Deadweight Loss in the Interest-based

and the Interest-Free (Islamic)

Microfinance Programs: A Comparative
Analysis
By
Basharat Hossain
Assistant Professor of Economics, Department of Business
Administration, International Islamic University Chittagong,Bangladesh
Paper presented at the first international conference on finance and
sustainable development. Organised by department of finance,
University of Chittagong.
2018 1
 Objective
• To identify and highlight the dead weight loss
in the interest-based Microfinance program
compared to the interest-free Microfinance in
terms of
• consumer surplus,
• producer surplus
• the quantity demanded of the Microfinance
loan.
2
 Methodology

• Data: Secondary Data

• Methods of Analysis:

• Graphical Analysis
• Numerical Example

3
 What is Microfinance?
Microfinance
Financial non-financial

Micro-credit
education

Micro-insurance healthcare

4
 Nature of Microfinance

Microfinance

Interest-based/ Interest-free/ Islamic

Islamic Microfinance
Microfinance

5
Differences between interest-based and Interest-free (Islamic)
Microfinance
Basis Interest-based Microfinance Interest-free Microfinance
Basic Financial services: Financial services-
Function Microcredit through Lending- Microcredit through
borrowing, .Profit-Loss sharing Business,
Micro-savings, .buying & selling (bai-murabaha),
Micro insurance Micro-savings,
Micro insurance
Interest free Loan/ Qard al-hasanah
Non-Financial services: Non-Financial services:
education; healthcare Similar + Zakat based program
Basis of Interest rate Profit-Loss sharing (Mudaraba;
Musharakah),
Loan
Profit rate on buying -selling
Interest free Loan
Religious charity 6
 Differences between interest-based and Interest-free
(Islamic) Microfinance
Basis Interest-based Microfinance Interest-free
Microfinance
Loan Sanction Cash Goods/Products
Real asset May be or may not be Must
building
Fund/Loan Easy Impossible
diversion
Methods of Group/center pressure Group/spouse
dealings with guarantee, Islamic
defaults ethics
Socioeconomic Secular, Religious motivation; 7
 Deadweight Loss
• ‘deadweight loss’ means the 'excess burden’ or ‘welfare loss’.

• the lost in total surplus that outcomes from a market inefficiency

or distortion,

• such as a tax ; monopoly, quotas and tariffs, or other distortions

like as inefficiency in resource allocation

Finally, this paper presents the deadweight loss in terms of

consumer surplus, producer surplus and quantity demand of loan

8
 Determinants of the Deadweight Loss in the
Microfinance
Interest-based Microfinance Interest-free Microfinance
No Profit-Loss Sharing Business
No Trade: buying & selling
Interest Rate/Loan Price: 20 - 33% Profit Rate/Loan Price: 0 - 15%
No Interest free Loan
May be or may not be Real Asset building is Must
Cash transfer Product or goods transfer
Fund/Loan Diversion is easy Fund/Loan Diversion is Impossible
Charity: Optional based on fund Charity: compulsory responsibility
9
 Interest Rate / Loan Price
Interest-based Microfinance Interest-free MIcrofinance
Name of MFIs Interest Rate Name of MFIs Profit Rate
Grameen Bank 20% Muslim Aid; Bangladesh 0%
(Quard al-
Hasanah)
BRAC 26% IBBL-RDS 12.5%
(Rebate 2.5%)
ASA 25% Exim Bank 9%
Microfinance
Buro Bangladesh 15-20% Al-arafah Microfinance 15%
Shakti Foundation 27% - -
Average 23.5% Average 9.125%
10
 Interest Rate / Loan Price: World by Region
Region Interest rate
Sub-Saharan Africa 31-33%
South Asia, 25-26%
East Asia and the Pacific 27%
Eastern Europe and Central 28-29%
Asia
Latin America and Caribbean 31-32%
Middle East and North Africa 31-32%
Average 29.33% 11
 Measuring the Deadweight Loss

•consumer surplus = willingness to pay of

the consumer - the amount actually
paid/Market price

•producer surplus = the sales revenue (at

the market price) - the cost of the producer
12
The Deadweight Loss in terms of Consumer Surplus (CS)

13
 Deadweight Losses in terms of the Quantity demand (Qd) and the Loan
Price (P)
Deadweight Losses in terms of the Quantity Deadweight Losses in terms of the Loan Price (P)
demand (Qd)
Qd of Qd of Qd of Price of Price of Price of
Islamic Microfinan Conventional Islamic Microfinan Convention
Microfinan ce Loan at Microfinance Microfinan ce Loan at al
ce Loan market Loan ce Loan market Microfinan
Average Average ce Loan
price price
Qd OQI OQm OQc OPI OPma OPc Loan Price

Losses of - Qm-QI Qc- QI - - -

Qd

Comparis OQI≻ OQm ≻ OQc OPI< OPma < OPc Comparis

on in term Islamic Microfinance is better Islamic Microfinance is better on in term
of Qd of price 14
The Deadweight Loss in terms of the Producer Surplus (PS)

15
 Key Findings of The study
• Dead weight loss is extremely higher in interest-based
Microfinance

• consumer surplus is extremely lower (at least 5 times) in

interest-based Microfinance

• Producer surplus: is higher in the Islamic Microfinance than

the interest-based Microfinance

• The average loan price is at least 142.05% (Bangladesh) and

241.84% (world) higher in interest-based Microfinance
than the Islamic Microfinance.
16
 Key Findings of The study
• Quantity demand of the Microfinance loan is higher in the Islamic
Microfinance than the conventional Microfinance.

• Islamic Microfinance has many exceptional tools such as profit loss

sharing system, quard al-hasanah or interest free loan, zakah and
sadaqah. On the contrary, these are absent in conventional
Microfinance

• Islamic Microfinance is highly responsible to build real asset

whereas conventional Microfinance insignificantly contribute to it.

17
 Key Findings of The study
• Fund diversion is the common phenomenon in
conventional Microfinance whereas it is almost impossible
in the Islamic Microfinance

• Finally, Islamic Microfinance is highly consumer friendly &

efficient than the conventional Microfinance, because it
offers lower loan price, interest free loan and religious
charity tools etc.

18
 Recommendations
• conventional Microfinance Institutions should eliminate the interest and use
the tools of Islamic Microfinance.

• Islamic MFIs should propagate the superiority of Islamic Microfinance in the

society and should offer research grants to conduct research on it for future
expansion.

• Islamic MFIs should increase its coverage by managing funds from different
sources.

• As like as banking conversion; the Microfinance regulatory authority of

Bangladesh should encourage and offer facilities to convert the conventional
Microfinance institutions into Islamic Microfinance institutions.
19
 Conclusion

• Islamic Microfinance has first rated Islamic financial and

charitable tools such as profit-loss sharing system,
Sadaqah, Zakah and Waqf.

• In terms of Deadweight Loss: Islamic Microfinance is the

Sustainable Microfinance program

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Thank you very much
for
Listening my paper
21