SMEs at present are generally not well served by Islamic banks, but there are some exceptions, as the Jordan Islamic Bank has much experience in this area. The major problems from the bank’s perspective are the risks involved and the relatively high transaction costs. SMEs, however, to some extent have only themselves to blame, as many have inadequate financial reporting, poor internal cash flow records, and are not sufficiently competent in formulating business plans. Some Durham PhD students, notably Heba Aljouni from Jordan, have undertaken detailed surveys of SMEs that confirm these constraints. Rather than banks providing the funding, a better way forward may be for Islamic investment companies to get more involved. Equity funding may be preferable for some SMEs to debt finance. Islamic private equity finance is in its infancy, but this has enormous potential, especially if Musharakah structures are used. Some of the issues relating to Musharakah structures will be covered in a lecture I am giving to the HSBC Islamic Society in London on the 20th September.
PROFESSOR RODNEY WILSON:
It is not just in Islamic finance that SMEs and their little brothers “micro”-enterprises are poorly catered for. It is difficult enough for them to obtain conventional “deficit-based” finance (ie credit) from banks – who tend to operate on the principle that they will supply an umbrella only if it is not raining. Moreover, the alternative available to major enterprises of “asset-based” finance, ie “equity,” is difficult and costly for SMEs and entirely impossible for micro-enterprises. The flood of investment banks to the Gulf and the huge global interest in Islamic finance has nothing whatsoever to do with an appetite for financing SMEs and micro-enterprises either, but for the most part a wish to assist in the investment of huge oil wealth in mega-projects. So the situation does not appear to be improving much. The fact of the matter is that the use of a “capital partnership” (ie Musharakah) using the new UK LLP – which is essentially an “Islamic corporate” – is not only a simple way of financing such businesses, but probably also optimal in terms of sharing risk and reward. As an example, I was recently involved in a small film constituted as an LLP. The producer, actors and myself all received “equity shares” (ie revenue shares and joint ownership) in return for our work, alongside investors/capital partners who funded the costs such as equipment hire, again in return for a share of the revenue, IF THERE IS ANY (which is not what a bank wishes to hear). Since an LLP is tax transparent, investors can offset “pre-revenue” losses against their other income or gains. Simple, radical, and of course Islamically sound at a deep level. Which is why you won’t hear about it from any consultants or professionals paid by the hour and therefore with a vested interest in complexity and conflicts. CHRIS COOK: Principal, Partnership Consulting LLP
At present financing to SME clients is small as compared to overall financing done by Islamic banks worldwide, but the growth trend is positive. Islamic banks, especially in Pakistan, are focusing on this sector and working to develop new and innovative products. Currently the Islamic banking product menu for SME clients consists of Murabahah-based solutions for local purchase and trade financing; Ijarah and diminishing Musharakah for longer tenure needs for fixed assets. With the expansion of the Islamic banking network to different cities, more SME clients are coming into the Islamic banking network. On the deposit side, Islamic banking offers a wide selection of Musharakah or Mudarabah-based business accounts with all the facilities offered by any conventional counterpart, with the exception of overdraft facilities. Moreover, Islamic banks offer investment accounts for short to long-term placement needs, as well as special pension and gratuity accounts for employees. On the deposit side Islamic banks have seen a healthy rise in SME clients in the last few years. However, the main challenge for Islamic banks in Pakistan and elsewhere is to educate and create awareness in the SME sector and in the public at large about Islamic banking concepts and solutions. Islamic banks needs to take a proactive approach and should come forward to conduct special seminars, training workshops and short courses for the public and SME customers, in collaboration with different trade bodies. The experience of such workshops and training programs at Meezan Bank is that they are quite successful in creating awareness and directing the customer to Islamic banking. Ahmed Ali Siddiqui: Vice President & Manager, Product Development & Shariah Compliance, Meezan Bank
In Malaysia at least, SMEs have at their disposal various debt Islamic products and programs to cater to their business requirements. This is especially true if we were to look at the requirements of SMEs, which are mainly trade in nature. What is perhaps lacking at the moment are the Islamic finance structures such as Istisnah (contract financing) and the likes of pure venture structures such as Musharakah or Mudharabah propositions that fit their contract or project financing requirements. What Islamic institutions should be looking at is to provide Islamic financing programs specifically dedicated to the SME sectors and also to work with government agencies, for instance in Malaysia with the Credit Guarantee Corporation (CGC), in order to come out with more financing programs and options to support the SMEs sector. Educating SMEs of the available products, services and options open to them would be the key to support this sector further. Ahmad Zaini Othman: Chief Executive Officer, AmIslamic Bank
To address this issue, first we need to realize that there are no separate efforts being made to cater for SMEs in Islamic finance, simply because most of the SMEs themselves do not differentiate between Islamic and conventional finance. From my experience dealing with SMEs, the cost of finance is paramount and the choice of products are also important for them. Hence, to further encourage the growth of Islamic finance amongst SMEs, the market players dealing with Islamic finance will have to be creative in creating products which would suit the needs of the SMEs, with competitive costs, of course. MOHAMED RIDZA: Ridza Law (Mohamed Ridza & Co)
Conventional banking in the GCC (or other emerging markets) has not addressed the needs of SMEs, so it does not make sense to imply, by singling out, Islamic finance’s inadequate attention towards them. For example, Bank Muscat International (BMI Bank), a conventional bank, just announced the launch of new division to cater to SMEs in Bahrain, with the acting general manager stating ‘…Given that the sector’s financial needs are currently not being met completely, we decided to launch a dedicated division for SMEs providing customized financial solutions.’ Islamic banks should be taking the lead in financing SMEs, as SMEs are ideal candidates for partnership financing. Let’s set aside the fact that sin sector activities that cannot be financed by Islamic banks, a number of issues can and must be addressed: 1. Islamic banking must become more risk takers, implies better credit and operational risk management. Islamic banks are sitting on a mountain of liquidity, and allocations to SMEs jump starts local communities/economies 2. There must be a credit scoring system established so banks can better understand (through 3rd parties) the financial health of such companies, some GCC countries have recognized this shortcoming and are making efforts here 3. There should be a Small Business Administration established, that could provide ‘credit enhancements’ for SME borrowings, as that would raise the comfort level of Islamic banks. Maybe the IDB can take a lead here, as this would assist its stated objective of increasing intra-OIC country trade and investment from the present low levels 4. Assuming the cost of raising capital is similar to banks, aggressive Islamic banks, should look into SME Sukuk (balance sheet offloading of Islamic loans via securitization). This may be ahead of its time as the amounts required by SMEs are small presently. In summary, by addressing the needs of SMEs, Islamic banks can deploy some of their liquidity which could spur local economic growth/development and possibly contribute to intra-OIC trade, and, thus, provide a lesson for conventional banks in the region. RUSHDI SIDDIQUI: Dow Jones Indexes
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