In the name of Allah (God), the Compassionate, the Merciful

" There is no deity except Allah and Muhammad is the Messenger of Allah

O My Sustainer! Open up my heart (Sadr) ( to Thy light).

And make my task easy for me. And remove the impediment from
my speech. So that people may understand what I say / so that they
might fully understand my speech. (Sura Taha -20: 25-28)
ANALYSIS OF ISLAMIC FINANCIAL INSTRUMENTS
in terms of
MICROFINANCE DEVELOPMENT FOR POVERTY
ALLEVIATION

Zohra Jabeen
Institute of Management Sciences, Peshawar

Islamic Microfinance Conference, Islamabad

July 22,2009
 This paper
How Islamic financing instruments can be
used
• to solve the microfinancing needs of the
neglected population
 This paper
• generic economic contracts
– particular focus- Ijara’h, Salam and Sukuk,
• highlighting their attributes
– which can be effectively utilized for poverty
alleviation in the context of microfinance
• AAOIFI Sharia’ Standards
– Main source of drawing the contract
structures-
 Brief Introduction
The current times
Growing poverty levels
• worldwide financial crisis,
– lending and investment streams at international levels
are also drying up or are already dried up.
• Problems of conventional Microfinance
lenders/NGO in Pakistan
• Islamic Finance- alternate resource mobilizing
techniques in reaching out to the poor of the
society
 Brief Introduction
Islamic finance
• based on economic justice and socio-
economic development
• operating on the non-debt principles,
• strictly prohibiting interest-taking and
• having an asset-backed ( and services
based) requisite for profit-making
economic transactions.
 Brief Introduction
Islamic finance
• By practicing the principles of Islamic finance,
the financial and real sectors are aligned.
– Artificial credit expansion and speculation does not
take place
• The Islamic principles call for leniency towards
the downtrodden and economically distressed-
pro-poor
– It follows a risk-based reward system and asset-
based system of economic transactions, which ties
monetary growth to real economic growth.
 Brief Introduction
Islamic finance
• In addition it does not consider money as
capital
• It detests mere ownership of money as the
reason for earning a reward in the shape
of interest. This it terms as the root cause
of injustice and extortions in the society
 Brief Introduction
Islamic instruments or methods of
economic transactions

• have an in-built, balanced system

promoting socio-economic
development and justice at product
level ( while analysing products as defined by
AAOIFI Shari’a Standards)
 Brief Introduction
Islamic finance
• but hardly utilized for microfinance
• Need for more awareness creation about
them in their actual generic form rather
than even the modified forms in some
cases.
 Islamic financial instruments-
The practice
observed
while analyzing some of the products of Islamic
banking and Islamic capital markets
they have undergone certain additions and
amendments
• primarily due to the money market and capital
markets’ prevailing trends,
• modified Islamic contracts suiting the specified
market conditions and requirements- although
Sharia’h compliant
 Islamic financial instruments-
The practice
• Examples-
– the cost of money
• linking product pricing to LIBOR
• the use of Ijara’h for acquiring a fixed asset over a
period of time
• However, the very generic contracts can
be utilized mostly in the same original
form in the area of poverty alleviation
through microfinance or can be
combined /developed for microfinance.
 Ijara’h
to give something on rent
mode of renting out usage of an asset
In agriculture – in sub continent traditionally
different kinds
• Sharing of crops’ yield, 50:50 or the monetary
equivalent as rent
• Horses for carriage , transportation
Al – Majallah (Ottoman Empire’s rules of business and
law)
 Ijara’h
• Originally, Ijara’h was not meant for transfer of
ownership of the underlying asset
• The mechanism was useful for giving a long
term durable /usable commodity (or a horse ,
mule etc. for transportation) on rent
• In the current Islamic Banking Ijara’h used as a
mode of financing for acquisition of assets
through periodic payments of the principal value
of the commodity and the rent accruing for the
usage of the commodity by the lessee.
• In this regard, it is similar to conventional
leasing [except difference of interest and risks ]
 Nature of Assets given on Ijara’h
basis
• should not perish after usage by the
lessee,
• that can be reused
– like land, building, a vehicle
 Ijara’h Wa Iqtinaa
• “compound” Ijara’h- inclusive contracts
designed to transfer ownership to the
lessee over a period of time through
installments
Ijara’h’s utility in Microfinance
• if the poor are provided the facility of using
an asset which they can’t purchase ( at
least initially) by using the Ijara’h
mechanism
– Providing agricultural machinery on rent
– Shop’s/premises’ usage on rent
Ijara’h’s utility in Microfinance
• renting out service can be for a very small
period of time, say a day or two and it can
also be for longer periods of time say one
year or many years, depending upon the
nature and utility of the asset under
consideration
• later gradually enhancing and improving
their capacity
– doable mechanism/s, yet devoid of interest
 Ijara’h in Microfinance
• Vehicles rental services
• A plot of land for growing crops/orchards
– Rental rate based on the going market rates in that
particular area for that rental service
utilized for helping the poor to do their own work
for generating their own income, running their
own small venture, and paying the Ijara’h rent
accruing out of their cash flows
A helping hand of sustenance
 Ijara’h in Microfinance
If lessees generating enough funds, over
and above their operating costs,
they can be encouraged to opt for ownership of
the underlying asset, through payment of the
installments
This gradual transfer of ownership -
diminishing Musharika or “gradually
reduced ownership” of the initial owner
 Ijara’h’s utility
• Provides the necessary real capital and
infrastructure by the donors/NGOs/ Even
private partners
– which can then be owned by the enterprising
people and institutions, gradually through
diminishing Musharika (or even Ijara’h Wa
Iqtina’a)
 Ijara’h’s utility
Benefit: access to usage of capital items
the nature of risk of loss will change from a
credit risk to either no risk ( especially in
immovable capital asset like land or building)
or risk of loss to movable capital .
This risk can be minimized too, if gradual
transfer of ownership to the lessee, the next
step.
 Ijara’h for Microfinance
A(Step I) Ijarah contract

Collective or individual ownership of capital assets to

be rented out as Ijara’h
B. (Step II) Diminishing Musharika contract
for transfer of ownership
Nature of relationship changes from lessee /lessor
Lease rentals form
periodic Ijara’h rentals
to joint owners till all amount paid by the client.

Underlying asset

Ijarah/lease of the
underlying assets
Underlying asset - its
price gradually paid to
investors
payments made to purchase
Lessees the underlying asset
sukuk retirement- maturity…
 Salam & Istisna’a
exceptional forward contract allowed by the
Holy Prophet Mohammad (PBUH) in order
to facilitate the poor farmers and traders.
However, these are not speculative, as no
short–selling
spot contracts undertaken at the market spot
price agreed among the two parties at the
time of commencement of the contract
 Salam & Istisna’a
advance payment made (at the time of
entering into the contract) &
actual commodities are delivered
Can be productively utilized in livestock
rearing and artisanship (handmade
embroidery, carpet weaving
 Sukuk
Another very effective mechanism, though grossly distorted
in practice
Sukuk are ownership scrips
represent undivided ownership in underlying assets.
Sukuk enable financing, following the principle of sharing
risk and return related to identifiable, tangible underlying
assets, usufructs and projects.
The return from the underlying asset/s is distributed among sukuk
holders

(AAOIFI, Sharia Standards, 2004-5)

 Sukuk Types-
Sukuk Al-Ijara’h for Microfinance
Collective capital funds . ownership title in the shape
of Sukuk scrips held

Sukuk investors
Owners of assets
Donors can free themselves from the capital
investment
Investment in
underlying assets Lease rentals form
periodic Sukuk
payments
Underlying tangible
asset

a.Sukuk sold to third party/ies.

Ijarah/lease of Ownership to the underlying
the underlying tangible assets change.
assets b. Dissolution of Sukuk
contract and sale of assets to
Lessees intending buyers
 Sukuk Types
Sukuk Investors
(donors /private
partners
Beneficiaries .
lessees/contract basis Musharika entity
(as Originators
users/ toll tax payers And issuers)
Project/Assets

1a. Contribution in
kind – Assets
1b. contribution in
3a rent/ toll tax, one time
payment cash
Long Term Sukuk
2a. subscription/
payment
2b. Scrips given

a. Sale/transfer of Sukuk
scrips.
b. Dissolution of Musharika
and sale of assets to
intending buyers
 Ijarah and Sukuk
the ownership of capital goods (movable
and immovable)
has a lot of significance particularly in the
context of microfinance
as it provides the necessary boost in income
generation while retaining ownership and
risks associated with them
 Rozgar scheme
In the recent Rozgar scheme of the
government in which (green) rickshaws
were given to the poor applicants on
loans, have a major flaw of sub standard
product
 Gauge Market Demand
Further, proper market surveys should help
gauge the market demand and the
quantity made available should not create
a glut of a particular item or service, lest
the chances of good business opportunity
for all are reduced.
 How benchmarking to real sector
can help here
pricing of the facility/Benchmarking
It is particularly important, not to attach the rentals to the
money market rates. Save the lessee from escalation in
rent due to changing interest rates during times of rising
interest rates
Currently the international lending rates too, are getting
more and more reduced However, the cost of living is
not reducing but increasing, at least in Pakistan. Hence
this practice shall prove to be beneficial for the
microfinance institutions as well as the lessees.
– Similarly , with inflation, at least most of the underlying assets’
prices would not be decreasing, and the owner of capital goods
will not suffer any loss
IF the microfinance financial institutions are able to get funds on
easy terms, they should pass over the benefit to the lessees.
Combining your capital with “local
Asset”
– Another advantage of ownership –based resource
mobilization appears in the form of utilizing the
available ( cash) resources in combination with a
“local asset” in order to generate economic activity.
This “local asset”, can be indigenous land for
cultivation, a building already available, and most
importantly the indigenous people , with indigenous
traits and skills who become economically productive
and useful for themselves as well as the rest of the
world, which buys their unique hand-made or partly
machine –made customized items, which would not
have been available for sale without the economic
support. (Hidden Capital concept-- Abbas Mirakhor)
 Salam

• can directly benefit the poor farmers

• provide them opportunity to produce more and good
quality products when demanded
• However, again exploitative pricing ( setting too low a
price) must be avoided ,
• and if the market price of the crops has escalated very
much at the time of crops’ harvesting and sale, out of
goodwill, the farmers should be given a little extra too so
that they won’t feel cheated because of their poverty and
the subsequent advance payment
• Salam can be best undertaken between the actual user
of the commodities and the farmers who grow the crops
 Conclusion
• one wonders why poverty was rising
amidst the economic growth till 2007?
• Is there anything seriously wrong with the
distribution of rewards ( of factors of
production and the definition of factors of
production) in the conventional system?
 Resource-sharing
& providing long term sustenance
• denying the due share to resources and access to
opportunities can cause a major damage which no
amount of microfinance can repair
• Risk and rewards sharing, providing long term
sustenance through capital based involvement create a
feeling of belongingness and sharing the fruits of
enterprise among the contributors of capital and
contributors of human efforts.
• This is what the Islamic financing techniques embody, in
one form or the other. These can be fruitfully applied for
poverty alleviation at the grassroots level as well as for
economic development at all levels of the society