Leveraging Islamic Finance

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Medina, Saudi Arabia. May 4-5, 2016. Zamir Iqbal, PhD. The World Bank Global Islamic Finance Development Center. Istanbu
Leveraging Islamic Finance Micro-, Small-, and Medium Enterprises (MSMEs)

AAOIFI International Conference Medina, Saudi Arabia May 4-5, 2016

Zamir Iqbal, PhD. The World Bank Global Islamic Finance Development Center Istanbul, Turkey [email protected]

Road Map


Why Financial Inclusion is Important?


SME Financing: State of OIC Countries


Islamic Finance and SMEs


Challenges & Recommendations


I. Why Financial Inclusion is Important?


2014: 25 Focus Countries: 73% of the world’s unbanked Out of 73% of the world’s unbanked, 22.2% are Muslim countries. Countries prioritized based on share of unbanked, IDA, and FCS: 2014 FINDEX

Sources: Global Findex 2014

Universal Financial Access (UFA) 2020 Goal By 2020, adults globally have access to an account or electronic instrument to store money, send and receive payments as the basic building block to manage their financial lives

Why it matters  

Strong link to Twin Goals: poverty reduction and income effects Enabler for WBG and country development goals

II. SME Financing: State of OIC Countries


Employment Contribution of SMEs Total Number of SMEs (million)

Formal SMEs (million)

Total Credit Gap*

Europe and Central Asia




East Asia and Pacific




South Asia




Middle East and North Africa




Sub-Sharan Africa




Latin America and Caribbean









*Includes both of underserved and unserved SMEs Source: (Stein, et al., 2013)

SMEs employ the largest number of people in aggregate and are responsible for 57.8% of total new jobs created at the global level.

There are around 400 million SMEs in the developing world, in which only 26 million is formal.

SMEs have considerably high level of credit gap, which can be defined as the supply and demand difference in accessing bank credit for SMEs.

Main obstacles affecting current operations and growth

 The main obstacles affecting the growth of SMEs in the OIC region are  access to finance  political instability  Large firms in OIC countries enjoy a greater freedom in obtaining credit. 8

Obstacles in obtaining loans

 For SMEs in the OIC region the main obstacles in obtaining loans are  Lack of appropriate collateral  Interest rates

Note: Sampling weights are employed. Spatial decomposition of the OIC countries in the right graph is as follows: Sub-Saharan Africa (SAFR): Benin, Burkina Faso, Cameroon, Chad, Côte d'Ivoire, Gabon, Gambia, Guinea, Guinea Bissau, Mali, Mauritania, Mozambique, Niger, Nigeria, Senegal, Sierra Leone, South Sudan, Togo, Uganda. East Asia and Pacific (EPAC): Indonesia; East Europe and Central Asia (ECCA): Albania, Azerbaijan, Bosnia and Herzegovina, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkey, Uzbekistan; North Africa (NAFR): Djibouti, Egypt, Morocco, Tunisia; Middle East (MEAS): Iraq, Jordan, Lebanon, Yemen; South Asia (SASI): Afghanistan, Bangladesh, Pakistan.


Sources of Fixed Asset Financing for SMEs Regional Decomposition

Income Level Decomposition

High dependence on retailed earnings/internal funds.

Bank loans are the dominant form of external funding for fixed asset purchases.

Why low penetration of SME financing? Demand side factors

Supply side factors

• High interest rates

• Unavailability of reliable credit history

• High collateral requirements • Weak management • Cumbersome processes • Lack of financial documentation • Lack of customized processes • Conservative lending approach • Financial literacy • High NPLs

• Religious belief  The SME penetration within he total lending is still at very low levels despite the remarkable increase in Islamic banking assets. For example, penetration in Pakistan, Egypt, Jordan, Yemen, and Morocco is 7.3%, 8.0%, 12.5%, 20.3%, and 24.0% respectively.

III. Islamic Finance and SMEs


Islamic Perspective on Financial Inclusion 

Economic development and growth, along with social justice, are the foundational elements of an Islamic economic system. From Islam’s Property Rights view, property is not a means of exclusion but inclusion in which the rights of those less able in the income and wealth of the more able are redeemed. Two Pillars of Financial Inclusion Risk-Sharing, or Asset-Linked Financing • Small-Medium Enterprises (SME) • Micro-Finance (MF) • Micro-Insurance (Micro-Takaful)

Redistributive Institutions • • • • • •

Zakah Sadaqat Qard-al-Hassan Waqf Khairat Khumus

Structured Approach to Enhancing Financial Inclusion

Extreme Poverty


(Below Poverty line)

(Above poverty line)

Redistributive Pillar

Redistributive Pillar

• Zakah, • Sadaqat • Waqf, • Khairat, • Khumus

Risk-Sharing Pillar • Collective risk-sharing through collective support during crisis.

• Qard-al-Hassan, • Zakah, • Waqf

Risk-Sharing Pillar • Micro-Finance (Murabaha, Musharakah) • Micro-Takaful

Low-Income Redistributive Pillar • Hybrid Solutions (Applications with marketbased solutions)

Risk-Sharing Pillar • Micro-Small-Medium Enterprises (MSME)

Islamic finance has certain features which give it the potential to effectively support SME financing, and economic growth and development

Participatory and risk-sharing financing Emphasis on materiality (asset-based) Real Sector Financing Entrepreneurship

Notion of Economic and Social Justice

IV. Challenges and Recommendations


Policy Considerations I – Institutionalization of Islamic Redistributive Instruments

Zakah, Waqf, and Qard-al-Hassan could play a catalyst in enhancing access to finance. Proper institutional framework and governance is essential. Integrate these institutions with the rest of the economic and financial system.

II – Need for Developing Supportive Regulatory and Supervisory Framework Public policy and strengthened institutional framework in developing countries can go a long way in enhancing financial inclusion. Development of economic institutions and improving financial infrastructure, should be the priority item in the policy agenda of Muslim countries. III - Ensure a Level Playing Field for Islamic Microfinance, SME, and Micro Takaful.

Policy Considerations (cont’d) IV -- Strengthen Financial Infrastructure for Financial Inclusion – Core components of the financial infrastructure such as credit information, investors’ rights, insolvency regimes, etc. are essential irrespective of type of financing, i.e. conventional or Islamic V - Financial Engineering – Consider developing hybrid solutions, through integrating different modes, i.e. Qard-al-Hassan and Waqf or Qard-al-Hassan and Zakat or other combinations. – Apply financial engineering to develop market-based solutions such as securitization with embedded redistributive instruments.

Key Challenges faced by SMEs…  Lack of adequate funding is a key challenge for SMEs at every stage of their evolution especially during inceptions and development stages Inception Stage • Lack of Initial Capital for Setting up the business • Bureaucratic processes when formally registering the business • Lack of well-trained labor force • Unstable political environment Development Stage • Lack of funds to expand the business • Lack of enough business skills • Insufficient infrastructure • Lack of well-trained labor force • Weak business environment and corruption

Maturity Stage • Insufficient demand conditions • Unstable political environment • Insufficient infrastructure • Threats from informal sector • Lack of intra-industry partnerships

19 Source: Islamic Banking Opportunities across Small and Medium Enterprises in MENA, IFC, 2014

Key Recommendations to enable Islamic Finance for SMEs

Increase product offerings Support standardization

Reduce transaction costs and taxes Improve use of movable collaterals Increase information sharing Improve capabilities of human resources and Islamic finance literacy Improve branding

Key Recommendations..

1: Increase Product Offerings Practical education, especially in risk management for equity-based financing

Risk mitigation techniques and systems for equity-based financing

Study tours and knowledge exchange

Supporting the establishment of nonbanking financial services

2: Support Standardizat ion of Contracts Adaptation of standards by central banks and Security Commissions and authorities responsible for nonbanking financial services

Criteria for the formation of Shari’ah boards and granting credentials to Shari’ah scholars

Centralizing Shari’ah boards and the issuance of guidelines (as done by the Malaysian Securities Commission).

3: Reduce Transaction Costs and Taxes

4: Use of Movable Collateral

Increased standardization and information-sharing will reduce costs

Legal framework for secured transactions, including movable assets

Further standardization of Islamic law practices in finance

Reliable collateral registries

Knowledge hub for standard Islamic financial documentation

Claim enforcement mechanisms

Taxation frameworks and laws that allow for the tax neutralization of Islamic financial instruments.

Capacity building and training on processes and systems.

5: Improve Islamic Finance Literacy

Multilingual Islamic finance education platform

Training and workshops for staff members of financial institutions who interact with clients.

Key Recommendations for Nonbank Financing Channels for SMEs

Credit guarantees

International knowledge transfer Technical assistance from international development organizations


Improved leasing laws

Capital Markets

Sukuk laws in G20 and EMDCs

Increasing funding sources

Increasing funding to serve larger base of SMEs

Venture capital

Angel investments/ Crowdfunding

Laws for Special Purpose Vehicles (SPVs)

Tax incentives for angel and crowd investors

Reducing capital gain taxation

Digital payments and company structuring

Enforceability of shareholder agreements

Crowdfunding regulation

Increase in government venture capital venture capital funds and programs

Cross-border capital transfer

Further standardization of Islamic law practices in finance Technical assistance, especially in Islamic leasing

Enforcement of laws

Human resources development

Human resources development

Incentives for SME stock exchanges


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