A Potential Model for Islamic Microfinance I: Introduction
I am embarking on a potential research program with established researchers in developing-country microfinance experiments (the research team of Dean Karlan). I am not sure if this research program will take off the ground (law enforcement logistics of doing anything in majority Muslim countries are often difficult). I gave a couple of presentations on the proposed structure, including in Abu Dhabi, hoping that somebody from ADIB would be there to give us feedback and possibly to facilitate the experimental study, but had no luck.
Part of my thinking was motivated by a senior thesis on which Mubeen Khumawala, a student at neighboring University of Houston, asked me to serve as external reader. I had known most of the details, but was struck by the sheer magnitudes:
- Approximately 528 million poor (below $2/day) Muslims in five countries: Indonesia, Bangladesh, Pakistan, Nigeria, and Egypt
- Approximately another 100 million poor Muslims in India
- Incredibly high degrees of financial exclusion of Muslims in OIC countries and India (67-80% of Muslims have minimal or no contact with the formal banking sector)
- A recent Consultative Group to Assist the Poor (CGAP) study by Karim, Tarazi and Reille (2008) reports results suggesting that large numbers of poor Muslims in various countries reject all forms of loans, including Grameen-style microloans, on religious grounds
- "Islamic microfinance" using the same ridiculous and insulting (sorry, I couldn't resist taking another shot at the nonsense that is marketed in the name of Islam) 1970s-style murabaha property flipping and other inefficient structures has failed miserably, keeping this subsector to 1% of overall microfinance even though Bangladesh, the epicenter of microfinance, is obviously mostly Muslim. Apparently, the poor illiterate Muslim majorities want something more than the cosmetic and expensive "Islamic" brand name
I have spent far too long arguing with highly-paid bankers, lawyers, and Islamic banking experts regarding the permissibility of conventional mortgages, and suggesting to their potential customers that their portrayal of Islamic jurisprudence is incoherent (e.g. what constitutes a loan as qard and what does not). With mostly illiterate poor populations, that is of course a lost cause, and the highly paid bankers, etc. have -- so far -- made it clear through their actions that they have no interest except for public relations purposes.
The structure that I proposed is a hybrid between the interest-free model of the Scandinavian JAK bank and the well known Rotating Savings and Credit Association (RoSCA) models that are popular in all Islamic societies (as well as non-Islamic developing countries). This model is known in the Egypt, where I grew up, and the rest of the Arab world as gam`iya (financial cooperative). It is a practice that the majority of traditional jurists, including the late Bin Baz have approved.
The need for a hybrid of the two interest-free models follows from shortcomings of each:
- The JAK model is very much focused on mortgage financing, where member loans are secured by the properties financed. (i) This makes it applicable, for example, as an alternative structure for North American or other countries' mortgage markets, but not for the microfinance sector. (ii) Also, the JAK model lacks the ability to utilize social capital through peer-monitoring, which is indigenous to RoSCA structures and successfully adapted by Dr. Yunus in his group-lending Grameen model.
- The RoSCA model suffers from (i) fragility, because one person's withdrawal would ruin the finance facility, (ii) symmetry of contributions to the pot, which makes it difficult for financing smaller consumer and larger business microloans simultaneously, (iii) does not have the flexibility to provide equity positions and/or return on savings for older/richer participants who do not need to receive the pot but would like to participate and receive a return, and (iv) is not conducive to growth and institutional development into bank or credit union structures.
I plan to summarize my proposed hybrid structure in the next posting.