INTRODUCTIONIslamic microfinance refers to financial transactions that are based on wider Islamic finance principles. These Islamic finance principles themselves are based on the teachings of the Prophet Muhammad (PBUH) and the Quran.
Islamic microfinance provides access to financial services for those who live in low-income households or economies.
The contractual terms of Islamic microfinance arrangements are not interest-based, but instead the terms are Sharia complaint. Islamic microfinance is viewed as a positive tool and concept for facilitating poverty alleviation and financial inclusion.
Research has shown that economies that operate or make available Islamic microfinance widen the market for any Muslim customer looking for structures that do not contravene Sharia rules and want a more ethical basis for their financial dealings.
WHAT IS ISLAMIC FINANCE?
Islam sets out principles that should govern financial transactions, especially commercial financial transactions. One of the main principles of Islamic finance is that the money itself does not earn - what this refers to is interest. Interest, or riba, is not permitted in Islam as money is not seen as an asset that earns in and of itself.Some of the main principles of Islamic finance are as follows:
- No interest (see above)
- Prohibition of involvement in haram industries and products
- Equity in profit and loss sharing
- Ethical and socially responsible investing
- Fairness and transparency
- Avoiding speculation or gambling
Any Islamic microfinance product or service in any capital form cannot mirror conventional finance arrangements. Many conventional financial arrangements, although able to provide financial resource, are not Sharia compliant.
Let's examine some of the key features of Islamic microfinance:
- Any Islamic microfinance commodity or service must ensure that there is no element of riba whatsoever. No interest is attached to the debtor, the lender, or the debt.
- In addition, microfinance transactions should always be linked to tangible economic activity. This means there cannot be any financial speculation or uncertainty that is excessive.
- Any product that is bought or sold must be clear and tangible. You cannot trade in or sell something you do not own.
- If involving activities, then these should be socially responsible activities that do not exploit or morally harm others.
KEY PRINCIPLES OF ISLAMIC MICROFINANCE
One of the main objectives of Sharia law and Islamic finance is to alleviate poverty and empower people and communities.
Whilst we have looked at some of the key principles above, let's have a look at them in more detail:
- Asset backed finance: Asset backed finance encourages finance options that are backed by real and tangible assets.
- Profit and loss sharing: Islamic finance is focused on profit and loss sharing arrangements. This means that the risk is also shared between the respective parties to the contract and transaction. Common forms of profit and loss sharing arrangements in Islamic finance include mudaraba and musharaka arrangements.
- Social welfare: Promoting social welfare is a central tenet of Islamic finance. Providing and facilitating access to education, healthcare, and essential services is seen as the promotion of social welfare so any form of financial arrangement that enables this to take place is seen favourably in Islam.
- Ethical investing: as is the case with social responsibility, Islamic microfinance heavily favours ethical investments. What this means in principle is that any investments need to add value to others and society. Examples of projects and investments that are deemed to be ethical include community development projects, agricultural, and healthcare projects.
- Interest (riba) avoidance: riba is strictly prohibited in Islam so any form of arrangement where interest is paid or charged is impermissible. Islamic microfinance steers clear of interest-based products (often used by lenders in Western economies which are credit and debt based).
One of the main principles of Islamic finance is that finance should serve society. What this means is that financial transactions must be conducted in a socially responsible manner. The foundation and ongoing management of Islamic microfinance products (on paper and in practice) should be equity-based.
The idea underpinning Islamic social responsibility is that there is a balance between social objectives and financial objectives. What this ultimately leads to is more sustainable finance long-term as the scope for exploitation and inequality within transactions is minimised.
In many ways, Islamic microfinance is underpinned by principles of benevolence, morality, unity, freedom, and equilibrium. Muslims believe that they all have a responsibility to society and the environment. Therefore, they must embody this commitment to social responsibility through their words and actions.
In this way, they can contribute to social justice (as prescribed by Islam) and ensure populations across the globe are not adversely impacted.
TYPES OF ISLAMIC MICROFINANCE
Islamic microfinance is based on the foundations of Sharia law. Sharia rules place great emphasis on transparency, fairness, social responsibility, and ethical behaviour.
Let's have a look at some Islamic microfinance products:
MICROCREDIT
Islamic microcredit is a term used to describe small financial services relating to credit. Microcredit operates within Sharia rules and is designed to ensure that entrepreneurs and small businesses are able to access fair and equitable financing options.
Islamic microcredit does not include any riba and is asset-based finance. Any loan issued is backed by assets or productive ventures.
MICROLEASING
Islamic microleasing (also known as microfinance leasing), enables small businesses and entrepreneurs to lease assets for varying periods of time. The leasing arrangements are compliant with Islamic finance rules.
In Islamic microleasing arrangements, the lessor (lender) will retain ownership of the asset and grants the lessee a right to use the asset for a period of time. The lessee then pays the lessor lease payments for the use of the asset.
MICROINSURANCE
Islamic microinsurance is also known as takaful insurance. This type of insurance does not contravene Islamic finance principles. Takaful is a cooperative arrangement based on shared risk and mutual assistance between the parties.
What this means in real terms is that businesses and individuals are able to access insurance coverage whilst remaining Sharia compliant.
ISLAMIC MICROFINANCE - THE PROSPECTS
It is estimated that over 60% of Muslims who live in Muslim countries do not use formal financial service institutions and services. One of the main reasons for this is that many Muslims view conventional finance institutions as incompatible with aspects of Sharia law.
This has led to the emergence of microfinance services and products being developed both inside and outside of Muslim countries and economies.
Muslims are increasingly keen to engage with financial services that comply with Sharia law and the rules of Islamic finance. Since 2006, the Islamic finance market has seen a four-fold increase, and this is likely to continue growing in the future.
What Islamic microfinance represents is the merger of two quickly accelerating industries - Islamic finance and microfinance. Not only does Islamic finance meet the commercial business demands within global economies, but it also provides individuals looking with Sharia compliant funding options.
UNLOCKING THE POTENTIAL OF ISLAMIC MICROFINANCE
Any financial transaction that meets Sharia rules is not only good for business, but it also means that transactions are socially and ethically considerate.
Islamic microfinance has the power and potential to operate in a fair, socially responsible and transparent way. What this means for businesses, the entrepreneur, individuals, and communities is that they too can access funding and enhance their ability to access finance and loans.
Providing financial access to poorer or marginalised communities who currently reject conventional, interest-based finance products means greater equity and economic development.
ISLAMIC MICROFINANCE AND POVERTY REDUCTION
Islamic microfinance is based on the foundations of equity and social and environmental responsibility.
One of the main advantages of Islamic microfinance is that it contributes to poverty reduction in various ways:
- Enterprise and entrepreneurship - Islamic microfinance supports individuals and businesses from low-income and under-developed communities. It enables these businesses and entrepreneurs to access capital for the ventures and establish sustainable and Sharia compliant livelihoods.
- Financial inclusion - as already mentioned, Islamic microfinance has become an important tool in encouraging and facilitating financial inclusion. Offering financial products that are not only accessible but also Sharia compliant means that marginalised groups can access funding for their start-ups.
- Skills growth - there are many Islamic microfinance organisations that offer training and skill enhancement programmes alongside their financial products and services.
- Community development - with a strong focus on equity and social responsibility, Islamic microfinance is committed to community development. This goes beyond offering financial assistance. Microfinance products can include access to healthcare, education, and a wide range of community benefits.
One of the main challenges for the Islamic microfinance industry is spreading awareness of the products and services on offer. Despite growing rapidly, this industry is still seen as being in its infancy.
Further advertising and outreach work is required to make sure that Muslims and socially responsible investors are aware of the microfinance options available to them.
The important thing to remember is that Islamic microfinance encourages and develops financial inclusion and freedom. Whilst the impact of Islamic microfinance funding options may vary depending on the regulatory environment, local economic conditions, and institutional capacity, Islamic microfinance is essential if we want to ensure the sustainability of Islamic finance initiatives and alleviate poverty.