Islamic Financing for SMEs
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Transcript of Islamic Financing for SMEs
Islamic Financing for SMEs Presented By: M.Shoaib MalickUnit Head-SME-Meezan Bank Limited
Islamic Financing for SMEsIntroduction to Islamic BankingSignificance of SME SectorDifference Between Islamic Banking & Conventional BankHow IB, can address business needs (100%)Comparison of Islamic Mode of Finance and ConventionalIslamic Modes of Financing• Short Term Modes of Islamic Financing• Long Term Modes of Islamic Financing• Trade Finance Facilities in Islamic Banking
Challenges in SME FinancingConclusion
Significance of SME Sector
1 Total Population 182Mn 100%2 Financially Included 18.2Mn 10%3 Financially Excluded 163.8Mn 90%4 Financially Excluded-Major Sector SME5 90% of all private enterprises SME6 SMEs access to finance from banking
sector:• Pakistan• India• Bangladesh
04%33%32%
7 SME lending of total credit 06%8 Surveyed Facts• Hard to borrow from banks • Not even have a bank account
51%31%
Contribution of SME Sector to Economy
GDP Exp. Mfgd Goods Mfgd-value
added Non-Agri Labor Force
0%20%40%60%80%
100% 30% 25%35%
75%
Overall Economy SME Sector
Current Status of SME Financing: SME financing witnessed continues decline by banks/DFIs since 2008. Due to consistent decline in this sector, share of SMEs also reduced from 16% to 6% in overall advances of banks in last 4-5 years.
Reasons for downfall: Adverse economic conditions. Law and order situation. Shortage & rising costs of electricity and other utilities.
Reasons for downfall: Growing NPLs.
Natural catastrophes also hamper this sector badly in consecutive years of 2010 & 2011 and created wipeout situation for small sized units.
Banks also took a risk-averse posture from this sector, due to deteriorating business conditions for SMEs.
5 Years trend of SMEs
`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120.00
500.00
1,000.00
1,500.00
2,000.00
2,500.00
3,000.00
3,500.00
4,000.00
Status of SME Financing (Rs. In Billions)
5 Years trend of SMEs
`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120
1,000
2,000
3,000
4,000
5,000
6,000
SME Borrowers Vs Total Borrowers (In Thousands)
5 Years trend of SMEs
`Dec-07 `Dec-08 `Dec-09 `Dec-10 `Dec-11 `Jun-120.00
50.00100.00150.00200.00250.00300.00350.00400.00450.00500.00
SME NPLs Vs Total NPLs (Rs. In Billions)
9.4% 16.1% 22.1% 28.9% 32.4% 38.9%
SME Financing For Working Capital Key portion of financing is used for working capital in SMEs, which constitutes 76% of total SME lending. However other is followed by Trade Financing & Long term/Fixed Investment.
Working Capital Fixed Investment Trade Fiance0
20,000
40,000
60,000
80,000
100,000
120,000
140,000Working Capital Requirement for SMEs
SMEs provide a significant portion of jobs world wide
Low Income Middle Income High Income0
10
20
30
40
50
60
70
SME contribution to formal country employment Median values
Source. Ayyagari, Beck and Demigirguc/kunt. 2003
GDP Contribution of the SME sector increases, and informality decreases with income
Low Income Middle Income High Income0
10
20
30
40
50
60
70
80
90
100
Residual, 37%Residual, 31% Residual, 36%
Informal ,47%
Informal , 30%Informal , 13%
SME Sector, 16%
SME Sector, 39%SME Sector, 51%
Definition of Riba
Any increase over and above the price, without due consideration is Riba
We find the differences are on three levels: 1. Conceptual & Socio-religious level
- not money lenders - cannot deal with interest & non permissible industries 2. Business model & Governing framework - IB actively participates in trade and production process - Governing framework in terms of Shariah Advisor &/or SSB
Distinguishing Features
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3. Product Level Implementation - usually asset backed & involve trading/renting of asset &
participation on profit & loss basis - Implementation is not just a mere change of paper work
and terms but it involves- having the right intention, - the correct sequence of steps and timing of execution
Distinguishing Features
Parties: Bank & ClientLimit : Rs 10.00 MnRate: K+2Tenor : 1 yearPurpose : To buy Cotton
Parties: Bank & ClientLimit: Rs 10.00 MnRate: K+2Tenor: 1 yearPurpose : To buy Cotton
Islamic Banking Conventional Banking
PERCEPTION OF ISLAMIC BANKING
Parties: Bank & ClientLimit : Rs 10.00 MnRate: K+2Tenor : 1 yearPurpose : To buy Cotton
Parties: Bank & ClientLimit: Rs 10.00 MnRate: K+2Tenor: 1 yearPurpose : To buy Cotton
Islamic Banking Conventional Banking
PERCEPTION OF ISLAMIC BANKING
= OWNERSHIP
Goods
Services
Islamic BankingBasic Difference between Islamic and Conventional Modes of Finance
Conventional
Client
Money
money + money (interest)
Bank
Islamic BankingBasic Difference between Islamic and Conventional Modes of Finance
Islamic
Bank ClientGoods & Services
money
Sales xxxCost of Goods Sold
Raw Material xxxDirect Labor xxxOver Head xxx
Gross Profit xxxOperating ExpensesAdmin. & Gen. ExpxxxSalaries xxxUtilities xxxOther xxxNet Profit xxx
Income StatementLiability/Deposit Products
Istisna/Tijarah
Murahaba
Istisna/Tijarah
Deposit Products
Current Assets:Stocks xxxReceivable xxxCash in hand xxxAdvances & Deposit xxx
Fixed Assets:Plant & Machinery xxxLand & Building xxxTotal Assets xxx
Owner’s Equity:Capital xxx
Liabilities:Creditors xxxFinancial Liabilities xxxTotal Liabilities & Equity
Balance Sheet
Murahaba/Import Murahaba/FIM/LC
Deposit ProductsIstisna/Tijarah/Bai-Salam/Usance-Murahaba
Musharka
Murahaba/LGs/Ijarah/Tijarah
Murahaba/Istisna/Tijarah/LG
DM/Ijarah/Murahaba
Conventional Banks Islamic Banks 1. The functions and operating modes of conventional banks are
based on fully manmade principles. 1. The functions and operating modes of Islamic banks are
based on the principles of Islamic Shariah. 2. The investor is assured of a predetermined rate of interest. 2. In contrast, it promotes risk sharing between provider of
capital (investor) and the user of funds (entrepreneur). 3. It aims at maximizing profit without any restriction. 3. It also aims at maximizing profit but subject to Shariah
restrictions. 4. It does not deal with Zakat. 4. In the modern Islamic banking system, it has become
one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.
5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks.
5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well.
6. It can charge additional money (penalty and compounded interest) in case of defaulters.
6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are give for early settlement at the Bank's discretion.
Difference Between Islamic Banking & Conventional Bank
Difference Between Islamic Banking & Conventional Bank
Conventional Banks Islamic Banks 7. Very often it results in the bank's own interest becoming
prominent. It makes no effort to ensure growth with equity.
7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.
8. For interest-based commercial banks, borrowing from the money market is relatively easier.
8. For the Islamic banks, it must be based on a Shariah approved underlying transaction.
9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.
9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.
10. The conventional banks give greater emphasis on credit-worthiness of the clients.
10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.
11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.
11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.
12. A conventional bank has to guarantee all its deposits. 12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position..
Meezan Bank Limited
Financing Product Comparison Islamic Vs. Conventional BankS.# Islamic Product Conventional Products
Working Capital Finance
1
a) Murabahab) Murabaha - Spotc) Istisna - Export & Locald) Meezan Tijarah - Export & Locale) Murabaha FE-25 Export & Import
Current Finance / Running Finance
2 Murabaha - Pledge Cash Finance
3
a) Ijarah - Plant & Machineryb) Ijarah - Sale & Lease Back for Plant & Machineryc) Diminishing Musharika - Plant & Machineryd) Diminishing Musharika - Premises / Land for Commercial usee) Diminishing Musharika - Sale & Lease Back (Plant & Machinery; Premises Land & Building)f) Musharaka
Demand Finance / Term Finance
Financing Product Comparison Islamic Vs. Conventional Bank
S.# Islamic Product Conventional ProductsExport Related Facilities:
1
a) Bai Salam against Discrepant Export Sight Billsb) Bai Salam against Export sight contractc) Murabaha against Accepted export Usance Bill (Bank Risk Line)d) Murabaha against Un-accepted export Clean Usance LCe) Murabaha against un-Accepted export Discrepant Bills under Usance LCf) Murabaha against export Usance Contract
Finance Against Foreign Bills
2 a) Murabaha against Un-accepted Local Usance LCb) Murabaha against Accepted Local Usance LC (Bank Risk Line) Local Bill Purchases
3
a) Istisna – Exportb) Islamic Export Refinance Facility (IERF) Part I & II - under Murabahac) Islamic Export Refinance Facility (IERF) - under Istisna (Local and Export) and Tijara (Local and Export)
Finance Against Packing Credit Part - I & II
Meezan Bank Limited
S.# Islamic Product Conventional ProductsImport Related Facilities:
1
a) Sight LC under MMFAb) Sight LC under Master Agency Agreement (For Ijarah & Diminishing Musharaka)c) Sight LC wihthout MMFA (Exceptional Cases)d) Usance LC without MMFAf) Usance LC under MMFA (Exceptional cases)g) Usance LC under Master Agency Agreement (for Ijarah and Diminishing Musharaka)
Import Letter of Credit
2a) Local LC(Sight) without MMFAb) Local LC (Sight) under MMFA (Exceptional cases)c) Local Usance LC wihtout MMFAd) Local Usance LC under MMFA (Exceptional cases)
Inland Letter of Credit
3 a) Murabaha - Financing of Imported Merchandise (FIM) Pledgeb) Murabaha - Financing of Imported Merchandise (FIM) Spot
Finance Against Imported Merchandise - FIM
4 Finance Against Trust Receipt Letter of Guarantee
1 Letter of Guarantee / Shipping Guarantee/Standby Letter of Credit Letter of Guarantee / Shipping Guarantee
Financing Product Comparison Islamic Vs. Conventional Bank
Short Term Financing Needs• Raw Material• Overheads / Utilities• Finished Goods• Trade receivable financing• Rental financing
Long Term Financing Needs• Acquisition/replacement/
expansion of fixed assets, plant & machinery
Issues & Challenges of SMEs
Demand Supply
Lack of Collaterals to Meet Bank’s Requirements
Shortage of Marketing Skills-(Bank Side)
Informal Organizational Structures
Informal Accounts & Management System
Lack of Credit & Collateral History
Low Level of Financial Literacy
Reluctance on part of SMEs
External Shocks
SMEs perceived as high risk borrowers
Corporate Finance Mindset
Lack of Infrastructure for SME Business
High Lending Costs
Absence of SME R&D Centers in Banks
•Plain Murabaha•Advance Payment Murabaha•Suppliers Credit Murabaha•SLC under MMFA•Tijarah•Istisna•Diminishing Musharaka•Ijarah•Bai Salam
•Plain Murabaha
Murabaha Agreement
Agency Agreement Order Form Purchase of
Goods by Agent
Payment of Purchase Price*
Intimation of possession of goods by the
agent (Declaration)
Offer & Acceptance (Murabaha Contract)
Payment of Murabaha
Price
*Payment of purchase price is either direct payment to supplier or through customer account
For Detail
•Advance Payment Murabaha
Murabaha Agreement
Agency Agreement Order Form
Payment of Purchase
Price*
Purchase of Goods by
Agent
Intimation of possession of goods by the
agent (Declaration)
Offer & Acceptance (Murabaha Contract)
Payment of Murabaha
Price
*Payment of purchase price is either direct payment to supplier or through customer account
•Credit Murabaha
Murabaha Agreement
Agency Agreement Order Form Purchase of
Goods by Agent
Intimation of possession of goods by the
agent (Declaration)
Offer & Acceptance (Murabaha Contract)
Payment of Purchase Price*
Payment of Murabaha
Price
*Payment of purchase price is either direct payment to supplier or through customer account
•SLC under MMFA
Murabaha Agreement
Agency Agreement
Order Form & LC Application
Establishment of LC
Receipt of Import
Documents
Intimation of possession of goods by the
agent (Declaration)
Offer & Acceptance (Murabaha Contract)
Retirement of LC Through Murabaha
Payment of Murabaha
Price
•Tijarah
Master Tijarah Agreement
Agency Agreement Written Offer
Payment of Tijarah Price
upon Acceptance
Delivery of Goods &
Acceptance of Delivery by
bank
Intimation of possession of goods by the
agent (Declaration)
Offer & Acceptance (Murabaha Contract)
Retirement of LC Through Murabaha
Payment of Murabaha
Price
For Detail
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