفس الوقت يسمح للمشروعات بإقامةالعالقات مع جميع العناصر .

األعمال/ لحاضنات التاريخي التطور : ب بدأت فكرة حاضنات األعمال في الواليات المتحدة االمريكية كأسلوب للتنمية اإلقتصادية يهدف إلى اإلستفادة من بعض المباني

القديمة باإلضافة إلى خلق وظائف في المناطق التي أختيرت بسبب)تدهور بعض الصناعات الكبرى مثل صناعة الحديد والصلب في الغرب

في تلك الفترة كانت حاضنات األعمال تهدف فقط إلى توفير مكان،(11 مناسب إلستقبال المشروعات ولكن عندما أظهرت الدراسات في بداية الثمانينات من القرن العشرين أن المشروعات الصغيرة التي

عامل هى صاحبة اإلسهام األكبر في تقليل20تعمل بعدد يقل عن نسبة البطالة على مستوى اإلقتصاد القومي وليس المشروعات الكبيرة كما كان يعتقد. عليه ظهر اإلهتمام الكبير بالمشروعات

203

الصغيرة وبدأت الجهود تتجه نحو إنجاحها حيث بلغ عدد الحاضنات في م1973 حاضنة في عام 13الواليات المتحدة االمريكية حوالي

حاضنة بحلول98وتضاعف هذا العدد عدة مرات حيث اصبح عددها م ، باإلضافة1994 حاضنة في العام 468م ثم وصل إلى 1985عام

إلى ذلك فقد إزداد أيضا عدد الشركات األعضاء في الحاضنات, حيث شركات عام4كان متوسط عدد الشركات في الحاضنة الواحدة

شركات ثم بدأت تنتشر الحاضنات بعد ذلك9م أصبح حوالي 1992. (12)في العديد من دول العالم

واهدافها/ األعمال حاضنات أنواع :ج تشتمل حاضنات األعمال على كل الحاضنات األكاديمية

والحاضنات العامة في غالبية دول العالم ، حيث تساعد الحاضنات األكاديمية على اإلستفادة من الدراسات التي يتم إعدادها في مراكز

البحث العلمي من ناحية كما تساعد أيضا على خلق فرص عمل للخريجين ، أما الحاضنات العامة فتعمل بصفة عامة على تنمية

لذلك تكون’اإلقتصاد المحلي وإنعاش السوق وإيجاد فرص عمل أهدافها ذات طبيعة قومية . لذلك يمكن تصنيف حاضنات األعمال أيضا

على حسب نوع النشاط الذي تمارسه المشروعات المرتبطة بها ، فنجد بعض الحاضنات التي تستضيف مشروعات تعمل جميعا في نفس

النشاط أو تعمل في مجموعة من المشاكل التي توجهها. نجد إن حاضنات االعمال توفر للمشروعات الصغيرة الناشئة

فرصة النمو السريع داخل الحاضنة كما أنها في نفس الوقت تحسن من فرص نجاحها فيكون أداؤها أقوى عند خروجها من الحاضنة، ويرجع

ذلك إلى أن الحاضنة توفر باإلضافة إلى المكان المجهز مجموعة من الخدمات واإلستشارات المتكاملة سواء كانت مالية أو إدارية أو قانونية

أو فنية، كما توفر أيضا فرصة التفاعل مع المشروعات األخرى ذات الظروف المشابهة سواء كانت تعمل في نفس المجال أو في مجاالت

أخرى. عليه يمكن القول بأن الحاضنات تهدف إلى تقديم الدعم

:- (13)للمجتمع وذلك ومن خالل اآلتي .زيادة عدد المشروعات مما يؤدي إلى إنعاش اإلقتصاد ويؤدي1

ذلك إلى تنمية اإلقتصاد . .زيادة فرص العمل وتقليل نسبة البطالة التي تمثل هاجسا كبير2

لغالبية دول العالم . .تشجيع الصناعات المحلية وتشجيع التنمية اإلقتصادية3

المستدامة..زيادة معدالت الدخل في المجتمع المحلي .4

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.تدعيم وتشجيع المشروعات التي تحتاج إليها السوق المحلية5مع تحديد المكان المناسب إلقامة هذه المشروعات .

.تشجيع المجموعات أو الفئات التي تمتلك الخبرات الكافية6 إلقامة مشروعات األعمال حتى تصبح مجموعات أو فئات

منتجة . .تنسيق األبحاث والدراسات التي تقوم بها الجامعات ومراكز7

البحث العلمي .مواجهة اآلثار اإلقتصادية واإلجتماعية الناتجة عن تطبيق8

سياسات الخصخصة . .نشر وتنمية مفهوم المشروعات الخاصة بين الفئات ذات9

الخبرة المحدودة في هذا المجال . .توجيه رجال األعمال نحو المشروعات عالية التكنولوجيا10

والمشروعات التي تهدف إلى حماية البيئة . .تدعيم الجهود التعاونية بين قطاع األعمال والجامعات ومراكز11

البحث العلمي والهيئات الحكومية والغرف التجارية للنهوض..بالمجتمع المحلي

تهدف الحاضنات في السودان إلى إنشاء المشروعات لتشغيل عدد من الخريجين الذين ال يجدون فرص عمل في سوق العمل وكذلك

كما تهدف إلى’فقراء المزارعين غير القادرين على تمويل أنشطتهم اإلستفادة من اإلمكانيات المادية في بعض المواقع كالجامعات التي

والتي توفر بدورها سلع اإلستهالك الضرورية’توفر مواقع للحاضنات كاأللبان والبيض واللحوم في السوق الذي تتميز فيه هذه السلع

بالندرة، ويستفيد الممول )البنك( من إستثمار أمواله في مجاالت ذات(. 14)فائدة له ولإلقتصاد الوطني

خامسا /نموذج حاضنة الطب البيطري واإلنتاجالحيواني بجامعة السودان للعلوم والتكنولوجيا

الحيواني/ واالنتاج البيطري الطب بحاضنة التعريف أالسودان : بجامعة

حاضنة الطب البيطري واإلنتاج الحيواني هى نتاج لتطور األفكار الرامية إلى التحول نحو مفاهيم عميقة لمؤسسات التعليم وتأهيل

دورها النهضوي في إحداث عمليات التغير اإليجابي للمجتمعات والمساهمة الحقيقية في حل مشكالت المجتمع بما تمتلكه هذه

الجماعات من عقول مستنيرة وما تحمله من منهج علمي ومقدرة على النظر واإلدراك وإمكانيات البحث والتدريب ، لتقديم النماذج

واألطر التي تسهم في إحداث التغيير نحو تنمية مستدامة’ وهو ذات

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النهج العلمي والتربوي لفلسفة مثل هذه المشاريع اإلنتاجية كآلية فاعلة إلستقطاب الخريجيين واستشارتهم للعمل الجاد وفق أنظمة

إنتاج تعتمد على استدارة رأس مال وتطوير المشروعات مقابل أجرنظير اإلنتاج مع التأهيل المستمر للمشروع والخريج.

وبدأت تجربة حاضنة الطب البيطري واإلنتاج الحيواني في العام م ومرت بمراحل عديدة تم خاللها تنفيذ عدد من المشروعات2006

تمثلت في :)المشروعات الصغيرة ، ومشروعات اإلستيعاب الحرفي للتدريب التحويلي والتأهيل المجتمعي(. بدأت الحاضنة كمشاركة بين جامعة السودان وبنك االسرة ،تقوم الجامعة بتوفير األرض للمشروع

ويقوم البنك بالتمويل ، فساهمت الحاضنة في نشر ثقافة العمل الحر وتهيئة الخريجين نفسيا للعمل خارج إطار الوظيفة واتضح لي ذلك جليا

من خالل الفترة التي كنت فيها مديرا إلدارة اإلستثمار بجامعة(. 15)السودان والتي تعتبر الحاضنات من روافدها

الحاضنة/ أهداف -: بتعمل الحاضنة إلى تحقيق عدد من األهداف أهمها :-

ترويج ثقافة الريادة واإلبداع واإلبتكار وتنمية مهارات العمل الحر-1.

تقديم مشاريع تحقق مبدأ التنمية اإلجتماعية .-2 توفير خدمات للجهات التمويلية وغيرها من حيث األبحاث-3

والمعرفة والتدريب واإلشراف .التأهيل والتدريب للخريجيين.-4 تحويل البحوث إلى مشاريع حقيقية تخدم المجتمع لتحقيق مبدأ-5

التنمية اإلجتماعية من خالل التنمية اإلقتصادية ألفراد المجتمع .خلق فرص عمل " تشغيل الخريجيين"-6 توفير البنية التحتية من الصناعات المغذية للمشاريع الكبيرة-7

القائمة بالفعل . تقديم مشاريع قوية للمجتمع في المستقبل قادرة على-8

اإلستمرار والتطور . تحويل قوة العمل العاطلة بالمجتمع إلى قوة إقتصادية قادرة-9

.( 16")على العطاء وتوفير الوظائف للغير " خريجيين ، حرفيين

المشروع/ تحقيق وسائل : ج تأسيس مشاريع منتجة يسهم فيها الخريج بتشغيل المشروع بأجر-1

محدد وفق اإلنتاج .

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تنمية المشروعات القائمة وتحويل بعضها إلى مشروعات منتجة-2تستقطب هؤالء الخريجيين .

إعتماد نظام التمويل األصغر للمشروعات التي تؤسسها الحاضنة-3. (17)والمشروعات الداعمة لزيادة اإلنتاج والتسويق

للحاضنة/ اإلداري الهيكل -: د الشكل الت��الي يوض��ح ويفص��ل في الهيك��ل ال��وظيفي للحاض��نة وال��ذي يتكون من مستويين يبدأ هرمي��ا بمجلس اإلدارة وتلي��ه اإلدارة التنفيذي��ة

وذلك لفاعلية الربط والمتايعة للعمل تحقيقا لألهداف .

( الهيكل اإلداري1شكل رقم )

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اإلدارة مجلس

فني مستشار قانوني الحاضنة مستشار مدير

التنفيذية اإلدارة

عالقاتعامة

إدارة المجموعا

ت إدارةتصنيع

المحاسب

وحدةاألعالف المجزرة

تصنيعاللحوم

مفوضمشتريا

ت

مفوضإنتاج

المصدر : جامعة السودان للعلوم والتكنولوجيا،كلية الطب البيطري واإلنتاجم2013م . الخرطوم 2013الحيواني – حاضنة الدواجن

نالحظ من الهيكل اإلداري للحاضنة الترابط الهرمي بين مجلس اإلدارة واإلدارة التنفيذية حيث ساعد ذلك على الضبط اإلداري ومعالجة اإلشكاالت

تأمينا للنجاحات .

المشروعات / تنفيذ منهجية -: هـ دراسة جدوي للمشروع إقتصادية تبنتها جامعة السودان للعلوم

والتكنولوجيا وتم تمويلها من بنوك التمويل األصغر " بنك األسرة " إلستيعاب الخريجين للتشغيل " والذين تم تمويلهم برأس مال تشغيلي

جماعي )انظر الجدول( ، على أن يتم سداد مبلغ األصول الثابتة في شهر وذلك بضمان أصول20 سنوات ورأس مال التشغيل في 5فترة

المشروع نفسه .

الحاضنة/ لمشروعات التقديم شروط : وأن يكون الخريج سوداني.-1 أن يكون خريج جامعة السودان للعلوم والتكنولوجيا كلية-2

البيطرة واإلنتاج الحيواني والزراعي .ال يعمل في أي مؤسسات حكومية أو خاصة .-3أن يمتاز الخريج بروح العمل الجماعي .-4

للحاضنة/ المالي الموقف تحليل : ز تم تمويل أصول مشروع الحاضنة من قبل بنك األسرة بمبلغ

مليون جنيه بصيغة المشاركة مع الجامعة والتي ساهمت1.200 % للبنك75باألرض واألصول الملحقة بها ، حيث كانت نسبة المشاركة

على أن تؤول الحاضنة بأصولها للجامعة بعد سداد’% للجامعة 25و تكلفة تمويل األصول بالبنك بعد الفترة المحددة بخمسة سنوات. في الجانب اآلخر مول بنك األسرة أيضا الخريجين جماعيا بمبلغ التشغيل

% سنويا يتم9وبصيغة المرابحة، بواقع تكلفة تمويل وصلت إلى شهر ، وهى الفترة المحددة لكل20سدادها بأقساط في فترة

مجموعة لتفسح المجال للمجموعة الجديدة للخريجين ، وهكذا يستمر

208

مفوضمبيعات

المشروع . الجدول التالي يوضح الموقف المالي للحاضنة بتفاصيله . (18)المتعددة

رقـم ( للحاضنة) 1جـدول المـالى للمـوقـف ملخـص جملة

المـبلغبالجـنية

البــراقالنجـاحالصـفـاءالمجـمــوعة

548230.00184310.00180660.00

مبلغ التمويل183260.00الممنوح للخر يجين

10أقساط 657876.6410أقساط

جملة اقساطأقساط10المرابحة

10أقساط 65787604010أقساط

جملة االقساطأقساط 10المدفوعة

جملة االقساط التى----لم تدفع

جملة اإليجاراتأيجار 15إيجار15إيجار 42000015المستحقة

جملة اإليجاراتإيجارات 7إيجارات7إيجارات2940007المدفوعة

جملة اإليجارات التىإيجارات3إيجارات3إيجارات1260003لم تدفع

جملة اإلنتاج بالطن76183274395.12394442649917.888.898.62763797.4726329.

5 جملة المبيعات2594772.1

بالجنية5951430.612020156.241972601

.371958673.0

0جملة المنصرفات بالجنية

136400.0055000.0022000.00

جملةالمدفوع 59400.00للخريجين

المصروفات الإلدارية170570.000.000.000.00للحاضنة

م2013المصدر :جامعة السودان إدارة اإلستثمار

يتضح من الجدول أعاله الفوائد المحققة من خالل مشروع الحاضنة بالنسبة للخريجين خاصة والمجتمع عامة حيث تحصل كل خريج حسب

جنيه وذلك بعد إكتمال8300النسبة المخصصة للتوزيع على مبلغ قدره 2700سداد مال المرابحة علما بأن هذا المبلغ يعادل في المتوسط

جنيه للخريج في كل فترة إنتاج ) الفترة شهرين (وتم حسابه من خالل ، في الجانب اآلخر على مستوى(19)جملة المبالغ المدفوعة للخريجين

761882المجتمع تم رفد السوق المحلي بإنتاج من الفراخ قدره

209

طنا ، وهذا يؤكد فاعلية التمويل لمشروعات حاضنة تشغيل الخريجين ويمكن زياة هذه الفاعلية من خالل تقديم تسهيالت في إجراءات

التمويل األصغر وتخفيض تكلفة التمويل التي تتحصلها البنوك كأرباح ، أو أقل من1 % لتكون رمزية وبنسبة 12 إلي 9وبنسبة تتراوح ما بين

% تحقيقا لهدف توزيع هذه الفوائد لجميع قطاعات المجتمع1 المحتاجة وبخاصة الخريجين وصوال لعدالة توزيع الثروة والدخول

وتخفيف حدة الفقر في المجتمع حتى ال يكون المال دولة بين األغنياء .

الحاضنة/ إسهامات : ح أسهمت الحاضنة بتشغيل عدد كبير من األفراد وصل إلى مائة

خريج ، كما ساهمت في إنعاش السوق المحلي71شخص منهم بتوفير فراخ للمستهلك وبأسعار معقولة بجانب الفوائد األخرى

والمتمثلة في أن الحاضنة كانت بمثابة حلقة وصل مع مراكز البحوثاألخرى .

رقم ( )2جدولالقوة العاملة في الحاضنة

العــــدد النــــــــوع الرقم الممولين1

) الخريجين (71

02 المشرفين202 الخفراء301 المدير401 المحاسب507 مجلس اإلدارة604 الترحيل706 القباضين806 العتالين9

100 المجمـــــــــوع

_ _ : ، كوكو حلة الخرطوم الحيواني واإلنتاج البيطري الطب حاضنة إدارة م2013المصدر .

يالحظ من الجدول أن الحاضنة قد أسهمت إسهاما فاعال في توفير فرص عمل لعدد مقدر من الخريجين على الرغم من قلة رأس المال

مليون جنيه سوداني1.200المستثمر في األصول والذي لم يتجاوز وهذا يؤكد فاعلية حاضنات األعمال ومساهمتها في إيجاد فرص عمل

حر للراغبين والمحتاجين إليه والناشطين اقتصاديا .

210

والتوصيات: النتائج أخيراالنتائج/ : أ

ساهمت حاضنة األعمال في تشغيل عدد مقدر من الخريجين-1( خريجا .71 شخص منهم )100وصل

ساهمت الحاضنة بإنتاج مقدر للسوق المحلي من الدجاج-2 طنا مما ساعد على توفير اإلحتياجات761882الالحم وصل

األساسية لمواطني والية الخرطوم والمحليات األخرى منالفراخ الالحم .

ساعدت الحاضنة الخريجين بتدريبهم ونشر ثقافة العمل الحر-3 وسطهم واكسابهم الثقة واإلستعداد النفسي للعمل خارج نطاق

الوظيفة التقليدية . اتضح من خالل الورقة المقدمة أن التمويل األصغر في الواقع-4

%( من محفظة التمويل12موجه رقمي من البنك المركزي ) بالبنوك والتي تم ترجمتها و تحويلها إلى أرقام نقدية محفوظة

في خزانات هذه المؤسسات ولم تستخدم بصورة فاعلة لتحقيق اهدافها الرامية إلى معالجة اإلشكاالت وإشباع الحاجات الملحة للفقراء والمحتاجين وتأكد ذلك من خالل اإلنتقاد الذي قدم من

قبل المسؤلين في الدولة. 9تعد الضمانات المطلوبة وهوامش األرباح التي تتراوح ما بين -5

% من المعوقات الرئيسية لفاعلية التمويل األصغر .12– توجد نجاحات في المشروعات الفردية )حاضنة األعمال بجامعة-6

السودان(وكثير من مشاريع التمويل األصغر مما يؤكد أن معوقات اإلنتشار للتمويل األصغر واإلستفادة منه مجتمعيا

متعلقة بالبنوك وسياساتها وليس باألفراد والمجموعات في عدمجدوى و فاعلية مشروعاتهم المقترحة والمنفذة.

التوصيات/ ب مركزة التمويل األصغر في مصرف واحد متخصص.1

ومخصص لنشاط التمويل األصغر يتبع سياسة واضحة تركز على األرباح اآلجلة للمجتمع ال األرباح العاجلة للبنوك من

خالل تقديم التمويل وحصاد األرباح عليه . تأسيس شركة مساهمة تعمل لتسويق منتجات حاضنات.2

األعمال وذلك إلبعاد المضاربين وسماسرة السوق وصوال

211

لتخفيف األعباء المعيشية عن كاهل المواطنين من خاللبيع المنتجات مباشرة للجمهور وبأسعار معقولة ومقبولة .

تخفيف هوامش أرباح البنوك على التمويل الصغير واألصغر.3 % تحقيقا ألهداف التمويل1 أو أقل من 1لتصل إلى

األصغر وتخفيفا للضايقة المعيشية عن المواطنين . العمل على التوسع في إنشاء حاضنات األعمال في.4

المجاالت المتعددة من خالل إنشاء مجمع متكامل لحاضنات األعمال واألعمال الصغيرة يلبي حاجات الراغبين في العمل وخاصة الخريجين ويوفر احتياجات المجتمع من

المنتجات المتعددة .

الهوامش قاسم الفكي على، أثر تطبيق سياسة التحرير اإلقتصادي في السودان-1

على القطاعات اإلنتاجية – الخرطوم مركز التنوير المعرفي – الخرطوم،م.2011

الصديق طلحة محمد رحمة ، التمويل اإلسالمي في السودان – التحديات-2ورؤى المستقبل ، شركة مطابع السودان للعملة المحدودة .

صالح جبريل حامد ، التمويل األصغر في السودان ، المفهوم والنماذج-3والتطبيقات .

micro finance unitبنك السودان المركزي ، وحدة التمويل األصغر -4(http:/www.mfu.gov.sd )

محمد عالء الدين عبدالقادر، البطالة، منشأة المصارف، اإلسكندرية-5م .2003

م2013الشركة السودانية لتنمية التمويل األصغر – الخرطوم -6المرجع السابق -7م.2006بنك االسرة ، الخرطوم ، مطبوعات ، -8

-جامعة السودان للعلوم والتكنولوجيا ، إدارة اإلستثمار واإلنتاج، الخرطوم9م .2013

212

م .2013-المصدر السابق ، الخرطوم 10 - جامعة السودان للعلوم والتكنولوجيا ، كلية البيطرة واإلنتاج الحيواني، ،11

.م2013حاضنة الطب البيطري واإلنتاج الحيواني م .2013- المراجع السابق ، الخرطوم 12م .2013- المراجع السابق ، الخرطوم 13- مدير إدارة اإلستثمار - جامعة السودان للعلوم والتكنولوجيا 14.2013 - المرجع السابق، الخرطوم 15 - مقابلة مع مدير حاضنة الطب البيطري واإلنتاج الحيواني- د/ أحمد النور16

2013.م2013- المصدر السابق17م2013- المصدر السابق18م2013- المصدر السابق19

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Paper 16

Islamic Microfinance and Sukuk:A Propose Regulatory Framework for Liquidity Issue in Indonesia

Dr. Raditya SukmanaLecturer in Islamic Economic, Faculty of Economics and Business,

Universitas Airlangga, Surabaya, Indonesia

AbstractData from ministry of cooperative 2010 in Indonesia revealed that microfinance sector contributes as many as 33% out of total GDP. If it is combined with the small and medium sectors, the total contribution may reach to more than 50% of the total GDP. Moreover, the number of employment in these sectors reaches to more than 90% out of total labor in Indonesia. These figure shows that Micro, Small, and Medium enterprises (MSME) has to be put in greater attention by government, particularly for the microfinance. The most common practice of the financial institution which deals with the microfinance is cooperatives. This institution is to some extent has the same function as banks that is financial intermediaries. Despite the importance of these cooperatives for the economic growth, there are many factors that impede this institution to develop faster than the current performance. Among the problem is on the liquidity issue. The current fact has shown that many, if not all, cooperatives (both Islamic and conventional) which are the backbone of the microfinance in Indonesia are in the shortage of liquidity. The main source of funds which is coming from their respective members is not enough to finance the recipients (in this case micro enterprises). Cooperatives need to find out for more liquidity, this paper attempts to create a regulatory framework to solve the liquidity problem by utilizing the sukuk instruments (issued by government). This instrument is adopted as in many cases government issud sukuk is oversubscribed. It is expected that with the support of the sukuk, the the Islamic microfinance performance will be developed faster in the future

1.Introduction

Islamic microfinance has been put in a greater attention by many. It is continuously discussed by

academicians, researcher as well as policy makers. Moreover, the university students particularly in

Indonesia has also study this sector as part of their courses. Conferences and seminars on this issue

have also extensively been done. It discusses the past and current performances, and its future

development. Identifying the problems and proposing solution are also part of the discussion (Bank

Indonesia 2009,2010, Hamada 2010).

Among the reasons of why this sector has gained momentum is because, during the financial

crisis, such as subprime mortgage in 2008, Islamic microfinance still perform well despite many big

companies, particularly currency exposed companies, are suffering. It was not affected by the

international financial turbulence as the operation of this sector such as acquiring raw material,

214

manufacturing process and marketing the product etc are done domestically and it is not exposed to

the external factors. In short, Islamic microfinance as well as conventional microfinance act as a

buffer in the crisis.

While it successfully prevents the economy from deteriorating due to financial crisis,

microfinance particularly Islamic microfinance is not without problems. There exist various aspects

within the industries that need proper regulations. Weak institutional capacity, weak capital base and

the liquidity issue are some of the problems that require government to step in with regulations.

Weak institutional capacity relies heavily on the skill of the human resources within the

institutions. Unlike banks with strict requirement ( such as academic performance, organizational

experiences, as well as softskill ability) for recruiting staffs, microfinance institutions, to the best of

the author knowledge, are not basing on the meritocracy for recruiting staffs rather it is due to

friendship which, to large extent, do not suit with the needs.

The availability of the capital is another aspect which needs to be regulated. The limited

capital would not provide cushion for the financing/ lending risk. While in banks, the capital needed

given the risk weigthed asset is very much regulated, such that in the microfinance industry has not

been treated as an important one. Hence, it is understood that not few microfinance institutions in

Indonesia close their operation due to this factor. The availability of the capital and the liquidity

management are among the important factors to have a successful operation of the MFIs including the

Islamic MFIs (IMFIs).

The shortage of the liquidity has been in existence for quite some time, evenmore in the

recent years whereby Indonesian economic growth has performed well with the rate around 6%

annually. Given the high economic progress, the demand for financing increase significantly. This

lead to the shortage funds within the IMFIs. To come up with solution for the liquidity shortage, the

IMFIs are normally requesting funds from Islamic banks, governmental related ministries as well as

put more capital by the IMFIs owner.

This paper aims to provide regulatory framework to solve the liquidity with the support of the

Islamic capital market instrument namely Sukuk. The argument of adopting sukuk to support the

microfinance industry is due to the high performance of the Indonesian sukuk issued by government

as the other engine for the economic growth.

The structure of the paper is as follow, after the introduction, it discussed the policy

framework needed to develop the microfinance industry. It follows with the performance of the

microfinance (both Islamic and conventional) industry in Indonesia. Section four describes the

theorethical background and literature review pertaining to the study on the sukuk issuance by

government. In this case, sukuk issuance by local government in Pasir Gudang, Johor Bahru Malaysia

will be explained to accompany the theory of sukuk. Section five is the gist of this paper in which the

role and the structure of the sukuk in supporting the IMFIs is elaborated. It will end with the

215

conclusion which basically mentions the importance of government to have policy to create

significant progress for the microfinance industry with the support of sukuk.

2. Microfinance policy framework

Regulation and policy are needed to overcome the problem above. However, in designing the policy

for microfinance, the objective should be comprehensive enough to create a significant progress in the

microfinance industries. The objectives that should be existed are as follow (Central bank of Nigeria,

2011)

1.Provision of financial services to the economically active poor. There are various types of

poor. Among the classification of the poor is on the active and passive poor. The former relates with

the poor who work hard to earn living. They have a mental which strive for the best and follow the

right order rules and regulation to get a better and prosperous living. Conversely, the latter is the poor

who are the dependent. It means, they prefer not to do work and rely on the almgiving by others. In

this context, financial service is given to the active poor who is ready to run the business whereas for

the later, another approach need to be taken specific that suit with the needs.

2. Creation of employment opportunities of the active poor in the countries. Microfinance

policy should not only regulate merely on the financing but also it should accomodate on how to

create the employment opportunities. In developing the microfinance industry, government has also to

facilitate the microfinance practitioners with the information about the potential market for them by

the support of the sophisticated Information Technology. This will enable them to get the project or

job opportunities to further increase their standard of living. The reason as to why this is important is

because the marketing skill ability by the MSMEs need to be very upgraded. (Webb, Kristiani and

Olaru, 2009)

3. Linkage program between the microfinance institution with other financial institutions

(Banks). In many cases, banks do not have limited number of staffs to cater for all small amount of

loan. Moreover, the staffs which may normally handle the corporate loan, then they will find

difficulty once they handle the microfinance (micro loan). The nature and the approach are certainly

different. For that case, rather than they have to handle number of applicants for small loans, they

prefer to create a linkage program to the microfinance institutions (MFIs). The program is for the

banks to provide loans to the microfinance institutions (MFIs). The linkage will also benefit MFIs

since not few MFIs are in the shortage of liquidity. In many cases, they reject the prospective loan

applicant simply due to the unavailability of the funds.

4. Enhancement the service delivery to the micro,small and medium enterprises (MSME). The

ability to provide service delivery to the clients is different between the big Financial institution and

MFIs.Given the large amount of capital that the banks have, they can provide service needed by the

clients. Example of this is the IT service. The big banks with a sophisticated IT will enable the clients

216

to make transaction remotely. This obviously can not be done by the MFI.another approach has to be

taken to maintain the loyality of the clients.

5. Mobilization of the savings for intermediation and rural transformation. the microfinance

policy has also to require the client to have savings. Albeit the limited income by the clients

(microenterprise practitioners), the saving has to be created. This is to educate them on the importance

of saving for the future.

6. Promotion of a platform service providers to network and exchange views and share

experiences. Each microfinance practitioners have different experiences in doing businesses. Having

this situation, it is worth to have venue for exchange the ideas and networking.

3. Islamic Microfinance in Indonesia

So far there is no agreed definition on the meaning of microfinance (Mohsin, 1995) including in

Indonesia context. One of the definition of microfinance prevail in the literature is the provision of the

financial services (both savings and credit) to low income clients (Arsyad, 2006). Another definition

by Indonesian ministry of cooperatives is that microfinance can be looked in term of the number of

the employee hired. Bank Indonesia defines microfinance based on the amount of the financing given.

While there is a debateable definition of microfinance. The institution which operate microfinance has

proven to be the important engine for the economic growth.

Microfinance institutions started to be a tool for economic development since 1990 (Arsyad,

2005). The main role of this institution is to serve the financial needs for specific segment of society

which has been neglected by the commercial banks or, in general, mainstream financial institutions.

There exist various reasons as to why these banks have rejected this segment of society. Among those

various reasons is that the borrowers do not have collaterals or it is called unbankable. As the bank is

a profit oriented business, then the bank has to reduce the risk by requiring the borrower to provide

collateral. When the borrower defaulted, the bank can take over the collateral to cover the losses

occurred. Since the low segment of society commonly do not have collateral then the existence of

institution which is less strict is very much needed. This institution largely is not requiring the

customers to provide collateral when they demand credit or financing.

To the best of the author knowledge, research on Indonesian conventional microfinance has

been many ( Rosengard et all, 2007,Seibel,2008, Nugroho, 2009, Martowijoyo, 2007). Hence in this

study, conventional microfinance institution is excluded and focus only in islamic microfinance.

With regard to the Micro Small Medium enterprises (MSMEs) in Indonesia which are

supported by the microfinance institutions and also banks, their role is important for the economic

growth. Based on the data by Indonesian ministry of cooperatives, there seems to have correlation

between the existence of Micro Small Medium Enterprises (MSMEs) and the country economic

growth.

217

Table 1 provides us with some important performance indicators of the MSMEs. In the case of

Indonesia having the population of more than 200 million, the number of Micro enterprises is more

than 53 million which contributes nearly 99% out of total companies in Indonesia. Meanwhile the

numbers of small and medium enterprises are as many as 573,601 and 42,631 unit. The share of this

two enterprises are 1,07% and 0,08% out of total number of MSMEs. This means that the existence of

micro enterprises is vital.

Another important figure is on the number of labor. Number of labors who works in

microenterprises is more than 93 million which contribute more than 90 percent out of total number of

labor in MSMEs. Meanwhile number of labor in small and medium enterprises contribute about 3,55

and 2,7 out of total number of labor in MSMEs.

The most important thing from table 1 is in the lowest part which is the contribution of

MSME to GDP. MSMEs contribute as many as 57.12% out of total GDP. The disaggregate data

shows that small and medium enterprises contributes about 9,86% and 13,46% out of total GDP and

the micro enterprise contribute about 33,81 %.

Given this figures, it turns out that the development of MSME has to be seriously taken into

account by government as developing this sector may also reduce the poverty incident (Nugroho

2009, Miyashita 2000 and Obaidullah 2008). Moreover, this sector remain perform well in the case

where the crisis exist. While many big companies, which exposes to the international environment,

had to experience the unexpected condition, this micro, small and medium enterprises were working

in such a normal way as if the crisis did not exist. This may be due to the fact that this sector uses the

local resources and sell it to the local as well and hence this sector do not really expose to the

exchange rate due to the absence of the overseas trading. Even if there exist MSMEs which deal with

international community, hence it expose to the exchange rate, the impact would not be significant.

Table 1

Profile of MSME in 2010

No Indicator Unit Year 2010 %Numbers of Unit Unit Numbers Share

1 MSMEs Unit 53,823,732 99,992 Micro Unit 53,207,500 98,853 Small Unit 573,601 1,074 Medium Unit 42,631 0,08

Number of Labor Person (unit) Numbers Share1 MSMEs Person 99,401,775 97,222 Micro Person 93,014,759 90,983 Small Person 3,627,164 3,554 Medium Person 2,759,852 2,7

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Contribution to GDP Rp Billion (unit) Numbers Share1 MSMEs Rp Billion 3,466,393,3 57,122 Micro Rp Billion 2,051,878 33,813 Small Rp Billion 597,770.2 9,854 Medium Rp Billion 826,745.1 13,46

Source: Ministry of Cooperative www.depkop.go.id, retrieved February 2012

Despite the important role of the MSME to the economic growth, there exist common internal

operational problem specifically within the MFIs (both conventional and islamic). Among the main

problem that prevent the IMFI to grow faster is on the liquidity issues. The less liquid would impede

the IMFI to develop further. There are many alternative solution on this issue. However, the

cooperatives may not as easy as banks with regard to the liquidity issues.

Many of the MFIs are not in the form of banks, they are mostly cooperatives in which the

fund sources depend heavily from the saving of the members which are very limited. If this is

continued then the progress of the cooperatives will be very slow. In order to speed up the

development of the cooperatives, they have to seek other sources of funds. Financial institutions

which may provide financial support for cooperatives are rural banks or commercial bank.

Cooperatives which are based on the Islamic principles can also request funds from Islamic Rural

banks and Islamic commercial banks (Bank Indonesia 2009, 2010). However, seeking funds from

these institutions is not without cost. Due to the opportunity cost, borrowing rate is expensive for the

MFI (Ascarya & Cahyono, 2011). Given the higher demand of financing by the MSMEs, MFI has to

borrow with high rate. As a result, the profit margin for the business would not be high.

As we aware, with regard to the liquidity issue, for the commercial banks, there is central

bank which acts as the lender of the last resort. It means that if banks could not get funds from other

sources, they can rely on the central bank with a relatively competitive price. However, that is not the

case in the context of MFIs. While seeking funds from commercial bank or rural banks are costly,

they may get funding from programs created by the various governmental ministries. This program

normally needs 2 or 3 years to complete and it does not guarantee that there will be another similar

program. Hence the issue of the sustainability is the major concern as new governmental appointed

minister may have different program.

Challenge to develop the microfinance by government is how to give fair treatment for the

commercial banks and to microfinance institutions which provide lending or financing to Micro Small

Medium enterprises.

Therefore, in this case, government should provide a kind of central bank or apex for the

MFIs to enable them to get cheap sources of funds. With this cheap price, obviously the MFIs can

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http://www.depkop.go.id/

lend with the relatively cheap price which lead to the economic growth as business which get

financing from IMFI also sell the product with cheap price.

In addition to the fast growth of the microfinance as well as Islamic microfinance in

Indonesia, there exists another Islamic financial instrument which has been put in more attention by

many. Retail sukuk issued by government have shown to be one of the better alternatives for the

investment. With the attractive rate and the low risk (as it is issued by government), every

governmental sukuk issuance has always been oversubscribed. This means that sukuk can be a better

alternative to raise funds.

4.Literature Review

4.1. Theoretical background (Theory of sukuk and securitization)

Sukuk has been put in greater attention in this decade, not only for the corporate to obtain funds to

expand their businesses, but also for the government as a tool to raise fund to develop the

infrastructures and facilities.

In a simple term, Sukuk can be understood as a shariah compliant bond. As we understand,

bond is debt based instrument. The issuer or the obligor is obliged to pay the interest and the principal

to bondholder on the date that has been specified upfront. Meanwhile, sukuk is not purely debt

instrument as in the case of bond, rather sukuk represents ownership of an asset or usufruct. The right

attached to the sukuk holders is not only claim on the financial term but also claim on the ownership

of an asset (depend on the type of asset securitization).

In middle ages, sukuk was widely used as means to support trade and commercial activities.

But, of course, given the current complex of financial environment, the structure of current sukuk is

very much distinct from that of the past. The current sukuk are akin, to some extent, the concept of

securitization. It is a process whereby ownership of the underlying assets is shifted to numbers of

investors via certificate which represents the proportionate value of the relevant assets.

There exist some advantages in using the securitization. Firstly, it enables to effectively use

the illiquid assets. In certain securities, originators should sell the underlying assets to the SPV

(issuer). Once it is successfully done, those assets will no longer appear in the originator financial

statement. The asset will register under the investor’s name. Therefore it allows expanding their

business without raising a new equity funds. Secondly, unlike borrowing which depend on the global

dynamic interest rate, the securitization will be another advantage since it is based on the asset level

rather than enterprise level. It means that the performance of asset determine the return paid to the

investor rather than the performance of the enterprise. Thirdly, with the developed capital market, it is

of no surprise that efficient, low cost of financing will be other advantage of securitization.

Fourthly, with the help of the information system, securitization business can improve its

performance. The issue of the capital market is on its efficiency. This has to do with the level of

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asymmetric information. If the information is disclosed at the same time (no insider information), then

the level of asymmetric information will be low which lead to the more efficient market.

Fifthly, Sukuk can be better alternative for the islamic financial institution to cater the

problem of mismatch between long term financing and short term deposit. Normally banks do not

want to finance long term project due to the characteristic of deposit as their main source of fund

which is short term in nature (the longest maturity period of deposit is 12 months). By issuing sukuk,

bank will have another source of fund, which has a longer maturity period than deposits. Sukuk period

can be designed as long as 20 years or more. Henceforth the issuance of sukuk enables the institution

to reduce the maturity mismatch. Specifically, sukuk may reduce the the issuer’s constraint of short

term liquidity and fullfill the enormous demand for infrastructure funding in Indonesia.

4.2. Mudharabah sukuk

This shariah instrument corresponds to a project or activity may adopt the concept of mudharabah

principle. Just as in its basic concept, it involves two parties namely mudharib and rabbul maal. The

former refers to the businessmen which have skill and ability on a certain project while the later is the

party which provide funds.

In applying mudharabah concept for sukuk, mudharib will be the issuer of the mudharabah

certificates. The rabbul maal in this case is the investors who subscribe the certificate. The holders of

the certificate mean that they own the assets/ project of the mudharabah and agree that whenever

profit incurred will be distributed accordingly.

The features of mudharabah sukuk are as follows:

1. It represents an ownership of specific projects.

2. The holders entitle to receive agreed upfront share of profit resulted from the projects.

3. The holders have rights to sell the certificate in the market provided that shariah requirement

is followed, particularly;

a. If the project is not yet started, then the certificate still represents money and not a

tangible asset. Consequently, in this case, the rule of Bai al Sarf has to be followed.

This rule says that exchange of gold, silver, monetary value/receivables or currencies

have to be equal for equal and the goods are homogeneous.

b. If the capital proceed is based on debt, then it must follow shariah rules on the trading

of debt.

c. All kinds of capital have to be assessed with the market value and mutual consent.

4. In this contract, there is no such thing as guarantee as it violates the main principle of

mudharabah which is profit and loss sharing. In other words, the prospectus should not have a

clause stipulated that the fixed amount of fund distributed to the holders.

5. The share is based on the profit and not on the revenue

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6. In an upturn economic condition whereby the project might earns huge profit, some portion of

the profit can be put as contingencies and later be used when the opposite situation happens.

The intention of this is merely for smoothing the profit earned by investors and this has been

approved by shariah advisors.

7. The guarantee mentioned in no 4 refer to the guarantee by either party in the mudharabah

project. However guarantee the mudharabah project still possible provided that the party

which give a guarantee is neither the mudharib nor the rabbul maal. This party should not

have any relationship at all to the mudharabah project.

4.3. Previous study

This section discuss the experience of sukuk mudharabah which has been applied in Malaysia. In

particular, this sukuk is adopted by one of the state of Malaysia namely Johor. Within this state, there

is a municipal called Pasir Gudang (PG). In 1995 this municipal wanted to raise fund to beautify the

city. The local government then made use of the sukuk mudharabah for that purpose.

Six series of different maturities mudharabah notes was issued by Special Purpose Vehicle

(SPV) namely PG Municipal Assets Berhad (PGMAB). This sukuk is rated “AAA” by Rating Agency

Malaysia (RAM),the highest rating in Islamic investment instruments. Moreover, RAM rates this

sukuk instrument as of premier quality. It means that it has highest safety capital preservation and

highest realizing expected return (Johorland, 2005).

This sukuk has some important features. Firstly, it deals with local authority (LA) in this case

Pasir Gudang Local Authority. The local authority is the tax offices which the main function is to

collect taxes particularly the property tax from the local society (individual as well as corporates).

Besides property taxes, the revenue for the municipal can be in the form of rental income, as well as

parking fines. Among these types of revenue only the property tax is compulsory made by the owners.

Moreover, the composition of the tax revenue shows that property tax collections comprise about 50-

95% of the total tax collected. Hence by using the tax stream revenue as the underlying asset, it

provides a lesser degree of uncertainty as compare to the use of other income stream such as rental

income and parking fines.

Secondly is the use of mudharabah in the sukuk structure. Previously, Islamic securities have

been predominantly with Bai’ Bithaman Ajil (BBA) which involves deferred payment sales. The use

of this BBA is debateable as the operation of this concept is close to that of the conventional concept

albait it is shariah compliance. However, rating agency in Malaysia called, Rating Agency Malaysia

(RAM) has argued that the use of mudharabah contract is a positive development in promoting

Islamic capital market in Malaysia.

In mudharabah sukuk, the development project must be existed. It means that the mudharib,

the party who have a skill, is collaborating with rabbul maal in this case investor to agree on a specific

project. The ownership of the investors is represented by the sukuk certificate that they will hold.

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However, the sukuk structure applied in Johor does not require the physical project to be

done. Rather the project is the ability of the tax officers to collect tax. In this structure, there are two

tier mudharabah for three entities namely investors, PG municipal and local authority. The first tier

mudharabah is between the investor and PG municipal who act as Special Purpose Vehicle (SPV) and

the second tier mudharabah is SPV (which act as rabbul mal) with local authority (which act as

mudharib)

Any amount receive by the local authority from the tax revenue will be shared by the local

authority and PG municipal accordingly. The portion for the PG municipal will later be distributed

between the PG municipal themselves and the investors.

The structure above can also be modified in the context of Indonesia, particularly to develop

the microfinance industry which is in liquidityshortage. In this paper mudharabah sukuk is still be

adopted. However, unlike the structure in Johor bahru which uses the tax management collection as

the project, this paper uses management of the government asset as the project. The detail explanation

will be elaborated in the following chapter.

5. Proposed sukuk structure for microfinance

As has been stated above, liquidity issue is the main obstacle in developing the microfinance and this

paper attempts to provide its solution. In order for the sukuk structure to be implemented, at least

three entities have to be existed. Those are,Investors, Special Purpose Vehicle, and Government.

Figure 1 will explain the proposed structure

Figure 1Proposed Sukuk structure

13 121 42 6 Central BMT MSMEs3 9 Bank Like 10 11 12

Investors 8 SPV Govt (CBL) BMT MSMEs

BMT MSMEs

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Govt Asset

In this case, while SPV acts as the party which issue sukuk, goverment’s role is to develop the

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microfinance, via supporting the liquidity. In addition to these three entities, it requires Central Bank

Like (CBL) for microfinance. It is not central bank that we understand that act as the lender for the

last resort for only banks, rather CBL’s role is to act as the lender of the last resort for Islamic

cooperative0. Moreover, CBL is also the regulator for the cooperatives which include Islamic

cooperative0 (BMT). BMT act as financial intermediaries which collects funds from party who have

excess funds and distribute to other party who is in need of funds (in this case MSMEs). The process

is as follows:

1. SPV, as a one dollar company created by government to issue sukuk, set up a profit sharing

basis of mudharabah with the investors. This means that the investors act as the rabbul maal

(parties which have excess funds) and SPV act as the entrepreneur who will manage the

funds.

2. As a rabbul maal, investors contribute fund to be given to SPV

3. As a countervalue after receiving funds is for the SPV to provide mudharabah sukuk

certificate to investors. This is to evident the investors on their participations in the venture.

Hence the mudharabah part is taking place between SPV and the investors. Bear in mind that,

the obligation of the mudharabah holder is not without limit. In this case the holders’

liabilities are limited up to the amount contributed in the venture.

4. The ijarah part will take place between SPV and Govt as the owner of the asset

5. The govt asset is rented to the SPV.

6. SPV give rental fee (advanced payment) to the govt. This fee is coming from the funds

contributed by the investors.

7. During the leased period, the profit generated from the leased asset will be managed by the

SPV

8. The profit will then be given periodically to the investors as the profit form the partnership

(mudharabaha)

Basically, it requires eight sequence step in order for the sukuk to be implemented. These steps cover

from where the funds come from until the step where the fund is given to CBL like for microfinance.

However, this structure has not explained the main purpose of this study that is how sukuk can

support the liquidity shortage for Islamic cooperatives (BMTs) which deal with Islamic microfinance.

The following is the process on the role of sukuk for microfinance:

1. The advanced payment received by government is to be given to CBL that act as lender of the

last resort for Islamic cooperatives.

2. The funds will then be distributed to the Islamic cooperative or BMTs.

0The role of ministry of cooperative will be limited as this CBL is introduced. The CBL can adopt the Apex sistem. Apex operate as a lender of the last resort for the non commercial banks0In this paper, islamic cooperatives and Baitul Maal wa Tamwil is used interchangebly

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3. As the price of the sources of funds is relatively cheap, BMTs will be more able to give lower

financing rate to the MSMEs. Moreover as the loanable fund increase. BMTs have more

opportunity to provide more financing

4. The profit from the businesses will be distributed between the MSMEs themselves as well as

the BMTs.

5. Profit portion for the BMTs will be divided by the BMTs themselves and the CBL. The

payment will be the profit portion for the CBL and this has been agreed upfront.

There advantages on using this sukuk structure:

1. It promotes sukuk as the alternative for the financing as opposed to the traditional financing

from Islamic bank. The existence of the financing alternative will give more option or choices

for needed fund parties to assess the risk and return that fit with their risk profile

2. This structure is to support the real sector which is consistent with the nature of the Islamic

finance. In this case, sukuk is adopted to support the liquidity shortage experienced by many

Islamic cooperatives

3. As the intention is to support the Micro Small Medium Enterprises particularly micro

enterprises via BMTs, the negotiated profit rate given to the government (through CBL) can

be designed to be very minimum. The big portion of the profit goes to MSMEs and certainly

in the long-term MSMEs will grow faster.

4. In many ijarah sukuk, there is a step of sell and buyback. Which means government is selling

the asset in which in the maturity date, the government is buying back the same asset. This

requires the purchase undertaking and the ownership given by government is beneficial

ownership and not a full ownership. This beneficial ownership remains the issue. Although

majority has said that beneficial ownership can be applied but still there are others who

oppose it. This structure attempt to get rid of the beneficial ownership issue. This is because

government is leasing (not selling) assets to the SPV in which the government is receiving the

advanced payment in full at the beginning.

The structure above has been designed to reduce the any possible risk encounter in sukuk issuance.

For example, the asset by government is a tollway which has been used daily by the commuters hence

there is unlikely to be defaulted on the payment. This means that investors face the less risk type of

investment.

With regard to the annual profit rate earned by the Micro enterprises, the current fact shows

that the profit rate can reach to more than 40% annually0. Although the rate is quite high, the

microenterprise still gain a moderat profit. This is because Microenterprises and in general MSMEs

have to repay back the loan to BMTs quite substantial.

0 Based on the discussion by the author with the practitioner who worked in Islamic microfinance institutions

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The pertinent question would be, why the BMTs charge a high profit rate to the MSMEs? The answer

is, other than there is no collateral which create financing risk, the high profit rate is due to the high

cost of funds. This is due to the fact that BMTs get an expensive loan from commercial banks.

It is the opportunity cost by the commercial bank to give financing to MFI/BMT. The commercial

bank need to compare the profit rate charge to BMT and other secured individual borrower. If the

secured individual borrower are charged quite high profit rate, then profit rate charge to BMT will

also be high or even higher. By introducing the sukuk structure above, microfinance institution may

get a cheaper price source of funding.

Other than that, the current practice is that the microfinance institution depends on various

ministry such as ministry of cooperative, ministry of agriculture etc to get the cheaper source of

funding. However, in term of the sustainability, the programs proposed by those ministries are not

sustainable. Different ministers may have different program which may or may not support the

microfinance institutions.

With the introduction of sukuk structure above, the funds are being put as a capital in the

CBL. So there is no such case of capital which is depleted. This is because the microfinance will

return back the capital plus the profit margin.The capital can be used to provide financing to other

microfinance institutions. Hence in term of the sustainability, the structure above is sustainable.

6.Conclusion

The paper aims to provide the regulatory framework to create solution of the problem that has been in

existence in the development of microfinance. Among various problems, the liquidity shortage is the

main problem which needs to be settled down.

The field experience has shown that micro enterprise may get profit more than 40% annually,

but the overall development of the microfinance is still moderate. One of the reason is because the

microfinance institutions charge high profit rate of financing to the microenterprises. This is because

microfinance institutions get an expensive rate of financing from Islamic commercial banks.

This paper attempts to provide a cheaper price of sources of fund by introducing the sukuk

structure. Basically mudharabah sukuk is issued by SPV which act as the manager of the government

asset. The profit given to the investors will based on the profit gain by the manager. The SPV manage

the government asset can be in the form of managing the less risk business project such as managing

the infrastructure facilities etc. The less risk of the projects will certainly attract more investors to

make investment. Hence the development of the microfinance will be faster.

As for the recommendation for the government facing the high profit rate charge to MSME,

government needs to settle down this issue. This paper attempts to provide the input to the

government for that issue by adopting the sukuk concept and establishing the CBL.

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Paper 17

Capital Requirement and Financing Provision Regulation inIslamic Microfinance Institutions (IMFIs):

Single and Double Mandate (s)

Suhal Kusairi, Ph.D.Assoc Prof. Nur Azura Sanusi, PhD

School of Social and Economic DevelopmentUniversiti Malaysia Terengganu

Tel: +6096684541; Fax: +6096684237Email: [email protected], [email protected]

Abstract

Microfinance has tremendously developed since the last two decades indicated by huge growth in number of institution and total outstanding financing. It becomes an interesting point for academics, practitioners and regulators because the important mandate of IMFIs in the alleviation of poverty rate and provide the main financing sources of microenterprise and poor people. In addition, the consequences of various mandates of IMFIs bring to the different business structure, i.e. banking, cooperation, NGO, development agency, credit institution and rural organization. As a result, the various structures will bring to the differentiation in regulation and supervision, the activity and operation of IMFIs might be flexible but might not become effectively and efficiently. In accordance with the role of financial institution, we need the regulation and supervision which is not disrupting the industry development but it is a preparation for soundness of institution, client protection and early effort to support the best infrastructure of industry. We classified the Islamic microfinance institution into three mandates, namely development agent, business and hybrid. In addition, microfinance is normally related to lending money to poor people or microenterprise without credit history, business records or collateral. Based on all limitation of microenterprise and unique characteristics of Islamic microfinance, how to set up the effectively and efficiently regulation and supervision from three perspective agents. In this regulation framework, this paper dealing and focusing on capital requirement and financing provision. Here, regulation framework should take account the asset quality and financing technology characteristic of IMFIs and risk based in supervisory framework. We argue that these two sides is very importance for financial intermediary’s soundness and prudential regulation.

Keywords: Capital Requirement, Financing Provision, Regulation and Supervision of IMFIs

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Introduction

Microfinance has a very important role in providing financing for microenterprise, it is a major

problem due to they usually fail to get financing from standard financial institution such as

commercial bank. The reason is usually this type of business cannot meet the requirements needed by

the commercial as collateral, proper documentation and financial statements. In addition,

microfinance has also an important role in reducing poverty rate by helping the low-income

households to increase their capacity and synchronies cash flow. In this case, microfinance institution

as complements of government programs for instance subsidies a free assistance or funds.

Empirical evidence showed, world data from 2005-2010 have shown that microfinance

institutions grew about 35% of the total establishments over the world and the number of active

borrowers increase about 108%, and about 25% the world’s population is poor and only about 10%

have access to financial system services. 33.3% of the poor population is Muslim, while 72% do not

use formal financial services. Islamic microfinance represents less than 1% of global microfinance

programmes (Azmi Omar, 2012). Even thought the Islamic microfinance is lagging behind, but

without a doubt, one of main contribution of Islamic microfinance institution to economic

development is to alleviate poverty (Ahmed, 2002).

In addition, academic studies have found that microfinance institution has important role in

equitability of income distribution either through financing microenterprise or low income households

(Ahmed, 2002) and Churcil & Coster (2001). In this case, microfinance institution provides greater

opportunities to the microenterprise sector developed where they have no chances to obtain financing

from standard commercial bank. It normally requires the strict requirements such as collateral,

financial status and financial administration. Gallardo (2001) and Hoxhaj (2010) supported the

previous studies that microfinance institution focused on financing found that total assets, financing

and number of microfinance institution itself always experienced a significant increase.

Based on several studies have been conducted, the major problem is the posture of

microfinance institution where the service users have not supporting financial data, lack of collateral

and it is start up business. Thus, it exposed to a high level of risk and should be strong provision to

support the possibility failure of repayment and provide income stability to the investors or benefit to

donor. In addition, the asset structure is weak due to it is normally very dependent on the government

budget and internal or external donor. Even though, the growth is high but dependent on government

policy and the existence of the donor. In other words, microfinance institution is poor regards to the

raising fund from the third party. Asset structure should be brought up to market-oriented not to a

specific policy. If both problems cannot be solved expected microfinance industries will not achieve

stability and sustainability. Unfortunately, law and regulation infrastructure for both activity are weak

and the regulatory process is too simple and there is possibility overlap between the departments

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within a country. Nevertheless, in any case, the development of microfinance institution is very

important for the industry due to increase people's capacity, reduce poverty and develop new

entrepreneur business by a selection process and fair competition.

The efficiency of microfinance industry is a golden goal which desired by all parties involved.

Industry and microfinance market describe the distribution of economic resources and how the

industry utilized it with more transparent, efficient and equitable. The market information which is

efficient, transparent and fair is importance to all interests of the parties involved, based this

information, ability and effort the consumer will decide whether make an investment or not. It gives

learning about the possibility that all people can thrive, and then financing is not a factor for the

failure of a person or business. Microfinance industry will be like the financial industry, such as

banking, but which distinguishes only financing and investment level with occasional small. How the

regulations and laws, the level of risk, stability and equal health system are strong and healthy.

The development of regulations and laws is to ensure the microfinance operations and

activities are going well and can be controlled to ensure the interest of all parties is very important.

Experience of Malaysia the microfinance is an important instrument for poverty alleviation.

Microcredit is as complimenting the government’s effort in reducing poverty. Microfinance divided

into two; regulated microfinance providers are bank institution and non regulated microfinance

providers are NGO, cooperation etc act as conduit of government loans to target poor household on

the other hand all focused on lending activities there is no mobilization deposit or partnership from

third parties. Regulatory agency is central bank (BNM), minimum capital and capital adequacy ratio

of regulated is required.

In addition, the current rules and laws that supervising of microfinance can be divided into

three authorities, under the ministry of finance, central bank, cooperatives and other irregularities. The

regulation was not enacted for the purpose of organizing and regulating all activities and operations of

microfinance, but only to give directions are very simple and far from prudential regulation. It is not

all microfinance institutions require prudential regulations due to a lot of microfinance do not raise

funds from third parties.

Microfinance providers have sought to expand the capacity and scope by increasing the

activity and operation. One of the main problems is the weaknesses of raising funds from the third

party for instance savings, investment even donation. Generally, third-party funds is very small except

the sourced fund from financial institutions but lead to higher financing costs due to microfinance

institution act as the middle man. In addition, the financing characteristic of the creditors or partner is

very high risk cause the minimal security and support information.

Unfortunately, the rapid development of microfinance institution does not be supported by

proper regulations and laws to all activities and operations. Whereas this is very important for

microfinance institutions are efficient and effective. It is also main sources of problem in collecting

fund and financing activities due to a lot unclear and overlapping regulation so might be exposed to

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investors. Objective of this paper is to explore the existing rule and regulation of microfinance

institution and how to supervise them. Find out the specific regulation and law in financing provision

and asset requirement and the best practice how to conduct supervision. These two issues are very

importance due to these parts will ensure the return and cost operational of microfinance institution

and risk management. In addition, it is to protecting the stakeholder of both sides; investor or

depositor and creditor or partnership from the excessive risk.

Structure and Behavior of Islamic Microfinance Industry

Landscape of financial system and environment of economy affect the structure and behavior of

Islamic microfinance institution. Generally, there are five structures of microfinance institution;

commercial banks, non-banking institution, cooperation, non-government organization and

government agency. First, commercial bank provides the microcredit as an integral part of their

services provided to customers. Microfinance unit also as a substitute and meet the needs of regulators

and the part of the credit must be extended to microenterprise industries. Second, non-banking

institution in this regard is a kind of attempt to give credit to the microenterprise. Third, cooperative is

an economic institution formed by members of groups that have a specific purpose whether in

production, marketing or finance. Fourth, NGO is an organization is established by group of citizen

with the specific objective normally they involved in social issues. Fifth, government agency is

established by the government to help the government program.

Diversity forms of these institutions provide their own flexibility on Islamic microfinance

institution however maybe become less effective in the regulatory and development regulations for

lack of clarity and focus. But rules and laws is a major factor in the industry. Because of the laws and

regulations will determine their behavior stakeholders. Over the longer will be the effectiveness and

efficiency of the industry as it will affect how a resource will be used and the level of competition, in

addition to providing certainty and control to the customer.

Activity of Islamic microfinance institution is different, as the main activity of financial

intermediaries properly is to mediate between the surplus and deficit funding. Funds will be collected

from savers or investors as well as equity capital itself. Various financial instruments offered in this

fundraising, the Musharakah, Mudarabah, Ijarah, etc. The funds collected will be invested in or loaned

to certain parties usually to small businesses and the poor. Both of these can be seen as a portfolio of

assets and financing.

Each Islamic microfinance institution haves different focus of activities. There is heavily on

financing activity, some are balanced, however rare heavy on fund raising alone. Nevertheless, almost

80 percent is lending activities. In addition, microfinance institution operations are currently from

starting up to ideal one. The main problem is how these institutions get financing and otherwise major

problems small businesses how things simple they get funding. Market share of microfinance in

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Malaysia 80 percent is commercial bank, followed by non-bank institution, government agency and

cooperation. It indicates that portion for poor household and start up enterprise.

The level of competition between microfinance service providers is actually high because no

clear criteria of suppliers. Microfinance can be provided by NGOs, government agency, non banking,

cooperative banks and businesses, each of which has an objective and characteristic of each

organization. Competition, this will determine the type of microfinance system costs vary and usually

high cost because of the high financial risk. Unfortunately, SMEs actually require lower cost of

financing or to compete with non microfinance funding costs so they can compete and grow so that

they can compete with the big companies from domestic or overseas.

Table 1 shows the feature of microfinance institution in selected Asian country. Ilanto (2006)

resumed that microfinance activities are distinguished into two activities of deposit and deposit &

loan, which might be the divided into regulated and the not regulated microfinance. In addition, all

microfinance whether regulated or not regulated the central bank or a unit in central bank or

microfinance development institution themselves is regulatory agency. Every country has legal basis

which might be distinguished set out at banking and non banking institution regulation but usually as

part or diversity of their activities. There is also a country that already has its own legal basis in

specific microfinance activities, such as Pakistan and Bangladesh. There is also the legal basis as rule

development acts and it is be as part of government programs. Majority of microfinance institutions

are not apply physical collateral in lending technology but normally in form of group guarantee or

personal guarantee.

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Table 1: MFIs Structure in Asian CountriesRegulated MFIs Non Regulated MFIs

Legal basis - Bank R/S- Non Bank R/S- Cooperative Rules- Microfinance Rules

- Bank R/S- Non Bank R/S- Cooperative Rules- Microfinance Rules

Regulatory agency - Central Bank- MF Division- Cooperative Dev

- Central Bank- MF Division- Cooperative Dev

Supervisory approach Traditional TraditionalActivity - Loan

- Deposit from public- Loan / as conduit of

government loans- Deposit from members

Minimum capital - Required- Suggestion

- Not required

Institution provider - Bank- Non Bank Institution- Cooperation

- NGO- Gov. Agency- Community

Collateral - Group guarantees- Joint guarantees- Personal guarantor

- Group guarantees- Joint guarantees- Personal guarantor

Interest rate / Ujra - Market determined + subsidies

- Fixed by government

- Market determined + subsidies

- Fixed by governmentCAP - Required - Required

- Not RequiredFinancial report to regulator Yes YesExternal audit Yes YesLoan loss provisioning - Required not specific

- Required 5%-10%, 5%-20%, 5%-50% and 100%

- Required not specific- Required 5%-10%, 5%-

20%, 5%-50% and 100%Source: Modified from Regulatory Architecture for Microfinance in Asia

Microfinance also requires any protect of the probability of loss with provide the loan loss

provisioning, certain rules of between 5% - 10%. Determination of the various benefits operation

which is the interest rate to be charged to the borrower is determined by the government or the interest

rates charged based on the market mechanism. Risk management is not fixed yet, there are

microfinance sets out the minimum capital and determined capital adequacy ratio. In terms of

reporting mechanism all microfinance institution should reported the financial statement to regulators

and conducted external audit process. Institution providers are various; commercial bank, NGOs,

government agencies and cooperation, as a result supervisory authority remains unclear between the

central bank and the department where microfinance operate.

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Regulatory and Supervisory Framework in Financial System

Financial system consist of three components; financial institution, financial market and financial

assets. Financial institutions act as financial intermediaries for fund surplus and deficit sector. There

are various financial institutions, commercial bank, insurance company, mutual fund, finance

company and deposit and saving company. It can be separate becomes two; banking and non-bank

institution. Financial market can be divided tow major namely money and capital market. Lastly,

financial instrument is product that traded in financial market. It shows the claim to real asset of

issuer. The role of financial system is very importance in economy due to it can distribute the

economic resources to various sectors effectively and efficiently through demand and supply process.

All activities and process should regulate and supervise so all party involved fell satisfaction.

The existence and its strong, competencies and effectiveness of the regulatory and

supervisory are a priority for each of the financial system of a country and the responsibility of the

central bank. This effort is significant because financial environment is constantly changing and these

changes are sometimes very fast though existing regulations are constantly changing to follow the

changes. Therefore, central bank always ready to respond to changes in the financial system remain

competitive, innovative and soundness. Central bank is responsible for the financial system stable and

reliable payment system and high confidence of savers and investors. To make sure all this can be

achieved, maintained and developed the central bank must always adopt a principle based and risk

based supervisory regulation.

Currently, principle based regulations framework get high attention in the development and

maintains the prudential regulation in financial system. Under this framework the principle based

regulation, bank regulation has progressively shifted to the development of high level principles

standard, and an ingredients are more details in bank regulation expectations related to soundness

bank and business. It means not to reduce supervisory but regulatory focused on the ability of

institutions to risk management as compliance with detailed rules. As a result, it will produce a

stronger regulation towards market changes, as well as attention to the limitations of the basic

principles of the rule system for all through a fair differential between institutions based on the size,

complexity and risk profile. Financial institutions can be considered as a flexible framework to

determine the most appropriate way in which bank regulatory expectations in line with the their

strategy, objective and business model. The central bank believes that the framework would be more

appropriate at all times to promote and enforceable financial stability and more competitive financial

system.

Actually, this standard stipulates the supervisory related to the composition of effective board

of directors or senior management that include a independent and dependent members, appropriate

and suitable experience and education background, transparency in the recruitment process and a clear

responsibility for the operation and function of the internal oversight.

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Supervisory process at the same time also expanded to ensure the directors and chief

executive officer of the financial institution appropriately meet and perfect criteria on existing

policies. Besides that, the bank is under review with regulatory compatibility of top management to

the appointment. The Bank should be more engaged with the management of financial institutions to

the risk of development strategies and institutional influence. This makes it more effective assessment

of how top management will be relieved of responsibility in practice, while the supervision of the

deeper issues of governance in the institution.

Regulation and Supervisory Framework in Islamic Microfinance Institution

Islamic microfinance institution is a new industry and growing very fast. IMFIs give a high

expectation on the economic development and reducing of poverty rate. It is in line with two main

roles of Islamic microfinance institution, namely provide financing services to microenterprise and

help low-income households in synchronize their cash flow. So it is good momentum must be

maintained and provided good infrastructure with developed regulation and supervisory system for

establish the soundness and competitive industry. La Porta et al (1998) found that law and regulatory

framework will greatly determine the performance of the industry. He argued that it will provide

direction and guidance industry in term of corporate governance, procurement and utilization of

economic resources and market competition.

Unlike with other the financial institution such as banking, insurance, mutual fund,

microfinance industry is very simple due to it is not complicated and a lot of voids in the tributaries

rules: the acquisition and utilize of resources, and operational activities, clients and service providers

as much less detailed characteristic of capital, provision and risk mitigation management. Most

academics suggestions that microfinance should follow the standard banking industry model in term

of prudential regulation and hierarchy regulation international, regional, and country . They argued

that the some microfinance provider, investors or donors are from outside the region or country, that

why beyond the country up to the rules and to ensure the interest of investors or donors. However,

Macchiavello, (2011) did not agree due to most microfinance activities are not much related to the

international environment in financing assets or resources. They proposed specific regulations based

on the purpose of funds or donor, at present a lot MFIs refer to CGGP rules who founded

independently but under the World Bank organization.

Other issue in IMFIs is the regulation should be rest on institution or activities. Majority of

researcher gravitate to activity regulation compare with institutional regulation. They argued that the

regulation on based institution is very difficult due to a lot variability of type institution and

characteristic of IMFIs. Then it is more reasonable and simple to regulate based on the activity of

IMFIs than institutionally. According Llanto (2006) the main activities of IMFIs as look like financial

236

intermediary are collect deposit, donor and or investment and provide financing to the microenterprise

and low-income household. In addition, there is issue or problem how to supervise the regulation

cause a lot authority power of the particular Institution.

Major activity of Islamic microfinance institution is collecting funds from internal and

external depositors or investors. This part is very important for financial institutions assets derived

from external parties through deposit or investment financial instruments. In Islamic finance, this

financial instrument could be created through Wadiah, Mudharabah and Musharakah contracts.

Hoxhaj (2010) and Boudriga (2009) argued that financial institution which collected funds from

external should be regulated to protect from moral hazard and adverse selection are stemming from

asymmetric information. However, discussion of this part microfinance institution faced with the

dilemma that some recommendations. Macchiavello, (2011) stated that microfinance institution

should be provided by clearly and detailed regulation to increase the opportunities of microfinance

institution to grow as complete financial intermediaries. As result, there is possibility they can

increase the amount of deposits and investments from third parties significantly which currently is

very weak. In contrast, Staschen (2006) stated that the detailed regulation relating to this collecting

funds activity is not necessary for a variety of reasons, one of the reasons is the most of microfinance

institution activities do not get financial sources from third parties, but from the government,

members and donors.

Other microfinance institution activity is financing, so far it is the main activity and seize bulk

hamper management priorities. It is not a very strange because the most microfinance institution is the

kind of government agents, NGO’s and cooperation who remain silent for implementing programs,

social reasons, which initially was to help low-income households or help increase the capacity and

increase the outreach of microenterprise to financial system especially in financing. In Islamic

finance, there are some possible contract that could be used to generate financial instruments in this

point like Ujra, Sales contract (Murabahah and Bai Bithaman Ajil) and partnership (Musharakah and

Mudharabah). In addition, a lot creditor and partner in Islamic microfinance institution is poor

documentation, financial position and collateral. As result the microfinance institution will expose to

the higher risk compare with standard commercial banks. So there is rational the microfinance

institution should focus on mitigate the risk with applied the certain regulation and provided provision

of the financing product.

No doubt, diversity type of microfinance institution causes difficulty in forming regulations

and supervisory frameworks that what IMFIs should be done or prohibited in their activities.

Therefore, regulator should define the clearly of Islamic microfinance institution, kind activities and

operation. Based on this regulation then we can be able to determine the supervision process, under

which authority should conduct the supervision process. All this kind law and regulation, the

microfinance industry is become more certainty, transparent and accountable. Finally the soundness

and sustainability of industry can organize, regulate and supervised.

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Nevertheless, good industry should provide the law and regulation towards all stakeholders to

make sure that all activities are regulated and supervised without reduces and disturbs the current

development and growth. Transparent and accountability are implemented, it will strengthen the role

of microfinance institution in assisting the government integrate the fiscal policy as well as the

possibility of microfinance institution a new monetary policy transmission are very important in the

future given the enormous opportunities in microenterprise financing as result the average market

share up to 30-40 percent of the country's financial assets and the majority of the population involved.

Proposed Asset Requirement and Financing Provision Regulation in IMFIs

Characteristics of microfinance institution are very specific. It differs than standard commercial bank

in term of asset quality. Normally, asset portfolio of microfinance institution consists of microcredit,

micro investment and fixed asset. In other side is source of fund, we call it as deposit, investment,

donor and equities. Microcredit portfolios frequently show lower delinquency than normal

commercial bank portfolios (CGAP, 1996). But MFIs has normally got higher volatility due to the

type of client and characteristic of business, especially if where management becomes puzzled from a

consistent focus on repayment performance. Thus system of trace and feedback to delinquency are

particularly critical to MFIs and suggested they should provide provision their overdue loans

somewhat progressively than conventional banks.

In addition, IMFIs have similarity in term of asset quality with conventional ones, but they

have special characteristics and philosophy in the basic idea and behaviors. There are three major

norms of Islamic system. All transactions in an Islamic system must be governed by norms of Islamic

ethics as enunciated by the Shariah, namely prohibition of riba and excessive gharar, and mutual co-

operation or Ta’awun, (Obaidullah, 2005). Financial instruments of IMFIs are defined based on the

background of a contract between the client and the borrower and IMFIs. Kusairi and Sanusi (2013)

classified into 4 main groups and each group there is some contracts. 1) Profit and loss sharing

contract, consisting of Musharakah, Mudarabah, Muzaraah, or Musharakah Mutanakisah. 2) Sale and

lease contracts; Murabahah, Istisna, or as Salam. 3) fee-based contracts such as Wakala, or Juala, and

4) benevolent debt like Qard-al Hasan. Customers should be treated based on the characteristics of the

type of business, total assets, objective, historical loan or partnership.

Unlike a standard commercial bank that has many methods to protect the safety of their credit

portfolio like high collateral, complicated documentation requirements and standards for borrowers

who have a high risk and proper risk management. Microfinance cannot conduct risk management

processes such as that because it is not possible for microenterprise and low income households. In

addition, IMFIs the advantage in simple process and the market loan segment is not meet with

collateral conditions.

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Even though, a lot of source funds from government program and international donor but the

regulations of the possibility failure of credit or investment is an importance from some perspectives

especially for IMFIs sources from third party. Donor and government require the funds are given to

IMFI should be managed well and invested in trust, accountability and generate value added to

existing funding sources. This means that the investment made by IMFI based on the concept of

financial economics that every investment should consider the risks and returns.

Minimum asset requirements and capital adequacy ratio of IMFIs is something that can be

considered when looking at the current and future expectations which IMFIs become more

independent and perfect financial intermediaries of both side the collection and usage of funds.

Minimum asset requirement is the condition entry to the industry. Currently most of the countries

applied this regulation. In addition capital adequacy is to support the risky assets generated by

management decision exposed to the credit and market risk. Although we know that currently IMFIs

more activities in borrowing funds compared with fund raising. However, IMFIs still have a social

mission of petrified funding to groups that cannot be achieved by normal commercial bank, there

should be minimal value when determined small assets in this sector. Besides that, most providers do

not have enough funds. Conversely, independent providers or depositor and investors have a lot of

capital that IMFIs should put their effort to generate deposit or investment financial instruments for

collecting capital.

There is tendency and a strong argument for allowing IMFI use more aggressive as the bank's

equity business. This is due to the huge demand and unmet by existing IMFIs. As previously

mentioned, risk factors should be considered in determining the asset. Two other factors have

considered the macro experience and data related to microfinance is very limited for all countries.

Second, because most IMFIs are not a fully financial intermediary, then the financial cost is high

enough to be exposed to bankruptcy faster than normal commercial bank. Considered all this, IMFIs

should be charged by CAR (capital adequacy ratio) higher than the existing BIS (Bank International

Settlement) which shows 8%.

In addition, the most important activities of IMFIs are the financing consist of lending and

investment technology. Loans are provided into microenterprise or low-income household that have

features more exposed to the financing risks. We know that the loans are not backed by traditional

collateral and normally required and supported be groups or personal guarantors. The lending

technology process is also without rigid credit analysis and it not supported by a strong and detailed

financial documentation. Then the financing portfolio is high risk as result of high failure. Therefore,

Gallardo (2001) suggested that MFIs should be regulated by providing provision for possibility high

failure.

Islamic financing technology might be compressed into three models: sales and lease based,

fee based contract and profit and loss based. Sales and lease based using Murabahah and Bai

Bithaman ‘Ajil contracts. Fee based using Wakalah, Ujr, Wadiah, and Tabarru contracts. Profit and

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loss based using, Musharakah, Mudarabah, Muzara’ah and Musharakah Mutanaqisah contracts.

According to Ahmad (2002) stated that these contracts would generated different risk characteristics

due to different properties of the contract. Sales and lease based is the lowest risk, fee based is

moderate risk, and profit and sharing is the highest risk.

Consequences of IMFIs features and MFIs itself, It should monitor, analyze and measure their

financing portfolio in regularly basis. Regulation of IMFIs should clearly state that requirement of

reporting regarding the current the non performing loan and investment. Financing or asset portfolio

might be categorized in to; standard, sub standard, doubtful and loss of every type of contact. The

regulator determines the requirement rate of financing provision for probabilities failure and type of

contract. We could propose the standard rate of financing provision into the measurement and give

weighted based on certain the portfolio policy that reviewed periodically. For instance table 2 states

the simulation of financing portfolio provision, the weighed for sale and lease, fee based and profit

loss sharing each 30%, 40% and 30% respectively and multiply with rate of every category of

nonperforming loan and investment for four each 5%, 20% 50% and 100% respectively.

Table 2: Simulation of Financing Portfolio Provision

Contract WeighedNPL Categories

Standard Substandard Doubtful LossSales and Lease 30% 5% 20% 50% 100%Fee Based 50% 5% 20% 50% 100%Profit and Loss Sharing 20% 5% 20% 50% 100%

Nevertheless, measurement of financing provision should be based on the basket of financing

portfolio, it’s not individually basis, and beside that all financing portfolio should provide the general

financing provision. In accordance with the characteristic of financing portfolio of IMFIs exposed to

higher risk. Then it should be recommended to be higher than normal financial institutions about 2.5

percent.

In addition, Islamic microfinance institution also has high liquidity risk compared than

commercial banks. Most microfinance clients are affected by seasonal factors and short-term;

dependent on the presence of the donor, the government program and short-term financial market that

should not be expected availability. IMFIs might be proposed prudential regulations that need to be

considered to determine liquidity risk standard.

Table 3 Application of Prudential Regulation in IMFIsRegulation Items Single Mandate Double MandatesMinimum Capital Requirement V VCapital Adequacy Ratio - VFinancing Provision V VLiquidity Provision V V

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For simplicity reason, IMFIs activities divided into focusing on financing activities only we call it as

single mandate and focusing on both financing and collecting funds we call it as double mandate.

Table 3 shows that single mandate’s IMFIs are required to fulfill the minimum capital, financing and

liquidity provision regulation. In addition, double mandate’s IMFIs are required to fulfill the

minimum capital, capital adequacy ratio, financing and liquidity provision. Argument on the

application of prudential regulation is to ensure the interest of all parties especially to protect the

client from misconduct behavior of IMFIs and provide the good infrastructure of microfinance

industry that suitable, soundness and competitive.

Llanto (2006) noted that different regulatory frameworks will have varying impacts on MFIs

and depositors. There is good and bad regulation, and more research is needed in order to determine

regulatory approaches that confer more benefits relative to costs. For microfinance regulation to be

considered effective, it must show at least the following, according to Vogel (2000). Because of the

diversity of institutes conducting or providing microfinance, less obvious or probable cause exists

overlapping between several agencies. Therefore, the argument that is strong existing regulation

should be based on the Activities of microfinance. In parallel, the supervisory appropriate and in

accordance with current requirements of the supervisory framework should be risk based supervisory

framework.

Figure 1 Supervisory Framework under Risk Based (RBSF)

241

Identify Significant Activities

Asses the Inherent Risk

Asses the operational Management

Assess the Risk Management Control Function

- Deposit - Lending

technology - Investment

- Credit performance

- Investment- Liquidity- Asset quality

- Business line- Objective- Manager

qualification & responsible

- BOD- Senior

Management- Internal audit- Shariah

compliance

Assessment of Capital & Earning

Assessment of Capital & Earning

Figure 1 states that risk based supervisory framework, started with identify the significant activities

namely lending and investment, and deposit and investment collection. Here, IMFIs utilizes the fee

based contract, sales and lease contract, profit and loss sharing, and benevolent contract. Second,

assess the risk of inherent activities at every contract. Third, assess the operation of microfinance

institution, as result, the operational risk, credit risk, market risk. We can see the process of lending

technology requirement in terms of administration, operational standards and etc. Previous

assessments focus on input and process of Islamic microfinance finance. Fourth, assessments to

decision makers or management related with human resources or capital. Top management or board

director needs to comply with appropriate standards like fit and proper qualification in terms of

education and experience, whether controlling function in the institution are in place.

Conclusion

The efficiency of microfinance industry is a golden goal which desired by all parties involved.

Industry and microfinance market describe the distribution of economic resources and how the

industry utilized it with more transparent, efficient and equitable. The development of regulations and

laws is to ensure the microfinance operations and activities are going well and can be controlled to

ensure the interest of all parties is very important. The current rules and laws that supervising of

microfinance can be divided into three authorities, under the ministry of finance, central bank,

cooperatives and other irregularities. The regulation was not enacted for the purpose of organizing and

regulating all activities and operations of microfinance, but only to give directions are very simple and

far from prudential regulation.

Characteristics of microfinance institution are very specific. It differs than standard

commercial bank in term of asset quality. Normally, asset portfolio of microfinance institution

consists of microcredit, micro investment and fixed asset. In other side is source of fund, we call it as

deposit, investment, donor and equities. Microcredit portfolios frequently show lower delinquency

than normal commercial bank portfolios. But MFIs has normally got higher volatility due to the type

of client and characteristic of business, especially if where management becomes puzzled from a

consistent focus on repayment performance.

There is tendency and a strong argument for allowing IMFI use more aggressive as the bank's

equity business. This is due to the huge demand and unmet by existing IMFIs. As previously

mentioned, risk factors should be considered in determining the asset. Two other factors have

considered the macro experience and data related to microfinance is very limited for all countries.

Second, because most IMFIs are not a fully financial intermediary, then the financial cost is high

242

enough to be exposed to bankruptcy faster than normal commercial bank. Considered all this, IMFIs

should be charged by CAR (capital adequacy ratio) higher than the existing BIS (Bank International

Settlement) which shows 8%.

Consequences of IMFIs features and MFIs itself, It should monitor, analyze and measure their

financing portfolio in regularly basis. Regulation of IMFIs should clearly state that requirement of

reporting regarding the current the non performing loan and investment. Financing or asset portfolio

might be categorized in to; standard, sub standard, doubtful and loss of every type of contact. In

accordance with the characteristic of financing portfolio of IMFIs exposed to higher risk. Then it

should be recommended to be higher than normal financial institutions about 2.5 percent.

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