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]
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
Middle East and North 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
(Below Poverty line)
(Above poverty line)
• 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
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
International knowledge transfer Technical assistance from international development organizations
Improved leasing laws
Sukuk laws in G20 and EMDCs
Increasing funding sources
Increasing funding to serve larger base of SMEs
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
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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