Some of the goodwill associated with micro-finance has recently vanished in Andhra Pradesh, India, as a combination of interfering politicians, profiteering firms, and people's lack of education created a subprime market environment, according to a story in the New York Times.
No, Islamic micro-finance is not the answer today. The micro-finance crisis in Andhra Pradesh should be a wake-up call for Islamic finance to examine an "innovative" inclusionary approach to enfranchising the masses at the "bottom of the pyramid."
If we are in agreement that Islamic finance is about inclusion, as part of the often repeated mantra of mercy, justice and equity, and not "financial apartheid" towards the non-bankable — today constituting a very large percentage of the 1.6 billion Muslims — then Islamic micro-finance should be a higher priority over, say, Islamic hedge funds. [Yes, its well understood there is a relationship between efforts and management fees; meaning, with micro-finance, a lot of effort, very little fees, and with hedge funds, less effort, more fees and longer lock up periods.]
Asset class
Its well established the industry needs to increase the number of Islamic asset classes, as today the number of compliant investable asset classes is generally confined to equity, real estate, private equity, commodity and Sukuk funds plus the Murabaha, Ijara etc.
Finally, with the price of oil over $70 (Dh257) a barrel, and as a major contributor to the diffusion of Islamic finance, the GCC surplus capital will continue looking for (geographic and product) diversification opportunities.
Traditional micro-finance has been lucrative for financial institutions; low default rates and respectable returns. But, where is "organised" Islamic micro-finance (IMF) established so that it could be exported to, say, Andhra Pradesh? [Lets put India's tepid interest, at best, in Islamic finance aside.] Is the appropriate model in Pakistan, Afghanistan, Indonesia, and/or parts of South-east Asia or Africa?
Islamic finance needs to position micro-finance, at stage one, as less of a financing opportunity and more as an emerging/frontiers alternative investment asset class that funds social enterprises. Put differently, its corporate social investment responsibility opportunity (CSIRO). But, the follow-up question is why invest over financing?
Islamic finance, today, is risk averse (Murabaha) and generally bias towards real estate financing in home country and Islamic consumer financing via salary transfer and individual credit scores (where available).
Obviously, a micro-finance opportunity in the non-home country is a no-go from start, especially in post credit crisis market environment. [In credit crisis, Islamic finance was cheered on as "immune" to stage one of financial institution bankruptcies and bailouts due to the Sharia prohibitions, but has been impacted in stage two, increasing non-performing loans and provisioning, as crisis impacted the real economy.]
But, there are many issues on what can go wrong in micro-finance, and risk averse Islamic banks, looking at micro-finance, need to be cognizant of them.
Some of the major issues including aggressive loan growth without any sustainable or income generating benefit, lack of education, training and/or follow-up mentoring, inadequate due diligence on ability repay, use of funds for refinancing (older micro financing) or consumer purchases, capping interest rates and extension of tenors, and so on.
Alternative asset
As part of wealth management offering, Islamic banks need to set up an Islamic mirco-finance fund, and, to ‘jump start' it, they should look to seed it with a combination of own funds, part investor fund, part Zakat and part charity donated income. If some enlightened Islamic banks are willing to defer profit payments on, say, Islamic mortgages during month of Ramadan, then "funding social enterprises," should be seen in similar light.
Efforts should be made to reach out to prominent local investors, even for nominal amounts, as a vote of confidence on credibility of offering to (1) minimise political interference and (2) dispel myths of it being a refinancing offer or consumption "debt trap."
Furthermore, it will lay the seeds for Islamic micro-savings, as fund users graduate to fund providers!
There are a number of success stories of micro-finance in places like Indonesia, where the recipients, having established excess surpluses, desire to circulate such funds within his/her community. This welcomed competition!
Islamic banks have traditionally outsourced managing of funds to third parties, hence, similar treatment of seeded Islamic micro-finance fund. There also needs to be a lock of funds from (early) redemption, not much different than Islamic PE funds, as a gestation period will be required. Obviously, the option to work with experienced host country NGOs should be examined.
Rushdi Siddiqui is Global Head of Islamic Finance at Thomson Reuters. The views expressed are his own and do not reflect that of his organisation or Gulf News.
