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Islamic microfinance: An emerging market niche

Published on 21st Nov, Edition 47, 2016


Islamic microfinance represents the confluence of two rapidly growing industries: microfinance and Islamic finance. It has the potential to not only respond to unmet demand but also to combine the Islamic social principle of caring for the less fortunate with microfinance’s power to provide financial access to the poor. Unlocking this potential could be the key to providing financial access to millions of Muslim poor who currently reject microfinance products that do not comply with Islamic law. Islamic microfinance is still in its infancy, and business models are just emerging but it is meant to provide certain sections of the society with an opportunity for financial inclusion that otherwise stay out of it on religious grounds.

High unemployment, poverty, and low levels of financial access in Muslim countries continue to create high demand for microfinance. While conventional microfinance has successfully reached large numbers of poor in Muslim countries (most notably, Bangladesh and Indonesia), there is evidence to suggest that there are many potential clients of microfinance that categorically reject products that do not comply with Islamic principles. Approximately 44 percent conventional microfinance clients worldwide reside in Muslim countries so by giving the right vision of Islamic microfinance to them we can attract large number of donors from all over the world. Muslims and non Muslims alike could take the edge from the Islamic microfinance for the social sustainability worldwide.

Broadly speaking, the market for microfinance in the Muslim world can be divided into three segments: 1) individuals who will accept conventional finance products; 2) individuals who state a clear preference for Shariah-compliant finance but — due to unavailability or price differentials — accept conventional finance, and finally, 3) individuals who only use Shariah-compliant products.

The ratios of these groups fluctuate by region. Overall, it is estimated that roughly 2/3 of the microfinance market in the Muslim world either insists on, or prefers Islamic financing.

While Islamic finance is a growing industry with more than 1,000 Islamic finance institutions and combined assets in excess of $1.8 trillion, the development of Shariah-compliant microfinance has been much less prolific. During last decade, the number of service providers offering Shariah-compliant microfinance products has doubled, albeit from a very small base, and the number of clients using such products has quadrupled. Nonetheless, customers of Shariah-compliant microfinance products represent less than 1 percent of the number of clients served by conventional microfinance. The high costs of providing Shariah-compliant products, particularly profit-and-loss sharing products such as musharaka or mudaraba, are often blamed for the lack of product diversity and customer take-up.

Islamic finance instruments could be categorized into two main categories:

1) Debt like financing (non profit and lost sharing) such as: Murabaha (cost plus mark up), Ijara waqtina’ (leasing), bai’ salam (forward contracts) and bai’ mua’jjal (spot sale), etc.

2) Investment Financing (profit and lost sharing) such as: Mudaraba (Trustee Financing), Musharaka (Equity Participation), Musaqat (Orchard Financing), Muzar’ah (Share of Harvest) and Direct Investment.

So far, the focus for Islamic microfinance practitioners has been on debt financing instruments that closely resemble conventional microfinance. The most widely offered Shariah-compliant contract is Murabaha (cost plus markup sale contract) and Qard-e-Hassan. Outreach is also low for trade-based products, such as salam.


Salam contracts reflect Islamic principles because they are investing in a productive activity, and the funder is taking a risk in the business. Salam products are particularly relevant for the rural poor, one of the largest segments of the unserved. Salam is essentially a sales contract with deferred delivery of goods often used in agriculture as advance payment against future delivery of a crop yield, allowing farmers to finance the advance purchase of inputs to be used in crop production. The type of crop, amount, and delivery date of the expected crop yield is agreed to in advance.

The question that arises is: Why hasn’t microfinance succeeded in reaching as many clients as conventional microfinance?

Although there is ample evidence of demand for Islamic microfinance products, this demand can only be met if low-income clients are convinced that the products offered are authentically Islamic. Critics of Islamic finance products suggest that the pricing of some products offered as Shariah-compliant too closely parallels (or even exceeds) the pricing of conventional products. For example, some institutions offering Murabaha seem to disguise interest as a cost markup or administration fee.

Pakistan’s experience so far…

While Islamic microfinance’s reach has increased considerably over the past few years, provision of Shariah-compliant products is still in its early stage, in Pakistan and globally. At the same time, the overall demand for Islamic microfinance products seems to be growing rapidly, and Pakistan is set to be one of the most promising markets.

Based on the current state of Islamic microfinance in Pakistan, there is huge potential for these providers to expand outreach in this niche market. This can be achieved by focusing on diversification in the range of products offered (going beyond credit products) as well as expanding geographic outreach, which is currently heavily concentrated in the province of Punjab.

Islamic microfinance offers an alternative paradigm for millions of poor people who are currently not served by conventional microfinance. In order to provide access to sustainable services on scale, it is imperative for the industry to adopt innovative and sound practices and prove that these models work. To this end, the industry requires deeper market research and a comprehensive initiative to build the capacity of players in the micro and macro levels, in order to help in developing and implementing appropriate business models.

Need of the hour is that all stakeholders of Islamic finance industry seek to engage with the broader microfinance and Islamic finance communities to find new ways to foster development and support this sector going forward. Given that the group of 2.5 billion unbanked includes a vast number of Muslims, expanding the availability of affordable and sustainable Shariah-compliant services can prove to be transformative for microfinance.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan


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