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Introduction to Microfinance and Riba

By:   •  November 23, 2017  •  Term Paper  •  5,019 Words (21 Pages)  •  1,097 Views

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Introduction

Definitions of microfinance have been given by many authors, such as The Consultative Group to Assist the Poorest or CGAP in Mukherjee (1998), Seibel and Khumar (1998), Khan (2008), and Obaidullah (2008). Microfinance can be defined as provision of financial products and/or services (such as, micro-credit, micro-savings, micro-equity, micro-transfers and micro-insurance) in sustained manner to the poor, marginalized people and/or low-income people whose low economic standing excludes them from formal financial systems. Microfinance helps many people in Malaysia and across the globe to lift themselves out of poverty by providing small loans to those lacking access to traditional financial services or funding opportunities. Microfinance institutions (MFIs) have grown popular over the past few decades because they offer impoverished people access to funds that can be used to develop small businesses that can then provide regular income, and they provide financial resources to underserved markets. As such, microfinance is an important tool not just to minimize the impacts of poverty, but also to promote business development.

Microfinance (MF) has seen rapid growth over the last three decades as it is fundamentally designed to serve the financing needs of the non-bankable who lack access to financial services. Microfinance (MF) is considered an effective method in poverty reduction, income enhancement, health and education improvement. According to the Asian Development Bank (ADB), Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and their microenterprises. It is widely believed that MF is the most effective tool in poverty. The World Bank announced 2005 as the year of microfinance. Moreover, microfinance has been recognized by the United Nations as the key factor for sustainable development, economic growth, and the most efficient tool to alleviate poverty.

Microfinance products and services are usually provided by microfinance institution (MFI), which includes a wide range of providers that vary in their legal structure, mission, and methodology. However, all share the common characteristic of providing financial services to clients who are poorer and more 3 vulnerable than traditional bank clients. An MFI can operate in the form of a commercial bank, rural bank, credit union, cooperative, other non-bank financial institution (NBFI), development organization, or non-government organization (NGO).

Typically, the characteristic features of microfinance programs are as follows:

• Loans are usually relatively short term, less than 12 months in most instances, and generally for working capital with immediate regular weekly or monthly repayments, they are also disbursed quickly after approval, particularly for those seeking repeat loans.

• The traditional lender’s requirements for physical collateral such as property are usually replaced by a system of collective guarantee (or solidarity) groups whose members are mutually responsible for ensuring that their individual loans are repaid.

• Loan application and disbursement procedures are designed to be helpful to low income borrowers and simple to understand, locally provided and quickly accessible.

Islamic Microfinance

Islamic microfinance is one of Islamic approaches to alleviate and eradicate poverty, so that the main target is not only the poor, but more importantly is the poorest of the poor, which has always been left out by mainstream microfinance. In Islam, poverty is in conflict with one of the primary objectives of Shariah, namely, “enrichment of self (nafs)”. Moreover, Islamic jurists have unanimously held the view that it is the collective obligation (fardu kifayah) of a Muslim society to take care of the basic needs of the poor. According to Obaidullah (2008), principles of Islamic approach to poverty alleviation includes:

  1. Compulsory charity (zakat) and voluntary charity (sedekah waqaf)

Zakat is the third among five pillars of Islam. Meanwhile, sedekah in general is encouraged in Islam. Therefore, charity plays a central role in Islamic scheme of poverty alleviation and eradication, especially for the poorest of the poor.

  1. Economic empowerment

Islam encourages people and nation to be independent (including financial independent). A famous Hadith of Sunan Abu Dawood, Kitab al-Zakah, Book 9, Number1637 explains, step-by-step, how to design and implement a strategy of poverty alleviation through economic empowerment (Obaidullah, 2008).

  1. Debt avoidance

Islam teaches Muslims to abstain from wasteful and luxurious living and live within their means, so that debt should be avoided, although it is not prohibited.

  1. Family cohesiveness

Islam gives utmost importance to family as nucleus social institution that plays a major role in shaping the future of mankind. Obaidullah (2008) adds that Islam also sees a balanced role for men and women in ensuring the economic and social well-being of the family.

Interest (Riba)

There are a number of illegal ways people make money today. People are also involved with a variety of immoral acts for the same purpose. However, the extent of destruction for such illegal ways of making money and immoral acts are not of the same level of those related to interest. Interest is one kind of fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal. The rate depends on time, value of money, the credit, and risk of the borrower and the rate of inflation. From Islamic point of view, interest means effortless profit which is free of exchange. However, today interest is well-known to all of us and has become so institutionalized and accepted in modern economies that it is almost impossible to conceive that an economy can run without interest. Muslims are now constantly being forced with fragile arguments in support of dealing with interest. As a result, many Muslims have surrendered to such pressure and so- called rationale arguments, leading them to accept the concept of interest.

Problem Statement

 

What is the awareness level of our society regarding Micro Finance and interest in perspective to Islamic views?

Despite the many benefits, microfinance institutions face a range of challenges that limit their reach, especially in predominantly Muslim countries. One of the challenge is by providing microfinance services under sharia, or Islamic law, which restricts the charging of interest for loans. While conventional microfinance is successful in many Muslim countries. The problem now is we as a Muslim do not even know the appearance of riba in the microfinance in our country. Therefore, a study will be conducted in order to understand the awareness level of our society on Islamic microfinance and interest.

Concept of Islamic Microfinance and Riba

In conventional Microfinance, repayment is usually made soon after the loan is sanctioned and disbursed. Repayment also includes a necessary interest payment that is levied on the original amount of the loan. While in Islamic microfinance, where interest is strongly prohibited this might not be the case. Islamic microfinance use different instruments and repayment of microfinance differs under each of the Islamic Microfinance instrument. The following are the primary financing instruments used for the Islamic Microfinance initiative:

  1. Profit and Loss sharing Financing

This is a mutual agreement between the supplier of the capital and the entrepreneur, who are agreed to undertake a specific business project. In which one party is providing his capital in form of money and other party puts his efforts and knowledge to run the project. Both the parties are agreed to the profit sharing on a pre determined basis. But in case of loss, it is beard only by the supplier of the capital i.e. bank unless loss is incurred due to misconduct, negligence, or violation for the conditions mutually agreed by both parties. According to Akhtar 1997, “Profit and Loss form of financing is quite suitable for professionals, artisans, and entrepreneurs who have innovative ideas/plans but cannot implement them due to the shortage of financing”.

  1. Partnership Financing

This concept is similar to business partnership or joint venture with little difference that the profits earned from a project are shared on the basis of agreed ratio but in case of loss, it is borne by the both parties on the basis of equity participation. A specific proportion of profitability should be granted to client as the “management fee”. The remaining profit is to be distributed between the bank and the borrower i.e. client on the basis of funds invested by both the parties. The loss is also shared both by the bank and the client in respective of the nature of their contribution toward capital formulation. Profit and loss sharing ratio is pre-determined and thereafter cannot be changed. It can be either continuous partnership or diminishing partnership for a certain period of time for instance for 12 months. Then after passing the time frame of partnership, the share of the bank ends through repayment of the agreed price and the whole project goes within the vicinity and control of the client. Some measures that should be taken in order to ensure the proper practice of the partnership contract, these conditions are described hereunder. A separate bank account should be maintained for the joint venture. Project material should be kept in safe custody and withdrawals made on agreed basis to use it efficiently. Material purchased for the contract should be supported by invoices and bills and this should be limited to the quantities and types mentioned in the contract. The client is required to submit period reports showing detailed results of the operations. Sales revenues should be deposited in the venture specific bank account regularly and detail for such revenues should be properly recorded in the sales book i.e. books of accounts. Above all, client should give adherence to the dates specified for the initiation and liquidation of the project.

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