Designing Products for

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Designing Products for Islamic Microfinance
Ahmed Ali Siddiqui Executive Vice President
Product Development Shariah Compliance Meezan
Bank Limited July 21, 2009
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• Islamic Product Development
• Product Design for Microfinance
• Target Market
• Compatibility with Islamic Finance
• Modes for Islamic Microfinance
• Model for Islamic Microfinance Banks
• Possible options for Micro-Business
• Road Map for Islamic banks
• The Way Forward

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• Importance
• New Product Development Research is an
  important area in which all Islamic Banks need to
  focus.
• To make Islamic banking as a alternative banking
  system, it is necessary to develop products in a
  manner in which they are not only Shariah
  complaint but also practical and marketable.
• It enables Islamic bank to satisfy customers
  needs, and compete in today's competitive
  financial services environment.

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• All transactions are generally asset-based
• It is socially-responsible banking because it
  operates under Shariah restrictions
• Does not permit financing of prohibited goods /
  Industries
• Ethics and moral values play a major role in
  investment decisions. Not a choice but a must

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Product Development Basic Permissibility
Prohibition
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• The Holy Quran
• The Sunnah of the Holy Prophet (SAW)
• Ijma (consensus of the Ummah)
• Qiyas (Anology)

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• Three Prohibited Transaction
• Riba
• Riba Al Naseah
• Riba Al Fadhl
• Maysir
• Gharar
• Al Jahalah, Bai Qablal Qubz etc.

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And Allah has permitted trading and forbidden
Riba (Al Baqara 275)
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Basic Difference between Islamic and Conventional
Modes of Finance
Conventional
money
Bank
Client
money money (interest)
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Basic Difference between Islamic and Conventional
Modes of Finance
Islamic
Bank
Client
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• Product Development for Islamic banks
• Need Identification
• Selection of mode / modes
• Concept Paper Refinements
• Approval of Concept paper by Shariah, legal,
  business
• Detail Product Program
• Legal Documentation
• Final Approval
• Soft Launch
• Full Launch
• Refinement / Improvement

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• Deciding Factors
• Market Survey
• Shariah Compliance Mode, Nature of assets
  involved, Process, Documentation
• Risk profile Depositors
• Cash flow Assets side
• Possibility of managing mismatch- Liquidity Vs.
  Profitability
• Risk mitigation measures
• Legal matters
• Regulatory aspects, SBP / SECP In vogue, Seeking
  changes through effective case presentation

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AAOIFI Shariah Accounting StandardsPractice
by Other Islamic banks locally abroadFocus
Research / Discussions with customerInputs from
Shariah ExpertsPrevious Ruling by different
Shariah Boards
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Product Design for Islamic Microfinance Finance
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• The potential target market of Microfinance is
  the population below the poverty line who are
  willing to work themselves out of the poverty
  vicious cycle.
• Also includes the population in Transitory
  Non-poor and Transitory Vulnerable categories.
• The Transitory Non poor have a tendency to move
  above and below the poverty line.
• Transitory vulnerable are transitory non-poor
  that have high probability of getting poor.
• Poor People or the Poverty Line is defined as
  person or household whose annual income is less
  than US 2 per day

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• Need Compatibility
• For Muslim majority country great need for
  Islamic MF exist and large target segment is
  averse to the interest based microfinance
  products.
• Both MF IF emphasize ethical, moral social
  factors to promote equality and fairness for the
  good of the society.
• Risk Sharing, individual duties, property rights
  and sanctity of contracts are part and parcel of
  Islamic code of finance.
• Both advocate entrepreneurship, risk sharing,
  partnership finance and participation of poor in
  economic activity.

MECHANICS
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• 80 of Islamic Microfinance is concentrated in
  Indonesia, Bangladesh and Afghanistan.
• Approximately 44 conventional microfinance
  clients worldwide reside in Muslim countries
  (Source MF Info Ex).
• Different studies have revealed that in countries
  like Syria, Jordan, Yemen, Algeria, Gaza 24 -
  60 responded showed preference for Islamic
  financial products.

MECHANICS
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• General Characteristics of Microfinance Products
• Normally MF products are not backed by physical
  collateral they usually mitigate risk by use of
  social collateral PGs.
• Repayments are kept small and in frequent
  installments (weekly/monthly), which makes it
  easier for the client.
• Financing is done for production purpose rather
  then consumption.
• Financing is usually made to members of a group
  and peer pressure from group members is used to
  ensure repayment.
• Recovery rates are generally higher around 95,
  which reflects that the poor are not un-bankable,
  as considered by the conventional banks.

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Key State Holders - Microfinance Customers-
Islamic Microfinance Provider - Fund Providers
/ Investors- NGOs and Government Agencies-
Regulators - MF Linkage Partners
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Modes for Islamic Microfinance
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• Product options for Islamic Microfinance
• Murabaha Financing
• Ijarah Financing
• Bai Salam Financing
• Qard-e-Hasana
• Zakah
• Mirco Takaful
• Working thru linkages Wakalah / Musharakah and
  Mudarabah
• New Innovative Concepts

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• Murabaha Financing
• Murabaha is the sale of goods on cost plus profit
  basis.
• Islamic Microfinance Bank (IsMFB) can purchase
  the required goods from market then sells the
  goods on credit to the client for a known profit.
  
• Application
• Purchase of raw material, live stocks, goods for
  cottage industry, agricultural products, PCOs etc
  

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• Ijarah Financing
• Ijarah is an Islamic alternative for leasing
• As per the concept of Islamic Micro Leasing, an
  IsMFB can lease certain fixed assets to
  individual microfinance customers.
• The assets would be purchased by IsMFB either
  directly or through the agency agreements with
  the customer
• The asset would remain in the ownership and risk
  of IsMFB through out the lease period
• Application
• Include agri machinery,farming tools, small
  shops, carts, transport other related
  equipments.

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• Bai Salam Financing
• A type of Sale with spot payment and delivery at
  a deferred date
• Mainly used for agriculture outputs.
• Application
• Islamic bank could purchase agricultural
  products like rice, wheat, pulses, etc from small
  farmers to be delivered after a specified period
  on a future date against full payment of the
  selling price at spot.

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• Qard e Hasana
• Islamic banks/MFIs can utilize charity funds for
  providing Qard-e-Hasana to MF clients
• A special trust or fund could be established
• Applications
• Small cash loan at zero percent could be given
  as Qard to eligible microfinance customers.
• Could also be used as an additional incentive
  loan for timely payment history.

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• Zakah Funds
• Zakah from individual and government can be an
  ideal helpful source used for poverty
  alleviation.
• From Zakah special Waqf or fund could be
  established
• Applications
• The fund can be used to provide training,
  providing health care, education to the needy.
• Could be given in kind eg Tools, equipments,
  raw material, trading goods etc.
• Provision of basic food items.

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• Micro Takaful
• An ideal alternative to Conventional insurance,
  based on a concept of mutual insurance. Unlike
  premium, clients pay donations to the Waqf.
• From the pool of funds, the needs of the
  affected are fulfilled.
• Waqf invests funds in profitable avenues but
  only that are permissible in Shariah like
  Murabaha, Tijarah, Salam, Istisna, Ijarah,
  Musharakah, Mudarabah, Sukuk etc.
• Applications
• It can be applied to provide credit cover in
  case of death, permanent disability, insolvency.
• Can be done for live stock, crop, theft, fire
  etc.

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• Developing linkages with MFIs/NGOs
• Rather than getting into the operational side of
  managing the microfinance assets Islamic Bank can
  develop special linkages with other active MFIs
  NGOs.
• Islamic Microfinance Product menu could be shared
  
• It could Result in efficiencies for Islamic
  banks Microfinance program in form of lower
  costs, better outreach, low default rate,
  efficient recovery, etc

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• These linkages can be developed along the
  following lines
• Wakalah
• Islamic bank (IB) can appoint a specialized
  MFB/MFI as Wakeel to manage the Special Musharkah
  Pool (SMP) for a fixed fee.
• The Wakeel using its time tested operational
  model would provide financing to MF clients based
  on murabaha, ijarah, etc.
• Profits of the Pool after deducting the related
  costs (including agency fee) shall be distributed
  as per the Musharkah or Mudarbah agreement
  between MBL and depositors.

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• Mudarabah/Musharakah
• IB will enter into a Mudarabah or a Musharakah
  agreement with a specialized MFB/MFI.
• The MFB/MFI will work as Mudarib/working partner
  while IB would be the Raab ul Maal/Sleeping
  partner.
• The MFB/MFI using its time tested operational
  model would provide financing to MF clients based
  on murabaha, ijarah, etc.
• Profits earned by the Mudarbah/Musharkah would be
  distributed between MBL and the MFB/MFI according
  to the pre agreed ratio at the gross profit
  level.

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MEEZAN BANK MICROFINANCE CENTRE
Business Advisory Accounting
School
Vocational Training
Microfinance Office
Medical Clinics
Incubator
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• Example 1
• Acquire 2-3 acres of farm land and establish
  a milk center wherein 50 individuals will be
  provided a financing to buy 2 cows each i.e. 100
  cows per center.
• Advantage
• You Create 50 individuals into business persons
• Provides economies of scale in procurement of
  animals, fords, medicine, etc..
• Provide a better opportunity to sell the milk to
  large companies like Nestle Engro at a premium.

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• Example 2
• Acquire 1 Acre of Land and establish a textile
  stitching unit with 100 stitching machines where
  one man owns one machine.
• Many Textile will be able to outsource to these
  individuals.

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Models for Islamic MF
Monitoring System
Islamic MF Banks MFIs
Goods
Zakah Charity Waqf
Edu. Inst.
Profit
Partnership
Health
Customer
Profit/loss
Qard
Character building
Skill training
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• 1. Capital Up to PKR 1,000 / USD 13 only
• Micro Business Opportunities within this Capital
  Limit
• Selling Confectionary Items.
• Mending leather boots, bags, belts etc.
• Stitching bed with jute.
• Sharpening knives used in kitchen or for cutting
  meats.
• Distributing tools for work to construction
  laborers.
• Selling Mobile Phone accessories and
  mobile/internet cards.
• Selling Balloons at Parks and other public
  places.
• Selling Popcorns at Parks and other public
  places.
• Selling vegetables and fruits.
• Selling stationary items.
• Selling woven caps, miswak, tasbeeh,
  non-alcoholic perfumes, Islamic books etc at a
  mosque.
• Selling seasonal dry fruits at parks.
• Islamic Financing Alternatives Used
• Zakah / Qard-e-Hasan / Ijarah (for durable
  assets) / Murabaha (for consumable assets /
  Istisna (where manufacturing of premise involved)
  / Diminishing Musharakah (where the asset can not
  be solely financed by funds provided by bank).

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• 2. Capital PKR 1,000 5,000 / USD 14 63.
• Micro Business Opportunities within this Capital
  Limit
• Financing bicycles on which milk can be
  distributed.
• Financing bicycles on which newspapers can be
  distributed.
• Financing Ironing machine and funds for 2 months
  electricity charges.
• Financing Sewing machine and funds for 2 months
  electricity charges.
• Financing machine for making fried potatoes.
• Financing ice cooler to enable sale of frozen
  desserts.
• Financing coal stove for baking sweet potatoes
• Selling vegetables, fruits, animal feed etc with
  little more variety and capital.
• Financing juicers for selling fresh fruit juices.
  
• Selling plastic kitchenware.
• Selling plastic toys.
• Islamic Alternative Used
• Zakah / Qard-e-Hasan / Ijarah (for durable
  assets) / Murabaha (for consumable assets /
  Istisna (where manufacturing of premise involved)
  / Diminishing Musharakah (where the asset can not
  be solely financed by funds provided by bank).

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• 3. Capital PKR 5,000 10,000 / USD 63 - 125
• Micro Business Opportunities within this Capital
  Limit
• Financing domestic cattles.
• Construction of a road-side cabin in allowed
  premises
• Financing computer on which typing work can be
  outsourced.
• Financing chopping machines for meat processing
  for a service fee.
• Financing washing machines for better laundry
  services.
• Financing road side cabin infrastructure for
  selling fresh juices, burger etc.
• Financing material and tools for becoming
  electrician, carpenter, welder etc. (Training
  Provided).
• Financing material/tools to plumber, mason, watch
  repairing etc.
• Financing training to learn repairing various
  forms of hardware
• Expanding the already mentioned opportunities
  with more variety and capital.
• Islamic Alternative Used
• Zakat / Qard-e-Hasan / Ijarah (for durable
  assets) / Murabaha (for consumable assets /
  Istisna (where manufacturing of premise involved)
  / Diminishing Musharakah

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• 4. Capital PKR 10,000 50,000 / USD 125 - 625.
• Micro Business Opportunities within this Capital
  Limit
• Financing CNG Rickshaw.
• Financing ingredients for catering services for
  parties/festivities.
• Financing stock in trade.
• Financing road side food cabin.
• Financing motorcycles for distributors to expand
  coverage.
• Financing motorcycles to enable outstation jobs
  for riders.
• Financing a photocopier, scanner, printer etc.
• Financing tools and materials required for
  becoming a key maker.
• Selling battery operated toys at a park/play
  area.
• Selling Patties, Sweets (Jalebi, Imrati),
  Samosas, Namak Parey etc. in a residential area.
• Islamic Alternative Used
• Zakat / Qard-e-Hasan / Ijarah (for durable
  assets) / Murabaha (for consumable assets /
  Istisna (where manufacturing of premise involved)
  / Diminishing Musharakah

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• 5. Capital PKR 50,000 100,000 / USD 625 1250.
• Micro Business Opportunities within this Capital
  Limit
• Financing Taxi for fare / Small vans
• Financing a shop / stall in a shopping centre to
  sell garments, shoes, perfumes etc.
• Financing machinery/equipment for cottage
  industries.
• Selling economical plastic/silverware crockery at
  a weekly bazaar. (IB may buy premise for that).
• Selling cut piece garments, dress specific
  accessories for men/women, artificial jewellery
  etc.
• Financing infrastructure (chairs, stove, wheel
  cabin, ingredients) for a restaurant offering
  better variety.
• Islamic Alternative Used
• Zakat / Qard-e-Hasan / Ijarah (for durable
  assets) / Murabaha (for consumable assets /
  Istisna (where manufacturing of premise involved)
  / Diminishing Musharakah

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Road Map for Islamic banks
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• Following options could be adopted by Islamic
  bank for Microfinance
• Options
• MF counters in existing branches
• Standalone MF Branches
• Establishment of Independent subsidiaries
• Developing Linkages with NGO-MFIs

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• Option 1 MF counters in existing branches
• Requires minimal changes in organizational
  structure.
• Cost effective.
• No approval required from SBP.
• Lower monitoring
• Counter Manger either Report to Branch Manager
  or the Division at Head Office-as per banks
  discretion

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• Option 2 Standalone MF Branches
• MF Exclusive Branches with separate MF Division
  at head office.
• More focus approach
• Separate policies and business model
• No separate license fee required.
• Administrative operating Head office cost will
  be shared

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• Option 3 Establishment of Independent
  subsidiaries
• Islamic Banks can also establish MFBs with
  independent board management.
• Existing branches having substantial MF growth
  potential may be clubbed together transformed
  into an independent MFB as a subsidiary of the
  IB.
• Independence focused approach
• Separate Business model strategies
• Support from parent group
• Operating cost would be higher

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MECHANICS

• Option 4 Developing Linkages with NGO-MFIs
• Partnership with the NGOs.
• No change in the organizational structure.
• No approval required from Central bank
• Banks may opt for whole-sale financing to
  NGO-MFIs for their on-lending needs, and/or
• Banks may develop linkages/agency arrangements
  for extending loans through NGO-MFIs

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MECHANICS

• Key challenges for success
• Commitment from Highest Level
• Require a Separate Mindset Business approach
• New Sector
• Cost efficient Infrastructure development
• Diversified Product Development
• Developing Linkage
• Getting to the target market
• Business Approach Sustainable growth
• Monitoring Recovery

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• Pros for entering in MF
• Close to Philosophy of Islamic bank to
  alleviate poverty
• Large untapped Market
• Emerging Segment
• High demand for Islamic MF product
• Attractive Returns
• Cons
• High Operational Cost Overheads
• Require Separate Business model
• Risky
• Regulations

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• Entering to Islamic microfinance arena by
  Islamic banks will help in uplifting a large
  segment of population esp in the Muslim world
• It will lead to the economic development of the
  poor
• Islamic banks are expected to perform in this
  area as part of their mission
• Islamic banks needs to put resources in this area
  to develop a suitable business model own
  fitaccording to their operating environment.

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JAZAK ALLAH