ENHANCING FINANCIAL INCLUSION THROUGH … · allowing bai al istijrar out of tasamu’ (tolerance),...

ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC MCROFINANCE IN PAKISTAN:

Operating Systems and Product Development Perspective

Dr. Muhammad Khaleequzzaman

Visiting Scholar, Islamic Research and Training Institute

International Islamic University, Islamabad, PAKISTAN

Objectives

General: To review and develop outlines for Islamic microfinance systems

and products aligned with the microenterprise environment in Pakistan that could enhance inclusion on sustainable basis.

Specific: 1. To examine various operating models and financial products to practice

Islamic finance for the benefit of poor and disadvantaged segments.

2. To consider enhancing the existing or devising new operating systems and products instituting Islamic finance intervention in productive and sustainable manner.

3. To draft a comprehensive and publishable working paper relating to the subject of research.

Issues of Islamic Microfinance

Very Thin Outreach

Paucity and piecemeal supply of Shariah compliant funds (donors’ driven)

High cost of operation (around 30%)

Islamic banks (short to medium term liquid) do not intend to downscale; disregard of Maqasid al Shariah and SBP persuasion

Deposit services; A missing ground, No Islamic MFB

Many potential clients do not participate owing to prohibition of riba (Demand >95%)

Exclusion of the poorest and destitute (non-enterprising)

All IMFIs (except Akhwat more than 90% clientele and GFP) are unsustainable operationally and financially

Short term lending appetite of IMFIs

Issues of Islamic Microfinance

Low Efficiency of Microenterprises

High cost of acquiring finance

Farmers’ recourse to Suppliers’ credit costs 62-80% (Haq et al. 2013)

Concentration of products in Murabahah; virtually no use of participatory finance

No supply chain intervention

Uneconomic size of business finance (Av. PKR 16,790 (USD 151) as low as PKR 5,000 (USD 47)); 50% of conventional loans

No sustainable market linkages (to and fro)

Mismatch of structure of financial products and business cash-flows

Review of Literature

Following subjects have been reviewed:

Islamic Microfinance Operating Systems/Models, particularly low cost endowments and zakat

Innovation in Participatory Modes for Microfinance

Value Chain Interventions

Supplier’s credit through Istijrar

Effectiveness of Solidarity Groups and Infusion of Islamic social capital

Islamic Banks for Microfinance Operations/Maqasid al Shariah

Micro-Insurance and Micro-Takaful


Conclusions Leapfrog approach is required to achieve relatively faster growth in

financial inclusion through Islamic perspective

Use of Waqf for Low cost financing to IMFIs and in turn microenterprises

Use of potential of zakat as social safety net, economic empowerment of the poorest and destitute, as well as, credit risk mitigating factor

Diversification into Supply chain products (financing of supply chain components) to increase productivity of the microenterprises

Product development to replace the current coercive practice of supplier’s credit, especially for small scale farmers

Microenterprise development through partnership finance (Musharakah)


Conclusions IMFIs are using conventional method of book keeping and treating all types

of financing as credit business, therefore, do not comply with the Islamic accounting

Downscaling of Islamic banks to meet objectives of distributive justice

Strategic linkages between IBs and IMFIs providing both financing and deposit services and gradual progression of IMFIs to Islamic MFBs.

Use of micro-takaful to help protecting the clients against inevitable risks and shocks, as well as, IMFIs against risk of default

Solidarity approach (infused with Islamic social capital) instils the sense of trust and cooperation and removes the barriers to financing the poor.

Musharakah for enhancing efficiency of the businesses of skilled entrepreneurs

Necessity of financial literacy programs

Recommendations have been framed as under: Operating Systems 1. Microfinance operations through alliances between Islamic

banks and IMFIs 2. Microfinance operations based on Islamic endowments (Waqf

and Zakat)

Product Development 1. Supplier’s Credit through Istjrar Agreement 2. Agricultural Supply Chain Financing for Small Rice Farmers in

Pakistan 3. Musharakah for Technically Trained Clients

Recommendations

1. Alliances Between Islamic banks and IMFIs [Restricted Mudarabah Line of Credit] LEAPFROG APPROACH is required to achieve faster financial inclusion

SBP to set mandatory targets for Islamic banks (as in case of SMEs and agricultural finance) [Persuasion has not worked]

IMFI: Poverty analysis---Poverty Score Card--- poverty bands (non-enterprising destitute, transitory poor, and enterprising poor)

IMFI – IB to enter MOU : Restricted Mudarabah terms of funding – mode, size, terms of intermediation, Shariah advisory/audit, product development expertise, etc.

IMFI: organize clients into solidarity groups/inculcate Islamic social capital (repayment, unity, econ. independence, ta’awun, adl, and Ihsan).

IMFI to submit its business and preparedness plan to financing IB.

Recommendations – Operating Systems

1. Alliances Between Islamic banks and IMFIs IB to provide Mudrabah capital out of bank’s equity and current accounts.

Generous approach of IB in deciding profit sharing ratio, enabling IMFI to undertake MF operation efficiently and build sufficient resource base.

Latter IMFI to invest its own capital terming a more productive Musharakah.

IMFI to move gradually from fixed return to participatory modes, however, Istijrar to be offered to small manufacturers, traders, and craftsmen/ women.

IMFI, in association with the takaful companies, arrange credit-life-takaful as mandatory (premium to be jointly born) while other products voluntary.

Default in repayment to be covered through zakat for eligible clients.


1. Alliances Between Islamic banks and IMFIs In return to subsidized services, IMFI to direct savings of clients to IB (Telco

linked ‘Asaan’ account) without any collection cost to IB [open sub-branch]

Very few IMFIs would achieve outstanding KPIs and transform to a district based Islamic Microfinance banks with major shareholding of financing IB.

Risk Exposure of IB Equity Investment Risk Agency Risk Fiduciary Risk


2. Microfinance operations based on Islamic endowments (Waqf and Zakat) [CASE OF PUNJAB PROVINCE] In Pakistan, the idea of cash waqf is novel, needs awareness campaign (both

public and gov. functionaries as custodians of waqf properties) Provincial Waqf Ordinances, 1979 do not accomodate cash waqf. Auqaf Department (shrines, agric. Lands, and comm. and housing units in

urban areas). Income is used for mosques, burial places, hospitals and other welfare

institutions Properties are enormous (older data: Count 1,269; Total area 30,809 hec.

(agric. 25,468 hec. and urban 5,454 hec.) These properties are underutilized, subject to corruption, and very low lease

payments collected. Urban properties consist of commercial and residential buildings mostly in

high value areas. The possible course to actualize this model proceeds as follows: The possible course to actualize this model proceeds as follows:


2. Microfinance ----- (Waqf and Zakat) [-----PUNJAB -----] The possible course to utilize these properties for Islamic MF is suggested as

under:

A. Revolving Fund Accumulated from Income of Waqf (Issuance of Ijara Sukuk based on Waqf Properties)

The Islamic microfinance program meant for empowering, in particular, the non-enterprising poor and destitute, at lower or no cost to the beneficiary.

The IWIMM type Cash Endowment has to be created and integrated as empirically tested by Alpay et al. (2015).

When the cash waqf would wait for promulgation of the proper legislation, the commercial waqf properties can be used for issuing sukuk to replace the old property with new one (Istibdal) to become corpus and cash flows build revolving fund.


2. Microfinance ----- (Waqf and Zakat) [-----PUNJAB -----]

The process would follow as under:

Difficult eviction of current businesses (lesees), formalized as potential lessees (through agreements to Ijara) in new property.

No such problem in case of urban residential properties as ample land could be found lying idle to build multistoried apartment buildings.

Maturity of sukuk to spread over 7 years (construction phase 2 years and productive phase (5 years).

The underlying assets to be identified and valued.

Political commitment seems highly necessary where Provincial Assembly to pass resolution binding Auqaf Deptt. to (i) issuing sukuk based on existing waqf properties (ii) leasing the new property first to the old occupants and (iii) allocation of 25% of sukuk cash flows to Islamic MF in first two years and 50% in the subsequent years.



The protection of cash flow and principle investment to the sukuk holders through takaful company: Credit Enhancement.

Rating of sukuk issue obtained.

The characteristics of being sovereign, tradability, credit enhancement, rating of the issue, and high valued site of the project would help to lessen the financial cost of raising sukuk, expecting even oversubscription.

Lower cash-flows denomination during first two years (construction phase) and higher denomination subsequently.

Once the sukuk are retired, the same property will be used as underlying asset for issuing further Ijara sukuk and thus creating another waqf property.

The possible course to actualize this model proceeds as follows: The possible course to actualize this model proceeds as follows:



A. Revolving Fund to be used for following purposes

1. Disburse financing to the clients through various modes suiting to different bands of poverty

i. The fixed return modes offered to the enterprising poor, would gradate for partnership finance

ii. Rehabilitation and entrepreneurial finance for non-enterprising destitute in two stages viz. First, social safety net meeting consumption needs through zakat fund + developing entrepreneurial capability. Second, providing fixed and working capital out of Zakat fund through repeated cycles + qard hassan until they graduate for participatory modes.

iii. Duration of stages would vary from case to case basis depending on time taken for rehabilitation, capacity to comprehend entrepreneurial training, and overcoming the constraints of new business.


Transformation Process of the Destitute

Working

capital-

Participatory

Mode

2. Microfinance ----- (Waqf and Zakat) [-----PUNJAB -----] Building Entrepreneurship [TOT for Credit Officers] CONTENTS Assessing clients’ basic entrepreneurial competencies

Help clients to identify business ideas

Help giving orientation about business operation

Simple financial management

The participants of TOT are required, towards conclusion of TOT, to conduct an exercise to create and close a business by applying the expertise learned

Building Islamic Social Capital

Find donors (PPAF, USAID, ILO, etc. ) and expert trainers (NRSP-IRM).

The trainers would be then utilized to provide entrepreneurial training to their prospective clients.


3. Cash Waqf Based Microfinance Till the time the provincial governments legislate to accommodate and

regulate cash waqf, IMFIs can create own cash waqf (Trust Act, 1982).

Board of trustees ---- Must have Shariah Board--- Act cannot not regulate.

Fund can be contributed by the individuals, organizations, and IFIs.

Comparative advantage over waqf of properties in terms of liquidity, high grade investment prospects, and divisibility in various pools.

Unlike the property waqf, cash waqf becomes popular as it gives opportunity to people from all walks of life to donate in any denomination.

IMFI (Muttawali of the fund) defines the denominations and categories.

IMFI will invest the corpus in diversified portfolios. Safest is the Islamic banks where highest weight is accorded.

Any probability of losing any part of corpus, an IRR can be provided.

Poverty bands will help to identifying different clients, products and graduation procedures.


1. SUPPLIERS CREDIT THROUGH ISTIJRAR: Supplier’s credit is the need of the time, especially for small manufacturers

and crafts men/women needing supplies intermittently but are able to pay back in lump sum on completing the business cycle.

In view of the exploitations faced from the suppliers, --------- end up in low returns.

The Murabahah as practiced by IMFIs does not serve the purpose (cumbersome, not practiceable).

Istijrar facilitates purchasing supplies from time to time in required quantities. Each time there is no offer and acceptance required. There is one master agreement where all terms and conditions are finalized.

Recommendations – Product Outlines

1. SUPPLIERS CREDIT THROUGH ISTIJRAR: The guidelines have been obtained mainly from Usmani, M.T. “Fiqhi Muamalat” Vol. 3, Karachi, 1998, p.233-260 He refers to the difference of opinion on use of bai al istjrar by different

schools of Islamic jurisprudence and finally settles with the Hanafi opinion allowing bai al istijrar out of tasamu’ (tolerance), Urf (custom), and Istihsan (juristic preference).

(i) Urf and Tasamu’ – A sale in which people customarily get the articles of routine household needs from supplier without actually buying them at the time of taking possession.

(ii) Istihsan – Since the use of merchandise by the buyer has been with the permission of seller, therefore, consumption of merchandise before the settlement date is permissible.


1. SUPPLIERS CREDIT THROUGH ISTIJRAR: Types of Istijrar:

1. Istijrar with advance payment:

Salam and Istisna: – Ruled out

Amanah, the seller cannot consume it – Ruled out

Qard, conditional upon the future expected sale – Ruled out

2. Istijrar with deferred payment:

The price is paid at the end when the contract is concluded and accounts are settled.

Seller tells the buyer the selling price at the time of each possession.

If the seller does not tell the buyer the price of merchandise, the parties understand that the sale is being executed at the market price.


1. SUPPLIERS CREDIT THROUGH ISTIJRAR: The feasibility of product development is found in deferred payment with price determination each time the goods are possessed. CASE EXAMPLE A small steel welding shop (manufacturer) in the town, engaged in manufacturing of steel items purchases raw material from a supplier. The supplier extends supplies as and when required against 15 days credit, but the business cycle of steel welding shop concludes in 60 days. Due to mismatch of the credit facility provided by the supplier and liquidity available with the manufacturer, the latter is forced to borrow from the market against payment of interest which lowers the business productivity, as well as, erodes the recycling capability of the manufacturer.


1. SUPPLIERS CREDIT THROUGH ISTIJRAR: Alternatives:

Conventional running finance facility ------- Not Islamic Running Musharakah ---- corporate orientation/complex computation/

subject to Shariah objections Murabahah ----- Not practicable Salam ----- Not practicable

Islamic banks can offer Istijrar through following process: The Islamic bank can enter Istijrar agreement separately with supplier and

the manufacturer where offer and acceptance is not necessary. The client is allowed to take possession of the goods from the supplier,

being authorized agent of the bank or IMFI. The supplier provides to the bank the record of all sales and respective

prices duly endorsed by the manufacturer, on fortnightly basis. Islamic bank can also participate in SBP Credit Guarantee Scheme where

60% of bank’s genuine loss is compensated.


1. SUPPLIERS CREDIT THROUGH ISTIJRAR: Expected Benefits:

The manufacturer is saved from borrowing from the market/money lender against heavy payment of interest.

The returns to the business increase due to saving in cost of borrowing and having opportunity of recycling the business returns.

Client settles with known customary and simple transaction. Islamic bank shoud be generous out of social responsibility to charge lower

or no markup on Istijrar financing, allowing the business to become more productive (resort to cross subsidization).

Istijrar financing allows to avail the Islamic opportunity instead of conventional one.


Istijrar Transaction

2. Agricultural Supply Chain Financing for Small Rice Farmers in Pakistan: CASE EXAMPLE: The current value chain of rice is inefficient and causes substantial loss to the farmer due to poor supplies and marketing system. There are two scenarios: 1. The private markets are controlled by arhties and middle-men. Their

intervention has increased ---- PASSCO ------ exploit the farmers ----- lending money to purchase the inputs and other expenses ------- farmers bound to sell to them ----- cost borne by the farmers 62-80% + delay in payment of price

2. In case, the farmers sell their produce to rice mills ------liquidity crunch ------ delay due to credit limit from bank ------ cost of credit of credit limit also transferred to the farmers ----- Delay/discounting of payment vouchers at 20-30% discount ------- ultimately result into loss in return to their produce.


2. Agricultural Supply Chain Financing for Small Rice Farmers in Pakistan: PROPOSED SOLUTION Two financing interventions: At Farmer’s Level: Providing inputs through Murabahah and liquidity

requirement through different maturity Salam transactions.

At Rice Mill’s Level: IMFI and the Rice Mill enter Restricted Murdarabah contract (IMFI being Rab al Maal and Rice Mill as Mudarib) for trading of rice, that is, purchasing paddy from designated farmers through prompt payment of price and then selling in the market.

Through tripartite agreement among Rice Mill, IMFI, and representative of the group of farmers, to be bound to honor their commitment. The rice mill will be required to purchase paddy from farmers within certain price range.

The Rice Mill to provide performance guarantee from its bank.


Financing of Clients for Paddy Production Liquidity requirements (hiring of tractor & implements,

sowing, transplanting, purchase of water, hiring of labor for preparation of land, seeding/transplanting, and harvesting, marketing)

Input requirements (seed, fertilizer, pesticides)

Guarantees (Agric. Pass Book and Hypothecation of crop)

Liquidity Inputs in kind

Sale of fertilizers, seed, pesticides

Liquidity

Need

Hiring for

Harvest +

Transportation

S

A

L

A

M

S

A

L

A

M

M

U

R

A

B

Liquidity

Need

Hiring Equip

and labor,

purchase

Water, elect.

Inputs in kind

Delivery of Paddy

Payment Murabahah

Delivery of Paddy

MA

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Ma

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un

De

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3. Musharakah for Technically Trained Clients: The product is particularly designed to address the employment of unique

segment of ‘chhota’ (intern or helpers), hailing from poor families, engaged in various businesses , mostly in urban areas (tea stalls, restaurants, automobile workshops, mobile phone repair shops, clothes stitching, electric repairing, small manufacturing concerns like USP and stabilizers, hand looms weaving, carpet weaving, etc.)

These inters are paid very low wages on daily basis (av. USD 0.93 or less; even lesser at USD 6.0 p.m.) against 12-16 hours of work.

The experience of NRSP, a conventional microfinance organization, of providing business capital to these interns and helping to detach from their masters and establish their own enterprises has proved very successful with default rate of 0.05%.

The main factor appropriating success has been the business skill during stay with his master (8-12 years).


3. Musharakah for Technically Trained Clients: Product Outline Preparations to Launch the Product

A survey would be conducted to assess the potential of certain businesses from their fitness in the market and the clientele (interns) with different experiences and ability to perform independently.

The IMFI will prepare pre-feasibilities of the selected businesses, for example we refer to the Auto Body Shop.

The following are the most significant considerations: relevant work experience required in repairing, body touchups, paining, etc.; technical competence; maintaining a referral network of customers; adequate inventory for denting and painting.


3. Musharakah for Technically Trained Clients: Outline of Musharakah IMFI will create its separate pool of Musharakah financing.

A business plan would be prepared comparable to the prefeasibility standards and on ground actual circumstances.

The client will be asked to offer his part of share in Musharakah through kind and in cash.

Based on the fixed and working capital requirements as per business plan, IMFI will work out its share of investment.

However, IMFI will cap its investment to certain extent, up to Rs. 75,000 in first cycle of 6 months, with increase of 25% in each subsequent cycle.

Cash flows and net profit would be determined according to the business results, but will be matched with the ones estimated on the basis of the business plan.


3. Musharakah for Technically Trained Clients: Outline of Musharakah In case the profits deviate much from the estimated ones, the IMFI will

become more vigilant in monitoring the business.

Profit sharing ratio will be predetermined, but the share of IMFI should preferably be equal to operating cost plus an appropriate growth margin (in case of waqf financing) and operating and financial cost and margin for growth (if funds acquired on cost).

A certain minimum amount of profit can be appropriated to the client every week or fortnight treated as ‘online payment’ to sustain the client’s consumption and business expenses subject to the settlement from subsequent profits.

IMFI would agree to give up his right to its share of the excess amount of profit in favor of the client in case the profit of the business exceeds certain threshold to induce the client to work harder.


3. Musharakah for Technically Trained Clients: Outline of Musharakah The Musharakah capital contributed by IMFI would be redeemed periodically

along with the profit (all installments of the capital investment to be evenly distributed against the term of Muharakah).

The client, as managing partner, shall be liable for any loss caused by his/her misconduct, negligence or breach of the specified terms. Otherwise, each party to bear loss in proportion to the investment.

However, IMFI may voluntarily absorb the loss in genuine cases if its financial capacity permits to do so.

The business would be properly monitored to prevent frauds, willful losses and depletion of capital invested by IMFI and the client.

The client will be required to keep minimum number of books of accounts to record daily income and expense transactions and creditors and debtors.

The credit officers of IMFI will impart necessary training to keep the record of financial transaction on daily basis.


3. Musharakah for Technically Trained Clients: Outline of Musharakah The client will be required to keep minimum number of books of accounts to

record daily income and expense transactions and business creditors and debtors.

The credit officers of IMFI will impart necessary training to keep the record of financial transaction on daily basis. [The strongest point is that the client already knows about taking supplies, attracting clients, and performing the job].


THANKS Any Questions?

ENHANCING FINANCIAL INCLUSION THROUGH … · allowing bai al istijrar out of tasamu’ (tolerance),...

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