Islamic finance and microfinance

Citation

Shubber, K. (2011), "Islamic finance and microfinance", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 4 No. 1. https://doi.org/10.1108/imefm.2011.35204aaa.002

Islamic finance and microfinance

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 4, Issue 1

The rapid expansion of the microfinance sector over the past five years has been nothing less than spectacular, ensuring thereby that millions of small farmers and traders have the means to develop their businesses and better their life styles. The sector has expanded so rapidly and become well-established with recognised institutions and methods of operation.

Estimates put the rate of growth in the value of assets of this sector at 70 per cent per annum over recent year, so much so that the industry has become a truly multi-billion-dollar one with its wings well spread over significant swathes of the national economies of some developing nations, such as India and Bangladesh.

It has to be remembered, however, that the microfinance movement is well and truly part of the conventional interest-based banking industry. While the sector focuses on providing small loans to the poorer sections of society to help them bridge gaps in cash flow requirements of their businesses, the income of lenders is attained essentially via charging interest.

Sharp tactics

And, the story does not end there. Loan providers make use of sharp tactics to ensure repayments, while the interest rates charged have often been viewed as exorbitant. All this is reminiscent of the repugnant practices of the small money lenders prevalent among poorer nations, over whose activities there is much distaste and even disgust.

And, the latest crisis which hit the sector in India late last year (2010) illustrates this issue fully. A wave of suicides among farmers and small traders in the state of Andhra Pradesh was blamed on microfinance debt-collectors and their harassment of debtors, prompting the state government to embark on emergency measures and order a suspension of debt collections by creditors.

While the Indian courts intervened to permit a resumption of collections, there was much talk of resistance and obstructions put up by local authorities, police and political workers. Meanwhile, many borrowers refrained from making repayments, in the expectation of a loan waiver.

Worse still, some of India’s commercial banks placed a temporary freeze on the wholesale credit flow to the microfinance sector, which is estimated at more than $130 million each week. All this caused consternation and ripple effects not merely within the microfinance sector and among their clients, but in the wider Indian banking sector as well.

Different framework

By contrast, Islamic finance is based on other premises and has a wholly different framework. To begin with, fixed interest is forbidden, while certain activities (gambling, liqueur, pornography, prostitution, pork, etc.) are completely shunned in terms of investment, financing and trading.

Islam calls for co-operation and partnership between those who possess funds and those who manage or initiate business activities. Those needing finance for their business can enter into musharakah (participation) with financiers, whereby the capital of the venture is put up jointly, and the two sides share in management and decision making, while both will take part in the profits or losses.

Other forms of Sharia – compliant financing include mudharaba (speculation), murabaha (profit margin) and ijarah (leasing), and all can be adapted to suit the particular type of business that may require funding.

It is therefore hoped that Islamic microfinance may emerge one day as a potent force, so as to enable small Muslim business-people to avoid those deals and practices that clash with their sacred beliefs.

All this represents one of the challenges facing the well-established and still-growing sector of Islamic finance and banking. Clearly, the leaders of this global sector will need to deal with the challenge sooner or later.

Kadom Shubber