Turning to Islamic Finance for Meeting Development Goals – II

The DEEP project was a trailblazer in many ways. The program was initiated at a time and in a region where two-third of population (according to World Bank estimates) was below the poverty line and not a single MFI was operating on a sustainable basis. With (a) the delivery of financial and promotional safety net interventions; (b) capacity building of intermediary organizations in offering financial services; and (c) development of program management unit into a sustainable organization as its major components, the program set a new trend in convergence of humanitarian and development finance.

The program was the first of its kind to document the preference of clients for Islamic over conventional microfinance and to incorporate this learning into program design. In an elaborate demand assessment exercise, it was estimated that the 150,000-odd micro enterprises in Palestine required about US$200 million as capital. At least one- third of this demand required borrowing in accordance with Islamic principles and an additional one-third of potential demand would prefer to borrow on Islamic terms if given the chance.

The DEEP program was distinct from many early birds – micro-credit based programs – that were trying hard to replicate the Grameen model by combining the lending technology of Grameen (group-based lending) with an “Islamic” micro-credit product, such as, a qard with service charge (sometimes deducted upfront!) or a murabaha/ bai-muajjal. During one of my field visits to a known Islamic microfinance project in Bangladesh that had started replicating Grameen almost a decade earlier, I had the privilege of observing how bai-muajjal based micro-credit was being provided at village centers. I learnt that a large of chunk the project staff had some kind of a “Grameen” background. At the same time, there was a distinct Islamic touch to the environment with centers being named after Islamic personalities. Some of the women were appearing in purdah. Before commencement of finance business, a leader would read out pages from a book that was about Islamic way of living. The staff with years of Grameen experience were now trying to swap a simple interest-based loan with a bai-muajjal financing. This Islamic financing was certainly cheaper. The profit rate charged was almost half of the interest rate on similar Grameen loans repayable in a year in forty equal installments. This was remarkable. This was made possible through partial absorption of operational and administrative costs by generous CSR funds donated by the parent Islamic bank. This was a significant advantage, making it more affordable to the clients, though not quite in tune with the prevalent market wisdom (it is “access” to credit and not the “cost” of credit that matters for the poor). However, the lending methodology had to be equally convenient, time-tested, and as simple as Grameen’s. In a Grameen loan, the loan amount was uniform. For example, if X amount of taka was given as loan the client had to repay X+Y amount of taka in given number of installments back to Grameen. A field officer on average, would serve around four hundred clients over five working days in a week, visiting them at the village center on a motorbike, disbursing loans and accepting deposits and then connecting to the head office on the sixth day. In case of our Islamic replicator, however, it was extremely difficult to operate with the same degree of efficiency. Our field officer (I was told the number of clients served by each per day was around 250) now had to deal with around 50 bai-muajjal transactions per day – buying the required commodity from the vendor and reselling the same to the client at a profit. And this had to be done in a sequence – the sale to the client had to follow the purchase from the vendor in two separate transactions. Commodities financed would naturally be of multiple types – livestock, merchandize, agricultural-inputs – and would command different prices. This would in turn, make the loan amount/ installments different for each client even while profit rate was same for all. The task was practically impossible. The outcome was frustrating. It was perhaps the same old wine in a new bottle – X amount of taka being provided to the client for X+Y amount of taka later in a given number of installments – and was therefore, non-halal.

It did not mean that the task could not be attempted in a different, yet Shariah-compliant manner. The bai-istijrar contract in Shariah was available for use for precisely the situation at hand. It could be used in case of repeated transactions from a single vendor. It provided flexibility in the settlement of the transactions that would now be bundled and settled periodically at pre-agreed or prevailing or normal price. The practical difficulty with Grameen replication indeed had a solution in the form of bai-istijrar, even though this did not find acceptance by Islamic microfinance professionals of the day. It was hard to see, why.

The bai-muajjal or murabaha based financings did not quite excite the market, notwithstanding its early start in mid-Nineties. There was so little difference between them and the conventional credit, which was further blurred in the context of rural settings and sheer frequency of repetitive transactions. It was widely believed that the Islamic replication of Grameen, though possible, was not going to be easy. It was being attempted only at the cost of diluting the Shariah-compliance dimension.

Bangladesh, called by many as the university of microfinance, had something more to offer. The runners-up in the race to corner a share of the microfinance pie was undoubtedly the Bangladesh Rural Advancement Committee, later known by its acronym only, as BRAC. Though it was an interest-based operation like Grameen, its model included provision of non-financial services as well. As a more comprehensive finance-plus model with a significant hand-holding component targeted at poverty reduction, it enjoyed growing traction from Islamic MF stakeholders, including the Islamic Development Bank (IsDB). BRAC, unlike Grameen was less rigid about interest rate playing a central role in its operations and agreed to provide leadership and guidance to an Islamic MF Bank in Sudan called Bank-al-Usrah or the Family Bank. It was the year 2008.[1] Backed by technical assistance from IsDB, this newly born Islamic MF Bank received hand-holding support from a successful developer institution like BRAC. It was perhaps another first in the list of pioneering poverty alleviation initiatives – a successful amalgamation of Islamic commercial banking with pro-poor development finance. (To be continued)

[1] BRAC founder Fazle Hasan Abed, was knighted two years later for his pioneering model of poverty reduction, which looked beyond micro-credit.

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