Can Islamic Finance Go Micro?
Washington, United States, September, 11 2008 -
With more than half-a-trillion dollars in assets and an annual growth rate that has outpaced conventional banks’ by nearly 50 percent, the Islamic finance industry is already making waves among investment fund managers. And this not only applies to the Muslim world: The Banker magazine recently named the United Kingdom to its list of the top 15 countries managing Sharia-compliant assets.
The new CGAP Publication Islamic Microfinance: An Emerging Market Niche, argues that the Islamic finance industry, with its unprecedented popularity and growth, may be well-placed to address a critical need in microfinance: reaching the some 72 percent of people in Muslim-majority countries who do not use formal financial services.
Much of that gap owes to unmet demand for products that comply with Islamic law, or Sharia, according to Aamir A. Rehman, former Global Head of Strategy with HSBC Amanah.
“Sharia compliance can help microfinance institutions reach a large number of Muslims who prefer Sharia-compliant forms of financial activity,” says Rehman. But he also adds that microfinance is “a fantastic opportunity for Islamic finance to reflect its core values and mission.” of supporting the underprivileged.
This “win-win” situation is stimulating greater discussion between microfinance practitioners and practitioners of Islamic finance, who seek to draw upon the experience of a highly professionalized microfinance industry while acknowledging that there may be no turn-key solutions for Islamic financial services directed to poorer customers.
Indeed, some Islamic financial institutions are adapting their own innovative products and methodologies to reach the “unbanked,” a trend that could ultimately enrich the entire microfinance industry, says CGAP Lead Microfinance Specialist Xavier Reille.
“Reaching these millions of ‘unbanked’ people is a critical challenge for microfinance practitioners, and the more innovation and resources we bring to the challenge the better,”
Still, the promise of Islamic microfinance far exceeds its performance to date. According to a wide-ranging CGAP survey of 125 institutions in 19 Muslim countries, Islamic microfinance providers—institutions that offer Sharia-compliant products—reach only 300,000 clients, one-third of them in Bangladesh alone. Another 80,000 clients bank through a network of Indonesian cooperatives.
Most microfinance providers are still weak institutions operating on a small scale, says Reille, this is one reason why Sharia-compliant products represents barely one percent of the total market for microfinance.
The other reasons are predictable: designing affordable products, building sound institutions, improving efficiency, and managing risk—all critical components of a sustainable business model. Islamic microfinance has not yet to prove itself as a large sale business.
Also complicating matters for Islamic microfinance institutions is the question of authenticity. Although many institutions rely on Sharia Supervisory Boards, or SSBs, to deem their products “Islamic,” there is no single standard for applying this judgment. Where individual countries, like Jordan and Kuwait, have established some regulatory oversight of SSBs, this is limited to the composition and competence of the boards, not to the jurisprudence itself.
In other words, the question of what exactly makes these institutions and their products “Islamic” remains unanswered—a fact that has kept demand in check among potential Muslim clients. Rehman points out that microfinance practitioners must find a way to work with Islamic scholars to “address skepticism about the Sharia authenticity of products.”
For its part, the Islamic finance industry “needs to adapt its product set and operating models—not fundamentally, since the basic structures are already there—to meet the needs of the poor, the target clients of microfinance.”