The Islamic microfinance sector has potential for rapid growth. Currently, the sector only forms 1% of all of Islamic finance globally. With the continued expansion of Islamic finance, there remains an opportunity for Islamic microfinance to continue to scale existing operations and create new opportunities in new markets that are simultaneously opening its doors to the wider Islamic finance space. MOHAMMAD RAAFI HOSSAIN contemplates the outlook of Islamic microfinance.
As the sector and its related Islamic microfinance product offerings mature, more microfinance institutions are looking to open windows of Shariah compliant products to their consumers and increase their footprint among their microfinance clients.
Interestingly, Islamic microfinance also only forms 1% of the total microfinance sector. The global microfinance sector has been expanding at the rate of 15% over the past couple of years and there are no signs of that pace slowing down. With new technologies around mobile banking and credit scoring, the costs of microfinance are declining which is inviting new players into the space. Islamic microfinance is seeking to follow suit.
They key barriers to Islamic microfinance’s increased penetration in the overall sector’s market share has been financing costs. Shariah compliant debt-financing instruments are costlier than those of their conventional counterparts due to the associated procedures in making these products Shariah compliant. With equity-based products, there are issues with mitigating risks and various other information asymmetries that make microfinance institutions still remain uncomfortable with this mode of financing.
Overall, microfinance will continue to play a big role in creating jobs and spurring economic development in emerging markets. With labor markets not organically creating opportunities for young people, there is an inherent demand to develop the micro and small-business segments of the economy in many of the same markets in which Islamic finance is just entering. Creating products that cater to this segment of the economy will be critical for Islamic microfinance institutions to be able to show value and create significant impact opportunities.
Review of 2015
The past year was highlighted by the continued growth of Islamic finance and the ramifications that it has had on Islamic microfinance. Jordan saw its first fully Shariah compliant microfinance institution formed, Ithmar, which was met with higher than expected demand from local constituents. This follows an announcement by government officials to create more opportunities for Islamic finance in the nation. Meanwhile, Morocco passed its first set of Islamic banking laws that consequently opened the doors for its first Islamic microfinance portfolio with the support of the IDB.
There has also been a wider interest by multiple organizations to continue to spur further innovation within the sector. In addition to the Islamic Microfinance Challenge sponsored by CGAP and others, this year the State Bank of Pakistan, in corporation with the UK, launched the Financial Innovation Challenge Fund, which focuses on Islamic microfinance. These types of challenges increase the pace of innovation and adoption of a more diversified pool of Islamic microfinance product offerings that are beyond the heavily relied upon Murabahah mode of financing.
Preview of 2016
According to multiple reports, Islamic microfinance is expected to continue to grow at a compound annual growth rate of 20% for the next few years. These forecasts are supported by the opening of new Islamic finance markets such as Morocco and with the ongoing formation of new, wholly compliant Islamic microfinance institutions in other frontier markets. Additionally, new opportunities to tap the SRI (sustainable and responsible investment) Sukuk markets may enable new investors to finance portfolios of Islamic microfinance institutions.
Additionally, with the launch of Narwi, a crowdfunding platform that caters to only Islamic microfinance institutions, there can be an expected rise in both financing going to Islamic microfinance institutions as well as the awareness and education of a potentially new set of future investors. The platform will also help spur conventional microfinance institutions to create Shariah compliant windows and target a new set of potential clients due to the lower costs of capital associated with the platform.
Much of Islamic microfinance’s future success will depend on how the sector embraces technology moving forward. More than any other domain within microfinance, the utilization of technology enables Islamic microfinance to roll out products that reflect its focus on cooperation and risk-sharing. Additionally, seeking to mitigate risk and information asymmetries through new forms of credit assessment may help Islamic microfinance institutions roll out more robust forms of equity-based products. In this case, collateralizing data and integrating mechanisms such as psychometric analysis will go a long way toward achieving more reliable forms of assessing the creditworthiness of prospective clients.
Incorporating both elements within Islamic microfinance products will help create a stronger value proposition among financial institutions and enable its continued growth within the overall microfinance sector. Finally, support from larger financial institutions within the Islamic finance sector and increased participation from domestic regulators will help establish more robust Islamic microfinance frameworks across the globe.
Mohammad Raafi Hossain is the founder and CEO of Finocracy, a non-profit Islamic social finance incubator and subsidiary of the World Congress of Muslim Philanthropists. He can be contacted at [email protected].