Sharia and Savings: Islamic Microfinance

> Posted by Allison Ehrich Bernstein, Executive Communications Specialist, Accion

Of the 2.7 billion people living in poverty around the world, an estimated 650 million of them are Muslims living on less than $2 a day. But in countries with significant Muslim populations like Afghanistan, Jordan, and Sri Lanka, microfinance institutions have to position themselves relative to Sharia doctrine, which outlaws accepting interest or fees. As such, banks act as investors rather than creditors. This arrangement shares the risk but results in institutions’ having a harder time guaranteeing returns, making attracting investors and sustaining operations difficult.

That challenge has given rise to an Islamic microfinance sector, an offshoot of mainstream Islamic finance, which marries financial services and inclusion with Sharia-compliant operations and policies. The sector now boasts an estimated 1.28 million clients (up from about 380,000 in 2007), but adapting traditional microfinance products for Muslim markets has proven challenging: Practitioners continue to struggle with establishing models that are diverse and financially sustainable.

A recent CGAP survey identified three main hurdles to the expansion and viability of Islamic microfinance, which highlight both the challenge this sector faces as well as a preview of where it may be headed:

  1. We need to better understand demand for Islamic microfinance products, in terms of both what products will be used and how best to offer them to Muslim clients. CGAP and others have noted gaps between what microfinance clients say they want and what they actually use. Additionally, most institutions can only offer a couple of products and lack evidence on how to adapt traditional Islamic finance models for a different scale and client base.
  2. We need to better understand what viable Islamic microfinance business models look like. As Michael Tarazi, one of the CGAP survey authors, noted in a recent web chat, “At the end of the day, what you or I or banks or MFIs or regulators think is authentic is irrelevant – our target clientele has to believe the product is Sharia compliant. Who or what they look to for an answer to this question no doubt changes by region or perhaps even education level.”
  3. We need to create a stronger market infrastructure to measure performance and better assess how different products are faring and what impact we have on our clients. In the same web chat, survey co-author Mayada El-Zoghbi noted that the CGAP report aimed to address this problem – and even then, the report notes low response rates and certain institutions and locations where no data is available at all.

There are other challenges at hand, too – for example, market penetration in sub-Saharan Africa and other underserved regions has been slow. In general, Islamic microfinance has scaled up at slower rates than its mainstream counterpart, even in countries with an established presence. In fact, about 82 percent of Islamic microfinance clients live in just three countries (Bangladesh, Indonesia, and Sudan).

The relative lower Muslim populations in sub-Saharan Africa, for instance, make expansion less of a priority; currently, just four of the 255 financial service providers offering Sharia-compliant microfinance products are in that region. Unfortunately, this CGAP report had poor response rates from Africa, meaning interested practitioners know less than they might about the potential of these markets. With better infrastructure – not only for generating data but also for knowledge-sharing and capacity-building – practitioners can scale up pilot programs and reach new (and growing) populations.

Sudan is an interesting and exciting exception to this trend, with 400,000 clients to date versus just 9,500 in 2006. CGAP, however, credits its impressive reach to the national government’s push to provide financial services and to laws requiring all domestic financial products to comply with Sharia – steps many countries with small Muslim populations are less likely to take.

Overall, the Islamic microfinance sector is operating effectively, with a nearly four-fold increase in clients since 2007, and bursting with potential – but we need to channel the momentum we see into a sector that more comprehensively serves more clients in more places. With a better understanding of both the people and the numbers at the heart of Islamic microfinance, we can truly expand financial inclusion to religious Muslims at the base of the pyramid.

Image credit: IFAD/Asad Zaidi

Have you read?

Islamic Microfinance, the Poorest of the Poor, and More – Top Picks of the Microfinance Blogosphere – April 13, 2011

Brazil, Islamic Microfinance, Industry Debates: Top Picks of the Microfinance Blogosphere – February 28, 2011

Continuing the Conversation on Inclusion in the Arab World