The global pandemic has cast its shadow over all aspects of human existence and the economic impact has been especially tough, sucking the lifeblood out of many businesses as customers dry up. MSMEs — the backbone of many economies — have been bearing the brunt. They are, however, also the way out of the current crisis.
In many developing economies, growth has been driven by the expansion of MSMEs, creating income-generating, self-employment and employment opportunities for the bottom of the pyramid. This trickle-up development was fueled by the provision of affordable credit through microfinance institutions.
Review of 2020
Last year, the total microfinance sector had steadily grown to an estimated 140 million clients globally with a credit portfolio of over US$100 billion, although less than 1% was Shariah compliant. Islamic microfinance is still dominated by a few big players such as Akhuwat in Pakistan, Islami Bank in Bangladesh or the BMT movement in Indonesia, although there are over 300 operators globally.
However, some 400 million people in Muslim-majority countries remain under the poverty line of US$1.9 a day. But many people who had barely escaped extreme poverty could be forced back into it by the convergence of COVID-19, conflicts and climate change. A World Bank preliminary estimate for 2020, incorporating the effects of the COVID-19 pandemic, projects that an additional 88 million to 115 million people will be pushed into extreme poverty, bringing the total to over 700 million globally.
This has dramatically affected the loan book of many microfinance institutions as their clients — mainly microentrepreneurs — find their revenues depleted and ultimately unable to repay their debts. This has caused, together with a number of regulator-imposed repayment moratoria, a liquidity crisis in many microfinance institutions the world over. Coupled with a very cautious approach to lend to economically vulnerable clients at a time of great uncertainty in terms of growth, hence poverty reduction has been significantly affected.
On the upside, there is unprecedented demand for capital or asset finance as MSMEs try to get over this lean period or invest in business adaptation. A very positive development was therefore Blossom Finance’s follow-up SmartSukuk for Indonesian BMT Bina Ummah, building on its world’s first primary Sukuk issuance on a public blockchain and the world’s first micro Sukuk in the previous year which raised US$50,000.
Preview of 2021
Some heavy lifting will be required if we want to get the economy back on track and it is clear that Islamic microfinance will have to play a central role. This requires significant financial input and institutions such as the IsDB Group will be critical. However, from the US$2.3 billion IsDB rescue package, while much is being injected into financial services, Islamic commercial banks and not microfinance institutions are absorbing the lion’s share. Therefore, an Islamic microfinance-specific rescue package would be a very welcome development.
Islamic microfinance institutions will not just need more capital to bolster their loan books during this crisis in order to provide longer-term concessional finance to microentrepreneurs rebuilding, but they will also have to invest heavily in business adaptation.
Microfinance is a very transaction- and client interaction-heavy business and doing business during and post-COVID-19 is likely to go digital. Islamic microfinance institutions will not only face increased competition from peer-to-peer lending platforms but also from fintech start-ups entering the micro market, taking advantage of the relatively low entry threshold. Mobile money will be king and the now-legendary M-Pesa service in Kenya that has skyrocketed financial inclusion in the country through the power of a basic mobile phone is likely to be replicated more widely.
The threat of commercial banks downscaling into the microfinance market which was quite strongly perceivable in many national markets, however, despite their advantage in terms of technology adaptation, seems to have receded. This is because MSMEs are now, of course, riskier businesses than ever which makes it less likely that banks will lend to them and even if they do, it will be more expensive.
A major concern remains the lack of product standardization especially for Qard Hasan, on which the Islamic microfinance industry relies heavily and which is likely to be the product of choice in these challenging times. The current AAOIFI product standard was drawn up with commercial banks in mind which have a suite of revenue-generating financial services. But for microfinance institutions which serve poor and vulnerable customers perhaps solely through Qard Hasan, full cost recovery opens up Shariah non-compliance risks under the current AAOFI interpretation. This is an urgent concern that the standard-setting body will have to address to support the growth of the industry.
It has been an extremely challenging year for Islamic microfinance. At the same time — with the right support from Islamic finance industry standard-setting bodies and the IsDB — we can now build a critical economic recovery engine. Beyond COVID-19 and with rating agencies and investment vehicles, Islamic microfinance can become a new social investment class.