Micro financing has its origin based on universal dictum of economic and social justice, to be brought in all societies so as to arrest the widening gap between the rich and poor and thus eradicate poverty from the globe. Similarly, Islamic laws based on the Quranic teachings, focusing all financial transactions, also uphold ethical values and social justice and make it incumbent on the State to promote equality and equal opportunity for all.
All the modes of financing under Islamic banking wherever introduced to replace Riba/interest are based on the following assumptions:
a) That all transactions under Islamic modes of financing involve the concept of risk sharing.
b) Everyone has a right to own assets, whether movable or immovable.
c) The contractual arrangements between financing bank and the client have legal validity.
On the other hand, micro financing promotes micro businesses even amongst the poorest of the poor and contains an element of risk sharing in all financial transactions and above all based on the very philosophy that poor should participate in economic activity so as to share national wealth. This provides compatible and ideological grounds for adoption of Islamic modes of financing to replace interest-based system or other modalities akin to Riba embedded in systems and procedures of micro finance banks.
Further guiding principle of micro finance banks/institutions is to become sustainable, side by side with promoting entrepreneurship amongst financially disadvantaged segment of the population with the sole objective of creating enabling environments for them to fully participate in the economic process and build up assets of their own. Islamic banking with total focus on basic philosophy of Islam which allows financial innovations, has evolved the strategies and products relating to deposit-taking and financing which are in consonance with the basic principles of social justice and ensure sustainability both for the financing banks and their clients projects.
Universally accepted Islamic banking products relating to deposit taking and financing, in vogue in the countries, including Pakistan, where attempts have been made to eliminate interest/Riba from the banking system are:-
a) Investment related Musharika, Modarba, term finance certificates and equity participation where the concept of profit and loss sharing with equity input by the financing bank and client or by the bank alone prevails.
b) Trade related instruments like Murabaha/Bai Muajjal, based on the concept of sale and purchase of goods and services by the banks, required by their customers on term where the price of goods/services plus margin of profit (mutually agreed) are to be paid on or before the specified future date.
c) Other instruments where element of interest is totally non-existence like Hire purchase, Leasing and rent sharing etc.
Qarz-Hasna and lending with service charge (this has also been practised by the public sector banks and until the recent past). It is to be seen which of the aforementioned instruments are more compatible to micro financing, which generally entails collateral free financing and at the same time strongly advocates sustainability of the financial institution itself.
The experience regarding lending with service charges and by way of Qarz-Hasna as has been practised in Pakistan no doubt affirms Islamic principles yet the solitary application of this mode of financing endangers the sustainability of organisation itself.
It is Bai Muajjal or Murahaba, which stems from the concept of trading of goods in vogue in Saudi Arabia and adjoining States since the period of our Holy Prophet (peace be upon him).
This mode of financing is applicable to various trade-related transactions. However in all transactions either of the following two modalities is involved:
a) The manufacturing concerns generally need bank finance to meet manufacturing or administrative expenses.
If they are accommodated under Murahaba arrangements, it implies purchase from customer something of value at a certain price, taken as sale price, and sell it back to the client on deferred payment basis, at a price, which includes mark up, and termed marked up or buy back price.
b) The modality involved regarding financing customers in trading business is, by sale of goods to them at marked up price on deferred payment basis.
The mark up included in the buy back and purchase prices in the cases discussed above represents the bank's return on financing done at agreed price. Here the vital question is risk management. Even in the case of conventional commercial banks there is shift from collateral based financing to performance-related financing.
Instead of relying in collateral, banks need to have safeguard against risk by taking into account the track record of the client and operational efficiency of the business reflected from funds/cash flow and other financial returns.
The same criterion can be used by micro finance banks/institutions, which have deep penetration in the communities they serve, hence can closely monitor and supervise the business operations of their clients to prevent misuse of funds, which generally end up in making the return of funds to financing bank doubtful.
In Pakistan, after the verdict of the Supreme Court to Islamize banking in letter and spirit, banks despite finding Moharaba easiest mode of financing are faced with innumerable problems in adhering to the requirement of their literal/constructive involvement in sale and purchase of goods/commodities and secondly, sticking to the agreed marked up price in a scenario when in case of defaults banks cannot have recourse against the borrowers through courts within specified time (maximum allowed time of 210 days after expiry of financing agreement).
In the case of micro finance banks, staff inducted generally come from the targeted communities/areas/villages for financing, it becomes easy for the micro finance institutions to cater to business needs in the literal sense. In other word constructive sale and purchase of raw material, equipment and machinery etc can take place through direct involvement of the bank as against current practice of delegating it to the client to purchase from the market. Similarly strict monitoring by micro finance banks' staff, specially through mobile teams and affordable loan repayment arrangements (from clients point of view) put in place, like payment of instalments on weekly or fortnightly basis ensures timely adjustment of finance. Thus problem of alteration in agreed marked up price will not be encountered.
In the present scenario, particularly relating to conventional commercial banks, it is an unilateral change in marked up price or charging of liquidating damages by banks in case of failure of client to adjust the advance in specified period, has attracted criticism and rendered mark up system akin to interest-based banking. Accordingly, Bai-Muajjal and Murahaba in the present form has been totally rejected by the Supreme Court and the banks have been asked to remove all loopholes in the system and implement it strictly in accordance with the philosophy behind it.
Micro finance banks dealing with clients from low and lower middle income groups to finance their micro businesses may opt for using more than one mode of financing for a client.
Side by side meeting clients fixed assets purchase needs through trade related modes of financing (through Murahaba/ Bai-Muajjal), they can provide the loan facility on service charge basis (rate of which to be calculated according to prescribed formula given by the State Bank of Pakistan) to meet overheads of the business. Low returns through service charge can be compensated by charging higher rate of mark up on financing for purchase of fixed assets of the business concerned.
Next are the Investment-related modes of financing like Musharika, Modarba, term finance certificates and equity sharing, selectively in use by the banks operating in Pakistan show little possibility of their application by Micro finance institutions except Modarba.
All other investment-related financing modules require client's equity input in the business, whereas in the case of Modarba the financier participates in the business by bringing in only funds and through his/her skill and expertise runs the entire business. As such for micro finance banks where majority of the clientele is from financially-deprived class, it would be feasible to make use of Modaraba module to finance business needs of their clients.
Unlike the interest-based system (capital provider does not share risk in business) the return on funds invested in business under Modarba arrangement are not fixed or predetermined. The profit accrued in business is shared between capital provider and entrepreneur in the ratio agreed mutually.
In case the business happens to incur loss, the entire loss is borne by the financier. However if it is proved that the situation is the outcome of sheer negligence on the part of entrepreneur then he/she will be called upon to take on the entire liability as per rules governing Modaraba.
So far the Modaraba floatation in Pakistan is restricted only to legal entities set up under the rules and regulations enforced through Modarba Companies Ordinance and monitored by the Securities ad Exchange Commission of Pakistan and the State Bank of Pakistan.
But in order to bring micro-financing also within the ambit of Islamic banking despite peculiar constraints and limitations with regard to clientele of these institutions who are the poorest of the poor having no assets of their own, Modarba module of financing turns out to be a feasible approach for micro finance institutions as their clients/ owners of micro businesses cannot afford to bring in equity in the business and secondly it is an ideal module of financing where risk-sharing can be practised in letter and spirit.
Under Modaraba module the role of Micro finance banks would be of capital/funds provider to their clients for setting up micro businesses, specially to those having good track record, adequate experience of the business and also those who own business of longer cash conversion cycle. For example for financing livestock business involving comparatively longer-term repayment arrangement can easily be covered under Modarba arrangements.
Modarba in fact entails issuing Modarba certificates to capital provider by the entrepreneur who uses the funds for establishing/running the business. In micro financing constraints regarding this modality can be handled by making the clients execute a legal document in the form of a certificate value of which would be bought back in instalments by the client/entrepreneur during the period the facility is availed of.
For example, financing of Rs 60,000/- is required for a period of 18 months, for purchase of three cows of different age groups. The financing under Modarba can be initiated by way of purchase of three certificates by the bank (by way of legal documents duly executed by the client).
It will be on condition that the client will buy back these certificates in three six-monthly instalments, on each cow attaining the age when it is profitably marketable. Profit on sale of each cow, would be shared by the bank at an agreed ratio on six monthly basis, on the capital amount in use in business during the preceding six months from each point in time.
Modaraba financing, however, has some limitations in the scenario of micro financing in the sense that clientele of these banks is least expected to maintain proper books of accounts.
As such it is difficult to ascertain the exact business transacted and funds generated so as to determine the profit to be shared by the bank. It is, therefore, advisable that this mode of financing be applied to ongoing concerns only, which are in need of expanding their business. The deliberate attempt by the clients to hoodwink the bank can easily be traced out, as micro finance banks are the banks of the communities.
They have presence even in far-flung areas and are run by the staff taken from the communities they serve. Hence they have extensive exposure to relevant markets, such as there is little chance of encountering loss.
No doubt at the initial stages of implementation of the above-discussed modes of financing, some anomalies be encountered by micro finance banks, but in the course of time these can be addressed by making minor modifications in the systems and the procedures without disturbing the very essence behind each mode of financing.
Since the Islamic banking upholds norms of social justice, fair and equal opportunities for all, it is more compatible to the objectives of micro finance institutions who cater to banking needs of the financially disadvantaged segments of population needing empowerment economically by mainstreaming them in the economic process.
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