Poverty is one of the fundamental problems in developing countries. It is estimated that around 80 percent of the world’s population is living in countries where income distribution gap is widening. Poverty rate is quite high in all Muslim countries except a few countries in Southeast Asia and the Middle East. Poverty levels have also been associated with high inequality alongside low productivity. Half of the Indonesia population (about 129 million) is living below the poverty line of $2 a day. While in South Asia two largest Muslim states Bangladesh and Pakistan – alone account for 122 million each living below the poverty line where as 100 million Muslims of India is also living below the poverty line. (Source: Islamic Microfinance Development: Challenges and Initiatives, IRTI website, 2007)
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Microfinance is a part of financial services which includes not only credit facility but also savings, insurance, and fund transfers to facilitate low-income people. The World Bank estimates that there are over 7,000 microfinance institutions; serving some 16 million poor people in developing countries. The total cash turnover of MFIs world-wide is estimated at $2.5 billion and the potential for new growth is outstanding. (Source: Micro facts: Data Snapshots of Microcredit, Global Development Research Centre website, 2008-2009)
The Microcredit Summit estimates that $21.6 billion is needed to provide microfinance to 100 million of the world’s poorest families. The Summit planners said it should be possible to raise US$2 billion from borrowers’ savings alone and the final figure may be even higher. (Source: Micro facts: Data Snapshots of Microcredit, Global Development Research Centre website, 2008-2009)
Fewer than 10 million out of the 500 million people who run micro and small enterprises have access to financial support for their business and fewer than 2% of the poor people have access to financial services (credit and savings) from sources other than lenders. (Source: MICROFACTS: Data Snapshots of Microcredit, Global Development Research Centre website, 2008-2009)
The supporters of microfinance believed that it will help in reducing poverty and the concept became more popular in 1974 when famine struck Bangladesh. At the time, Dr. Muhammad Yunus was a professor of economics at the University of Chittagong. He subsequently started Grameen Bank which has been a wonderful success with more than 90 percent recovery rate. (Source: Short history of Grameen Bank, Grameen Bank website, 2010)
Studies have also shown that during an eight year period, among the poorest Bangladesh with no credit service of any type, only 4 % pulled themselves above. But with only individuals and families with credit from Grameen Bank, more than 48% rose above the poverty line. (Source: MICROFACTS: Data Snapshots of Microcredit, Global Development Research Centre website, 2008-2009)
In Pakistan there are 25 Microfinance institutions with the total deposit of $52.3 million which covers 1.83 million of population out of total population of 174 million (Fehmeen, 2010). Pakistan is ranked 6th in terms of population with the labor force of 53.78 million as estimated for 2009. (Source: CIA world Fact book, Central Intelligence Agency website, no date)
Figure 1: Unmet Demand for Microfinance in Pakistan from 2008-2009
Source: Microfinance Hub Website
From the statistical figures of 2008-2009; it can be said that the population below the poverty line is 29,928,000 million which represents 17.2 % of the total population and the unemployed population is 26,448,000 which means 15.2% of the total population; that sums up to 32.4% out of the total population of Pakistan. These people need microfinance support to improve their living standard because the people living below the poverty line are not even able to get basic necessities of life (Fehmeen, 2010).
In this regard, the Financial Inclusion Program (FIP) has been implemented by SBP with support of the UK Department for International Development (DFID), which aims to transform the financial market with a clear objective to provide equitable and efficient market-based financial services to the otherwise excluded poor and marginalized population including women and young people. FIP has developed an evidence based policy and a realistic target of reaching out to three million microfinance users by the end of 2010. (Source: Financial Inclusion Program, SBP, no date)
Some facts about the outreach of Islamic Microfinance in different countries are mentioned in the Table 1.
Region
No. of Included Institutions
% of Female clients (Avg.)
Total no. of Clients
Total Outstanding Loan Portfolio (US$)
Avg. Loan Balance (US$)
Afghanistan
4
22
53,011
10,347,029
162
Bahrain
1
N/A
323
96,565
299
Bangladesh
2
90
111,837
34,490,490
280
Indonesia
105
60
74,698
122,480,000
1,640
Jordon
1
80
1,481
1,619,909
1,094
Lebanon
1
50
26,000
22,500,000
865
Pakistan
1
40
6,069
746,904
123
West Bank and Gaza
1
100
132
145,485
1102
Saudi Arabia
1
86
7,000
586,667
84
Sudan
3
65
9,561
1,891,819
171
Syria
1
45
2,298
1,838,047
800
Yemen
3
58
7,031
840,240
146
Total
63
299,441
197,583,155
564Table 1: Outreach of Islamic Micro Finance by Country
Source: CGAP Survey, 2007
Islamic finance is still in its introductory phase, but it has achieved double digit growth both in Pakistan and around the world. Some of the well known Islamic finance instruments are Murabaha (Sale Contract), Musharakah (Equity Participation), Mudarabah (Partnership), Ijarah (Lease Financing), Bay Muajjal (sale on Credit or deferred payment sale), Bay Salam (Deferred Delivery Sale) etc.
1.2 Problem Statement
Interest based micro lending carries high interest rates and is impermissible in Islam; hence, this study strives to analyze how the mix of debt and equity based Islamic finance contracts be used in providing Islamic micro financial services in Pakistan which has more than one quarter people living below the poverty line and huge rural population.
1.3 Objectives of the study
It will identify and analyze various instruments of Islamic microfinance that can eliminate poverty effectively than conventional micro financing.
It will recognize and analyze the mix of debt and equity based Islamic finance contract; used in providing Islamic micro financial services in Pakistan.
It will explore the scope of opportunities for Islamic microfinance in Pakistan.
It will discover the challenges that Islamic microfinance could face in Pakistan.
1.4 Importance of the study
This study highlights the importance of Islamic microfinance to help reduce poverty in Pakistan. As the poor are becoming poorer in Pakistan due to rising inflation and very limited sources of employment, this research will discuss how the Islamic microfinance could help in poverty alleviation, equitable redistribution and employment creation.
1.5 Research Methodology
This research study will inquire that how far Islamic microfinance would be helpful in reducing poverty in Pakistan. To substantiate the case for microfinance; the study will analyze five major countries where microfinance is prevalent. Panel data on four variables which include per capita income, education which will be measured through literacy rate, poverty measured through percentage of population living below the poverty line and inequality measured through gini co-efficient will be taken from the selected five countries. The period of study will be different for each country starting from when microfinance started in particular countries to the current period. Secondly, the research will identify and analyze the mix of debt and equity based Islamic finance contract which could be used in providing Islamic micro financial services in Pakistan. For this purpose, specific entrepreneurial activities with investment requirements will be identified and then the ideal Islamic mode to be used in specific entrepreneurial activities with particular investment would be recommended.
1.6 Plan of the study
This study consists of five phases. Work in each phase would be reported as a separate chapter. The first chapter of study will cover the introduction which includes the background of the study, Problem statement, Objectives of the study, importance of the study and scope of research. The second chapter will cover the literature review of will the academic and practical progress in Microfinance. The third chapter will discuss the research methodology i.e. the various tools and techniques that will be used to conduct research. The fourth chapter will include the data collection and findings obtained from the analysis of the data collected. The fifth chapter will comprise the research conclusion based on the findings.
1.7 Limits of the study
This study on application of Islamic microfinance in poverty alleviation would be useful and provide experiential support to future studies on Islamic microfinance in Pakistan. There exist no full fledge Islamic microfinance bank in Pakistan. Hence, the models and instruments discussed have not been put into practice and empirical analysis of performance will be hard to make.
CHAPTER 2
LITERATURE REVIEW
2.1 What is Microfinance?
According to Abedelhamid 1991 (p. 57-64).
“Microfinance is a set of financial services which provides loans to clients who are excluded from the traditional financial system on account of no or little collateral. In the third world countries, microfinance has become very popular because inflation tends to be high and volatile; government is often incompetent; and the necessary legal framework for financial services is often missing”
Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and, their microenterprises. Microfinance services are provided by three types of sources:
Formal institutions, such as rural banks and cooperatives;
Semiformal institutions, such as nongovernment organizations; and
Informal sources such as money lenders and shopkeepers.
Institutional microfinance is defined to include microfinance services provided by both formal and semiformal institutions. Microfinance institutions are defined as institutions whose major business is the provision of microfinance services. (Source: Finance for Poor: Microfinance development Strategy, ADB website, 2000)
2.2 History of Microfinance
Microfinance history dates back to the mid of the 18th century when the philosopher Lysander Spooner was doing research on the advantages from small loans to entrepreneurs and farmers as a way to get people out of poverty.
The economist Timothy Guinnane at Yale had been doing some research on Friedrich Wilhelm Raiffeisen´s village bank movement which started in 1864 in Germany and by the start of the year 1901 the bank reached 2 million rural farmers. As per Timothy Guinnane explanation it was proved that microcredit could pass the two tests concerning people’s payback moral and the possibility to provide the financial service to poor people. Today, the expression Microfinance has its roots in the 1970s when the Grameen Bank of Bangladesh was established.
At that time a new span of microfinance initiatives introduced many new procedures into the sector. Pioneering enterprises started doing experiments with providing credits to the poor people. Increasingly, it was thought that people could be relied on for repayment of their borrowings and it is feasible to provide financial services to underserved people through market based enterprises without subsidy. In 1974, Shore bank was the first microfinance and community development bank founded in Chicago for the first time in USA. (Source: History of micro finance, Global envision website, 2006)
Today the World Bank estimates that more than 16 million people are served by some 7000 microfinance institutions all over the world. CGAP experts suggested that about 500 million families benefits from these small loans making new business possible. (Source: Micro facts: Data Snapshots of Microcredit, Global Development Research Centre website, 2008-2009)
2.3 Present Situation and Growth of Microfinance
The year 2008 is considered as the beginning of a challenging period for microfinance in a number of countries. The economic and financial crises that reached MFIs and their clients turned calm waters into rough shores for many institutions in the industry. The year 2009 MIX Global 100 Composite Ranking captures the effects of this changing environment, where global growth rates slowed for the first time in years, and many MFIs faced stagnant or rising costs, and in some instances a slow rise in credit risk.
Figure: 3 Growth Pattern of Microfinance in all continents
Source: MIX Global website, 2009
The 2009 edition of the MIX Global 100, surveyed 955 institutions from nearly 100 countries as illustrated in Table 2. As a group, surveyed institutions represented nearly 85 percent of the known pool of microfinance borrowers, serving 72 million borrowers with 37 billion USD in loans and holding 22 billion USD in deposits from 67 million microfinance clients (Source: MIX Global website, 2009).
Table 2:2009 MIX Global 100 Composite Ranking Countries with Most MFIs in Top 100
Country
MFIs in Top 100
All Ranked MFIs
India
20
51
Ecuador
9
44
Egypt
6
12
Philippines
6
34
Bangladesh
5
9
Cambodia
5
13
Bolivia
4
22
Bosnia and Herzegovina
4
13
Armenia
3
7
Mexico
3
27
Morocco
3
5
Dominican Republic
2
2
Jordan
2
6
Mongolia
2
4
Nepal
2
16
Peru
2
54
Serbia
2
4
Vietnam
2
5
Source: MIX Global website, 2009
Microfinance is assured as one of the tools that can decrease as well as eradicate poverty. According to Saefullah (2010) numbers of research have been conducted in order to measure the success of microfinance. The stories of Grameen Bank in Bangladesh, Bank Rakyat Indonesia (Indonesian People Bank) in Indonesia, Self-Help Group in India show the extent to which microfinance can eliminate poverty. Obaidullah (2008) has also done research that attempts to identify the glory of microfinance.
Table: 3 Poverty Level and Financial Access in Bangladesh, Indonesia and Turkey
Source: Islamic Microfinance Development: Challenges and Initiatives, 2008, IRTI, IDB
Name of Member Counrty
Human Poverty index Rank
Income poverty Index Population Below
Population in millions
No. of poor in millions
Financial access percentage (2007)
$ 1 a day (%)
$ 2 a day (%)
Poverty Line
People’s republic of Bangladesh
85
36
82.8
45
147.37
122
32
Republic of Indonesia
41
7.5
52.4
17.8
245.45
128.6
40
Republic of Turkey
21
3.4
18.7
20
70.41
13.2
49
Impact of microfinance in household and community level components
According to study of Chowdhury & Bhuiya (2004) the wider impacts of BRAC (Bangladesh Rural and Advancement Committee) poverty alleviation program found that there was a positive impact on living standard as the survival rate and schooling of children improved.
The Impact of microcredit on borrowers of Grameen Bank by Khandker (2003) illustrate that there was a positive impact on the households’ poverty reduction that availed the microfinance facility. Latif (2001) in his study on the effects of microcredit on the household saving of Bangladeshi borrowers concluded that saving-income ratio was significantly higher for the customers of microfinance as compared to poor who were not participants of microfinance institutes.
Another research conducted by Zaman (2001) on the Impact of microcredit on poverty and vulnerability found that there is positive impact on income and decision making capability of poor using microfinance.
Bangladesh Institute of Development Studies (2001) researched on the Impact of microcredit on savings and informal borrowings discussed that microcredit increased savings and this was more prominent in women than men.
Hakim (2000) in the study Impact of microfinance program highlighted the higher social relations and mobility among women clients and the positive impact of microfinance on asset-ownership.
Mosley and Hulme (1998) studied the possible conflict between growth and poverty alleviation. Their main finding is that the income and assets of the borrowers had increased due microcredit.
Halder (1998) in the research identification of the poorest and the impact of credit on them asserted that the members of BRAC (Bangladesh Rural and Advancement Committee) consumed high calories as compared to non-members.
Pitt and Khandaker (1996) explained in their study the Impact of microcredit on borrowers of BRAC, BRDB (Bangladesh Rural Development Board) and Grameen Bank that there was positive impact in women employment, total per capita weekly expenditure and women’s non-land assets. Villagers’ attitude and other behaviors can be changed through credit programs.
(The Challenge of Poverty and Mapping out Solutions: Requisite Paradigm Shift from a Problem-Solving and Islamic Perspective Dr. Mohammad Omar Farooq)
M.A.Hamid (no date) found in his research that from 200 customers of Grameen Bank 46 were willing to join the Islamic bank of Bangladesh limited and one of the three main reasons was that this Islamic bank will provide services of microfinance within the limits of Islamic Shariah and Grameen Bank will not.
Microfinance has a very essential role to play in development according to proponents of microfinance. As per UNCDF (2004) studies microfinance plays three vital roles in improvement. First of all it helps needy people to fulfill their basic needs and protect against hazards and is also related with up gradation of household economic welfare and lastly it motivates women by their participation in economy and also encourage equality.
Results of a research on monitoring and evaluation of PKSF (Palli Karma-Sahayak Foundation) (2005) sponsored microfinance programs shows that absolute poverty decreased by 9% and moderate poverty reduced by 5% through 1997 to 2000.
Amin et al. (2003) in his study the Impact of microcredit on clients of Grameen Bank, BRAC and ASA concluded that Microcredit program was successful in reaching poor
Objective of microfinance according to Otero (1999) is not just about providing capital to the poor or fight against poverty on an individual level but it also has a responsibility on an institutional level. It seeks to create organizations that can provide their financial services to the poor, who are continuously ignored by the formal sector. According to Littlefield and Rosenberg (2004) study people that are below poverty line are not part of financial services sector of the economy so that’s why microfinance institutions have established to provide solution to these issues. MFIs become a major part of financial sector of country by providing these services to poor people and hence it can also access capital markets for the funding of their lending portfolios. (Otero, 1999)
The overall collision of microfinance can be analyzed on three things including level, type and its variable. Level defines its depth that on which level it has affected the target market whereas type of impact examines how it has benefited the people along with the impact variables as mentioned in fig. 2.
Impact of microfinance on household can be accessed on two levels household and community through its types by considering its different variables. It can be scrutinize through income, education, empowerment and other social things as well.
Level s of Impact
Types of Impact
Impact Variable
Economic Variables:
Income
Household Assets
Housing
Access to food
Human Capital:
Education
Health
Confidence
Skills
Empowerment
Social Capital:
Social Networks
Social Mobility
Household
Community
Social
Economic
Figure: 2 Impact of Microfinance in House hold and community level
Source: Eoin Wrenn, 2005
2.4 Challenges for Microfinance
The achievement in microfinance in the world has been impressive relative to the status in the 1970s. However, a number of major problems remain.
2.4.1Policy development environment for financial sectors programs
The policy environment for microfinance in many countries still remains unfavorable for sustainable growth in microfinance operations. For example, in countries such as People’s Republic of China, Thailand, and Viet Nam, the ceilings on interest rates limit the ability of MFIs to provide increased and continuing access to an increasing segment of the excluded households.
2.4.2Inadequate financial infrastructure
It is another major problem in the world. Financial infrastructure includes legal, information, and regulatory and supervisory systems for financial institutions and markets. Most governments have not focused to build financial infrastructure that supports, strengthens, and ensures the sustainability of such institutions or programs and promotes participation of private sector institutions in microfinance. The other major financial infrastructure-related problems include lack of:
A legal framework conducive for emergence and sustainable growth of small-scale financial institutions,
Regulatory and supervisory systems for microfinance in countries where the microfinance subsector is approaching a level of maturity, and
Emphasis on development of accounting and auditing practices and professions
2.4.3Limitation of retail level institutional capacity
Most retail level institutions do not have adequate capacity to expand the scope and outreach of services on a sustainable basis to most of the potential clients.
Lack capacity to leverage funds,
Are unable to provide a range of products and services compatible with the potential clients’ characteristics.
Do not have an adequate network.
(Source: Finance for Poor: Microfinance development Strategy, ADB website, 2000)
2.5 Islamic Microfinance
According to Mufti Muhammad Taqi Usmani( no date) , from years Muslims are trying to frame their style of living according to Islam that’s why they restrict themselves within the limits of Shari’ah which on the basis of Islam prohibits the practice of Riba or interest in any of the financial or trade activities.
According to Dr. Abbas Mirakhor, Executive Director of the IMF as referred by Chaudhri
(2006)
“An important function of Islamic finance that is seldom noted … is the ability of Islamic finance to provide the vehicle for financial and economic empowerment … to convert dead capital into income generating assets to financially and economically empower the poor…”
Islamic Microfinance is the way of financing to the underserved population without using the concept of interest. Microfinance is already more structurally aligned to applying Islamic equity financing structures. As microfinance programs are based on group sharing of risk and personal guarantee while maintenance of trust and honesty is tied to the availability of future funds.
2.5.1 Importance of Islamic Microfinance
In his famous book Wealth of Nations,
“Adam Smith argued that participation in religious sects could potentially convey two economic advantages to adherents. The first could be seen as a reputational signal while the poor might look alike to potential employers, lenders, and customers, membership in a specific group could convey a reduction in risk associated with the particular individual and ultimately improve the efficient allocation of resources. Second, religious groups could also provide for extra-legal means of establishing trust and sanctioning miscreants in intra group transactions, again reducing uncertainty and improving efficiency, especially where civil remedies for failure to uphold contracts were weak.”
(Case study: Islamic microfinance and socially responsible investment Anderson and Noland, 1988).
Islamic finance techniques could give thousands of entrepreneurial poor the access to microfinance an option they might not consider if traditional, interest-based commercial loans were offered. More experimentation and practice in the field should contribute to more knowledge and a better understanding of effective loan delivery mechanisms using Islamic banking principles (Muhammad Ramzan, 1996).
2.5.2 Islamic approach to poverty alleviation
All principles or laws in Islam owe their origin to its holy book – the Quran and the sayings and deeds of its Prophet (peace be upon him) encapsulated in books of Hadith. A saying of the Prophet (peace be upon him) forcefully drives home the central message of Islam regarding poverty: “Poverty is almost like disbelief in God.”. On another occasion, the Prophet (peace be upon him) is reported to have said “Allah! I seek refuge with you from the affliction of poverty…” (Soruce: Sahih Bukhari: read, study, search online Volume 8, Book 75, Number 379).
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Islam views poverty to be a curse to be eradicated through productive efforts. Poverty is in conflict with “enrichment of self (nafs)”, which is one of the primary objectives (maqasid) of Shariah. Islamic jurists have unanimously held the view that it is the collective obligation (fardkifayah) of a Muslim society to take care of the basic needs of the poor. (Obaidullah, Muhammed (2008)
2.5.2.1Charity
Charity occupies a central position in the Islamic scheme of poverty alleviation. The broad term for charity in Islam is Sadaqa. When compulsorily mandated on an eligible Muslim, Sadaqa is called Zakah. When Sadaqa results in flow of benefits that are expected to be stable and permanent (such as, through endowment of a physical property), it is called Sadaq-e-jariya or Waqf.
Establish Prayer and dispense the Purifying Alms (Zakat) and bow in worship with those who bow (Al-Quran, (2:43))
The research paper by Professor Habib Ahmed (no date) asserts that Zakah play an important role in eliminating poverty and a significant impact of Zakah can be seen if the macroeconomic policies are in the alignment with poverty reduction objective.
Zakah is the third among five pillars of Islam and payment of zakah is an obligation on the wealth and production of every Muslim. The primary issue with a zakah or sadaqa-based solution to the challenge of poverty is the issue of sustainability. Funds mobilized through these tools tend to fluctuate from time to time and may not lend themselves to careful planning and implementation. Further, these funds are meant mostly for the extremely poor and function as a safety net for meeting their immediate and basic needs. Benefits from waqf, assets are of course, meant to flow to the community at large and also on a sustainable basis (M U Chapra, 2008).It has been In FY 2009, approximately Rupees 150 billion were paid by people in Pakistan in charity, of which 90 percent was for the purpose of paying Zakat. (Dawn, September, 7, 2009)
According to Dr Mohammad Omar Farooq people when pay Zakah should be concerned with its impact on the society in the long or short term to get the solutions for poverty alleviation.
In another research conducted by Nafis Alam (no date) states in his study Islamic venture philanthropy: a tool for community development that Islamic charities are significant influential tool for sustainable community development.
2.5.3 Islamic Microfinance Products
Islamic approach to poverty alleviation is a composite of a mission based and market-based interventions. Islamic Microfinance need not be restricted to not-for-profit modes alone. Islam permits for-profit trade and creation of wealth. It depends on the customer that what he/she wants to do with the money either needs just security of the money against which he/she may not claim the profit or wants to invest the money and share both profit and loss.
The poor need a range of microfinance services, such as, micro-savings, micro-credit, micro-equity, micro-Takaful and micro-remittance. In the context of mainstream Islamic finance, people come across a host of for-profit modes through which such services may be provided to the poor. These could be used for microfinance with minor modifications wherever needed (Obaidullah, 2008).
Micro-Savings
Micro-savings is a critical financial service for poor and excluded households. Poor people want secure, convenient deposit services that allow for small balances and transactions and offer easy access to their funds. However, microfinance institutions across the globe tend to neglect this product while giving undue importance to micro-credit. The contract underlying a savings product must be free from elements of Riba and Gharar.
This constitutes one of the most well known Islamic products, consisting in “a cost-plus profit financing transaction in which a tangible asset is purchased by an Islamic institution at the request of its customer from a supplier. The Islamic institution then sells the asset to its customer on a deferred sale basis with a markup reflecting the institution’s profit
Various contractual options for designing savings products are: wadia, qard hasan and Mudarabah (Obaidullah, 2008).
Micro-Credit
The Islamic alternative to interest-based conventional loan is trade based or lease-based credit that permits the ownership and/or use of commodities or physical assets needed for productive ente
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