Nov 5 (Reuters) - A series of German-funded studies and pilot projects aims to bridge the gap between Islamic finance and microcredit, to the benefit of communities in developing countries which remain on the fringes of the financial industry.
Islamic banking has been growing rapidly over the last few years in several parts of the world, particularly the Gulf and southeast Asia, but sharia-compliant versions of microcredit - the provision of very small loans to low-income borrowers who lack collateral and a credit history - have been slow to develop.
Expanding the appeal of Islamic microfinance is crucial for an estimated 650 million Muslims who live on less than $2 a day, according to the Washington-based Consultative Group to Assist the Poor (CGAP).
The German government’s international development agency GIZ is helping to develop regulations, education and training for Islamic microfinance in developing countries, said Matthias Range, Frankfurt-based internal advisor at GIZ.
“The combination of microfinance and Islamic finance is scattered and in the fledging phases. There has been almost no experience in implementation older than eight to 10 years. The development is far behind its potential.”
A study of Islamic microfinance products by GIZ and CGAP aims to identify ways to lower costs, while a separate GIZ study is exploring demand factors, Range said.
GIZ is also sponsoring a study to compare Islamic finance regulations across five countries. “We will tender this year and hope to have the publication at hand in June 2015.”
Islamic finance products must be vetted by a board of sharia scholars, a costly proposition for most lenders, and this problem is compounded by a lack of scholars with enough financial literacy, said Range.
CGAP data suggests high costs and customer perceptions are major reasons for the poor take-up of Islamic microfinance, which currently reaches about 300,000 clients in 14 countries, mostly in Indonesia, Afghanistan and Bangladesh.
This is tiny even for majority-Muslim Bangladesh, where 100,000 Islamic microfinance clients pale in comparison to 8 million conventional microfinance borrowers in the country.
In 2005, GIZ partnered with Indonesia’s central bank to set up seven Islamic savings and loan cooperatives in Aceh province. It has also worked with Bahrain’s Al Baraka Banking Group in Algeria’s Ghardaia region, developing a profit-sharing product in 2008 which the bank now offers across the country.
But the global range of sharia-compliant microcredit products remains very small; most are based on a cost-plus-profit arrangement known as murabaha, with benevolent loans (qard hassan) a distant second.
This raises issues of authenticity and sustainability. Murabaha is criticised by some Islamic scholars as too closely resembling a conventional loan, while qard hassan is structured as an instrument of charity - the microlending institution has to extend the maturity in case of non-payment, so many lenders do not see it as a commercially viable business model.
Profit-sharing contracts are common in Islamic finance but when applied to microfinance, their reporting and accounting requirements become cumbersome, adding to operating costs.
“We have almost no innovation in the market...Murabaha has no value-added for the client,” said Range.
GIZ supports an Islamic microfinance challenge run by CGAP in partnership with the Jeddah-based Islamic Development Bank , Al Baraka Banking Group and Dutch fund manager Triple Jump; the competition awards prizes to the best Islamic microfinance initiatives.
The current theme of the competition is “Beyond Murabaha”. (Editing by Andrew Torchia)