The conceptual framework for Islamic microfinance requires that the contracts and transactions between the multiple parties involved in the process are Shariah-compliant. Most importantly, they must not violate the prohibitions against riba and gharar. While there seems to be a consensus on the meaning of these prohibitions, there is less agreement on the interpretation and manifestation of the prohibited elements in real-life situations. Further, Shariah-compliance of the contracts in form in no way provides an insurance against exploitation. Several observations are in order.
1. Rates on micro-murabaha and micro-ijara financing are deemed Shariah-compliant while interest rates are not. However, both can be and often are exploitatively high.
2. In case of participatory modes e.g. mudharabah, musharakah and mudharaa the sharing ratio could be unfairly biased against the poor beneficiary because of their low bargaining power. Similarly, in case of fee-based modes, e.g. wakala, hawala the agent-MFI may charge an exorbitant fee for the same reasons.
3. The permissibility of salam (sale of non-existent produce) is linked to the economic benefits it confers on poor farmers in need of pre-cultivation financing. However, salam can often involve exploitation when the advance price paid to the poor farmer is artificially pegged at low levels due to his/her weak bargaining power.
4. For Islamic modes of finance involving multiple contracts, e.g. murabaha and ijara, Shariah compliance often requires careful sequencing of contracts to ensure that profits are associated with risk-bearing. However, in the context of microfinance involving large number of repetitive contracts involving small values, adherence to desired sequencing become practically impossible.
5. When MFIs price a benevolent transaction, e.g. qard and kafala (they are permitted to charge actual costs without any element of profits) they may actually be passing the costs of their inefficiencies to their beneficiaries.
6. When pawnshops provide qard that is backed by collateral or rahn and charge custodial fee from the borrower, it may well be a case of disguised riba, especially when the quantum of fee moves in direct proportion to quantum of loan.
A mechanism to redress the above undesirable possibilities may be found in the following:
1. Prudential regulation of markets to ensure healthy and adequate competition among the players and thereby, remove abnormal and/or illegal profits through mispricing.
2. Creative fiqhi solutions (for instance, replacement of murabaha with istijrar may bring in the required flexibility in settlement of repetitive transactions in microfinance)
3. Vigilance by Shariah scholars to prevent disguised riba (for instance, scholars may ensure that custodial fees are delinked from quantum of loan or that actual administrative costs recoverable from the beneficiary in qard are not overstated)
4. Identifying appropriate organizational structure (in case of earlier salam example, a farmer’s cooperative may replace the vendor and thus prevent exploitation of individual farmers by the latter)
Notwithstanding the varied nature of Islamic modes for microfinance, the fact remains that murabaha remains overwhelmingly popular among IsMFIs. Its popularity is attributable the following reasons:
1. Murabaha is simple. The straightforward calculation of the installments for repayment is more easily comprehensible by the beneficiary. In contrast to this, the payments under a partnership-based mode are uncertain and therefore, less favored.
2. In contrast, partnership-based modes are demanding on the part of the beneficiary in terms of the need for proper book-keeping and ascertainment of the financial results of the business. Financial illiteracy acts as a constraint. Further, the beneficiaries may be justifiably reluctant to share info relating to all aspects of their business with the MFI.
3. Murabaha is familiar. For conventional MFIs venturing into Islamic MF and using murabaha, the transition is least demanding. Among all Islamic products, murabaha comes closest to interest-bearing micro loans.
Mohammed Obaidullah | June 12, 2013