5.4 Towards an Islamic Microfinance Model
5.4.1 Islamic microfinance models: Waqf (Endowment)-based and Charity-based
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Islamic microfinance models are skewed towards social outreach and social welfare rather than financial sustainability which has long been a focus of attention of conventional microfinance. These models follow the central theme of resource redistribution consistent with the aims of an Islamic welfare state. Their objectives are aligned with the components listed in Islamic concepts of poverty alleviation. The Waqf (Endowment) is considered an important feature in the history of Islamic finance. The concept has been widely acknowledged by a number of researchers (Khan, 2001; Ahmed, 2007; Kaleem and Ahmed, 2009; Adam and Lahsasna, 2013), but the model comprises some built-in risks that make its practical applicability ambiguous. For example, the Waqf endowments used for microfinance loans have some inherent risks such as high transaction cost of generating funds that do not cover the face value of loans in interest-free lending. The substitution effect occurs if the cost of generating loan is higher than the value of loan. In that case, the Waqf endowment could be invested in higher profit businesses rather than microfinance. Secondly, in countries like Pakistan, the Waqfs are managed by the provincial government authorities. These provincial authorities do not allow the Waqfs to work autonomously, therefore, they are not able to provide financial support to microfinance. In addition, legal complexities delay the lending process and require formal approval from the government departments thus making it inefficient.
On the other hand, the charity-based model uses Islamic charities as a source of funding for their operation especially Zakat, Sadaqat, and Qard-Hasna. One such model is proposed by Kaleem and Ahmed (2009) which uses the Waqf certificate instead of ordinary shares. The funds generation is proposed to take place through the sale of interest-
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free Waqf certificates that could be used to finance the interest-free micro lending. Also, the volunteers are involved in the system to assist the professional management, but the model did not elaborate how the transaction costs in the system will be kept at par because appointing professional management needs their salaries and perks that can affect the cost of loan. Another important issue in the said models is the issuance of Waqf certificates that may require an approval from the legal authorities of the hierarchal order under which Waqfs operate, that can create legal complications. Figure 5.6 shows the charity based Islamic microfinance model.
Figure 5.6: Charity based Islamic Microfinance Model Source: Kaleem and Ahmed (2009)
Waqf certificates PROFESSIONAL MANAGEMENT PLUS VOLUNTEERS Source of Funds SADAQAT (Optional Charity) ZAKAT (Compulsory Charity) QARD HASAN (Interest Free Deposit) Usage of Funds BASIC LIVING FACILITIES (food, water, shelter, clothing) EDUCATION AND TRAINING QARD HASAN (interest Free Loan) R
ich People Poor People
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Some other models of Islamic microfinance propose the inclusion of Islamic banks for fund generation that is a good strategy for financial inclusion. The joint-venture of Islamic banks with microfinance will enhance the technical expertise of microfinance through training. However, a possible conflict of interest may come into play if the microfinance’s customers directly approach the Islamic banks for borrowing.
5.4.2 A Proposed Mosque-based Islamic Microfinance Model
The model shown in Figure 5.7 shows an Islamic microfinance model that uses the mosque (Islamic prayer place) as a channel for the redistribution of funds.
Funds Generation
Funds Redistribution
Figure 5.7: Basic Framework of Islamic Microfinance (IMFI) through Mosque Coded Classification: IMFI LENDERS DONORS BORROWERS ER POORESTS Zakat (religious obligation)
Sadaqat (optional) Almsgiving (optional) Benevolence Loans Interest-free Loans MOSQUE Other Loans
Grants and Subsidiaries
FOR CONSUMPTION FOR ECONOMIC ACTIVITIES
Zakat (religious obligation)
Benevolence Loans Interest-free Loans
Other Loans
Sadaqat (optional)
Almsgiving (optional)
133 IMFI: Islamic Microfinance Institutes
Mosque: Muslims’ worship place (used for channelizing the funds)
Lenders: Funds providers including Government and private sources, Islamic banks, other banks.
Donors: Donations providers including local and international agencies, local individuals.
Borrowers: Small and active entrepreneurs relatively less poor (productive user of funds). Poorest: Extremely poor, needy and deprived, live below poverty line (consumption
loans).
The proposed model has the potential to alleviate poverty because it uses a dual strategy of helping the poorest of the poor through consumption loans and providing loans to the relatively less poor (but active entrepreneurs) who need funds to continue their economic activities. The inclusion of the mosque gives the edge of low transaction cost because the screening and monitoring operations could be performed through the prayer leader (Imam). The backward channel of funds generation includes both Lenders and and Donors. The lenders are the suppliers of funds and who need repayment of their loans, while the donors are those who provide donations on virtuous grounds and, being charity providers, do not demand repayment of donations. The classification of funds is based on Shariah compliance as the only fund reserve for the consumption lending to the poor is Zakat which is a religious obligation and which cannot be used as an ordinary loan because once given it cannot be taken back according to Shariah principles. Nevertheless, other charity funds may be used in a cyclic form to generate economic activities like sadqat, almsgiving, and other donations. Figure 5.8 shows the process flow diagram of lending through IMFI.
Figure 5.8: Operational Process Flow Diagram START (Loan Application process) Loan application submitted to Imam
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Successful Pre-Screening by Imam A Application Rejected Screening by two financial experts (volunteers) Production
Loan Consumption Loan
Payment to poorest after the sanction of
IMFI head
Process End
Project
Financing Cash Loan
Process End Payment to borrower
after the sanction of IMFI head Project Feasibility Check Send to Financial Experts (volunteers)
for project re- evaluation
Purchase of machinery / project
financing after the sanction of IMFI head
Machinery handed over to borrower by IMFI head Modified Project Feasibility Re-check Application Rejected Process End Purchase of machinery / project
financing after the sanction of IMFI head Yes Failure Success Failure No No Yes Yes No Succes s
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