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Islamic Microfinance: Emerging industry, Emerging opportunities

The Consultative Group Against Poverty (CGAP), a World Bank initiative, estimates that roughly 72% of individuals in Muslim-majority countries are not using formal financial services. There are approximately 650 million Muslims that live on less than $2 per day. The potential for microfinance in this market segment is self-evident.

However, there are three responses which have emerged in the Muslim world in response to conventional, Western finance:

1) Acceptance of conventional finance

2) Preference for Shariah-compliant finance, with conventional finance as a second choice
3) Exclusive preference for Shariah-compliant finance products

Demand for and reach of Islamic microfinance

These preferences obviously vary considerably from country to country. For example, individuals who are in the third group comprise more than one third of the market in Yemen, but in Bangladesh are less than one third. Overall in the Muslim world, roughly two thirds of the individuals using microfinance products insist or prefer them to be based on Islamic financing. Similarly, although traditional microfinance has reached and impacted people in Muslim countries such as Indonesia and Bangladesh, there are still communities that reject these products because they do not comply with Islamic principles.
This is not to say that everyone who lives in Muslim countries is seeking Islamic microfinance, but rather that it is an emerging alternative. According to CGAP,  roughly 80% of the 380,000 Islamic microfinance clients worldwide are concentrated in Bangladesh, Indonesia, and Afghanistan. If we compare the reach of microfinance institutions in the Arab world, the Shariah-compliant services only reach 2,000-7,000 individuals whereas conventional microfinance reaches tens and hundreds of thousands.

How does Islamic microfinance work?

There are several different tenets that comprise Islamic finance. One is the prohibition of interest, which can make it impossible to use traditional microloan models. Murabaha (cost plus markup) is a debt-financing instrument and is similar to conventional microfinance. Another encourages the creation of wealth through equity investment in business activities. However, this requires that financial service providers share in risk and does not guarantee any returns.

What’s Next?

To begin taking Islamic microfinance to scale, the Islamic Microfinance Challenge was developed as a collaboration by CGAP, Deutsche Bank, Islamic Development Bank, and Grameen-Jameel. The goal was to scan the industry and gather ideas for business models that were sustainable, scalable, and compliant with Islamic principles. This developed a considerable amount of interest and response, as they received 130 applications from academics, consultants, multi-sectoral NGOs, and Islamic or conventional microfinance institutions in 43 countries. The winner of the 2010 challenge, Yemen’s Al-Amal Microfinance Bank, became the first microfinance bank to offer Shariah-compliant products in the Arab World. The second challenge was held a few months ago and was co-sponsored by Triple Jump. Pakistan’s Wasil Foundation was awarded the $100,000 grant for their products that are aimed at smallholder farmers.

For now Islamic microfinance is niche, currently serving a relatively small number of Muslims, many of whom are concentrated in three countries. However, it is clearly an option which can appeal to the 72% of individuals in Muslim countries not using formal financial services. This can help the poor searching for Shariah-compliant products and provide them with access to finance to improve their livelihoods. This growing sub-sector definitely is worth the attention and involvement of social financiers here in Canada, as well as further research and development.

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