Over the years, there have been many tools and strategies used by economists, philanthropists and governments to encourage sustainable growth, development, and ultimately a better quality of life amongst low income communities. Among the millions of dollars of FDI (foreign direct investment) from multinational giants and aid loans given to governments – which bring rapid yet often insignificant results for the world’s poor – micro financing has surfaced as an interesting alternative.
As the name implies, microfinance refers to “programmes that extend small loans to very poor people for self-employment projects that generate income in allowing them to take care of themselves and their families” (Microcredit Summit, 1997). Poorer people in rural areas have always had little access to financing and are often reliant on bigger businesses and organisations to take development initiatives, leaving them little influence of their own. Micro financing institutions empower people to be entrepreneurial, to build small businesses, often literally, from the ground up and to get away from dependency on aid.
Microfinance is championed by Nobel peace prize winner and founder of Grameen Bank Bangladesh, Dr Muhammad Yunus. What makes the Grameen model unique is the emphasis on trust and cooperation between loan recipients. Simple short term loans are given, without collateral, to locals who are part of a group of loan recipients. Upon repayment, group members can apply for another loan. This process is aimed at generating capital amongst the locality, which those with local knowledge can use to maximum efficiency.
The true innovation in the model is how the risk of non-repayment is minimized. A regular bank would have trouble assessing whether borrowers are creditworthy or not. To cover the risk involved, they would have to charge higher premiums or use assets as collateral,neither being an option for the world’s poor. Grameen bank works around this by having a simple rule – in the event of non-payment, the whole group would no longer be eligible for new loans. This acts as an incentive for group members to support each other in their enterprises and allows the model to work on trust rather than collateral or premiums. The bank has been undeniably successful, having distributed 11.35 billion dollars in loans, with 10.11 billion of it repaid. (Grameen Bank 2011-10 Monthly Report). It’s plain to see that microfinance as exercised by Grameen bank and others fills a real need in developing nations, while putting those with all too often unrealized potential in the drivers seat.
From an Islamic finance point of view, the model aligns with the principles of Islamic finance in so far as it positively impacts society however, it cannot be called Islamic finance. The intention behind the scheme is highly commendable, as it is effective in building wealth and real tangible assets among the people who need it most, without the use of collateral or premiums. However, conventional microfinance is not deemed sharia compliant as there is interest involved in the loans.
With the synergy between the outcomes of microfinance and the aims of the sharia in promoting sustainable development and welfare for the needy, the potential for Islamic microfinance, using sharia compliant finance products with the aim and spirit of providing credit on a micro level, could be very significant in combating poverty.
Initiatives such as IFAD (The International Fund for Agricultural Development) and Lend With Care, are using basic contracts such as murabaha, mudaraba and ijarah, to finance agricultural projects in underdeveloped areas. The contracts’ terms are kept as simple as possible and are always tied to tangible assets or valued services. The emphasis on profit and loss sharing in these contracts encourage mutual cooperation and networking, which can improve the sustainability of these small projects.
If these early Islamic microfinance efforts bear fruit and their effectiveness gains credibility, we could see more up-scaled models with higher public participation, as well as other funds such as sadaqah used to fund future operations; the profits could be re-used to give the projects more longevity.
Still this approach to lending is relatively new in Islamic finance and certainly not the topic of discussion for most, but maybe it should be. This refreshing take on lending provides capital for social change with the recipients at its centre and does not develop dependency cultures associated with aid. This kind of lending is far more agreeable with loans as classically understood in Islam, where to lend to people in need is an act of worship, and earnings come from tangible work and entrepreneurism. As Islamic finance’s revelance to ethics is being brought into question, microfinance provides practical examples of the substance of the sharia at work, promoting fairness, social justice and infustructure for those who need it.
“Who is he that will Loan to Allah a beautiful loan? for (Allah) will increase it manifold to his credit, and he will have (besides) a liberal Reward” The Quran 57:11