Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
No. 49 August 2008
Nimrah Karim, Michael Tarazi, and Xavier Reille
47001 Islamic Microfinance: An Emerging Market Niche
n estimated 72 percent of people living in
demand for Islamic microfinance products is strong.
Muslim-majority countries do not use formal
Surveys in Jordan, Algeria, and Syria, for example,
revealed that 20–40 percent of respondents cite
financial services are available, some people view
religious reasons for not accessing conventional
conventional products as incompatible with the
financial services (Honohon 2007).
financial principles set forth in Islamic law. In recent years, some microfinance institutions (MFIs) have stepped in to service low-income Muslim clients who demand products consistent with Islamic financial principles—leading to the emergence of Islamic
Islamic microfinance has the potential to expand access to finance to unprecedented levels throughout the Muslim world.
microfinance as a new market niche. This Focus Note provides an overview of the current Islamic microfinance represents the confluence of two
state of the Islamic microfinance sector and identifies
rapidly growing industries: microfinance and Islamic
possible challenges to its growth. It is intended as an
finance.2 It has the potential to not only respond
introduction to Islamic microfinance primarily for the
to unmet demand but also to combine the Islamic
donor community and other potential entrants into
social principle of caring for the less fortunate with
microfinance’s power to provide financial access to the poor. Unlocking this potential could be the key
Principles of Islamic Finance
to providing financial access to millions of Muslim poor who currently reject microfinance products that
Islamic finance refers to a system of finance based
do not comply with Islamic law. Islamic microfinance
on Islamic law (commonly referred to as Sharia4).
is still in its infancy, and business models are just
Islamic financial principles are premised on the
general principle of providing for the welfare of the population by prohibiting practices considered unfair
In a 2007 global survey on Islamic microfinance,
or exploitative. The most widely known characteristic
CGAP collected information on over 125 institutions
of the Islamic financial system is the strict prohibition
and contacted experts from 19 Muslim countries. The
on giving or receiving any fixed, predetermined
survey and a synthesis of other available data revealed
rate of return on financial transactions. This ban on
that Islamic microfinance has a total estimated global
interest, agreed upon by a majority of Islamic scholars,
outreach of only 380,000 customers and accounts for
is derived from two fundamental Sharia precepts:
only an estimated one-half of one percent3 of total microfinance outreach.
• Money has no intrinsic worth. Money is not an asset by itself and can increase in value only if it
The supply of Islamic microfinance is very concentrated
joins other resources to undertake productive
in a few countries, with the top three countries
activity. For this reason, money cannot be bought
(Indonesia, Bangladesh, and Afghanistan) accounting
and sold as a commodity, and money not backed
for 80 percent of global outreach. Nevertheless,
by assets cannot increase in value over time.
1 Honohon’s study finds that in the Islamic Development Bank’s 56 member countries, only 28 percent of the adult population uses formal (or semi-formal) financial intermediaries, whether through deposit accounts or borrowing. This percentage includes non-Muslims living in such countries. 2 Today, the total assets of Islamic financial products is estimated at US$500.5 billion (The Banker 2007) and the Islamic finance industry’s 100 largest banks have posted an annual asset growth rate of 26.7 percent, outpacing the 19.3 percent growth rate of their conventional counterparts (Kapur 2008). 3 Based on an estimated 77 million microcredit clients (Microfinance Information eXchange 2007a). 4 Sharia is derived from four sources. The main source of Sharia is the Quran, considered by Muslims to be divine scripture. The second most authoritative source of Sharia is hadith—the practice, conduct, and sayings of the Prophet Muhammad. If further clarity is required, jurists seek consensus on rulings among Islamic scholars. In the event that none of these sources provides the necessary legal authority, a jurist may use reasoning by analogy and apply an accepted principle or assumption to arrive at a rule of law. Adapted from http://www.expertlaw.com/ library/family_law/islamic_custody.html (accessed 22 March 2008).
• Fund providers must share the business risk.
be conflicting views on the implementation of these
Providers of funds are not considered creditors
principles in designing and extending Islamic financial
(who are typically guaranteed a predetermined
rate of return), but rather investors (who share the rewards as well as risks associated with their investment). Islamic finance, however, extends beyond the ban of
Development of the Islamic Finance Industry Growth of Islamic Finance
interest-based transactions. Additional key financial principles include the following:
The global Islamic finance industry is rapidly growing. In the past 30 years, the industry has witnessed
• Material finality. All financial transactions must
the development of over 500 Sharia-compliant
be linked, either directly or indirectly, to a real
institutions, whose reach now spans 75 countries
economic activity. In other words, transactions
(KPMG 2006). These institutions include 292 banks
must be backed by assets, and investments may
(fully Islamic institutions and those institutions with
be made only in real, durable assets. This precludes
Islamic subsidiaries), 115 Islamic investment banks
the permissibility of financial speculation, and
and finance companies, and 118 insurance companies.
therefore, activities such as short selling are
Today, the industry’s total assets are estimated at
considered violations of Sharia.
US$500.5 billion (The Banker 2007).5
• Investment activity. Activities deemed inconsistent with Sharia, such as those relating to the
Since 2006, nearly 80 Islamic financial institutions
consumption of alcohol or pork and those relating
have been newly established or are being created
to gambling and the development of weapons of
(The Banker 2007). The 100 largest wholly Sharia-
mass destruction, cannot be financed. In broader
compliant banks have posted an annual asset growth
terms, Sharia prohibits the financing of any activity
rate of 27 percent, outpacing the 19 percent growth
that is considered harmful to society as a whole.
rate of their conventional counterparts (Kapur
• No contractual exploitation. Contracts are required
to be by mutual agreement and must stipulate exact terms and conditions. Additionally, all involved
Demand for Sharia-compliant investment portfolio
parties must have precise knowledge of the product
management is increasingly being met by Islamic
or service that is being bought or sold.
investment funds, which include private equity funds and approximately 250 Sharia-compliant mutual
The jurisprudence used to engineer Sharia-based
funds, with assets under management valued in
financial contracts is complex (see Box 1). Scholars
2006 at US$16 billion (Forte and Miglietta 2008). The
must complete several years of training before
Islamic bonds (sukuks)6 market is also growing since
becoming certified to issue financial rulings. The
Malaysia’s pioneering issuance of sukuks in 2001.
industry’s most prominent Islamic finance scholars
The size of the sukuk market in 2007 was estimated
are in general agreement on the basic set of financial
at US$47 billion, compared with US$10 billion in
precepts listed above. However, there is no centralized
2005 (AME Info 2008). The Islamic insurance market
Sharia finance authority, and consequently, there can
remains in its formative stage of development, with
5 Despite the rapid growth of Islamic finance, it remains a very small portion of the global market. While the largest Islamic bank, Bank Melli of Iran, has US$22 billion in assets, Mizuho Financial Group of Japan, the conventional banking industry’s largest bank, has total assets estimated at US$1.28 trillion. In fact, there are only six Islamic banks worldwide with assets exceeding US$10 billion. 6 Sukuks do not feature prominently in Islamic microfinance. For a discussion on sukuks, see Clifford Chance Limited Liability Partnership (2006).
Box 1. Basic Islamic Microfinance Contractsa The following are the most widely available types of Islamic microfinance contracts. Each can either operate individually or be combined with other contracts to create hybrid instruments.
maintenance, remains with the financier. An ijarah contract may be followed by a sale contract, in which event the ownership of the commodity is transferred to the lessee.
• Murabaha Sale (cost plus markup sale contract). The most widely offered Sharia-compliant contract is murabaha, an asset-based sale transaction used to finance goods needed as working capital. Typically, the client requests a specific commodity for purchase, which the financier procures directly from the market and subsequently resells to the client, after adding a fixed “mark-up” for the service provided. It is permissible for the financial institution to appoint the client as an “agent” on its behalf (by means of a contract) to directly procure the commodity from the market. However, ownership of the commodity (and the risk inherent thereto) strictly lies with the financier until the client has fully paid the financier. In most cases, clients repay in equal installments. The markup is distinct from interest because it remains fixed at the initial amount, even if the client repays past the due date. Among the primary conditions for a murabaha sale to remain Sharia-compliant are (i) the financier must own the commodity before selling it, (ii) the commodity must be tangible, and (iii) the client must agree to the purchase and resale prices.b
• Musharaka and Mudaraba (profit and loss sharing). The profit and loss sharing (PLS) schemes are the Islamic financial contracts most encouraged by Sharia scholars. Musharaka is equity participation in a business venture, in which the parties share the profits or losses according to a predetermined ratio. Musharaka can be used for assets or for working capital. Mudaraba denotes trustee financing, in which one party acts as financier by providing the funds, while the other party provides the managerial expertise in executing the project. In mudaraba, profits are shared according to a predetermined ratio; any losses are borne entirely by the financier. If the mudaraba joint venture results in a loss, the financier loses the contributed capital and the manager loses time and effort. Both PLS schemes require particularly vigilant reporting and a high level of transparency for profits and losses to be distributed justly. Consequently, though promoted strongly by Sharia, they result in substantial operating costs particularly for micro and small enterprises that are not accustomed to formal accounting.
• Ijarah (leasing contract). Ijarah is a leasing contract typically used for financing equipment, such as small machinery. Duration of the lease and related payments must be determined in advance to avoid any speculation. For the transaction to be considered Islamic (and not a sale with camouflaged interest), the ijarah contract must specify that the ownership of the asset, and responsibility for its
• Takaful (mutual insurance). The equivalent of Islamic insurance, takaful is a mutual insurance scheme. The word originates from the Arabic word “kafala,” which means guaranteeing each other or joint guarantee. Each participant contributes to a fund that is used to support the group in times of need, such as death, crop loss, or accidents. Paid premiums are invested in a Sharia-compliant manner to avoid interest.
a There is only one type of permissible “loan” according to Sharia, the Qard-Hassan (or Benevolent) Loan, which is interest-free and often considered a form of charity because it is typically forgiven in the event of default. All other mechanisms are better termed financing agreements, or contracts. However, for the purposes of this Focus Note, the term “loan” may be used to denote financing arrangements within the Sharia context. b Adapted from Khan (2008). c For a detailed discussion of takaful, see Maysami and Kwon.
Box 2. How Does Savings Work? Islamic savings products are deposits that are invested pursuant to the principles set forth in this paper. A typical savings product is a form of mudaraba, in which the saver “invests” her deposit in the business of a financial institution. The financial institution invests its managerial expertise and intermediates the deposits/ investments in a Sharia-compliant manner. Profits (or losses) are shared pursuant to prior agreement. Such
a savings arrangement also could be considered a form of musharaka because other depositors are also depositing funds for investment in the same financial institution. Even takaful can operate as a savings product because premiums are invested in a Shariacompliant manner and are often disbursed at the end of an agreed term, regardless of any insurance claim.
an estimated US$5 billion in premiums held in 2007
Northern Sudan, for example, adopted Sharia-
against a global insurance turnover of US$3.7 trillion
compliant regulatory frameworks for the entire
banking sector in 1984. Indonesia broke new ground in the realm of Islamic finance by creating in 1992 a
formal, regulated Sharia banking sector alongside, and not instead of, its conventional banking sector.7
Despite its origins in the Persian Gulf, Sharia-compliant
New regulations in Malaysia, Brunei, and Pakistan also
banking has proved popular with Muslims in other
have supported the expansion of an Islamic finance
countries as well, leading to the development of new
industry alongside conventional financial services.
Islamic banks across North Africa and Asia. Of the total US$500.5 billion global Islamic finance market,
A second regulatory approach has been to address
36 percent is located in the Gulf Cooperation Council
the growth of Islamic finance by separately regulating
(GCC) countries (Bahrain, Kuwait, Oman, Qatar, Saudi
unique aspects of Islamic banking, such as Sharia
Arabia, and UAE), 35 percent in non-GCC Southwest
Supervisory Boards (SSBs). For example, several
Asia and North Africa, and 23 percent in Asia (primarily
countries (such as Kuwait, Jordan, Lebanon, and
Malaysia, Brunei, and Pakistan) (The Banker 2007).
Thailand) have regulated the competence and composition of SSBs, as well as related rules governing
Over time, Islamic financial services also have
appointment, dismissal, and qualifications of SSB
expanded well beyond the Muslim world and are
members (Grais and Pellegrini 2006). However, no
offered not only by Islamic banks, but also by Islamic
country is known to regulate the Sharia jurisprudence
subsidiaries of international financial institutions.
to be used by SSBs in judging Sharia compliance
Islamic financial services are currently provided in
(though countries like Jordan and Kuwait do impose
countries such as India, China, Japan, Germany,
SSB member unanimity or majority vote requirements)
Switzerland, Luxembourg, the United Kingdom, the
(Grais and Pellegrini 2006).
United States, and Canada. The United Kingdom, which currently ranks tenth in The Banker’s listing
of “Top 15 Countries by Sharia-compliant Assets” (2007), has recently announced its aim to make
In parallel with increased attention by regulatory
London a global center for financial markets in the
authorities, international organizations also have
been created to set Islamic finance accounting and other standards:
Government Regulation • The Islamic Financial Services Board (IFSB), based Islamic financial services originally operated in an
in Malaysia, issues prudential standards and
unclear regulatory landscape. However, as they
guiding principles for Islamic finance. IFSB has
expanded, they presented several regulatory
issued guidelines on risk management and capital
challenges that governments have attempted to
adequacy for Islamic banks.
address to various degrees.
• The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), based in
One approach has been to proactively encourage,
Bahrain, promotes financial reporting standards for
even mandate, Islamic financial services by law.
Islamic financial institutions.
7 Decree No. 72 (1992) concerning Bank Applying Share Base Principles.
• The Islamic Development Bank (IDB), a multilateral
• More than 60 percent of low-income survey
body headquartered in Saudi Arabia, fights poverty
respondents in the West Bank and Gaza claim a
and promotes economic development in Islamic
preference for Islamic products over conventional
country members. It promotes microfinance and
products. More than half of such respondents
poverty alleviation programs through its Islamic
prefer such products even if they come at a higher
Solidarity Fund for Development (ISFD), which
price (PlaNet Finance 2007).9
recently committed US$500 million to microfinance
• In Jordan, studies by USAID (2002) and IFC/FINCA
development through its Microfinance Support
(2006) show that 24.9 percent and 32 percent,
respectively, of those interviewed cite religious reasons for not seeking conventional loans. The
Despite a shared core of Islamic values, these
IFC/FINCA study also showed that 18.6 percent
institutions often diverge with national regulators
of those interviewed rank religious reasons as the
(and each other) over Sharia standards. For example,
single most important factor in their decision on
AAOIFI standards are mandatory in only a handful of countries and are selectively implemented elsewhere (Islamic Banking & Finance 2008).
obtaining a loan. • In Algeria, a 2006 study revealed that 20.7 percent of microenterprise owners do not apply for loans primarily because of religious reasons (Frankfurt
School of Finance and Management 2006). • In Yemen, an estimated 40 percent of the poor
demand Islamic financial services, regardless of price.10
Conventional microfinance products have been
• In Syria, a survey revealed that 43 percent of
very successful in Muslim majority countries. One
respondents considered religious reasons to be
of the earliest microfinance programs originated in
the largest obstacle to obtaining microcredit. In
Bangladesh with the experience of the Grameen Bank
addition, 46 percent of respondents who had never
initiated by Nobel Prize winner Mohammed Yunus.
applied for a loan stated that religious reasons were
Islamic countries, such as Indonesia and Pakistan, have a
the primary reason they had never applied. Nearly
vibrant microfinance industry; approximately 44 percent
5 percent of current borrowers said they would not
of conventional microfinance clients worldwide reside
apply for another loan for religious reasons (IFC
in Muslim countries. Yet, conventional microfinance
products do not fulfill the needs of many Muslim clients. Just as there are mainstream banking clients
In addition to the IFC–commissioned studies, a 2000
who demand Islamic financial products, there are
Bank Indonesia report indicated that 49 percent of
also many poor people who insist on these products.
the rural population of East Java considers interest
Indeed, Sharia compliance in some societies may be
prohibited and would prefer to bank with Sharia-
less a religious principle than a cultural one—and
compliant financial institutions.
even the less religiously observant may prefer Shariacompliant products.
Although there is a market of poor clients who strictly engage in Islamic transactions, there is also
A number of IFC-commissioned market studies suggest
a category of Muslim clients who use conventional
a strong demand for Islamic microfinance products:
products but prefer Islamic ones. Microfinance
8 Based on figures provided by the Microfinance Information eXchange. 9 Thirty-five percent of West Bank respondents and 60 percent of Gaza Strip respondents stated that they do not access finance because of the Islamic prohibition on interest. 10 Phone interview with executive director of the National Microfinance Foundation, Yemen.
practitioners11 in Muslim-majority countries indicate
arrangements for offering Islamic microfinance:
that in Afghanistan, Indonesia, Syria, and Yemen,
via (i) the creation of Islamic microfinance banks,
some conventional microborrowers tend to switch
(ii) Islamic banks, (iii) conventional banks, and (iv)
over once Islamic products become available.
conventional microfinance banks. The guidelines set forth requirements regarding licensing, appointment
Anecdotal evidence, however, suggests that survey
of Sharia advisers to rule on Sharia compliance, and
respondents may verbally express a preference for
segregation of Islamic product funds (and related
Islamic products simply to demonstrate piety or
documentation) by banks and MFIs that offer both
(when given a choice in practice) will opt for a lower
conventional and Sharia-compliant products.12
priced conventional product. Consequently, despite indications of demand for Islamic microfinance products, further research is needed to ascertain the
Banks Downscaling and Expanding Product Line
nature and extent of the demand and how to meet this demand in a cost-effective manner.
An encouraging development in the growth of Islamic microfinance is that Islamic commercial banks have
Government Promotion of Islamic Microfinance
started to offer Islamic microfinance services. Yemen’s Tadhamon Islamic Bank, for example, opened a micro and small enterprises division in late 2006 (IFC
As in the case of the larger Islamic banking industry,
2007a). In addition, some Islamic banks are planning
government regulation can play a significant role in
to offer Islamic microfinance products beyond just
the expansion of Sharia-compliant microfinance.
microcredit. On 20 January 2008, Noor Islamic Bank and Emirates Post Holding Group announced plans to
Indonesia. In Indonesia, the government has actively
establish a company that will offer Sharia-compliant
promoted Islamic microfinance. In 2002, Bank
banking services to the low-income segment of
Indonesia prepared a “Blueprint of Islamic Banking
the UAE population. The proposed company will
Development in Indonesia” in which it developed
provide a wide array of Islamic microfinance products,
a nine-year plan for development of the Islamic
including microcredit, insurance, debit and credit
finance sector, including support for the 105 Sharia
cards, remittance and currency exchange, and salary
rural banks. Indonesia now provides a supportive
payments (Emirates News Agency 2008). Also in
regulatory framework and has licensed 35 new Islamic
January 2008, Allianz Life Indonesia announced that,
rural banks in the past five years. Bank Indonesia
after an 18-month pilot project, the Sharia-compliant
also is spearheading efforts in capacity building by
microinsurance “Family Umbrella” product is now an
establishing a center in Medan to offer training and
certification on Islamic financial operations to Sharia rural bank staff, managers, and directors.
Islamic Microfinance: CGAP Survey Results
Pakistan. The State Bank of Pakistan, which already has a legal and regulatory framework in place for
CGAP conducted a global survey on Islamic
conventional MFIs, also developed guidelines in
microfinance in 2007, collecting information on over
2007 for the rapid expansion of Islamic microfinance.
125 institutions and contacting experts from 19
The guidelines stipulate four types of institutional
Muslim countries. This section presents the principal
11 These practitioners include FINCA (Afghanistan), German Technical Cooperation (Indonesia), Sanadiq in Jabal-al-Hoss (Syria), Social Fund for Sustainable Development (Yemen), and Hodeidah Microfinance Program (Yemen). 12 Guidelines for Islamic Microfinance Business for Financial Institutions (Annexure to Circular No. 05 of 2007), State Bank of Pakistan Islamic Banking Department, available at http://www.sbp.org.pk/ibd/2007/Annex-c5.pdf.
Box 3. What About Iran? The Iranian government requires all of its commercial banks to provide Sharia-compliant noninterest bearing loans to the low-income population. Typically, these loans are disbursed to cover personal expenses, such as wedding expenses, repayment of outstanding debts, home rental and repair costs, medical expenses, tuition fees, and the purchase of consumer goods. Outreach is very significant and, as of March 2008, the Central Bank of Iran estimated that 3 million families benefit from approximately 6,000 Qard-Hassan institutions (“benevolent loan funds” known in Iran as Qarzul-Hassaneh Funds), with a total outstanding loan amount of 50 trillion rials (or US$5.5 billion). However, Qarzul-Hassaneh Funds are most often considered charities, and not MFIs, because loans
are typically (i) made for large one-time expenditures and (ii) forgiven in the event of default. They are not generally considered to provide access to finance in a sustainable manner. Outside the Qarzul-Hassaneh Funds, microfinance in Iran is informal, though a number of originally charitable organizations have reportedly started microfinance operations. These organizations have been registered by the Ministry of Interior and are outside the scope of Central Bank regulation. Consequently, statistics on Iranian microfinance and Qarzul-Hassaneh Funds are not reflected in this Focus Note.
findings of this first global survey on the performance
by the CGAP survey is only 2,400 clients (and none
and outreach of Islamic microfinance.
has more than 50,000 clients).
The supply of Islamic microfinance is very concentrated in a few countries. Indonesia, Bangladesh, and Afghanistan
The outreach of Islamic finance is very limited.
account for 80 percent of the global outreach of Islamic
According to the CGAP survey, Islamic MFIs13 reach
microfinance. In all other countries, microfinance is still
300,000 clients through 126 institutions operating in
in its infancy, with no scalable institutions reaching
14 countries and an estimated 80,000 clients through a
clients on a regional and national level.
network of Indonesian cooperatives. According to the survey, Bangladesh has the largest Islamic microcredit
For most countries, the average Islamic microloan
outreach, with over 100,000 clients and two active
amount (with respect to primarily the murabaha
institutions. However, Bangladesh is also the country
product) is similar to conventional microloans.
where conventional microfinance products have the
There are notable exceptions, however, such as in
largest outreach—nearly 8 million borrowers—and
Indonesia (where the average Islamic product loan size
Islamic microfinance represents only 1 percent of its
is 45 percent higher than the average conventional
microloan)15 and in the West Bank and Gaza.
In all Muslim countries, Islamic microfinance still
Like conventional microfinance, Islamic microfinance
accounts for a very small portion of the country’s
tends to focus on female clients—a majority of
total microfinance outreach. For example, in Syria and
Islamic MFI clients according to the CGAP survey
Indonesia, Islamic financing instruments comprised
were women (59 percent on average, but up to 90
only 3 percent14 and 2 percent, respectively, of
percent in Bangladesh). Overall, the percentage of
outstanding microfinance loans in 2006. In addition,
female clients using Islamic microfinance products (59
the average outreach of the 126 institutions covered
percent) is comparable to those using conventional
13 The term “Islamic MFI” in this Focus Note refers to any institution offering Islamic microfinance services and not just to Islamic institutions. 14 Sanabal Microfinance Network data. 15 Microfinance Information eXchange.
Table 1. Outreach of Islamic Microfinance, by Country Region
# of Included Institutions
% Female (Avg.)
Total # of Clients
Avg. Loan Balance (US$)
Total Outstanding Loan Portfolio (US$)
West Bank and Gaza**
* Micro and rural banks only. **There were seven MFIs in the West Bank and Gaza that offered, with the help of training and funding facilities offered by the Islamic Development Bank, a total of 578 Islamic loans between 2005 and 2006. Data on only one of these seven are displayed in the table because the remaining six MFIs were disbursing Islamic loans with average loan sizes higher than 250 percent of the region’s gross domestic product per capita.
microfinance products (65.7 percent globally, and 65.4
was provided by the Deprived Families Economic
percent in the Arab world) (Microfinance Information
Empowerment Program). The table excludes the
outreach of Indonesia’s 4,500 Islamic cooperatives. However, according to experts in Indonesia, only 60
Finally, the CGAP survey identified that over 70
percent of these Islamic cooperatives are still active,
percent of the products offered are murabaha. Islamic
and their total outreach is estimated at 80,000 clients.
MFIs generally offer only one or two Sharia-complaint
As in the rest of this Focus Note, an MFI is defined as
products. Concentrating primarily on asset financing,
an institution targeting the poor and whose average
the industry still lacks product diversification to serve
loan size is less than 250 percent of the country’s
the various financial needs of the poor.
gross domestic product per capita.
Table 1 includes the outreach data of only the
Islamic Microfinance by Institution Type
institutions that CGAP was able to contact during its survey, except with respect to those institutions in
Among the institutions that offer Islamic microfinance
Indonesia (about which information was obtained from
products, nongovernment organizations (NGOs) are
the Indonesian Central Bank’s 2007 Statistics) and in
the dominant players in reaching the largest number
the West Bank and Gaza (about which information
of clients, with just 14 institutions reaching 42 percent
Table 2. Outreach of Islamic Microfinance, by Institution Type Total # of Clients Institution Type
# of Institutions
% of Total
Total Outstanding Loan Portfolio (Islamic) US$
% of Total
Avg. Loan Size (Islamic) US$
Village Bank (Syria)
NGO Rural Bank (Indonesia) NBFI Commercial Bank TOTAL
Note: This table reflects the data of only those institutions (mixed and fully Islamic) that provided reliable outreach information to CGAP during its 2007 global survey of Islamic microfinance. Data regarding the 105 rural banks in Indonesia were obtained from the Indonesian Central Bank’s 2007 Statistics. This table excludes data on the outreach of Indonesia’s 4,500 cooperatives. As in the rest of this Focus Note, an MFI is defined as an institution targeting the poor and whose average loan size is less than 250 percent of the country’s gross domestic product per capita.
of clients. Commercial banks (represented by only
BPRSs are more socially oriented than BPRs. Their
two institutions: Yemen’s Tadhamon Islamic Bank
mission statement calls for supporting the community
and Bangladesh’s Islami Bank Bangladesh Limited)
and, in particular, microentrepreneurs. They also have
have the second largest outreach with over 87,000
strong links with Indonesian Muslim mass movements,
clients. Interestingly, 105 Sharia-compliant rural banks
such as Nahdlatul Ulama or Mohammedia. Each
in Indonesia account for 25 percent of total clients, but
BPRS has a Sharia board to monitor the conformity
62 percent of the outstanding loan portfolio because
of products to Islamic principles. However, board
of their significantly higher average loan size and focus
rulings are not consistent, and consequently, Islamic
on small and microenterprise financing.
microfinance products can vary widely depending on the specific BPRS. BPRSs primarily offer murabaha
Focus on Indonesia
products and savings services based on a revenuesharing model.16 They have been quite successful at
Indonesia gives insight into the development of Islamic
mobilizing savings for the community, and their loan-
microfinance because of its dual conventional/Islamic
to-deposit ratio is over 110 percent.
microbanking system, which includes both conventional rural banks (Bank Perkreditan Rakyat or BPRs) and
It is impossible to draw general conclusions on the
Sharia-compliant rural banks (Bank Perkreditan Rakyat
performance of Islamic MFIs based only on the limited
Syariah or BPRSs). BPRSs are privately owned and are
case of Indonesian BPRSs. Nevertheless, BPRSs offer
regulated and supervised by Bank Indonesia. They are
some insights on profitability and efficiency.
licensed to offer banking services (loans and savings facilities, but no payments services) in a district area
Higher costs. The average operational efficiency ratio
only. As of December 2006, there were 1,880 BPRs
of BPRSs is 20 percent—higher than the 15 percent
and 105 BPRSs.
operational efficiency ratio for conventional BPRs.
16 This savings product is a form of mudarabah (see Box 1) in which the depositor acts as “financier.”
Table 3. Financial Performance of Indonesian MFIs Compared to Small Asian MFIs
Number of Institutions
Average Total Assets (US$)
Average Outstanding Loan Portfolio (US$)
PAR > 30 days
Operational Efficiency Ratio
Sharia Rural Banks (BPRSs) Conventional Rural Banks (BPRs) Small Asian MFIs
Source: Bank of Indonesia (2007a). Operational Efficiency figures are based on BPRs in North Sumatra (Microfinance Innovation Center for Resources and Alternatives).
The difference may reflect the higher transaction
the ROA of BPRs (2.2 percent). However, the range
costs inherent in certain Sharia-compliant products.
for both was wide, with several being very profitable
BPRSs are mainly engaged in murabaha, which incurs
and others not breaking even. BPRSs are still young
the expense of first procuring the commodity to be
institutions without a proven track record. It is too
later resold and the expense of managing its resale
early to draw conclusions about BPRS profitability;
through the murabaha contract. However, although
however, several factors might explain a lower ROA,
overall transaction costs are higher, the extra cost to
including the social mission of BPRSs.
the customer may be offset by wholesale prices and the related saving of time otherwise spent selecting
BPRSs are meeting a growing demand for Sharia-
suppliers and negotiating contract terms. Both BPRs
compliant microfinance products. Their rate of growth
and BPRSs do not compare well with their closest
has been impressive: from March to December 2007,
“peers”—small MFIs in Asia —as far as operational
these banks’ murabaha receivables increased by
efficiency is concerned. This could be due to a number
26 percent, musharaka financing increased by 27
of factors, including average loan size, cost structure,
percent, and mudaraba financing increased by almost
and staff productivity.
50 percent (Bank of Indonesia 2007b). BPRSs can be profitable but nevertheless, like many microfinance
Elevated portfolio delinquency, but improving over
providers, they face several challenges in reaching
time. The average portfolio at risk (PAR) at 30 days for
sustainable scale (see Box 4).
both BPRs and BPRSs are comparable at approximately 9 percent—high by microfinance standards. By comparison, small Asian MFIs have a PAR at 30 days
Possible Challenges to the Growth of Islamic Microfinance
of 1.9 percent. But over time, late payments seem to be recovered and long-term loss (defined as payments
Islamic microfinance could potentially expand access
more than 180 days overdue) for BPRSs is reported
to finance to unprecedented levels throughout the
at 3.1 percent.18 Consequently, portfolio delinquency
Muslim world. However, the industry has yet to
does not generate significant long-term loss.
demonstrate it can provide financial services that meet the needs of poor people on a large scale. A
Lower return on assets (ROA). The average ROA for
deeper base of market research and proven business
BPRSs was 1.4 percent in 2006, significantly lower than
models are very much needed. Nevertheless, several
17 As identified in the MicroBanking Bulletin (2007). 18 Statistik Perbanken Syariah (Islamic Banking Statistics), Bank Indonesia (Direktorat Perbanken Syariah), December 2007.
Box 4. A Tale of Two Islamic Microfinance Banks BPRS Wakalumi in Ciputat, was established in 1990 by a foundation (Yayasan Wakalumi) as a conventional BPR; for religious reasons, it converted into a BPRS in 1994. It has 118 shareholders, among them Bank Muamalat Indonesia (19 percent, down from 49 percent), the former Minister of Cooperatives (23.5 percent), a Citibank manager (26 percent), the founding foundation Yaysan Wakalumi (5.6 percent), and more than 100 individuals, mostly Muslims working at Citibank.
2003 of 4.1 percent, 3.65 percent, and 3.35 percent and ROEs of 20.3 percent, 21.05 percent, and 24.1 percent, respectively, it is highly profitable.
The bank seems to have a successful staff promotion strategy: the president director, with a bachelor’s degree in agriculture, has been with the bank since 1994, learning on the job and being promoted up the ranks; the director, a woman with a diploma in accounting, has been an employee since 1997 and was promoted to director in 2003. The bank has grown rapidly, and now has five branches and a staff of 38, including 13 loan officers.
The bank, located next to a local market, has 1,150 savers and 163 clients. With a staff of 11, including six loan officers, it offers doorstep collection services to about 200 clients a day. It also offers deposit services to school children and institutions. Total assets are IDR 1.4 billion, deposits total IDR 0.62 billion, and financings outstanding equal IDR 1.21 billion.
Its 2,000 clients are mostly small traders on traditional markets, to whom it sells its financings as Islamic products. It has four financing products, with murabaha being the dominant one. Through eight savings products and four term deposit products, it has attracted 5,000 savers. With ROAs in 2001–
BPRS Artha Fisabililah, in Cianjur, was established in 1994 by nine shareholders. By 1997, as a result of lack of management experience, it was technically bankrupt and was restructured. The new management was not very dynamic and was replaced in 2001 by a retired bank credit officer.
Its overall performance is not yet satisfactory. Its main problem is lack of funds, because of a shortage of deposits and capital from the owners. The bank was in the black for the years 2001, 2002 and 2003, with ROAs of 2.3 percent, 1.7 percent, and 2.4 percent and ROEs of 7 percent, 4.3 percent, and 8.75 percent, respectively. Its main future strategy to improve efficiency is staff upgrading through training.
Source: Adapted from Seibel (2007).
possible challenges to scale up Islamic microfinance
poor. Managing small transactions is expensive, and
can be identified.
MFIs must innovate to reduce transactions costs. In murabaha or ijara transactions, the provider of
Building Sustainable Business Models
funds purchases a commodity (such as equipment or inventory) and resells or leases it to the user with
Islamic microfinance business models are still
a markup. Islamic MFIs may benefit from cheaper
being developed and no performance benchmarks
prices on the wholesale market, but the costs
have been established. However, two areas are of
associated with purchasing, maintaining, selling, or
particular importance: operational efficiency and risk
leasing a commodity (such as a sewing machine) are
expensive, and the added costs are often passed on to clients. However, some institutions have cut
• Operational efficiency. Operational efficiency is
their costs in murabaha transactions by requiring
key to providing affordable financial services to the
the end user to search for and identify the desired
commodity. Islamic institutions should consider
financial experts and Sharia experts on product
developing similarly novel techniques and practices
authenticity, (ii) encourage exchange of experiences
to minimize costs and offer more attractive pricing
among religious leaders (particularly those serving
to their clients.
poor populations at the local level) relating to Sharia
• Risk management. Risk management is another
compliance of microfinance products, and (iii) educate
important factor to building sustainable institutions.
low-income populations, in collaboration with local
The conventional microfinance industry has
religious leaders, on how financial products comply
developed a set of good practices to manage credit
with Islamic law.
risk, and MFIs boast excellent portfolio quality.19 Conventional MFIs generally do not secure loans
through collateral but instead rely on peer pressure and strict discipline for collection. Such techniques
Capacity building is needed at all levels to realize
should be adapted to comply with the risk-sharing,
the full potential of Islamic microfinance. At the
and no-interest principles embedded in Islamic
macro level, the Islamic Development Bank and
finance. For example, some suggest that pressure
Islamic financial standard setters (such as IFSB or
from the religious community and appeals to a
AAOIFI) should consider developing global financial
sense of religious duty should complement reliance
reporting standards adapted to microfinance to
on peer pressure.
build the infrastructure for transparency in the global Islamic microfinance sector. This infrastructure
The Question of Authenticity
would entail comprehensive disclosure guidelines on Islamic microfinance accounting principles, pricing
Although there is ample evidence of demand for
methodologies, financial audits, and eventually, rating
Islamic microfinance products, meeting such demand
requires that low-income clients are comfortable that the products offered are authentically Islamic. Critics
At the micro and institutional levels, international
of Islamic finance products suggest that the pricing
donor agencies can play a major role in expanding
of some products offered as Sharia-compliant too
access to finance in Muslim countries by helping
closely parallels the pricing of conventional products.
existing institutions reach scale and funding pilot
For example, some institutions offer murabaha where
projects testing various business models. In addition,
interest appears to be disguised as a cost markup or
more efforts should be made to train Islamic MFI
administration fee. Islamic finance sometimes suffers
managers and staff through, for example, the
from the perception that it is simply a “rebranding”
development of operational tools and manuals (such
of conventional finance and not truly reflective of
as those developed by Deutsche Gesellschaft für
Technische Zusammenarbeit for use in Indonesia).
Consequently, low-income populations, who often
rely on local religious leaders to address questions of religion, must be convinced of the authenticity
Islamic MFIs rely heavily on the murabaha (cost plus
of Islamic financial products if Islamic microfinance
markup sale) product.20 However, poor people have
is to reach its full potential. Greater efforts should
diverse financial requirements, and for many, savings
be explored to (i) increase collaboration between
or housing products may be more urgent needs. The
19 The 1,200 MFIs reporting to the Microfinance Information eXchange report an average PAR at 30 day is less than 5 percent. 20 The murabaha sale is the sole product of 34 percent of the MFIs operating in Northern Sudan. In addition, as of December 2006, murabaha sales accounted for 62.3 percent of the outstanding portfolio of Indonesian Islamic rural banks.
innovative design of a range of Sharia-compliant
tendency to view zakat (funds donated pursuant to the
products and services would provide greater financial
Muslim obligation to pay alms) as a source of funding.
access to a broader segment of Islamic microfinance
Indeed, given the underlying principle of Islamic
finance to promote the welfare of the community, zakat funds appear ideally suited to support Islamic
Leveraging Zakat and Islamic Funds
microfinance. However, a heavy reliance on charity is not necessarily the best model for the development
Throughout the Muslim world, microfinance (Islamic
of a large and sustainable sector, and more reliable,
or otherwise) is still seen as a philanthropic activity
commercially motivated streams of funding should
rather than a business enterprise. Consequently, in
the context of Islamic microfinance, there is a growing
Grais, Waifk, and Matteo Pellegrini. 2006. Corporate Governance in Institutions Offering Islamic Financial Services. World Bank Policy Research Working Paper
AME Info. 2008. “Sukuk Issuances Continue to Rise
4052. Washington, D.C.: The World Bank, November,
Despite Slowdown.” AME Info, February. http://www.
ameinfo.com/147369.html. Accessed 4 April 2008. Honohon, Patrick. 2007. “Cross-Country Variations in Bank of Indonesia. 2007a. Indonesian Banking
Household Access to Financial Services.” Presented
Statistics, Volume 5, no. 12 (November).
at the World Bank Conference on Access to Finance, Washington, D.C., 15 March.
Bank of Indonesia. 2007b. Statistik Perbanken Syariah (Islamic Banking Statistics). Bank Indonesia (Direktorat
IFC and FINCA. 2006. Business Plan for a Microfinance
Perbanken Syariah), December.
Institution in Jordan. Commissioned by IFC and FINCA, 26 September, Table C.16.
Clifford Chance Limited Liability Partnership. 2006. Introduction to Sukuk: Client Briefing. London,
IFC. 2007a. Assessment of MSE Financial Needs
United Kingdom: Clifford Chance Limited Liability
in Yemen Final Report. Washington, D.C.: IFC/The
World Bank, December.
Decree No. 72. 1992. Concerning Bank Applying
IFC. 2007b. Syria Microfinance Market Assessment,
Share Base Principles.
Draft Report. Washington, D.C.: IFC/The World Bank, November.
Emirates News Agency. 20 January 2008. http://www. ameinfo.com/144233.html.
Islamic Banking & Finance. 2008. “Rocked to the Foundations.” Islamic Banking & Finance
Expertlaw.com. 2008. http://www.expertlaw.com/
library/family_law/islamic_custody.html. Accessed 22 March.
Kapur, Suchita. 2008. “Islamic Banks Post 26.7% Growth Rate.” Emirates Business 24/7, 24 March.
Forte, G., and F. Miglietta. “Islamic mutual funds as faith-based funds in a socially responsible
Khan, Ajaz Ahmed. 2008. “Islamic Microfinance
context,” University of Milan. http://www.failaka.
Theory, Policy, and Practice,” Islamic Relief,
Accessed 7 April 2008. KPMG. 2006. Making the Transition from Niche to Frankfurt School of Finance and Management
Mainstream. Financial Advisory Services.
(Bankakademie International). 2006. Access to Finance Study in Algeria, Final Report. Frankfurt: Frankfurt
Maysami, Ramin Cooper, and W. Jean Kwon. “An
School of Finance and Management, July.
Analysis of Islamic Takaful Insurance—A Cooperative Insurance Mechanism.”
Microfinance Information eXchange. 2007a. “How
State Bank of Pakistan Islamic Banking Department.
Many MFIs and Borrowers Exist?” Washington, D.C.:
2007. Guidelines for Islamic Microfinance Business
Microfinance Information eXchange, September.
for Financial Institutions. (Annexure to Circular No. 05 of 2007.) State Bank of Pakistan Islamic Banking
MicroBanking Bulletin, Issue 15 (Autumn):58.
PlaNet Finance. 2007. Microfinance Market Survey
The Banker. 2007. Top 500 Financial Islamic
in the West Bank and Gaza Strip. Washington, D.C.:
Institutions Listing. 5 November.
PlaNet Finance, May. Zawya. 2008. “Takaful Has Miles to Go.” http://www. Seibel, Hans Dieter. 2007. “Islamic Microfinance in
Indonesia: The Challenge of Institutional Diversity,
Accessed 4 April 2008.
Regulation and Supervision.” Presented at Harvard Law School Symposium Financing the Poor: Toward an Islamic Micro-Finance, 14 April.
No. 49 August 2008
Please share this Focus Note with your colleagues or request extra copies of this paper or others in this series. CGAP welcomes your comments on this paper. All CGAP publications are available on the CGAP Web site at www.cgap.org. CGAP 1818 H Street, NW MSN P3-300 Washington, DC 20433 USA Tel: 202-473-9594 Fax: 202-522-3744 Email: [email protected]
© CGAP, 2008
The authors of this Focus Note are Nimrah Karim; Michael Tarazi, senior policy specialist, CGAP; and Xavier Reille, lead microfinance specialist, CGAP. The authors would like to thank the following for their help in producing this Focus Note: Matthias Range, Mohammed Khaled, Samer Badawi, Wafik Grais, Meynar
Sihombing, Hans Dieter Seibel, Syed Hashemi, Steve Rasmussen, Deepak Khana, Momina Aijazuddin, Kate McKee, Ignacio Mas, Jeannette Thomas, the Sanabel Microfinance Network, the Islamic Development Bank, the Islamic MFIs, and all other institutions participating in the CGAP survey.
CGAP publications are frequently cited in other works. The suggested citation for this paper is as follows: Karim, Nimrah, Michael Tarazi, and Xavier Reille. 2008. “Islamic Microfinance: An Emerging Market Niche.” Focus Note 49. Washington, D.C.: CGAP, August.