Microfinance

One mechanism of poverty alleviation is referred to as microfinance, which is the extension of small loans by Microfinance Institutions (MFIs) to impoverished individuals in low-income groups. These loans can be used to develop businesses, providing a stable and consistent income for the beneficiary, in addition to emergency needs and major life-cycle events like birth or death, that require funding.

Islamic Microfinance

Operations relating to Islamic Microfinance must comply with the same principles governing Islamic Finance, which are primarily derived from the Shariah law. The various instruments utilised, take into consideration the prohibition of Riba (usury/interest), Gharar (uncertainty) etc and provide access to funds whilst simultaneously striving to cover the overhead costs of MFIs, share risks and be sustainable. The Islamic approach is more inclusive than the conventional one and favours equity and cooperation-based models as opposed to instruments that create debt. Islamic Microfinance takes the form of mission-based not-for profit modes and market-based for-profit modes.

  • Mission-based not-for-profit modes involve poverty alleviation mechanisms such as Sadaqah (voluntary charity), Zakah (compulsory charity), Waqf (endowment) and Qard Al-Hassan (interest-free loans).
  • Islam also permits for-profit mechanisms that allow for the creation of wealth. There exists a host of for-profit modes in Islamic Finance, which with the necessary modifications, can be applied to the services that Islamic Microfinance aims to provide to the poor.

The financial services are as follows:

Types of Arrangements

Micro-Savings

Poor people are in need of secure and convenient deposit services, allowing for small transactions and balances, in addition to easy access of funds and Halal (permissible) returns. The contract underlying a savings product must be Shariah-compliant and free of Riba and Gharar.

The mechanisms that can be applied are:

Wadiah

It refers to an Islamic deposit and is entrusted to the institution, either for safekeeping or to be utilised in Shariah-compliant avenues for which the depositor does not share in the risks or returns.

 
Qard Al-Hasan

It refers to the loan granted by the MFI without expectations of any return on the principal.

 
Mudarba

It refers to a partnership-in-profit arrangement where the depositor provides a minimum balance capital (Rabb Al-Maal) and the MFI (Mudarib) provides management skills and labour for investing the funds. Profits are shared between them according to a predetermined ratio and losses are borne solely by the MFI.

 

Micro-Savings

Poor people are in need of secure and convenient deposit services, allowing for small transactions and balances, in addition to easy access of funds and Halal (permissible) returns. The contract underlying a savings product must be Shariah-compliant and free of Riba and Gharar.

The mechanisms that can be applied are:

Murabaha

Murabaha is an arrangement involving a mark-up sale contract in which a Shariah-compliant commodity is purchased on the spot and sold on a cost-plus-profit margin, usually on a deferred payment basis.

Bai' Muajjal

It refers to a sale based on deferred payments. To avoid Gharar, at the time of contracting, the price of the underlying commodity and terms of payment must be specified. Unlike profit-sharing mechanisms, Bai’ Muajjal does not require the customer to present written records which would be difficult to maintain at a micro-level and sometimes, would lead to false record-keeping.

Ijarah

Ijarah is an arrangement where a property/commodity is leased under which a usufruct is obtained for a certain period of time in return for a permissible consideration. The MFI is the lessor, who leases the asset to the customer (lessee receives the benefits associated with owning of the asset against the customer’s payment of periodic rentals. The MFI bears responsibility of the risks associated as the asset is to be returned to it at the end of the period. The cash flows cover the cost of the asset as well as generate a fair return to the MFI.

Bai' Salam

Salam is an arrangement where a Shariah-compliant commodity is purchased on the spot for deferred delivery. The price (Salam Capital) is paid at the time of contracting and the delivery of the commodity (Al-Musalam Fihi) is deferred. A MFI purchases a farmer’s output on a deferred delivery basis, while the latter receives the full price of the output on the spot. At a future date,the output is delivered by the farmer to the MFI who in turn, sells it in the market at the prevailing price.

Bai' Istisna

Istisna is an arrangement where Shariah-compliant items that are to be manufactured/constructed must be delivered to the customer by the manufacturer/contractor upon completion. The MFI can undertake a Parallel Istisna arrangement by assigning the roles of manufacturing or construction to a third party, since the seller and manufacturer may be different entities.

Bai' Istijrar

It refers to an arrangement where a customer purchases different quantities of a commodity from one seller over a period of time in installments. It is ideal for micro-entrepreneurs who buy their raw materials from the same seller over an extended period of time.

 

Micro-Equity

Two mechanisms involving equity are available:

Mudaraba

It refers to a partnership-in-profit arrangement where the depositor provides a minimum balance capital (Rabb Al-Maal) and the MFI (Mudarib) provides management skills and labour for investing the funds. Profits are shared between them according to a predetermined ratio and losses are borne solely by the MFI.

Mushkara

It refers to a partnership between two or more parties where each one contributes a certain amount of money which gives them the right to deal with the assets in the partnership. In this regard, both the MFI and the micro-entrepreneur contribute to the capital in the partnership to carry out the desired business venture. Profits are distributed according to the predetermined ratios, whereas losses are borne by the partners based on their initial capital contributions.

 

Micro-Remittance

Apart from savings and financing, poor people require transfer services such as sending and receiving money, for instance, from relatives living in distant countries. Therefore, services for remittance may be easily provided by a MFI via a fee-based (Ujrat) arrangement. To ensure that Riba is eliminated, the fee is based on the costs incurred to offer the services and is not linked to the funds involved.

 

Micro-Takaful

Risk-protection options for the poor need to be easy to understand and affordable. Ideally, the arrangement applied is a not-for-profit cooperative venture called Takaful Ta’awuni which is in the form of mutual guarantee by members.

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