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Is­lamic Mi­cro-Fi­nance and Poverty Al­le­vi­a­tion

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Mi­cro­fi­nance refers to mak­ing small loans avail­able to poor peo­ple ( es­pe­cially those tra­di­tion­ally ex­cluded from fi­nan­cial ser­vices) through pro­grammes de­signed specif­i­cally to meet their par­tic­u­lar needs and cir­cum­stances (Khan, 2008; p.6). The needs of the poor in Is­lamic coun­tries are no dif­fer­ent from the poor in other so­ci­eties ex­cept that th­ese are con­di­tioned and in­flu­enced by their faith and cul­ture in a sig­nif­i­cant way. They need fi­nan­cial ser­vices be­cause they are of­ten faced with events that call for spend­ing more money than might be avail­able around the house or in the pocket ( IRTI, 2007, p. 20)

The Is­lamic world is enor­mous with over 1.2 bil­lion peo­ple, stretch­ing from Sene­gal to the Philip­pines. Poverty rate is quite high in all Mus­lim coun­tries ex­cept a few coun­tries in Southeast Asia and the Mid­dle East.

Poverty lev­els have also been as­so­ci­ated with high in­equal­ity along­side low pro­duc­tiv­ity. Half of the In­done­sia pop­u­la­tion (about 129 mil­lion) is living be­low the poverty line of US$2 a day. While in South Asia two largest Mus­lim states - Bangladesh and Pak­istan – alone ac­count for 122 mil­lion each living be­low the poverty line where as 100 mil­lion Mus­lims of In­dia are also living be­low the poverty line ( IRTI, 2007, p. 18).

1Sources sug­gest that about 72 per­cent of peo­ple in Mus­lim coun­tries do not use the for­mal fi­nan­cial ser­vices be­cause fi­nan­cial sys­tem is in­ter­est based which is pro­hib­ited in Is­lam ( Karim, Tarazi and Reille, 2008). This study at­tempts to give an over­view of Is­lamic mi­cro fi­nance devel­op­ment in Mus­lim coun­tries while fo­cus­ing on its op­er­a­tions in Pak­istan. It takes a case study of Akhuwat, an Is­lamic mi­cro­fi­nance or­ga­ni­za­tion. It was es­tab­lished in 2001 and the ob­jec­tive was to help the peo­ple living in ab­ject poverty with in­ter­est free credit The re­search pa­per analy­ses the fi­nan­cial per­for­mance of Akhuwat for the pe­riod 20022006 and gives rec­om­men­da­tions for the fu­ture po­ten­tial of Is­lamic mi­cro­fi­nance in the coun­try.

Con­ven­tional mi­cro fi­nan­cial ser­vices fa­cil­i­ties do not meet the needs of ma­jor­ity of Mus­lim pop­u­la­tion in de­vel­op­ing coun­tries like Pak­istan, Bangladesh, In­done­sia as well as in de­vel­oped coun­tries like UK, USA and Australia. The rea­son is that con­ven­tional mi­cro fi­nan­cial

in­sti­tu­tions charge in­ter­est on their loans pro­vided to small and medium en­ter­prises as well as women en­trepreneurs. A vast ma­jor­ity of mus­lim pop­u­la­tion re­frains from avail­ing con­ven­tional mi­cro fi­nan­cial ser­vices due to the el­e­ment of in­ter­est that is con­sid­ered re­pug­nant to Sharī’ah. Over 470 mil­lions Mus­lim pop­u­la­tion is living be­low poverty line (less than $2 per day) in four largely pop­u­lated Mus­lim coun­tries: Pak­istan, Bangladesh, In­done­sia and In­dia (IRTI, 2007). In this sce­nario, Is­lamic mi­cro fi­nance has tremen­dous po­ten­tial in th­ese coun­tries and could be used as a pow­er­ful weapon to fight against poverty. It can de­velop a valu­able hu­man cap­i­tal base by sat­is­fy­ing the fi­nan­cial needs of Mus­lim com­mu­nity and pos­i­tively con­trib­ute to­wards the eco­nomic growth in those coun­tries.

Over the last few years mi­cro­fi­nance has been in­creas­ingly rec­og­nized as an im­por­tant com­po­nent in poverty al­le­vi­a­tion strate­gies. Poor house­holds face dif­fi­culty in gen­er­at­ing regular and sub­stan­tial in­come to save for fu­ture and are ex­tremely vul­ner­a­ble to eco­nomic, po­lit­i­cal, and phys­i­cal down­turns. A lit­tle drop in in­come or in­crease in ex­pense can have a dis­as­trous ef­fect on their al­ready low stan­dard of living. They have limited ac­cess to health care fa­cil­i­ties; have low lit­er­acy rate and poor living con­di­tions. Death, sick­ness, or ac­ci­dent may force them to dis­pose their prop­erty or some of the pro­duc­tive as­sets, which in turn fur­ther de­creases fu­ture in­come and cur­rent liveli­hood. The fre­quency of losses is also greater for the poor; many are reg­u­larly ex­posed to nat­u­ral dis­as­ters ( like flood), fire, and theft with limited means of re­cov­ery (Pa­tel, 2004; Ah­mad, 2007; Given the dom­i­nance of west­ern cul­ture and val­ues as well as plight and vul­ner­a­bil­ity of to­day’s Is­lamic world, there has al­ways been an in­ces­sant con­flict be­tween the two civ­i­liza­tions. Mus­lims have al­ways been strug­gling for decades at al­most ev­ery walk of real life to re­tain their val­ues and cul­ture. The phi­los­o­phy be­hind such strug­gle is un­der­pinned in pow­er­ful ex­pres­sion of col­lec­tive iden­tity that is mul­ti­ple and highly di­ver­si­fied fol­low­ing the con­tours of each cul­ture and his­tor­i­cal for­ma­tion of each iden­tity. The feel­ing of this col­lec­tive iden­tity has urged Mus­lim schol­ars to find so­lu­tions of cur­rent eco­nomic prob­lems to make their lives com­pat­i­ble with Sharī’ah and to safe­guard the Mus­lim Ummah against the per­ils of the west­ern cul­ture.

While con­ven­tional mi­cro­fi­nance prod­ucts have been suc­cess­ful in Mus­lim ma­jor­ity coun­tries, th­ese prod­ucts do not ful­fill the needs of all Mus­lim clients. Com­bin­ing the Is­lamic so­cial prin­ci­ple of car­ing for the less for­tu­nate with mi­cro­fi­nance’s power to pro­vide fi­nan­cial ac­cess to the poor has the po­ten­tial to reach out to mil­lions more peo­ple, many of whom say they would pre­fer Is­lamic prod­ucts over con­ven­tional mi­cro­fi­nance prod­ucts. From af­ford­able loans and in­sur­ance prod­ucts to safe places to save, mi­cro­fi­nance ser­vices have been pow­er­ful weapons in the fight against poverty, es­pe­cially in Latin Amer­ica and South Asia.

The World Bank es­ti­mates that there are over 7000 mi­cro­fi­nance in­sti­tu­tions, serv­ing some 16 mil­lion poor peo­ple in de­vel­op­ing coun­tries. The to­tal cash turnover of MFIs world-wide is es­ti­mated at US$ 2.5 bil­lion and 2the po­ten­tial for new growth is out­stand­ing. The Mi­cro­cre­dit Sum­mit es­ti­mates that US$21.6 bil­lion is needed to pro­vide mi­cro­fi­nance to 100 mil­lion of the world’s poor­est fam­i­lies.

Other es­ti­mates tell us that world­wide, there are 13 mil­lion mi­cro­cre­dit bor­row­ers, with USD 7 bil­lion in out­stand­ing loans, and gen­er­at­ing re­pay­ment rates of 97 per­cent; grow­ing at a rate of 30 per­cent an­nual growth.

De­spite all this less than 18% of the world’s poor­est house­holds have ac­cess to fi­nan­cial ser­vices (Grameen Foun­da­tion, 2007). Ah­mad (2007) points out that Mi­cro­fi­nance ini­tia­tive is widely ac­claimed as a new ap­proach to al­le­vi­ate Poverty, to bring about eco­nomic devel­op­ment and to im­prove the living con­di­tions of the poor.

The ap­pli­ca­tion of Is­lamic fi­nance to mi­cro­fi­nance was first

dis­cussed in depth by Rahul and Sap­canin (1998).

They demon­strate that Is­lamic bank­ing, with its em­pha­sis on risk shar­ing and, for cer­tain prod­ucts and col­lat­eral- free loans, is com­pat­i­ble with the needs of some mi­cro-en­trepreneurs. Vi­able projects that are re­jected by con­ven­tional lend­ing in­sti­tu­tions be­cause of in­suf­fi­cient col­lat­eral might prove to be ac­cept­able to Is­lamic banks on a profit-shar­ing ba­sis How­ever, they con­cluded that from a mi­cro­fi­nance stand­point the mu­daraba model (profit-shar­ing) has more draw­backs than the murabaha model (cost plus markup). The murabaha model is over­all more cost ef­fec­tive, has a lower mar­gin of er­ror, and pro­vides im­me­di­ate col­lat­eral for a MFI be­cause the MFI owns the goods un­til the last in­stall­ment is paid. Dusuki (2006) has pre­sented the idea of Is­lamic mi­cro­fi­nance ini­tia­tive in the per­spec­tive of Ibn Khal­dun’s con­cept of ‘As­abiyah or so­cial Sol­i­dar­ity that em­pha­sizes group ef­forts and loy­alty over self­in­ter­ests of in­di­vid­u­als. He ar­gues that Is­lamic mi­cro­fi­nance can be pro­moted through group lend­ing to the poor who are nor­mally de­nied ac­cess to main­stream bank­ing ser­vices.

Ac­cord­ing to Dr. Ab­bas Mi­rakhor, Ex­ec­u­tive Direc­tor of the IMF as ref­ered by Chaudhri (2006): “An im­por­tant func­tion of Is­lamic fi­nance that is sel­dom noted … is the abil­ity of Is­lamic fi­nance to pro­vide the ve­hi­cle for fi­nan­cial and eco­nomic em­pow­er­ment … to con­vert dead cap­i­tal into in­come gen­er­at­ing as­sets to fi­nan­cially and eco­nom­i­cally em­power the poor...” Mi­cro­fi­nance is al­ready more struc­turally aligned to ap­ply­ing Is­lamic eq­uity fi­nanc­ing struc­tures. As men­tioned pre­vi­ously, mi­cro­fi­nance pro­grams are based on group shar­ing of risk and per­sonal guar­an­tee while main­te­nance of trust and hon­esty is tied to the avail­abil­ity of fu­ture funds (Chaudhri, 2006).

Ah­mad (2007) opines that con­tem­po­rary Is­lamic fi­nance has been largely dis­en­gaged from mi­cro­fi­nance. On the one hand, most mi­cro­fi­nance in­sti­tu­tions ( MFIs) are not Is­lamic as their fi­nanc­ing is in­ter­est based. On the other hand, Is­lamic fi­nan­cial sys­tem has been dom­i­nated mainly by Is­lamic banks. He fur­ther ar­gues that MFI has to cre­ate var­i­ous re­serves to cover var­i­ous risks aris­ing due to the na­ture of its as­sets and li­a­bil­i­ties. To pro­tect from with­drawal risks, the MFI can use taka­ful and profit- equal­iza­tion re­serves to give de­pos­i­tors com­pet­i­tive re­turns. The pa­per shows that the pro­por­tion of waqf funds that can be al­lo­cated into mi­cro­fi­nanc­ing will de­pend on the taka­ful and eco­nomic cap­i­tal re­serves.

Obaidul­lah ( 2008) has iden­ti­fied that ab­sence of in­sti­tu­tional credit guar­an­tee is an im­por­tant fac­tor that de­mo­ti­vates the com­mer­cial banks and IFIs to be in­volved in mi­cro- credit ac­tiv­i­ties for low in­come groups of so­ci­ety as well as small and medium en­ter­prises. He main­tains that it is es­sen­tial to es­tab­lish link­ages among var­i­ous in­sti­tu­tions at mi­cro, meso as well as at macro level for the growth of Is­lamic MF in­dus­try. He fur­ther as­serts that if var­i­ous or­ga­ni­za­tions in­clud­ing Govt. agen­cies, Cen­tral Bank, Com­mer­cial and Is­lamic Banks, Taka­ful and Co­op­er­a­tive Com­pa­nies as well as NGOs and NPOs could be in­ter­linked, they can reach at ‘ the poor­est of the poor’ of a so­ci­ety and sig­nif­i­cantly con­trib­ute to­wards the devel­op­ment of mi­croen­ter­prises, en­hanc­ing the fi­nan­cial in­clu­sion and al­le­vi­at­ing the poverty from the gross- root lev­els of a so­ci­ety.

Frasca (2008, p.3) while fo­cus­ing on the com­pet­i­tive­ness of Is­lamic Mi­cro­fi­nance, ar­gues that Is­lamic fi­nance could be po­ten­tial ‘heaven’ for the in­vestors who have be­come vic­tim of cur­rent global credit cri­sis to re­lieve them from the spec­u­la­tive ex­cess of the con­ven­tional sys­tem. Karim et. al (2008) con­ducted a sur­vey, which in­cludes 125 in­sti­tu­tions in 19 Mus­lim coun­tries. It shows that Is­lamic mi­cro­fi­nance providers still reach only 300,000 clients, one-third of them in Bangladesh alone. They ar­gue that to reach more peo­ple and build sus­tain­able in­sti­tu­tions, it is es­sen­tial to fo­cus on designing af­ford­able prod­ucts, train­ing and re­tain­ing skilled loan of­fi­cers and ad­min­is­tra­tors, im­prov­ing op­er­a­tional ef­fi­ciency, and man­ag­ing over­all busi­ness risk.

Ac­cord­ing to IDLO Re­port (2009), mi­cro­fi­nance re­mains less de­vel­oped in the Arab world than, for ex­am­ple, in Asia, Africa or Latin Amer­ica and, although it seems to have taken hold in many Mid­dle Eastern and North 3African (MENA) coun­tries, it re­mains largely un­de­vel­oped in Saudi Ara­bia and in its in­fancy in the UAE.

How­ever, since 2006, the UAE has staged sev­eral high pro­file mi­cro­fi­nance con­fer­ences show­cas­ing 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. On 17 Jan­uary 2008 Noor Is­lamic Bank an­nounced its com­mit­ment to serv­ing the “un­bank­able” seg­ment of the UAE pop­u­la­tion and, on 20 Jan­uary 2009 at the Arab Eco­nomic, So­cial and Devel­op­ment Sum­mit in Kuwait City¸ the League of Arab States an­nounced the for­ma­tion of a US$2 bil­lion fund run by the Arab Devel­op­ment Fund that is set to in­clude a mi­cro­fi­nance pro­gramme that is aimed at help­ing small busi­nesses through the credit crunch, ex­tend­ing credit to cottage in­dus­tries and re­duc­ing un­em­ploy­ment across the Arab world.

The Ta­ble 1 shows the out­reach of Is­lamic mi­cro-fi­nance CGAP global sur­vey in 2007 as re­ferred by Frasca in which in­for­ma­tion was col­lected from over 126 Is­lamic MFIs and MFI ex­perts in 19 Mus­lim coun­tries. The sur­vey re­veales that Is­lamic MFIs have a to­tal global out­reach of 380,000 clients ( or an es­ti­mated one-half 1% of to­tal mi­cro­fi­nance out­reach). 80,000 of the above clients are served through a net­work of In­done­sian co­op­er­a­tives and an­other 100,000 of the to­tal clients are served by two large MFIs in Bangladesh. It must be stressed that the MENA re­gion is par­tic­u­larly un­der­served as CGAP’s sur­vey re­vealed that Is­lamic MFIs were con­cen­trated in three coun­tries In­done­sia, Bangladesh and Afghanistan, ac­count­ing for 80% of the global out­reach.

In Pak­istan, the con­di­tion of peo­ple is pa­thetic as com­pared to other Mus­lim coun­ties. Al­most 80 per­cent of Pak­ista­nis are poor ac­cord­ing to the Eco­nomic Sur­vey 2005-06 (de­fined as ‘ ex­tremely poor’, ‘ ul­tra poor’, ‘ poor’, ‘ vul­ner­a­ble’ and ‘ quasi- non poor’). The num­ber of peo­ple in the low­est three of th­ese in­come cat­e­gories is over 36 mil­lion yet ac­cord­ing to a USAID study, only 600,000 peo­ple in Pak­istan re­ceived mi­cro­fi­nance in 2005. Although this is sig­nif­i­cant growth from 60,000 in 1999, it leaves many peo­ple out. While some peo­ple not us­ing mi­cro­fi­nance are just not in­ter­ested in it, many may opt out of con­ven­tional mi­cro­fi­nance due to its re­liance upon in­ter­est-based fi­nanc­ing, pro­hib­ited by Is­lam as riba (Goud, 2007).

Apart from the banks, there are two no­table Is­lamic mi­cro­fi­nance in­sti­tu­tions ( IMFIs) in Pak­istan: Akhuwat and Is­lamic Re­lief. This re­search pa­per takes an over­view of func­tions and op­er­a­tions of Akhuwat in the coun­try and at­tempts to see its con­tri­bu­tion to­wards povety al­le­vi­a­tion in the coun­try based on its past per­for­mance.

Akhuwat was es­tab­lished in 2001 with the ob­jec­tive of pro­vid­ing in­ter­est free mi­cro credit to the poor so as to en­hance their stan­dard of living. Akhuwat is ded­i­cated to im­prov­ing the lives of the poor; those who are fi­nan­cially abused, aban­doned and disregarded by so­ci­ety.

Akhuwat has de­vel­oped a unique mosque-cen­tered struc­ture. Is­lamic mi­cro­fi­nance is dis­pensed by small in­ter­est- free char­i­ta­ble loans (qard al-hasan) with an ad­min­is­tra­tion fee of 5 per cent in a spirit of Is­lamic brotherhood. There is no fund­ing from in­ter­na­tional donors or fi­nan­cial in­sti­tu­tions. All ac­tiv­i­ties re­volve around the mosques and in­volve close in­ter­ac­tion with the com­mu­nity. There are no in­de­pen­dent of­fi­cers and loans are dis­bursed and re­cov­ered in the mosque. It uses col­lat­eral- free group and in­di­vid­ual fi­nanc­ing based on mu­tual guar­an­tees. Anec­do­tal ev­i­dence sug­gests that the fact that loans are dis­bursed in a mosque, also at­taches a re­li­gious sanc­tity to the oath of re­turn­ing it on time ( Karim, Tarazi and Reille, 2008).

A lot have been writ­ten on the im­por­tance of sus­tain­abil­ity is­sues of MFIs. Im­me­di­ate thing that comes in mind about sus­tain­abil­ity is its fi­nan­cial as­pect - op­er­a­tional self suf­fi­ciency and fi­nan­cial self suf­fi­ciency. Ac­tu­ally fi­nan­cial and op­er­a­tional sus­tain­abil­ity is only one ma­jor di­men­sion.

Af­ter see­ing the Fig­ure 1, Crit­ics would ar­gue that AKHUWAT is not op­er­a­tionally sus­tain­able with the given stan­dards. AKHUWAT is not cov­er­ing 100% of its op­er­a­tional cost.

Yes, it is true in fi­nan­cial terms but there are some other di­men­sions of sus­tain­abil­ity where AKHUWAT is per­form­ing bet­ter. Th­ese dif­fer­ent di­men­sions of sus­tain­abil­ity are: 1. Mi­cro­fi­nance ser­vices for all living be­low the poverty line in­clud­ing the “ex­treme poor”. 2. In­ter­est free loans as a pow­er­ful

tool against poverty. 3. The role of AKHUWAT is ex­tend­ing the help­ing hand and not do­ing busi­ness with poor. Con­stant growth in loan port­fo­lio would be chal­leng­ing for the akhuwat and need to be tack­led in an ef­fec­tive man­ner.

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