An Innovative Islamic Microfinance Institution
In the paper titled “Leveraging Philanthropy: Monetary Waqf for Microfinance” Dr Muhammad Anas Zarka comes up with some interesting and innovative suggestions for designing an Islamic microfinance institution. Some of the key points he underlined in the initial pages of his paper include:
- Philanthropy-driven and not-for-profit funds are scarce. Use of such funds should be optimised.
- It is possible to configure a combination of zakat, sadaqah, waqf and qard-hasan that eliminates transaction costs of microfinance.
- An Islamic MFI can take the form of a monetary waqf or cash waqf based organization. The use of temporary cash waqf as the basis optimizes mobilisation by permiting large numbers to make small donations.
- Additionally, the Waqf-MFI sources its funds from (1) simple donations of sadaqah and zakah and (2) qard-al-hasan deposits similar to demand deposits for mainstream banks. Dr Zarka attributes this novel idea of funding a Waqf through demand deposits to his discussions with the well-known Islamic economist Dr Mohammed El-Gary.
Leveraging Funds through Guarantees
The innovation that Dr Zarka suggests is essentially about leveraging scare funds where guarantees replace actual fund-based lending. His model has actors called guarantors of liquidity for the Waqf. Such a guarantor promises and commits to lend the Waqf a certain sum of money as qard-al-hasan if and when the Waqf needs liquidity to honor withdrawals of existing qard-al-hasan depositors. These guarantees effectively replace the idea of “reserves” that is maintained by banks to guard against the risk of withdrawals.
To my mind, the most interesting and significant innovation that Dr Zarka’s paper throws up relates to the use of zakat funds as guarantee against losses.
Dr Zarka stresses upon the point that zakat funds must be given as one-way transfers and cannot take the form of a loan. In a way, Shariah rules out creating a lending portfolio funded through zakat funds. At the same time, Shariah prescribes gharimun as one of the eight eligible recipient (mustahiq) categories of zakat. Zakat funds can be given to a microfinance beneficiary who has turned into a gharim or an indebted individual. Dr Zarka’s model has actors called guarantors against losses due to defaults by the beneficiaries of microfinance who come forward with their zakat contributions to cover the risk of defaults and delinquencies.
How does leverage work here?
For example, you need USD100 to be able to give a loan of USD100 to a microfinance beneficiary. However, you need just USD5 to cover a loan of USD100 (insure against losses or provide a guarantee against default) if the expected default rate is capped at 5 percent. In other words, with USD100, you are in a position to cover a loan portfolio of USD2000 that is 20 times larger. Indeed, the use of group or social collateral based lending methodologies (due credit should be given to Grameen for introducing this winning idea) has brought down the actual loan defaults to less than 5 percent for many MFIs. It is claimed to be less than 1 percent for Akhuwat, for example, in which case you can cover a loan portfolio 100 times large with your X dollars.
Has there been any real-life application of this interesting model?
As project leader for Islamic Social Finance Report (2015) I had the privilege to visit a few Islamic microfinance experiments in Sudan including the IRADA Microfinance project by Bank of Khartoum. IRADA was given the mandate to implement the SDG 200 million Al-Aman Fund for Microfinance. The Fund was formed by a strategic partnership between the Diwan Zakah (apex body of zakah management in Sudan) and 32 Sudanese Commercial Banks. The Fund provided a guarantee to the microfinance portfolio against “genuine” defaults by clients at a higher level. At the first or base level, the default is covered by individual personal guarantor(s) brought in by the client (See Page 148 Section 5.4.3 of ISFR 2015 for more details on IRADA).
The emergence of new technologies have thrown up new possibilities. It is now possible to design and develop an Islamic microfinance platform along the above lines that will be much more efficient in terms of bringing down transaction costs and mitigating risks by employing blockchain technology and smart contracts. IBF Net with its mission to create a miniature Islamic economy on the blockchain invites interested parties as partners/investors to support a project of this nature.
“Leveraging Philanthropy: Monetary Waqf for Microfinance” in Shariah-Compliant Microfinance, edited by S. Nazim Ali, Routledge (2012)