SMEs are a key economic driver and represent a potentially valuable avenue for Islamic investment. MOHAMMAD ABDULLAH DEWAYA explains why Islamic banks should move into microfinancing to encourage this sector.
The economic philosophy of Islam is mainly based on cycling wealth among the different layers of the society. The rich are given full rights to further invest money in order to grow wealth by Halal means. Nevertheless, they are also supposed to fulfill the responsibilities that are imposed on them by Allah, the original owner of the money, in order to pay thanks for granting that wealth.
Mainly, this is achieved by the mechanism of fulfilling the obligation to provide a minor fraction of their wealth — not exceeding 2.5% — to the poor who don’t have enough resources to live without needing charity. That is known in Islam as Zakat-ul-mal. The sum of the 2.5% paid by the eligible people can create a huge fund which can contribute to the establishment of hundreds of SMEs. But the question is, in the absence of the Bait-ul-mal which used to collect and distribute money under the Zakat system, what should be our role?
I think some practical alternatives can be found. The management role which was played by the Bait-ul-mal can be played by the Islamic financial institutions if not fully then at least partially, by financing and encouraging the SME projects.
Going back to the original philosophy of the Islamic financial system, the rich are not allowed to freeze the money nor lend it on an interest basis, because that would be an act of greediness and would prevent society from getting the benefits of money circulation through investing in various productive projects.
One may suggest the Qard-ul-hassan or the Islamic interest free loan method of providing liquidity to other party: a Shariah compliant solution where the capital remains 100% protected and the return is in the form of reward from Allah. It is optional to give Qard-ul-Hassan but not compulsory, however, and some may not wish to participate for various reasons.
Islamic banks could play the part of a secure and reliable party to collect funds from the parties having excess money (Rab-ul-mal) and act as manager or agent (Mudarib or Wakeel) to invest the same in a Shariah compliant manner into different projects including SMEs.
Based on the above, the Islamic banks are fully qualified to provide a full solution on the micro level. This role could be more effective if a partnership based on a true will to encourage SMEs can be formed between the Islamic banks and government bodies. This will help to provide funds for the SMEs which can then contribute towards GDP and the development of the country.
Moreover, the Takaful industry can also play an important role, which will distinguish it from the conventional insurance companies. However, this will be subject to regulatory authorization.
The Islamic divisions of central banks could work together with the Islamic banks’ board of directors, the respected Shariah supervisory boards and the product developers to provide integrated programs for SMEs where the banks can provide financing on easy terms and the regulatory bodies can facilitate the success of these SME projects.
Moreover, placing the activity of these SME projects and their progress under the microscope of these watchdogs can offer an alternative to the difficult terms and conditions that normally form a barrier for SMEs to obtain finance from the banks.
Am I asking too much from Islamic banks by giving them the role of watchdog? No, not at all. The nature of Islamic banks’ activities by default makes them behave as watchdogs, as they enters into real partnership with the clients, and in many cases purchase and sell tangible assets and bear all the relative risk as per the Shariah principles. This is unlike the conventional banks, which are not allowed by law to enter into any form of trading, as their role is merely lending and borrowing.
Islamic banks could be the perfect solution for financing SMEs, with a contractual obligation on the entrepreneur to keep the bank fully aware of its business progress.
Alternatively, they could obligate the SMEs to operate all their financial deals through an escrow account in the same bank to allow control of activities. The Islamic banks could also perhaps charge an administrative fee for this purpose.
Finally, we come to the question of the cost of funding of SMEs and the risk affiliated with this. I can 100% guarantee that if the Islamic banks allocate some percentage of their investment funds for financing SMEs and then compare the return and the performance of the same with any other known investments, such as corporate or home finance, they will see that SMEs provide better performance and returns.
I say this based on the fact that SMEs have proven to be an economic driver. However, special products must be designed for SMEs to ensure that they get relief in the first year from paying high returns to the bank, as per the financing structure.
Similarly, the risk from SMEs will be less as it will be distributed between a wide number of clients and the financing amounts will be in a reasonable range. So if a default happens the overall invested pool will be easily able to sustain it — unlike mega projects where a hit can be destructive for the bank and may incur a big loss to the shareholders and the Rab-ul-mal.
Mohammad Abdullah Dewaya is the head of Shariah compliance and audit as well as the secretary to the Shariah Supervisory Board at BankDhofar Oman. He can be contacted at
[email protected]
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