Enhancing Financial Inclusion through Islamic Finance, Volume I 3030399346, 9783030399344

Table of contents :
Preface
Acknowledgments
Contents
Notes on Contributors
List of Figures
List of Tables
Part I: Enhancing Financial Inclusion Through Islamic Finance
Chapter 1: Introduction
References
Chapter 2: Empowering the Poor and Enhancing Financial Inclusion from a Multidimensional Perspective
2.1 Introduction
2.2 Why Is Financial Inclusion So Important?
2.3 Property Rights and Economic Equality
2.4 Multidimensional Concept of Financial Inclusion
2.5 Financial Literacy and Access to Financial Services
2.6 Income and Wealth Redistributive Instruments
2.7 Development of Micro, Small, and Medium Enterprises
2.7.1 SME Capital Market Development
2.7.2 Crowdfunding and Social Impact Investor Platforms
2.7.3 Microfinancing Programs
2.7.4 Vocational Training Programs for the Poor and Disabled
2.7.5 Sound Regulatory, Supervisory, and Enforcement Framework
2.8 Adequate Metrics for Performance Measure
2.9 Behavioral Issues in Financial Decision-Making
2.9.1 Behavioral Approach to Financial Inclusion
2.10 Conclusion
References
Chapter 3: Causes of Income and Wealth Inequalities: Perspectives of Economists from the Fields of Conventional and Islamic Economics
3.1 Introduction
3.2 The Views of Economists from Conventional Economics on Inequality
3.2.1 The Views of the French Economist Thomas Piketty Concerning Inequality
3.2.2 The Views of Nobel Laureate Joseph Stiglitz Concerning Inequality
3.2.3 The Views of Positive Money Concerning Inequality
3.3 The Views of Muslim Economists on Inequality
3.3.1 The Views of Al-Ghazali Concerning Inequality and the Role of Interest (Riba)
3.3.2 The Views of Mufti Taqi Usmani Concerning Inequality
3.3.3 The Views of Mufti Muhammad Shafi Concerning Inequality
3.4 Comparison of the Above Views of the Conventional and Islamic Economists
3.5 Conclusion and Recommendations
Bibliography
Chapter 4: Contribution of Islamic Microfinance Studies in Achieving Sustainable Development Goals
4.1 Why Islamic Microfinance Studies Matter?
4.2 Studies on Research Mappings
4.3 MDGs and SDGs
4.4 ‘What Is Going on Here?’ Methodology
4.5 Mapping of Islamic Microfinance Studies
4.6 Conclusion and Recommendation
4.6.1 Recommendation
References
Chapter 5: Islamic Finance and Its Impact on Financial Inclusion
5.1 Introduction
5.2 Poverty and Financial Capability
5.3 Financial Inclusion
5.4 Financial Inclusion Through Risk-Sharing
5.4.1 Small-Medium Enterprises
5.4.2 Microfinance
5.4.3 Micro-Takaful
5.5 Financial Inclusion Through Redistribution Institutions
5.5.1 Sadaqah
5.5.2 Zakat
5.5.3 Qard al-Hasan
5.5.4 Waqf
5.6 Relation Between Financial Inclusion and Financial Capability
5.7 Propositions
5.8 Conclusion
References
Chapter 6: A Critical Review of Takaful Companies’ Contributions to Economic Developments in Fulfilment of Maqasid al-Sharı̄ʿah: Evidence from Malaysia
6.1 Introduction
6.2 Literature Review and Hypothesis Development
6.3 Methodology
6.4 Results and Discussion
6.5 Conclusion
References
Part II: Islamic Financial Inclusion: Cases and Modeling
Chapter 7: Making Islamic Finance a Vehicle for Social Inclusion: A Case for Revisiting the Liquidity Management Practices by Islamic Banks
7.1 Introduction
7.2 Learning the Lesson?
7.3 Strengths of Islamic Finance System
7.4 Islamic Finance as in Vogue—The Issue of Approach and Mindset
7.5 The Way to Achieving Social Inclusion through Islamic Finance
7.6 Liquidity Risk, Liquidity Management, and Its Tools
7.7 The Myth of Excess Liquidity with Islamic Banking Institutions
7.8 Islamic Banks’ Practices for Liquidity Management
7.8.1 Tawarruq/Commodity Murabaha/Sukuk Murabaha
Why Tawarruq to Be Excluded from IBIs’ Kitty?
7.8.2 Shari‘ah-Compliant Derivatives as Liquidity Management Tools
7.9 What Islamic Banks Need to Do for Liquidity Management?
7.10 Conclusion
Appendix
References
Chapter 8: Improving Access to Financial Services: Theory and Practice Around the Globe
8.1 Introduction
8.2 Causal Mapping of Theories of Economic Development
8.3 Understanding the Dynamics of Financial Inclusion—Practices from Different Parts of the World
8.3.1 The Farmers’ Cooperatives
8.3.2 Microfinance Institutions/Banks
8.3.3 Interest-Free Loans (Qarz-e-Hassan)
8.3.4 Social Networks at Work for Financial Inclusion in the UK
8.3.5 Financial Inclusion in India—Impact of Social Banking and Pro-market Reforms
8.3.6 Financial Literacy in South Africa
8.3.7 Education and Income Improve Financial Inclusion in Africa
8.3.8 Financial Inclusion and Country Characteristics
8.3.9 Financial System Structure
8.4 Islamic Sharing Institution: A Tool to Enhance Financial Inclusion
8.5 Conclusion
References
Chapter 9: Fintech and Financial Inclusion in Pakistan: An Exploratory Study
9.1 Introduction
9.2 Overview of Financial Inclusion in Pakistan
9.3 Information and Communication Technologies Environment in Pakistan
9.4 Comparison of Pakistan Performance in ICT in the Years 2015 and 2016
9.5 Fintech and Its Applications and Financial Inclusion
9.5.1 Digital Payments
9.5.2 Crowdfunding and P2P Lending
9.5.3 InsureTech
9.5.4 Big Data Analysis and Cloud Computing
9.5.5 Blockchain and Smart Contracts
9.5.6 Artificial Intelligence, Internet of Things and Robo-Advisors
9.6 A Pragmatic Scheme “Five Points Agenda” for Pakistan
9.6.1 Leadership with True Vision and Will
9.6.2 Regulatory Sandbox for Fintech
9.6.3 Digital Infrastructure and Latest Technologies
9.6.4 Interoperability, Coordination, and Collaboration
9.6.5 Awareness of ICT and Financial Literacy
9.7 Conclusions and Implications
References
Chapter 10: Financial Inclusion for Farmers Through Appropriate Financing Products: Analytic Network Process Approach
10.1 Introduction
10.2 Research Objectives
10.3 Sharia Financial Institutions
10.3.1 Theory and Concepts of Sharia Financial Institutions
10.4 The Role of Sharia Financial Institutions in the Agricultural Sector
10.5 Research Methodology
10.5.1 Profile of BMT as Salam
10.5.2 Data Source and Data Collection
10.5.3 ANP Method
10.5.4 BOCR Analysis
10.5.5 ANP Research Stages
10.6 Analysis and Discussion
10.6.1 Problem Decomposition
10.7 Geometric Mean Results of the BOCR Model
10.7.1 Geometric Mean of Cluster Benefit
10.7.2 Geometric Mean of Cluster Opportunity
10.7.3 Geometric Mean of Cluster Cost
10.7.4 Geometric Mean of Cluster Risk
10.7.5 BOCR Synthesis Results
10.8 Conclusions
References
Transcripts of Interview
Chapter 11: Skill-Based and Interest-Free Microfinance Model of Entrepreneurship as the More Sustainable Model
11.1 Introduction
11.2 Pakistan’s Microfinance Industry
11.3 Literature Review
11.4 Research Methodology
11.5 Results and Discussion
11.5.1 Descriptive Statistics
11.6 Case Studies
11.7 Conclusion
References
Index

Citation preview

PALGRAVE STUDIES IN ISLAMIC BANKING, FINANCE, AND ECONOMICS

Enhancing Financial Inclusion through Islamic Finance, Volume I

Edited by Abdelrahman Elzahi Saaid Ali Khalifa Mohamed Ali Muhammad Khaleequzzaman

Palgrave Studies in Islamic Banking, Finance, and Economics Series Editors Mehmet Asutay Business School Durham University Durham, UK Zamir Iqbal Islamic Development Bank Jeddah, Saudi Arabia Jahangir Sultan Bentley University Boston, MA, USA

The aim of this series is to explore the various disciplines and sub-­disciplines of Islamic banking, finance and economics through the lens of theoretical, practical, and empirical research. Monographs and edited collections in this series will focus on key developments in the Islamic financial industry as well as relevant contributions made to moral economy, innovations in instruments, regulatory and supervisory issues, risk management, insurance, and asset management. The scope of these books will set this series apart from the competition by offering in-depth critical analyses of conceptual, institutional, operational, and instrumental aspects of this emerging field. This series is expected to attract focused theoretical studies, in-depth surveys of current practices, trends, and standards, and cutting-­edge empirical research. More information about this series at http://www.palgrave.com/gp/series/14618

Abdelrahman Elzahi Saaid Ali Khalifa Mohamed Ali Muhammad Khaleequzzaman Editors

Enhancing Financial Inclusion through Islamic Finance, Volume I

Editors Abdelrahman Elzahi Saaid Ali Islamic Research and Training Institute Islamic Development Bank Jeddah, Saudi Arabia

Khalifa Mohamed Ali Islamic Research and Training Institute Islamic Development Bank Jeddah, Saudi Arabia

Muhammad Khaleequzzaman International Islamic University Islamabad Islamabad, Pakistan

ISSN 2662-5121     ISSN 2662-513X (electronic) Palgrave Studies in Islamic Banking, Finance, and Economics ISBN 978-3-030-39934-4    ISBN 978-3-030-39935-1 (eBook) https://doi.org/10.1007/978-3-030-39935-1 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

Among those of us committed to advancing access to Islamic financial services for the poor, the importance of a picture of Islamic financial inclusion that transforms thinking, planning, and action cannot be downplayed. We are therefore extremely pleased at the release of this volume that provides us with a wealth of knowledge that looks in depth at where Islamic financial inclusion stands and how far we have come. The main messages embedded in Part I of this volume are empowerment through Islamic financial inclusion, contribution of Islamic microfinance in achieving Sustainable Development Goals, and how Islamic finance tackles income and wealth inequality. Part II provides empirical cases of Islamic finance as a vehicle for social inclusion, for improving access to financial inclusion, and for the design of appropriate products for farmers as well as entrepreneurship. This volume contains a wealth of detailed information for public- and private-sector stakeholders working in the Islamic finance field. It is our hope that it will enable policymakers, regulators, researchers, business people, advocates, the development community, and others to see what is working, what isn’t, and how focus on more effective efforts can be made to reach the goal of universal Islamic financial inclusion. The volume is designed to be a comprehensive, accessible, practical-oriented introduction to Volume II of the collection. Jeddah, Saudi Arabia Jeddah, Saudi Arabia  Islamabad, Pakistan 

Abdelrahman Elzahi Saaid Ali Khalifa Mohamed Ali Muhammad Khaleequzzaman v

Acknowledgments

The two volumes of the book Enhancing Financial Inclusion Through Islamic Finance result from two international workshops on Enhancing Poor’s Capability and Financial Inclusion, 11–12 December 2017, and The Role of Islamic Financial Inclusion in Achieving Sustained Economic Growth and Poverty Alleviation in IsDB Member Countries, 25–26 November 2018, organized under the auspices of the Islamic Research and Training Institute (IRTI), Jeddah, Saudi Arabia; International Islamic University, Islamabad, Pakistan; and Ibn Sina University, Khartoum, Sudan. We thank all workshop paper presenters, participants, session chairs, and paper reviewers for their timely and valuable contribution toward the realization of these international workshops. The inspiring engagement of scholars in these workshops generated groundbreaking ideas for enhancing the poor’s capability to achieve sustained economic growth and to reduce poverty. The workshops were planned when Professor Dr. Azmi Omar was the DG of IRTI. The book publishing was approved with Palgrave Macmillan by Dr. Sami Al Suwailem the acting DG of IRTI. We thank the Honorable Chancellor of Ibn Sina University Professor, Prof. Nasr El-Din Ahmed Mahmoud; His Excellency President, IIUI Prof. Dr. Ahmad Yousif A. Al-Draiweesh; and His Excellency Dr. Masoom Yasinzai, Rector IIUI. We also thank Prof. Dr. Mohamed Hassan Azrag and Prof. Dr. Muhammad Khaleequzzaman for contributing to the success of the two workshops and for providing logistical support for the workshops. vii

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ACKNOWLEDGMENTS

We extend our thanks to the two anonymous independent expert referees for providing constructive comments that enhanced the two volumes; to Wahida Mohamed Ali of IRTI for the excellent editorial and formatting assistance; and to Prof. Dr. Anis Ahmad, Prof. Dr. Muhammad Tahir Mansoori, Prof. Dr. Sayyid Tahir, Mr. Ser Jehan, Dr. Mohamed Hasan Adam, Dr. Bushara Musa Bushara, Dr. Suad Elfatih, and Dr. Mohammed Hasan Adam for chairing different sessions of the workshops. We are grateful to Dr. Khalifa Mohamed Ali and Dr. Abdelrahman Elzahi Saaid Ali of IRTI, Dr. Mohamed Hassan Azrag, and Dr. Muhammad Khaleequzzaman for reviewing papers for the workshops. The authors acknowledge and thank Dr. Asad Zaman, Dr. Anwar Shah, and Dr. Shahid Qureshi; Prof. Badr Edin Ibrahim; Dr. Adnan Aziz, Shariah Head of Noor Islamic Bank, Dubai; Mr. Fahad Liaquat, CEO of AZM Foundation Pakistan; and Agha Ali Javad, General Manager, National Rural Support Program, Islamabad, Pakistan, for helping in various ways and for their discussions in the process of preparing some of the draft chapters for workshop sessions. Finally, we thank Tula Weis, Senior Editor of Palgrave Macmillan, for her gracious support for publishing this book and Jacqueline Young for helping us through the production process of the books. Abdelrahman Elzahi Saaid Ali Khalifa Mohamed Ali Muhammad Khaleequzzaman

Contents

Part I Enhancing Financial Inclusion Through Islamic Finance   1 1 Introduction  3 Abdelrahman Elzahi Saaid Ali, Khalifa Mohamed Ali, and Muhammad Khaleequzzaman References 12 2 Empowering the Poor and Enhancing Financial Inclusion from a Multidimensional Perspective 13 Hazik Mohamed 2.1 Introduction 13 2.2 Why Is Financial Inclusion So Important? 14 2.3 Property Rights and Economic Equality 16 2.4 Multidimensional Concept of Financial Inclusion 17 2.5 Financial Literacy and Access to Financial Services 18 2.6 Income and Wealth Redistributive Instruments 19 2.7 Development of Micro, Small, and Medium Enterprises 20 2.7.1 SME Capital Market Development 22 2.7.2 Crowdfunding and Social Impact Investor Platforms 23 2.7.3 Microfinancing Programs 27 2.7.4 Vocational Training Programs for the Poor and Disabled 28 ix

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2.7.5 Sound Regulatory, Supervisory, and Enforcement Framework 29 2.8 Adequate Metrics for Performance Measure 31 2.9 Behavioral Issues in Financial Decision-Making 32 2.9.1 Behavioral Approach to Financial Inclusion 33 2.10 Conclusion 34 References 36 3 Causes of Income and Wealth Inequalities: Perspectives of Economists from the Fields of Conventional and Islamic Economics 39 Muhammad Imran Ejaz 3.1 Introduction 39 3.2 The Views of Economists from Conventional Economics on Inequality 40 3.2.1 The Views of the French Economist Thomas Piketty Concerning Inequality 40 3.2.2 The Views of Nobel Laureate Joseph Stiglitz Concerning Inequality 42 3.2.3 The Views of Positive Money Concerning Inequality  45 3.3 The Views of Muslim Economists on Inequality 45 3.3.1 The Views of Al-Ghazali Concerning Inequality and the Role of Interest (Riba) 45 3.3.2 The Views of Mufti Taqi Usmani Concerning Inequality 47 3.3.3 The Views of Mufti Muhammad Shafi Concerning Inequality 48 3.4 Comparison of the Above Views of the Conventional and Islamic Economists 48 3.5 Conclusion and Recommendations 49 Bibliography 50 4 Contribution of Islamic Microfinance Studies in Achieving Sustainable Development Goals 51 Murniati Mukhlisin, Luqyan Tamanni, Toseef Azid, and Rifka Mustafida 4.1 Why Islamic Microfinance Studies Matter? 51 4.2 Studies on Research Mappings 53 4.3 MDGs and SDGs 54

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4.4 ‘What Is Going on Here?’ Methodology 55 4.5 Mapping of Islamic Microfinance Studies 58 4.6 Conclusion and Recommendation 61 4.6.1 Recommendation 77 References 78 5 Islamic Finance and Its Impact on Financial Inclusion 81 Wissal Msellek 5.1 Introduction 81 5.2 Poverty and Financial Capability 82 5.3 Financial Inclusion 82 5.4 Financial Inclusion Through Risk-Sharing 82 5.4.1 Small-Medium Enterprises 82 5.4.2 Microfinance 83 5.4.3 Micro-Takaful 84 5.5 Financial Inclusion Through Redistribution Institutions 85 5.5.1 Sadaqah 85 5.5.2 Zakat 86 5.5.3 Qard al-Hasan 86 5.5.4 Waqf 87 5.6 Relation Between Financial Inclusion and Financial Capability 87 5.7 Propositions 88 5.8 Conclusion 89 References 89 6 A Critical Review of Takaful Companies’ Contributions to Economic Developments in Fulfilment of Maqasid al-Sharı̄ʿah: Evidence from Malaysia 91 Abu Umar Faruq Ahmad and Rashedul Hasan 6.1 Introduction 91 6.2 Literature Review and Hypothesis Development 92 6.3 Methodology 98 6.4 Results and Discussion 99 6.5 Conclusion103 References104

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Contents

Part II Islamic Financial Inclusion: Cases and Modeling 107 7 Making Islamic Finance a Vehicle for Social Inclusion: A Case for Revisiting the Liquidity Management Practices by Islamic Banks109 Muhammad Ayub 7.1 Introduction109 7.2 Learning the Lesson?111 7.3 Strengths of Islamic Finance System112 7.4 Islamic Finance as in Vogue—The Issue of Approach and Mindset113 7.5 The Way to Achieving Social Inclusion through Islamic Finance114 7.6 Liquidity Risk, Liquidity Management, and Its Tools116 7.7 The Myth of Excess Liquidity with Islamic Banking Institutions117 7.8 Islamic Banks’ Practices for Liquidity Management120 7.8.1 Tawarruq/Commodity Murabaha/Sukuk Murabaha121 7.8.2 Shari‘ah-Compliant Derivatives as Liquidity Management Tools124 7.9 What Islamic Banks Need to Do for Liquidity Management?127 7.10 Conclusion131 Appendix133 References135 8 Improving Access to Financial Services: Theory and Practice Around the Globe137 Muhammad Azeem Qureshi and Toseef Azid 8.1 Introduction137 8.2 Causal Mapping of Theories of Economic Development138 8.3 Understanding the Dynamics of Financial Inclusion—Practices from Different Parts of the World144 8.3.1 The Farmers’ Cooperatives145 8.3.2 Microfinance Institutions/Banks146 8.3.3 Interest-Free Loans (Qarz-e-Hassan)146 8.3.4 Social Networks at Work for Financial Inclusion in the UK146

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8.3.5 Financial Inclusion in India—Impact of Social Banking and Pro-market Reforms146 8.3.6 Financial Literacy in South Africa147 8.3.7 Education and Income Improve Financial Inclusion in Africa147 8.3.8 Financial Inclusion and Country Characteristics147 8.3.9 Financial System Structure147 8.4 Islamic Sharing Institution: A Tool to Enhance Financial Inclusion148 8.5 Conclusion154 References157 9 Fintech and Financial Inclusion in Pakistan: An Exploratory Study159 Hassnian Ali and Rose Abdullah 9.1 Introduction159 9.2 Overview of Financial Inclusion in Pakistan163 9.3 Information and Communication Technologies Environment in Pakistan167 9.4 Comparison of Pakistan Performance in ICT in the Years 2015 and 2016167 9.5 Fintech and Its Applications and Financial Inclusion170 9.5.1 Digital Payments171 9.5.2 Crowdfunding and P2P Lending172 9.5.3 InsureTech173 9.5.4 Big Data Analysis and Cloud Computing174 9.5.5 Blockchain and Smart Contracts175 9.5.6 Artificial Intelligence, Internet of Things and Robo-Advisors176 9.6 A Pragmatic Scheme “Five Points Agenda” for Pakistan178 9.6.1 Leadership with True Vision and Will179 9.6.2 Regulatory Sandbox for Fintech180 9.6.3 Digital Infrastructure and Latest Technologies181 9.6.4 Interoperability, Coordination, and Collaboration182 9.6.5 Awareness of ICT and Financial Literacy183 9.7 Conclusions and Implications184 References186

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Contents

10 Financial Inclusion for Farmers Through Appropriate Financing Products: Analytic Network Process Approach193 Dika Megantara and Anita Priantina 10.1 Introduction193 10.2 Research Objectives195 10.3 Sharia Financial Institutions196 10.3.1 Theory and Concepts of Sharia Financial Institutions196 10.4 The Role of Sharia Financial Institutions in the Agricultural Sector196 10.5 Research Methodology198 10.5.1 Profile of BMT as Salam198 10.5.2 Data Source and Data Collection199 10.5.3 ANP Method200 10.5.4 BOCR Analysis200 10.5.5 ANP Research Stages202 10.6 Analysis and Discussion203 10.6.1 Problem Decomposition203 10.7 Geometric Mean Results of the BOCR Model207 10.7.1 Geometric Mean of Cluster Benefit210 10.7.2 Geometric Mean of Cluster Opportunity210 10.7.3 Geometric Mean of Cluster Cost213 10.7.4 Geometric Mean of Cluster Risk213 10.7.5 BOCR Synthesis Results215 10.8 Conclusions216 References217 11 Skill-Based and Interest-Free Microfinance Model of Entrepreneurship as the More Sustainable Model221 Farhat Mahmood and Adeeba Ishaq 11.1 Introduction221 11.2 Pakistan’s Microfinance Industry222 11.3 Literature Review226 11.4 Research Methodology230 11.5 Results and Discussion230 11.5.1 Descriptive Statistics230 11.6 Case Studies233 11.7 Conclusion239 References240 Index243

Notes on Contributors

Rose Abdullah  is a senior lecturer in the Faculty of Islamic Economics and Finance and the director of the Center for Research and Publication, Universiti Islam Sultan Sharif Ali, Brunei Darussalam. She is also a member of the Shariah Advisory Board of Bank Islam Brunei Darussalam. Rose received the Emerald Award of Excellence for best papers in 2015. Abu  Umar  Faruq  Ahmad is an associate professor at the Islamic Economics Institute, King Abdulaziz University, Jeddah, Saudi Arabia. His research focuses on Islamic law, Islamic jurisprudence, and Islamic economics and finance. Several of his books and journal articles on Islamic finance have been published, and Abu’s current editorial roles include serving as founding editor, senior editor, and editorial advisory board member of a plethora of internationally reputed refereed journals. Hassnian  Ali is the assistant director (research) at the International Centre for Research in Islamic Economics (ICRIE). He is one of the pioneer authors in the area of Fintech and Islamic finance and co-author of the book Fintech, Blockchain, and Islamic Finance: Building the Future in the New Islamic Digital Economy. Khalifa Mohamed Ali  is a senior economist at IRTI. Before this, he was Associate Professor of Economics at the United Arab Emirates University and taught economics at Iowa State University, USA. Mohamed Ali is the editor of the Arabic edition of Islamic Economic Studies, one of IRTI’s flagship publications, and has written extensively in the area of Islamic finance. xv

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Notes on Contributors

Muhammad  Ayub is director (research) at Riphah International University, Islamabad, editor of their JIBM, and non-resident editor of the Bahrain-based AAOIFI’s Journal of Islamic Finance Accountancy. His unique contribution to Islamic finance is the textbook Understanding Islamic Finance, which has been translated into Arabic, Malaya Bahasa, Urdu, and Turkish. Toseef  Azid  is Professor of Economics at the College of Business and Economics, Qassim University, Saudi Arabia. He has taught in Pakistan, Brunei, the UK, the USA, and Saudi Arabia. His research focuses on technological change, development economics, labor economics, Islamic economics, and Islamic finance. Over 60 papers of his have appeared in local and international journals, and he has authored and edited a number of books. Muhammad Imran Ejaz  is primarily an economics teacher. Muhammad has two MS degrees: one in Islamic banking and finance (thesis entitled “Preventing the Next Financial Crisis: Does Islamic Finance Hold the Key”) and a second in public policy (concentration in economic policy in which he wrote the thesis entitled “Pakistan and the IMF”). He holds an undergraduate degree in economics and management from the University of London and has done master-level courses in international finance and microeconomics also from the University of London. He has written research papers on both conventional economics and Islamic economics and finance and presented them at conferences. Abdelrahman  Elzahi  Saaid  Ali is a senior economist at the Islamic Research and Training Institute (IRTI) of the Islamic Development Bank (IsDB). Before joining IRTI, he was Associate Professor of Economics at Sudan University of Science and Technology. Elzahi Saaid Ali has written and edited a number of academic works including Revitalization of Waqf for Socio-Economic Development (Palgrave, 2019). Rashedul  Hasan is a senior lecturer in the Faculty of Business, Communication and Law at INTI International University, Malaysia. Having completed his PhD in accounting at International Islamic University Malaysia (IIUM), Rashedul’s research interests include Islamic finance and corporate governance. His papers have appeared in ABS, ABDC, and SCOPUS indexed journals.

  Notes on Contributors 

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Adeeba Ishaq  is serving as a lecturer in Pakistan Institute of Development Economics (PIDE), Islamabad, Pakistan. She has been a PhD student at Quaid-i-Azam University since 2014. Teaching courses on macroeconomics and development economics at PIDE, Adeeba is interested in the areas of Islamic banking and macroeconomics. Muhammad  Khaleequzzaman  studied economics at the University of Illinois at Urbana‐Champaign, USA, and Islamic Banking and Finance at the International Islamic University Islamabad, Pakistan. Khaleequzzaman is a certified Islamic banker from the State Bank of Pakistan. Farhat  Mahmood is serving as a lecturer in Pakistan Institute of Development Economics (PIDE), Islamabad, Pakistan. Having completed a PhD at the Asian Institute of Technology (AIT), Thailand, Farhat teaches Islamic banking and finance at her institute and supervises students in this area of research. Her areas of interest are Islamic banking, international finance, and international economics. She has also written two research papers and two conference papers in the aforementioned areas. Dika Megantara  is working under Product and Business Development Division of PT BPRS Al Salaam Amal Salman, an Islamic rural bank in Bogor, Indonesia. Hazik  Mohamed is a multidisciplinary entrepreneur with a PhD in Islamic finance, focusing on behavioral research and decision-making analysis using game theory. His wide research interests include financial inclusion, poverty alleviation, and sustainable practices through disruptive technologies. He is the published author of Belief and Rule Compliance and Blockchain, Fintech and Islamic Finance. Wissal Msellek  is a master’s student in finance in the Faculty of Economics and Business in the University of Malaysia Sarawak. Her research is about the moderating effect of the board capital on the relationship between product diversification and Islamic banks’ performance in Malaysia. Wissal’s areas of interest are Islamic banking, Islamic finance, and Islamic economics. Murniati Mukhlisin  has working experiences in banking, finance, university, and financial technology. She is the rector of Tazkia Islamic University College, Indonesia, and serves as editor, editorial board member, and reviewer in several reputable journals. For research, Murniati works in the areas of financial reporting, Islamic accounting, finance, and

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Notes on Contributors

financial literacy. She has authored tens of books and international journal papers, as well as written hundreds of articles published in national and international media. Rifka Mustafida  is research assistant in LPPM Tazkia. She is studying a master’s degree in Islamic banking and finance in International Islamic University Malaysia. Before that, in 2016, she graduated summa cum laude from the Department of Islamic Economics, Tazkia University College of Islamic Economics. In 2015 and 2016, she was finalist in the call for papers on Islamic economics and finance research forums held by Indonesian Financial Services Authority, and she was also awarded the best researcher in the call for papers on redenomination held by Bank of Indonesia. She has written and conducted research on waqf, banking, sustainability, and accountability. Anita  Priantina  is an assistant professor at Islamic Economics Department, Tazkia Islamic University College, Bogor, Indonesia. Her research focuses on Islamic economics and finance, and several of her book chapters and journal articles on Islamic economics and finance have been published. Muhammad  Azeem  Qureshi  is Associate Professor of Finance at Oslo Business School, Oslo Metropolitan University, Norway. He holds a PhD in system dynamics (2008), MPhil in system dynamics (2004) from the University of Bergen, Norway, and MBA (1989) from Bahauddin Zakariya University, Multan, Pakistan. Muhammad started his career as an investment banker in Pakistan, during which time he earned his banking diploma DAIBP (1993). Joining academia in 1997, Muhammad then moved to Norway in 2009 for his current position where he teaches courses in international finance and managerial accounting. His research focuses on corporate finance, sustainability, Islamic banking and finance, and social economics. He has published several papers in academic journals, edited a book, contributed several book chapters, and presented papers in peerreviewed conferences across the globe. Muhammad is also an editor and reviewer for many journals. Luqyan Tamanni  is a senior lecturer at Tazkia Islamic University College, Indonesia. He serves a position as Shariah Supervisory Board member in several financial institutions and as deputy director at National Committee for Islamic Finance, Republic Indonesia. Luqyan has research interest in Islamic banking and finance. He has authored several journal papers on those areas.

List of Figures

Fig. 2.1 Fig. 7.1 Fig. 7.2 Fig. 8.1 Fig. 8.2 Fig. 8.3 Fig. 8.4 Fig. 8.5 Fig. 8.6 Fig. 8.7 Fig. 10.1 Fig. 10.2 Fig. 10.3 Fig. 10.4 Fig. 10.5 Fig. 10.6 Fig. 10.7

A multipronged strategy to financial inclusion. The multidimensional approach will involve behavioral aspects in implementation. (Source: Author’s illustration) 18 Process flow—interbank bai muajjal of sukuk (organized tawarruq) in Pakistan. (Source: Author’s own) 133 Structured flow of secured commodity murabaha134 Causal structure of theories of economic growth 139 Causal structure of people-centred theories of economic development140 Causal structure of socio-economic groups–centred theories of economic development 140 Causal structure of theories of social justice and economic development141 Causal structure of Islamic moral economy 143 Financial landscape in developing and emerging economies. MSE, micro and small enterprises; MCE, medium size corporate enterprise. (Adapted from Rabobank 2006) 144 Difference between access and use of financial services. (Source: Adapted from Claessens 2006) 145 Financing composition of Islamic bank in November 2015. (Adapted from OJK 2015) 194 ANP BOCR network structure. (Adapted from Ascarya 2012) 201 BOCR network structure. (Adapted from Ascarya 2012) 201 Stage of research using ANP. (Adapted from Ascarya 2012) 204 ANP-BOCR network framework 208 Priority of benefit, opportunity, cost, and risk elements 209 Priority of all BOCR elements 209 xix

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Fig. 10.8

Priority of benefit elements for IFIs/BMT (left) and farmers (right)210 Fig. 10.9 Priority of overall benefit elements 211 Fig. 10.10 Priority of opportunity elements for IFIs/BMT (left) and farmers (right) 212 Fig. 10.11 Priority of overall opportunity elements 212 Fig. 10.12 Priority of cost element for IFIs/BMT (left) and farmers (right)213 Fig. 10.13 Priority of overall cost elements 214 Fig. 10.14 Priority of risk element for IFIs/BMT (left) and farmers (right)214 Fig. 10.15 Priority of overall risk elements 215 Fig. 10.16 Priority of short-term alternative strategies 216 Fig. 10.17 Priority of long-term alternative strategies 216 Fig. 11.1 Comparison of entrepreneurship models 231 Fig. 11.2 Incremental loans trend during 2011–2015. (Source: Authors’ compilation from annual reports of KB and AF) 232 Fig. 11.3 Incremental loans trend with male/female loan distribution during 2011–2015. (Source: Authors’ compilation from annual reports of KB and AF) 232

List of Tables

Table 2.1 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 4.6 Table 4.7 Table 5.1 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 Table 8.1 Table 8.2 Table 9.1 Table 9.2 Table 9.3

Compilation of social impact investor platforms 25 List of the Millennium Development Goals (MDGs) 55 Number of empirical research papers on Islamic microfinance (1995–2017)58 Empirical studies of Islamic microfinance related to MDGs and SDGs (1995–2017) 59 Empirical studies in Islamic microfinance (1995–1999) before implementation of MDGs 61 Empirical studies on Islamic microfinance (2002–2008) after implementation of MDGs 62 Empirical studies on Islamic microfinance (2009–2014) after implementation of MDGs 63 Empirical studies on Islamic microfinance (2015–2017) after SDGs 70 Pillars of financial inclusion 82 Growth of takaful in Malaysia 93 Variable definitions 100 Descriptive statistics 100 Pearson correlation analysis 102 Regression statistics 103 Formation of intangible capital from tangible capital in moral economy150 Traditional vs. ISI venture philanthropy 152 Indicators of financial inclusion in Pakistan 164 Active digital stored-value account ownership among demographics166 The current networked readiness for growth and jobs 168 xxi

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Table 10.1 Table 10.2 Table 11.1 Table 11.2 Table 11.3 Table 11.4 Table 11.5

Experts and practitioner respondents ANP scale. (Adapted from Ascarya 2012) Microfinance industry performance snapshot (2010–2014) List of all MFBs, CED and NGOs of Pakistan Khushhali Microfinance Bank case studies Akhuwat Foundation case studies Center for Entrepreneurial Development (CED) case studies

199 203 223 224 233 234 236

PART I

Enhancing Financial Inclusion Through Islamic Finance

CHAPTER 1

Introduction Abdelrahman Elzahi Saaid Ali, Khalifa Mohamed Ali, and Muhammad Khaleequzzaman

Financial inclusion, as considered by the World Bank, targets the individuals and businesses having “access to useful and affordable financial products and services that meet their needs—transactions, payments, savings, credit and insurance—delivered in a responsible and sustainable way”. However, the World Bank cites several challenges when about 200 million formal and informal micro, small and medium-sized enterprises in emerging economies lack adequate financing to thrive and grow (World Bank 2017). These enterprises are constrained by the absence of collateral, informality of the businesses and credit history. Women and rural and remotely located inhabitants are affected more than the others.

A. Elzahi Saaid Ali (*) • K. M. Ali Islamic Research and Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia e-mail: [email protected]; [email protected] M. Khaleequzzaman International Islamic University, Islamabad, Islamabad, Pakistan e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_1

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In the same direction, the Sustainable Development Goals (SDGs) require that extreme poverty (people living under USD 1.25 a day) should be eradicated by 2030, ensuring that all men and women, the poor and the vulnerable, have equal right to economic resources and financial services, including microfinance, and their integration into value chains and market linkages. This objective requires that policy frameworks based on pro-poor and gender-sensitive development strategies, in both rural and urban settings, be framed to support accelerated investment in poverty eradication. The Islamic Development Bank (IsDB) and the UNDP (2016) collaborate on account of SDGs and have identified priority areas for coordinated action, including innovation, poverty reduction, sustainable energy and employment. The IsDB recognizes that the most significant driving factor to achieve SGDs rests with access to affordable finance, at the same time, taking into consideration its inefficiencies as evidenced by the financial crisis of the recent past. Although SDGs relate to various development areas, the role of Islamic finance in achieving the SDGs resonates with the core mandate of the IsDB Group. This book is the outcome of the Thematic Workshop on Enhancing Poor’s Capability and Financial Inclusion from Islamic Perspective, held from 11–12 December 2017, co-organized by the Islamic Research and Training Institute (IRTI), a member of Islamic Development Bank Group, and the International Islamic University Islamabad. This workshop addressed different aspects of financial inclusion, such as SDGs and socio-­ economic development in Islamic framework, Islamic insurance (takaful) and maqasid al-Sharı̄ʿah, the role of zakat in eradicating poverty and enhancing inclusion, processes and procedures for financial inclusion derived from empirical research, use of fintech for financial inclusion and the different views about income disparity caused as a result of using interest. This book, titled Financial Inclusion from Islamic Perspective, is very essential reading to explain how Islamic financial inclusion tackles the problems of poverty and income inequality. The majority of the countries in the globe fall into low- and lower middle-income categories. This is also true for the IsDB countries and the countries in the Arab region. The countries with low income accommodate poorer, high-income inequality, unemployment and hunger. They spend less on health and the progress in education is slow. They have low access to finance. All these factors reinforce each other and consequently slow their progress in fighting poverty. Access to finance and financial services play pivotal role in poverty

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alleviation and achieving sustainable development. Accessing and using financial services to achieve financial inclusion is challenging to countries all over the world. These challenges are more severe in IsDB member countries due to the non-availability of funds or the shortage of responsible finance that could meet the communities’ demand. Apart from the international community, Arab countries called for urgent financial inclusion strategies to check rising unemployment among the youth and women and reduce poverty among their communities. Moreover, the disadvantaged might face more challenges for financial inclusion, which may be associated with their financial capability, illiteracy, security and conflict, and the unavailability of demand-driven financial inclusion products. Hence, this study concentrates on financial inclusion from Islamic perspectives in Muslim countries. Financial inclusion is an important element in the formulation of Sustainable Development Goals (SDGs), the new development architecture that succeeds the Millennium Development Goals (MDGs). In addition, it was given significant prominence at the United Nations Third International Conference on Financing for Development (FfD), held in Addis Ababa, Ethiopia, in July 2015. At the Group of Twenty (G-20), financial inclusion has been given greater prominence in the reform and development agendas (Annual Report 2014). According to Global Findex data (2011), 47 per cent of women and 55 per cent of men worldwide have an account at a formal financial institution, whether a bank, credit union, cooperative, post office or microfinance institution. The gender gap varies widely across economies and regions. Among the regions, South Asia and the Middle East and North Africa have the largest gender gaps, with women making about 40 per cent less likely than men to have a formal account. Financial inclusion or inclusive finance is where effort is made to ensure that all households and businesses, regardless of levels of income, can effectively access and use appropriate financial services they need to improve their lives. Financial inclusion incorporates a range of initiatives that make formal financial services available, accessible and affordable to all segments of the population, including women, rural populations, the poor, persons with disabilities and other disadvantaged groups (A.  E. S.  Ali 2019). Financial inclusion goes beyond improved access to credit to encompass enhanced access to savings and risk mitigation products and a well-functioning financial infrastructure that allows individuals and companies to engage more actively in the economy while protecting user rights (Triki, T. and I. Faye 2013). Financial inclusion is

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about the delivery of financial services at an affordable cost to the large sections of disadvantaged and low-income groups. Moreover, it covers at least 8 out of 17 Sustainable Development Goals. These eight goals under the financial inclusion are very vital to IsDB member countries for which this book is dedicated. The first sustainable goal under financial inclusion is SDG 1, which is related to poverty eradication. Recently the number of poor and disadvantaged in IsDB member countries skyrocketed due to civil wars and political and economic instability. Low access to finance and low financial capability in countries such as Yemen, Syria and sub-Saharan Africa might explain the causes of chronic poverty of the households in these areas. Ending hunger and ensuring food security (SDG 2) is another sustainable goal that falls under the umbrella of the financial inclusion. Hence financial inclusion is rather essential for these countries, due to drought and desertification and economic and political instability. Many refugees, particularly women, in the countries afflicted by civil wars and conflicts are at high risk and exposed to hunger due to the lack of financial access and fewer employment opportunities. Poverty significantly increases the vulnerability1 of Syrian women. This is in addition to high unemployment among the youth. The health and well-being that fall under SDG 3 is the third essential goal to be achieved through financial inclusion. A recent report showed that more women around the world died to complications of pregnancy and childbirth.2 Most of these victims are from the low- and middle-income countries and almost two-thirds lived in sub-Saharan Africa. Financial inclusion can help at least in mitigating this problem through enabling them to access finance and improve their financial capability and hence raise their income. This book is Volume I of two volumes and is divided into two major parts. Part I, titled ‘Enhancing Financial Inclusion Through Islamic Finance’, comprises six chapters focusing on the role of the Islamic financial inclusion on empowering the poor, overcoming the causes of income and wealth inequalities and achieving the SDGs. Chapter 2 by Hazik Mohamed looks at empowering the poor and enhancing financial inclusion from a multidimensional perspective. He notes that traditional economic thinking assumes that the poor want to earn their way out of poverty. Moreover, studies show that poverty makes people feel powerless and helpless. They are subjected to extraordinary levels of stress and anxiety that makes their favourable decision-making more difficult. Above all, the poor lack the institutional framework which enhances decisions

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towards affluence as in case of more prosperous and advanced economies. This chapter used a multidimensional approach to achieve financial inclusion and empower the poor. It lists the five key areas that need to be developed in order to holistically secure a just and prosperous future for all. The critical components of the financially inclusive future include financial literacy; access to financial services; income and wealth redistributive instruments; development of micro, small and medium-sized enterprises (MSMEs); and a sound legal and enforcement system to ensure that these components can take root ethically. As a last measure, an adequate metric set to measure effectiveness, performance and progress of such initiatives is also required. The study includes the behavioural issues in financial decision-making and suggests a behavioural approach to strategic implementation. Chapter 3, by Muhammad Imran Ejaz, explains the causes of income and wealth inequalities, providing perspectives of economists from the fields of conventional and Islamic economics. Comparing conventional and Islamic economic thoughts, the study shows a tremendous problem within the capitalist system. He refers to Piketty who has succeeded in bringing the issue to the limelight in his book published in 2013.3 Although income inequalities are recognized by the conventional economists, the causes given here differ from the explanations put forward by Islamic economists. Piketty eventually blames inheritance, and other Western economists have put different causes of the problem. However, the central cause forwarded by Islamic finance and economics is only whispered in the whole din or it is mentioned only as a part and minor component of the causes. They hold that the central cause rests with interest. Only recently some Western movements such as Positive Money highlighted interest as the culprit, but this is a whisper compared to the loud voices of prominent economists such as Piketty and Stiglitz who are looking in another direction. This theoretical and analytical study examines the views of different economists from both conventional and Islamic perspective. It holds that conventional economists largely fail to admit that interest is the fundamental causative factor in generating income and wealth inequalities, something Islamic economists have been claiming for a long time. In Chap. 4, Murniati Mukhlisin and Luqyan Tamanni explain the contribution of Islamic microfinance in achieving the SDGs. Based on the national definitions, the SDGs aim to eradicate extreme poverty by 2030 and reduce at least half the proportion of men, women and children of all

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ages living in poverty in all its dimensions. This study reviews the empirical studies in the area of Islamic microfinance with the purpose to analyse the contribution of Islamic microfinance for SDGs by mapping research direction on the SDGs. The studies have been categorized based on the discussion on research paradigm, countries being researched, methods employed and results that lead to action for achieving MDGs and SDGs. The study found that research direction reviewed employ mostly the post-­ structuralism and interpretivism paradigm and the countries being most researched are Bangladesh, Malaysia and Indonesia. This review provides insights for future research aiming to promote the achievements and issues faced in the implementation of SDGs. In Chap. 5, Wissal Msellek investigates the impact of Islamic finance on financial inclusion from Islamic perspective. The author describes the global economic and financial challenges on financial inclusion and holds that Islamic finance has demonstrated its resilience by continuing to grow at double digits across all sectors. Despite the fast growth, more efforts need to be made to support the socioeconomic aspects that still face some difficulties. The study states that poverty, financial incapability and financial exclusion are some of the problems that need to be addressed. The study also discusses the relationship between financial inclusion and financial capability of the poor and how Islamic finance can help raise the financial capability of the poor through risk sharing and asset-linked financing such as small and medium-sized enterprises (SMEs), microfinance and micro-takaful and redistribution institutions which are sadaqah, zakat, qard al-hasan and waqf. These two are the pillars of financial inclusion in Islamic finance. Chapter 6, by Abu Umar Faruq Ahmad, critically reviews takāful companies’ contributions to economic development in fulfilment of maqasid al-Sharı̄ʿah. The author states that the Islamic financial system has evolved over the last three decades and takāful has emerged as a Sharı̄ʿah-compliant alternative to conventional insurance, embedded to fulfil its underlying maqasid (goals or objectives) Sharı̄ʿah. Contrary to previous studies that attempted to provide evidences that takāful products are compliant with the Sharı̄ʿah in practice of takāful companies (TCs), this study seeks to take a different approach to investigate their compliance with the fulfilment of the three broad categories of maqasid al-Sharı̄ʿah: essentials or daruriyyat, followed by the complementary benefits, or hajiyyat, and then the embellishment or tahsiniyyat. Considering the theoretical perspective of maqasid, each objective was operationally defined for statistical analysis. Six TCs

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from Malaysia were selected and five-year data (2011–2015) collected from the World Bank’s website and annual reports. Secondary data were analysed through balanced panel data approach. Hausman test results indicate that fixed effects model was more appropriate in explaining the explored phenomena. Profitability of TCs is not found to have a significant impact in fulfilling maqasid al-Sharı̄ʿah. Taxes paid by TCs were found to have a significant positive impact on economic growth and poverty alleviation, while payment of zakah was found to have a negative impact. The prohibition of riba (interest) should not be the only decisive difference between Islamic finance and its conventional counterpart. Islamic banks and TCs are accountable towards Allah and thus their activities should be directed towards the fulfilment of maqasid al-Sharı̄ʿah. While earlier published literature has explored efficiency and profitability of TCs, this chapter focused on the ability of TCs in serving the maslaha (public interest/common good of the community). Part II of this book comprises five chapters focusing on cases and modelling on financial inclusion from Islamic perspectives. Chapter 7, by Muhammad Ayub, explains how Islamic finance could be a vehicle for social inclusion. He revisited the case of the liquidity management practices by Islamic banks. The study elaborates that Islamic economics and finance is theoretically said to be leading to socio-economic inclusion and balanced development of human societies and economies by dint of its established strengths. Some major strengths include the ban on interest, avoidance of gharar, ban on short selling and speculation, ban on financing certain economic sectors, the profit- and loss-sharing principle and the asset-backing principle. However, Islamic finance as being practised is losing its meaning and rationale due mainly to replication of almost all products in use by conventional interest-based finance. Despite this erratic approach, shortage of liquidity management (LM) tools is the most serious issue hampering the growth of Islamic finance. Although liquidity shortage is a genuine concern for Islamic banks, practically the excess of liquidity has been the hallmark rendering liquidity management a case of profit maximization even by compromising on the Shariah principles and becoming a conduit for transfer of liquidity to the interest-based system. This study analyses such products/practices and suggests a new approach enabling Islamic finance to serve the cause of humanity by enhancing socio-economic inclusion. Islamic banks are holding public money as a trust and they are accountable both to individuals, to society as also to Allah Almighty. It suggests the policy changes to be introduced to evolve

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into a real, stable and sustainable Islamic system of finance that could be a means to achieving the SDGs with focus on fair and just distribution of the benefits of sustainable growth. Chapter 8, by Muhammad Azeem Qureshi and Toseef Azid, discusses improving access to financial services from theory and practice perspectives. The authors explain the current-day problem regarding the lack of access to formal financial services for poor segments of the society and its potential consequences. However, they argue that it is not only the poor that lack access to formal financial services. The limited access to financial services by non-poor entrepreneurs is likely to be even more important for growth and overall poverty reduction.4 Therefore, they broaden the definitional scope of financial inclusion to include poor as well as non-poor entrepreneurs. They then use systems thinking to present causal mapping of the organic relationships found in the development theories to locate financial inclusion as a development tool to materialize quality of life in both worlds. To improve the operationalization of our conceptualization, they take a stock of the practices around the globe by reviewing the relevant literature and present their framework to address this issue. Chapter 9, by Hassnian Ali and Rose Abdullah, is an exploratory study on fintech and financial inclusion in Pakistan. The authors explain that financial inclusion is an important element of sustainable and inclusive growth which could unleash the wide and unseen potential of formal savings, investment propensities, proper household consumption and investment decisions of the poorer strata of society. Empirical shreds of evidence show that Pakistan is considered among highly financially exclusive countries. They conclude that fintech has big potential to promote financial inclusion by providing immediate, and secured digital payments, financing, as well as investments through crowdfunding and P2P lending to unserved or less served businesses and start-ups. It increases access to financial services to the unbanked segments. They add that fintech bears the capacity to boost Islamic financial inclusion if Shariah compatibility in applications is taken. Fintech, deploying and using the latest technologies, including big data analytics, clouds, IoTs, blockchain and artificial intelligence, and providing highly secured, instant, easy-to-access/use, low-cost and more customer-centric financial services and products, has resulted in real-time efficiencies. The study provides an overview of financial inclusion and status of digital finance in Pakistan to assess the performance of ICTs in Pakistan. The study also elucidates the potential of fintech

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applications and proposes a pragmatic approach to develop a fintech ecosystem to help in achieving the goal of financial inclusion in Pakistan. Chapter 10, by Dika Megantara and Anita Priantina, uses the analytic network process (ANP) approach to look at financial inclusion for farmers through appropriate financing products. The authors analysed that yield from farming has been deemed as insignificant; therefore, the farmers and the land owners tend to sell their land for fast cash. This represents one of the biggest issues pertaining to the access to capital. Many crops, such as rice, mature in several months, and as such, this raises a constraint allowing the banks to finance the farmers. Farmers’ incomes realized seasonally and not more frequently as monthly renders them non-bankable. However, being an extraordinary example, Baitul Maal Wat Tamwil (BMT) in Demak, Indonesia, offers financing to the farmers to be repaid after harvest. This research has analysed the benefits, opportunities, costs and risk elements (BOCR) related to the product implementation. The analytic network process (ANP) is applied to conduct various stages of research. All elements are observed from the farmers’ as well as from Islamic financial institution/BMT’s perspective. In-depth interviews with experts, farmers and bankers determine various elements related to BOCR. Results from pairwise comparison from all elements conclude that the benefit and opportunity of this product carry more significant weight compared to the cost and risk elements. The study has also proposed alternative strategies to maximize the benefit and opportunity while minimizing cost and risk. The respondents have accorded priority to the cooperation from government institutions in both short and long run for effective implementation of the program. Chapter 11, by Farhat Mahmood and Adeeba Ishaq, presents ‘Skill-­ Based and Interest-Free Microfinance Model of Entrepreneurship’ as the most sustainable model. They investigate whether skill-based interest-free microfinance to entrepreneurs in Pakistan is a more sustainable model of microfinance. The study is quantitative (descriptive statistics) and qualitative (multiple cases of Pakistani entrepreneurs who have successfully initiated their own businesses) in nature. The study is interested to compare three entrepreneurs’ microfinance models prevailing in the country which are interest-free, skilled-based financial investment, interest-free financial investment and interest-based financial investment. The findings verify that out of the three models, the skilled-based and interest-free model of microfinance is not only innovative but also more sustainable model of microfinance for entrepreneurs.

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Notes 1. According to a June 2018 study conducted by ‘UN Women’. 2. https://sustainabledevelopment.un.org/sdg3 3. Piketty. 4. Beck, Demirgüç-Kunt et al.

References Addis Ababa Action Agenda of the Third International Conference on Financing for Development. (2015). United Nations Report. Annual Report. (2014). World Bank. Ali, A.  E. (2019). Empowering Women Through Financial Inclusion: Some Evidence from Comoros. International Journal of Asian Social Science, 9(2), 256–270. Global Findex Data. (2011). World Bank. Triki, T., & I.  Faye. (2013). Financial Inclusion in Africa. African Development Bank. UNDP-Islamic Development Bank (IsDB) MoU and Action Plan. (2016). What’s Happening in the Missing Middle? Lessons from Financing SMEs. (2017). World Bank.

CHAPTER 2

Empowering the Poor and Enhancing Financial Inclusion from a Multidimensional Perspective Hazik Mohamed

2.1   Introduction Financial inclusion is about availing financial products and services to those who do not have access to them. All those without a bank account— or access to any other financial services—with a formal financial institution such as a bank, credit union, cooperative, post office, or microfinance institution are among the financially excluded. In practice, there is a continuum of inclusion spanning those who use no financial services, those who use only informal services, those who use some mix of informal and formal services, and those who use exclusively formal services. Recent concepts of financial inclusion do not only refer to access, but also the usage and quality of financial services. Even those with access to some formal financial service may be partially excluded by the lack of access to others. It is also important to note that some people are voluntarily excluded from

H. Mohamed (*) Stellar Consulting Group, Singapore, Singapore e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_2

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the financial system because they have no rewarding use of it or are content with informal alternatives. About half of the world’s adult population does not have an account at a formal financial institution and extreme disparities in access to and usage of formal financial services across and within countries (World Bank 2014). Financial inclusion can be a key driver of economic growth and poverty alleviation, as access to finance can boost job creation, reduce vulnerability to shocks, and increase investments in human capital. In Indonesia, the main goal of its financial inclusion thrust is to achieve economic welfare through poverty reduction, redistribution of income, and overall financial stability. Bank Indonesia believes it can be achieved by creating financial systems that can be accessed by all people in its country at an affordable rate. The financial inclusion program in Bank Indonesia is being run as part of the financial system stability pillar, where “financial system stability” is characterized by a strong financial system capable of withstanding economic shock and that is able to ensure intermediary function, settlement of payments, and diversification of risks. In this chapter, we discuss a multidimensional approach to make financial inclusion work, and list the five key areas that need to be developed in order for us to position ourselves advantageously in the bid to secure a just and prosperous future for all. The critical components of the financially inclusive future are financial literacy and access to financial services; income and wealth redistributive instruments; development of micro, small, and medium enterprises (MSMEs); a sound legal and enforcement system grounded in a universal set of ethical and moral values; and, lastly, an adequate metric set to measure performance and progress. The main thrusts to achieve financial inclusion and shared prosperity are covered in Sect. 2.2 under five subsections which expand on each of these critical components. Section 2.3 discusses what and why there are psychological biases to financial inclusion and economic inequality. It also looks at why there are more behavioral issues concerning financial access. Finally, we focus a possible solution by taking a behavioral approach to financial inclusion and provide inputs to effective implementation.

2.2   Why Is Financial Inclusion So Important? The poor are far more often excluded from conventional financial services. Of the 2.5 billion “unbanked” people, most live in developing countries (World Bank 2014). An estimated 59% of adults in developing countries

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are unbanked, compared to only 11% in developed countries. According to the World Bank, of those living on $2 per day, fully 77% lack a bank account. Household income, education, and whether one lives in a rural area are factors that are strongly related to the extent of financial inclusion, even more so in developing countries. Park and Mercado (2015) emphasize that financial inclusion is important because it is a necessary condition for sustaining equitable growth due to the fact that it provides the poor with opportunities to build savings, make investments, and understand uses of credit. More importantly, access to financial services helps the poor to insure themselves against income shocks and equips them to meet emergencies such as illness, death in the family, or loss of employment. The focus of financial inclusion is basically on the poor, unbanked, and rural populations with the aim to reduce poverty and lower income inequality (Dusuki 2008; Hannig and Jansen 2010). The poor face tremendous financial challenges and require access to financial services to meet essential needs, more so than the nonpoor. The income of the poor is not only lower but also more volatile. People who live on average on $2 per day, make $4 one day, $2 the next, and $0 the day after, as they rely on a range of often unpredictable jobs and often lack salaried employment; or big earnings even come only once a season with, for instance, harvest income (Banerjee and Duflo 2007). Portfolios of the Poor (Collins et al. 2009) found that managing day-to-day cash flow was one of the main three drivers of financial activities of the poor. Transforming irregular income flows into a dependable resource to meet daily needs is a central challenge for the poor. Access to formal financial institutions can bring needed reliability, while informal services may be unreliable, risky, costly, and unsafe (Collins et al. 2009; Roodman 2012). Also, as financial inclusion has the potential to benefit the poor through an array of channels—managing day-to-day resources through credits and savings to smooth consumption, improve the condition of housing, or enhance the productivity of a very small or micro enterprise through savings or credit—its implementation may have other benefits too like implications for financial stability (see Morgan and Pontines 2014). In its inclusive development, the Indonesian government has adopted a triple-tracked strategy, that is, “pro-growth,” “pro-job,” and “pro-poor.” With respect to pro-poor strategies, the government has various programs to alleviate poverty directly or indirectly. The implementation of these programs complements economic growth as the main engine to eliminate poverty, rather than being a substitute for it. The most popular program is

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the National Self-Reliant Community Empowerment Program (Program Nasional Pemberdayaan Masyarakat Mandiri). It empowers people directly at the level of subdistrict and village enabling them to decide on the development priorities of their respective regions (Tambunan 2012). Other pro-poor programs include Unconditional Direct Cash Assistance (Bantuan Langsung Tunai), Public Health Insurance (Jamkesmas), School Operational Support, the provision of subsidies (e.g., rice, fertilizers, and program credits), and the Family Hope Program (Program Keluarga Harapan), which are earmarked for poor and near-poor families all over the archipelago. The Family Hope Program is implemented to meet the basic needs of households that are unable to meet them in any other way. Some of the programs, such as the Program Nasional Pemberdayaan Masyarakat Mandiri, are in the form of the “fishing rod,” to empower disadvantaged communities through the provision of funds up to Rp3 billion per subdistrict per year, the use of which is determined by the people themselves at the village level, according to Tambunan. In addition, the government also allocates a budget for MSMEs in the form of subsidized credit, and the banking sector has been requested to channel a certain portion of their funds as credit for MSMEs. This MSME credit policy is a key element of Indonesia’s policies for financial inclusion (Tambunan 2015).

2.3   Property Rights and Economic Equality Economic, legal, and political institutions—the rules, laws, and customs that guide behavior—help determine living standards around the world. Using conventional tools of the trade like cross-country regressions, instrumental variables, and more nuanced institutional economics methods, several well-cited studies1 have asserted the importance of private property for economic growth. Taking this one step further, economist Hernando de Soto put forth the boldest and most articulate version of the property rights claim: “not only are stable, secure and well-defined property rights incidental to growth, but they are necessary for it.” Similarly, Acemoglu and Johnson (2005) revealed that among these institutions, well-defined and enforced property rights are most important in shaping long-run economic growth and thus prosperity. In any economy there are two key rules of the game: property rights institutions, which include protections against expropriation by the government, and contracting institutions, which facilitate private contracts between citizens. Acemoglu and Johnson found that when property rights institutions protect

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people from expropriation (e.g., via high taxes, price controls, or outright confiscation), individuals can profit from investment in both physical and human capital. This investment produces higher rates of growth, which eventually yield much higher living standards. In the other key rule, the authors find that contracting institutions (such as those determining how difficult it is to resolve contractual disputes through the legal system) have little effect on measures of long-term prosperity. Instead, when contracting institutions are weak or flawed, but property rights are protected, individuals seem to simply alter the terms of their contracts to avoid most of the adverse effects of such flaws. However, the only sure way to avoid predation by the state in the face of weak property rights is to refrain from investing in the first place— which incurs poverty in the long run. From the Islamic perspective, property rights are to be protected and respected between human beings. Property is not a means of exclusion but inclusion in which the rights of those less able are redeemed from the income and wealth of the more able (Iqbal and Mirakhor 2013). One of the goals of laying down Islamic law via Islamic jurisprudence is to develop an egalitarian, just, and prosperous economy with a social structure where all members of society can maximize their intellectual capacity, improve their well-being, and actively contribute to the economic and social development of their society. Economic development and growth, along with equal opportunity and social justice, are the building blocks of an Islamic economic system, in fact, any truly holistic economy. It means creating a level playing field where all members of the society must be given the same opportunities to advance themselves, which includes access to all available resources. For those unable to earn an income due to reasons beyond their control and for those that cannot work (including the aged, handicapped, and the displaced refugees), society must afford the minimum requirements for a dignified life by providing shelter, food, healthcare, and education.

2.4   Multidimensional Concept of Financial Inclusion In order to deliver the benefits and virtues of financial inclusion, it is important to have a holistic perspective of the existing economic and financial system, and this may be achieved from different disciplines

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Financial Literacy and Access

Metrics for Performance Measure

Wealth Redistributive Instruments

Financial Inclusion

Sound Regulations and Enforcement

Micro, Small and Medium Enterprises

SME Capital Market Crowd-funding and Social Impact Investing Micro-financing Programs Vocational Programs for the Poor and Disabled

Fig. 2.1  A multipronged strategy to financial inclusion. The multidimensional approach will involve behavioral aspects in implementation. (Source: Author’s illustration)

working as one unit toward a single common goal. This involves adopting innovative (even unconventional) approaches to adapt to the evolving complexity of today’s problems. A multidimensional approach requires teams where all participants from multiple disciplines collaborate and share ideas from the beginning to create a comprehensive plan that covers all necessary analyses and recommendations for a master plan, policy, or steps to address a specific crisis. For instance, fighting unruly market behavior or trying to implement socioeconomic policies like financial inclusion may involve regulators, the government, consumers, and industry players. The following sections will explain in broad terms the mechanisms behind a system that will put in place the pillars of financial inclusion and institutionalize the trek toward empowering the poor (Fig. 2.1).

2.5   Financial Literacy and Access to Financial Services First of all, the government, through its central banks, can make financial education a priority, to increase the effectiveness of central bank policy and as part of its socioeconomic equality strategy. The better people understand finance and the economy, the better central bank policy transmission and compliance will be. A cooperation framework can be implemented

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through national coordination, from responses of related ministers and other stakeholders. Salient areas for increasing the financial literacy level should include the identification of target groups, composing a financial education strategy, and setting program indicators to monitor and evaluate effectiveness, ensuring financial education programs attain the targets that have been set and lead to optimum results. Through financial education, more awareness in the society is raised toward the goal of improved financial behavior. To reach this goal, financial education should start at an early age. Even so, the household financial decisions today lie in the hands of income-earning adults with varying degrees of financial literacy and understanding. Hence, different approaches should be adopted for different target groups when communicating financial education. However, the core education aspects should include basic financial planning, banking products and services, and complaint and dispute resolution. Having said that, it is important to note that making people aware of financial services or making available such services is not sufficient. What is required is to help them build their assets where they had none to begin with and subsequently making their assets not just lie dormant but actively working for them. This in turn invigorates the entire economy by optimizing the use of all net assets.

2.6   Income and Wealth Redistributive Instruments One of the most important economic justice instruments that exists as a principle in Islam that operationalizes the objective of achieving social justice is the income and wealth redistributive mechanism. The Islamic view holds that it is not possible for the wealthy to accumulate riches without simultaneously economically depriving the disadvantaged. The holy Qur’an reminds us that the enlightened and more able should act responsibly as trustees to resources that has been bestowed to all. As such, Islam views property as a means of inclusion in which the rights of those less able are redressed from the income and wealth of the more able (Iqbal and Mirakhor 2013) within the limits stipulated in the Shari’ah. This would result in a more stable economy without extremes of wealth and poverty. The operational mechanism for redressing the rights of the poor from the more able is the system of obligatory and voluntary payments such as zakat (2.5% on wealth) and charitable property transference such as wakaf, sadaqah, and infaq.

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The institution of zakat, for example, is expected to play an important role in income distribution and resource allocation. First, the zakat serves as a safety net designed to provide for the relief of poverty and other forms of social security. Its redistributive effect is expected to increase the aggregate demand in the economy. Second, the zakat is expected to have a strong stimulating effect on investment and productivity. By discouraging property owners from holding idle assets, the zakat will create incentives for wealth owners to ensure the maximum turnover of their net capital (Gambling and Karim 1991). Together with the proscription of extravagant spending, the zakat is expected to reduce the transaction demand2 for money. The stimulating effect of the zakat, together with the ban on interest, is expected to reduce the precautionary demand3 for money. Furthermore, the redistribution effects of zakat are expected to have a positive impact on the level of aggregate savings. Such channels allow for money to flow through the different levels of income in an economic system, and societies that are sharing grow faster than societies that are stratified by large income gaps:

∆ GDP = 1 / (1 − MPC )  ∆I



where GDP is the gross domestic product of a country and MPC is its marginal propensity to consume. As MPC rises, every dollar of investment increases the GDP greater than if MPC was lower. The MPC of the poor is generally higher than the MPC of the rich. Hence a system like the zakat (including wakaf, khums, sadaqah, and infaq), which channels money back from a section of the society that tends to save to a section of the society that tends to spend, actually prospers the nation by increasing its GDP.

2.7   Development of Micro, Small, and Medium Enterprises Perhaps some of the most important skills required in constructing an economic strategy for financial inclusion can be observed from entrepreneurs. The last two decades have witnessed both large (conglomerate) companies increasingly concentrating on core competences and experiencing mass layoffs (especially in traditional manufacturing industries) and high-technology innovative small firms having come to the forefront of

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technological development in many (new) industries. These developments would suggest the key importance for modern economies of a sound entrepreneurial climate for achieving economic progress and shared prosperity. Entrepreneurs play a vital role in economic development as key contributors to technological innovation and new job growth. Furthermore, entrepreneurs help build communities in ways such as providing jobs, conducting business locally, creating and participating in entrepreneurial networks, investing in community projects, and giving to local charities. Driving entrepreneurship also relieves governments from spending on social security programs, which instead could be used to help build new economy infrastructure and other sovereign investment programs. Due to the positive influence entrepreneurship has on the general growth of economies, it is considered as the engine that drives the economies of the majority of nations (Gorman et al. 1997; Navarro et al. 2009). Thus, it is the characteristics of entrepreneurs that we wish to cultivate in order to secure the future of shared prosperity. Moreover, entrepreneurship has been a large part of Islamic culture and Islam always encouraged Muslims to be innovative, entrepreneurial, and active in the real sector of the economy. The literature reveals that an entrepreneur is the organizer of factors of production (Carton et al. 1998), the developer of spot opportunities and an innovator (Dana 2001), and an organizer of resources and risk-taker (Deakins and Freel 2009) and is creative and imaginative and identifies and acts on opportunities that involve entrepreneurial activities (Rae 2012). Indeed, entrepreneurs are made, not born, and researchers reveal that problem-solving and leadership can be learned and taught through education and training programs (Gorman et  al. 1997; Henderson and Robertson 2000; Young and Sexton 2003). Thus, education for entrepreneurship places importance on students’ development and increases and fosters the mindset and skills of an individual to embrace entrepreneurship (Formica 2002; Hannon 2006). In Indonesia, the number of MSMEs has steadily increased every year (Badan Pusat Statistik 2010). In 2012, the share of MSMEs in total enterprises (including large enterprises) was around 99%. The majority of them are micro and small enterprises (MSEs), which are scattered widely throughout rural areas and, therefore, likely to play an important role in helping develop the technical and entrepreneurial skills of villagers, and particularly women. However, most MSEs are established and run by poor individuals or households, either as their primary or secondary

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(supplementary) source of income, because they cannot find better employment. Therefore, the presence of MSEs in Indonesia is often seen as a reflection of the problems of poverty and unemployment, rather than as a reflection of entrepreneurial spirit. Also, there are other aspects, like regulatory policy, to be considered. For instance, the Central Bank of Indonesia has started an SME rating pilot project in 2012. The methodology for risk assessment covered management risk, business risk, and financial risk. The objectives of the pilot project are to assess the willingness of SMEs to be surveyed in order to obtain the ratings and also to assess the effectiveness of the rating results in the loan approval process. The long-term proposal for the SME rating program is to be aligned with the national agenda for the regional credit guarantee system and increased access of SMEs to financial services. 2.7.1  SME Capital Market Development In Asia, a joint study by the Asian Development Bank (ADB) and Organisation for Economic Co-operation and Development (OECD) (2014) found that the nonbank sector and the venture capital industry are at early stages of development and have not established feasible SME products. In addition, the policy framework is not sufficiently advanced to support innovative financial instruments for SMEs. However, Asia’s rapid growth is gradually generating the base of growth-oriented SMEs and forming a new demand from them for stable long-term funding for sustainable business growth. Moreover, lessons from the 1997/1998 Asian financial crisis and the 2008/2009 global financial crisis have motivated many Asian countries to develop alternative financing models that go beyond traditional bank lending. Accordingly, SME capital markets are seen as one potential policy area for SME development in Asia. In this context, how to create the base of investors as risk capital providers to SMEs is a critical challenge for well-­ functioning SME capital markets. The ADB and OECD also found that there is a strong dependence of SMEs on debt instruments, which might be rational as debt instruments tend to suit SMEs needs better than equity-type ones because they are less costly and technically less intensive; they have a different tax treatment (interests on debt are deducted before calculating overall profits while dividends on equity are paid after taxes are deducted); and firm owners might not be inclined to give ownership or control rights in exchange

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for capital. Also, contractual agreements that are steeped in risk-sharing principles like silent partnership (mudarabah) and joint venture (musyarakah) are deemed to be very risky by conventional standards, hence not particularly favorable from a conventional bank’s standpoint. Likewise, profit markup (murabahah) contracts are considered less risky, but these mirror conventional agreements which entrench risk-­ transfer techniques by the bank to the consumer. The benefits to the Islamic principles of risk-sharing are many, and the reliance on equity and equity-type financing arrangements helps to restrain excessive leveraging, which was one of the core components of the global financial meltdown. The close linkage between the amount of financing and an underlying asset also helps to limit leverage, and the sharing of risk and reward (al ghunm bil ghurm) implies that long-term targets become more important and excessive short-term risk-taking is discouraged. Financial institutions then become more like business partners with their clients and have stronger incentives to evaluate financing requests carefully and exercise prudence in extending such financing. As “business partners,” financial institutions are also more likely to assist borrowers in working through bad times, thus reducing the pressures to sell assets at “fire-sale” prices. This protects the system against a general fall in asset prices and reduces the probability of cascading defaults. The sharing of losses in the profit-­ loss sharing (PLS) arrangements also reduces the probability of contagion to the rest of the financial system. Furthermore, dividends on equity instruments, however, are only paid if the firm has been profitable, while debt has to be paid always. 2.7.2  Crowdfunding and Social Impact Investor Platforms While the big traditional banks remain broadly averse or unable to offer credit to MSMEs, the alternative financing industry, through financial technologies and crowdfunding, has been growing by leaps and bounds. All this growth has turned the industry into an evolving mix of nontraditional lenders, accessible platforms, and innovative products. As increasing numbers of small business owners seek nontraditional funding platforms, the alternative financing industry keeps expanding with new, yet similar-sounding products. The most popular forms of crowdfunding can be segmented into the following:

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1. Peer-to-peer lenders, or P2P lending, is a form of financing that occurs directly between individuals or “peers” without the involvement of a traditional financial institution. Loan amounts are ­typically small, a maximum of US$10,000. Loan terms are also fairly short, from one to five years. Much of the success of P2P lending is a result of the social networking power and infrastructure of the internet. P2P lending sites offer an online marketplace where borrowers and lenders can come together. Often, there will be several private lenders per borrower who each share in partially funding a given loan amount. These sites typically provide identification and verification services, as well as an assessment of the borrowers’ creditworthiness and the risk involved in lending to them. Clear, precise documentation covers the loan’s terms and conditions, as well as the repayment schedule and tax payments as determined by both parties. 2. Crowdfunding allows business owners and entrepreneurs to raise funds by requesting a small amount of money from many different people online. By tapping into the power of the internet, entrepreneurs can pitch their ideas to a large group of people, who, if interested, will respond by donating a small portion of the money the business or entrepreneur needs to help reach the target. Unlike more traditional forms of business capital, the money raised through crowdfunding is not directly repaid. Recipients may instead offer their investors some specified item or service in return for their financial support, such as a free sample of their product. The more common crowdfunding models can be characterized as donation-­ based, equity-based, and reward-based depending on the different structures and objectives. The most popular online microlending institution is Kiva, which can make a loan to an entrepreneur across the globe for as little as US$25 (Table 2.1). Kiva Microfunds is a nonprofit organization that allows people to lend money via the internet to low-income entrepreneurs and students in over 80 countries. Kiva’s mission is “to connect people through lending to alleviate poverty.” Social impact investment, also called simply “impact investing,” focuses on investing in companies or organizations to create a measurable societal benefit and generate a financial return. Impact investing is typically centered around addressing a social issue, such as poverty or education, or

5,000,000

3.85

250,000

300,000

3850

1,500,000

EcoAsia Southeast Asia Agriculture Fund Gandeng Tangan IIX Growth Fund

Insitor Management

15,000,000

500,000

Avantage Ventures

1,200,000

1,500,000

70,000

30,000

ARUN

Maximum (US$)

Minimum (US$)

Social impact organization 2009

2011

www. insitormanagement. com/

2001

www.gandengtangan. 2015 org/ iixglobal.com/ 2009 iix-growth-fund/

www.ecoasiafund. com/

Mekong Region and Indian subcontinent across India, Vietnam, Laos, and Myanmar

Bangladesh, Indonesia, Philippines

Indonesia

Southeast Asia

China, Southeast Asia

Cambodia, Southeast Asia

(continued)

Climate change, women empowerment in clean energy, climate-smart agriculture, water, health, sanitation, green technology Poverty alleviation, access to energy

All social enterprises

Small farmers, employment for women and students, marginalized communities Healthcare, rural development, education, clean energy, disenfranchised community Agricultural value chain, food security, climate change issues

Operational Target geographies Sectors since

csip.vn/en/content/ 2008 avantage-ventures

www.arunllc.jp/en/

Website

Table 2.1  Compilation of social impact investor platforms 2  EMPOWERING THE POOR AND ENHANCING FINANCIAL INCLUSION… 

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Worldwide Asia

All social enterprises Circular economy, sustainable energy, and social impact: all sectors except for nuclear power, the weapons industry, coal mining, coal-fired power plants, and the tobacco industry

Operational Target geographies Sectors since

10,000 50,000 www.kiva.org 2005 15,000,000 (for Undisclosed http://www.sfc-asia. 2016 Circular com/funding Economy and Sustainable Energy Proposals) 5,000,000 (for Social Impact Proposals)

Website

Kiva Sustainable Finance Collective (SFC) Asia

Maximum (US$)

Minimum (US$)

Social impact organization

Table 2.1 (continued)

26  H. MOHAMED

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healthcare or an environmental issue, such as clean water, agro-industrial projects, or renewable energy. Impact investment provides both debt and equity financing to businesses and institutions, with an emphasis on alleviating hunger and poverty problems, fostering entrepreneurship, establishing food production, and education programs, and working on climate change issues. The forms of impact investing include small business loans to grow a business, expand staff, or increase energy efficiency. Just as the formation of the venture capital industry ushered in a new approach and mindset to funding innovation within the private sector, social impact investment has started to create opportunities to harness entrepreneurship and capital markets to drive social improvement. Impact investors distinguish themselves from traditional investors not from its investment vehicles or products they employ, nor the markets or the sectors they concentrate, but rather through the motivations behind their investment behavior and the factors they consider when making their investment decision. They are flexible in capital provision to suit the needs of the request. An impact investor may invest in equity in one entity while providing credit or guarantees to another. They are willing to provide soft funding to entities that lack asset sizes or revenue streams that traditional investors may shun. 2.7.3  Microfinancing Programs Microfinancing specifically refers to financial help to low-income households in poverty areas and countries that do not have well-developed banking systems. Many of these loans are used to help finance medical bills, small businesses, education, and agricultural development. A document from the European Bank for Reconstruction and Development (2006) noted that nearly 6000 microfinance institutions operated across Central and Eastern Europe and the CIS—approximately a third of all microfinance was undertaken by traditional financial intermediaries, that is, commercial banks (including formalized microfinance banks). The remaining two-thirds of all microfinance was provided by nonbank MFIs (credit unions, finance companies, NGOs). In Asia, the Banking with the Poor Network (BWTP) works with nongovernmental organizations, commercial banks, and policy institutions from nine countries in Asia to promote and develop microfinancing services in Asia through research, dialogue, advocacy, and capacity building.

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Specifically in Indonesia, probably the most important and famous microfinance scheme in the post-Soeharto era is Kredit Usaha Rakyat (KUR), or people/community business credit, launched by President Susilo Bambang Yudhoyono in November 2007. The main aim of KUR is to help finance feasible, but not bankable, MSMEs. This is known as credit without collateral and is a loan for working capital and investment capital for individual producers or owners of productive MSMEs and cooperatives with a credit upper limit up to Rp500 million. The scheme is 100% financed by national commercial banks, that is, BRI, Bank Negara Indonesia, Bank Mandiri, Bank Tabungan Negara, Bank Syariah Mandiri, Bank Bukopin, and Bank Negara Indonesia Syariah (Tambunan 2015). KUR received by MSMEs is guaranteed (70%) by two insurance companies, that is, PT Asuransi Kredit Indonesia and Perusahaan Umum Jaminan Kredit Indonesia (PT Jamkrindo), and by other companies which have voluntarily joined the program. Further to innovative microfinance products, micro-leasing is another avenue that provides assistance through solving the problem of lack of collateral faced by smaller businesses mostly involved in the production sector. The partner banks could potentially play a role in downscaling existing leasing operations to amounts that could benefit MSE clients, or assisting nonbank microfinance institutions to develop this product. 2.7.4  Vocational Training Programs for the Poor and Disabled Vocational training programs can be a way to develop the poor and disabled as part of the skilled labor force. Skills are valuable to any organization especially businesses; a skilled person is an asset to any economy. Vocational skills training programs are suited for those with limited education and prefer more hands-on work or are simply good with their hands in diverse fields of the economy, across the cross-section of the real sector. One way is to partner with rural communities to incorporate multi-­ skilled job and life skills training as part of the secondary school curriculum. We develop the curriculum, recruit the trade practitioners (plumbers, carpenters, electricians, etc.) from the local communities, and train them to be instructors. The state government buys equipment and pay for the running costs and other expenses for a period of three years. Poor youths take the classes, based on well-developed curriculum, three days during the school week for one year. They also carry out various aspects of running a business, namely accounting, finance, marketing, and customer

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service for real through various revenue-generating projects and earn real income, of which they contribute 30% of their paycheck back to the vocational training program for the period that they were trained as a means of paying forward the benefits gained from it. In Bangladesh, Nuri et  al. (2012) conducted a study to evaluate the effectiveness of a vocational training program in enabling 261 persons with disabilities to find employment in Bangladesh. Interviews and focus group discussions assessed the effect of the training program on key individual, societal, and physical factors set out by the WHO International Classification of Functioning, Disability, and Health.4 They found that 157 persons with disabilities (about 60%) secured employment after training. Of these, 74% reported that they were able to provide a better livelihood for their families, 92% reported increased social acceptance, and 83% reported improvement in overall quality of life. Of those who did not find employment, 15% cited issues related to the training course, 6% mentioned discriminatory attitudes of potential employers, and 12% had problems related to physical access. These results suggest that the vocational training program improved the (re)entry of persons with disabilities into employment, despite discriminatory attitudes toward some of them were reported. 2.7.5  Sound Regulatory, Supervisory, and Enforcement Framework Any financial program or economic system has to be protected by a sound legal and enforcement system that protects the rights of individual, not only property rights, but also intellectual property. When the objectives of financial inclusion are set and rules are framed to achieve them, an effective mechanism must be implemented to make sure that the rules are enforced and observed. Effective enforcement requires a mechanism to detect the violation and proper sanctions to deter anyone from violating the rules. An advantage of religious law, like the Shari’ah, is that it is not subjected to the dictates of political power, and this creates a vital distinction between the power of the executive and the rule of law. We discuss the salient points of the conventional as well as the Islamic legal system based on contractual and obligations for consideration. Typically, historians of the economy differentiate between two forms of enforcement. The first is self-enforcement, what Grief (1994) terms “private-­order enforcement mechanism,” where the “credible” threats to

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reputation and the threat of market exclusion induce contractual compliance. This environment is characterized by “optimal contracts” that are “fundamentally self-enforcing” and “institutions do not matter.” The focus is on the ex ante conditions to drafting contracts with watertight clauses that supposedly render them self-enforcing. The second is third-­party enforcement, where agreements are drafted between parties in the presence of an independent individual (strongmen, chiefs, or other local authorities) or entity (state, court). Some academic scholars call these “incomplete contracts” because their enforcement requires public enforcement institutions. Muslim cases in the trans-Saharan trade community do not fit into either of these distinct scenarios (Lydon 2008). For them, the act of drafting a contract in a “session” following formal legal guidelines from the Qur’an and the Sunnah required third-party enforcement through the use of witnesses. In trade practice, they approached the issue in two ways for enforcing contracts through the mechanism of prevention and the mechanism of remediation: 1. Prevention of contractual failure required literacy skills and legal knowledge (contractual models and principles), resources (copies of documents, communication channels), connections (witnesses with impeccable reputations), and authority (merchants, muḥtasibs,5 qāḍis). 2. Remediation took various forms, such as the mediation of third parties (contract witnesses, qāḍis), pressuring contracting party directly or via correspondence (threats to tarnishing their reputation, their client base and instilling them with the fear of ex post consequences to future transactions, pressure on family members), or engaging in costly litigation.6 Furthermore, the institution of al-hisba (market supervision) is meant to monitor the behavior of contracting parties (market participants) and set the legal standards for fostering ethical and moral behavior. This is an important example to consider when dealing with tribal and rural communities, particularly in Muslim-dominated Indonesia, where buy-in can be gained by drawing parallels to historical religious institutions while relating to governing secular legal institutions.

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2.8   Adequate Metrics for Performance Measure For any system, economic or otherwise, its system-wide adoption can only take place wholeheartedly if it has the promise to produce the expected results. With that, an effective set of balanced metrics has to be designed. This would enable for the necessary growth and performance measurements that will now include social responsibility and ecological sustainability. In terms of empowering the poor and financial inclusion, it is a means to capture policy performance in a more holistic terms, besides merely measuring productivity and output. Similarly, a much better metric for eliminating poverty should be literacy and education, side by side to standard of living and income bracket. The current dominant standard metric of economic performance, GDP, is only until recently believed not to adequately up to its task.7 A report by leading economists, Mismeasuring Our Lives: Why GDP Doesn’t Add Up (Stiglitz et al. 2010), concluded that too much focus on GDP could send policymakers in the wrong direction—for example, expanding their banking industries and ignoring more basic things such as access to education or health. “If we have the wrong metrics, we will strive for the wrong things,” they concluded. High-quality global innovation requires investment in new perspectives. Yet GDP has become such a powerful proxy for what governments hold dear that nations find it hard to see past it. Few economists are blind to its many limitations as an effective indicator, and most do not fathom there can be anything better. There definitely has to be a better way to reflect economic reality, and this will be the new metrics for empowerment of the poor and inclusion. Morgan and Pontines (2014) in their paper raised the question of whether financial stability and financial inclusion are complementary or incongruent. They found that an increased share of lending to small and medium-sized enterprises (SMEs) aids financial stability, mainly by reducing nonperforming loans (NPLs) and the probability of default by financial institutions. This suggests that policy measures to increase financial inclusion, at least by SMEs, would have the side benefit of contributing to financial stability as well. Such research (although it is limited at this time) allow us to assess through quantitative models on the impact of financial inclusion variables (e.g., literacy education, redistributive instruments, etc.) on the overall financial stability, because it could help us to define the key performance indicators of financial inclusion activity. Furthermore, the extent of financial regulation on financial inclusion should also be considered as one of the independent variables to get a better understanding

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of how financial inclusion activities support the overall financial stability of the economy, including the supporting regulation. This is recommended so that in implementing a more just and financially inclusive system, we are striving for the right things (with strong empirical economic data) and measuring them the right way.

2.9   Behavioral Issues in Financial Decision-Making Making mistakes when choosing and using financial products and services affects all of us, but especially the poor. People find it easier to think about things they know well and that are physically conceivable and concrete. Financial products, however, are inherently abstract, and people, particularly the financially less literate, find them complicated. Even if they found the process difficult to understand, the more financially literate will still find it important enough to pursue them for the economic benefit. The poor, however, are not aware of such products or do not have access to them. In a conventional capitalistic and profit-driven banking/ finance industry, the poor simply fall out of the radar as a targeted clientele. Here, we see that the behavioral issues not only stem from the mindset of the poor but also the narrow motivations of financial gain targeting the financially well-off by the product issuers. Moving up the poverty line, the risk of lower-income consumers making mistakes is exceptionally high in the financial services because financial decisions can be very emotional to the investor. Investment decisions that go bad bring on a sense of shame and incompetence even at higherincome levels. Psychoanalytical studies using conflict/compromise model put forward by Freud, then later articulated by Brenner (Shefrin 2002), also show that investment decisions involve other deep-seated emotions such as anxiety, fear, and regret. Stress, anxiety, fear of losses, and regret, rather than the costs and benefits of the choices, can drive decisions. From the perspective of financial product tenures, learning from past errors can be difficult, and not only for infrequent decisions like mortgages, pensions, and annuities, but also for charging structures, such as overdrafts. The choices of these products are made infrequently, with little learning from others and with consequences revealed only after a long delay. The less financially literate consumers either shun these products because they do not understand them or adopt them after being coerced without really understanding their risks and consequences.

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2.9.1  Behavioral Approach to Financial Inclusion Standard economic thinking assumes the poor will want to earn their way out of poverty. But as studies from countries as different as Ethiopia and France show, poverty makes people feel helpless and dulls their ambitions, so they may not even try to improve their situation. The poor are exposed to extraordinary levels of stress: childhood illness is more likely to be life-­ threatening; harvest failure can lead to impoverishment. And stress makes them too risk-averse and makes good decision-making harder. Above all, the poor lack the institutional framework which, in the more affluent countries, improves decisions. Everywhere, people underestimate the benefits of education and save too little for their retirement. But children in advanced economies go to school as a routine; pension systems make some savings automatic. Poor countries provide few such paths to prosperity. Traditional development programs focus on resources and markets. The logic is that people are poor because they lack resources: not just money but roads, hospitals, schools, and irrigation systems. In reality, such thinking is unable to eradicate poverty because it fails to capture the behavioral aspects that leads to poverty. The behavioral approach focuses on how decisions are made and how they can be improved. For example, in Bogotá a conditional cash-transfer program paid mothers a monthly stipend if they took their children to school (World Bank 2014). Attendance during the school year was good but re-enrolment rates were low. A shift in the timing of the handout—withholding a part of the regular payment until just before the start of the school year—boosted enrolment sharply. This makes little sense in conventional economic terms: going to school is so beneficial that families should not need extra incentives and the overall sum available did not change. Yet the payoff was substantial. Actions like this sound marginal but policymakers should be paying attention to the details of policy implementation. Paying attention to how the poor actually think would also imply big changes to financial inclusion policies. Muhammad Yunus of the Grameen Bank saw that people would never lend to poor Bangladeshis, as they had no collateral to hold against the loan. By lending to small communities, he harnessed the power of peer group pressure which ensured the loans were repaid. And it is also important to note that the excluded are the groups of people who have certain distinguishing characteristics which consistently

34 

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contributed to their failure to benefit from a nation’s progress (World Bank 2013). These groups were among the poorest in a nation, but they were not consistently the poorest. They were often, but not always, minorities. What set them apart was that they were members of excluded groups—indigenous people, new immigrants, people with disabilities, people with different skin tones, people who spoke the official language imperfectly. These were people labelled by disgrace, stereotypes, and false notions. They are challenged with unique barriers that kept them from fully participating in their country’s political and economic life.

2.10   Conclusion The discussion in this chapter supports the common understanding that a well-functioning and inclusive financial system could help alleviate the effects of information asymmetries and reduce transaction costs. Related institutions should innovate delivery channels to increase creative approaches to enhance financial inclusion in order to invigorate economic growth, spread equality of opportunities, promote redistribution of wealth, alleviate poverty, and support SMEs as the critical contributors to the economy. Public policy and reinforced institutional framework grounded in Islamic tenets in developing countries can go a long way to enhancing financial inclusion. Examples of policy improvements include better corporate governance, including supervision, monitoring, and management, which can reduce damage to currency, household, sovereign wealth due to economic and financial mismanagement, achieving and sustaining economic and political stability, and developing the financial sector. In terms of the institutional framework, these includes clear and secure property rights, upholding contractual agreements and enforcement, securing trust, and building social capital among people and between government. The mutual belief and trust between citizens, authorities, and other institutions can reduce risk, uncertainty, and ambiguity and strengthen social solidarity while bringing private and public interests into closer harmony and ensuring economic coordination to improve holistic risk sharing (Mirakhor 2009, 2010). Public policy could also help in mobilizing savings of poor households and thus reduce their vulnerability to income shocks. In addition to mobilizing savings and encouraging microfinance, better access to the financial sector by developing microcredit and insurance markets in rural and poverty-stricken regions are

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promising ways by which public policy can assist the development of risk sharing to allow them to better cope with such risks. Integrating Shari’ah-compliant products and financial inclusion strategies into the formal financial sector will not only enhance access, but will also help integrate Islamic principles of inclusiveness into existing systems of finance. This will also help Shari’ah-compliant institutions develop hybrid solutions, through integrating different models with different contracts (e.g., wakaf institutions extending qard-al-hassan scholarships or mortgages for the poor). In the SME sector, technological innovations may spur development of market-based solutions such as green technology and internet access, which enables access to reliable power and energy sources as well as levelling the competitive field through access to new disruptive services afforded through mobile apps. The changing global context is expected to make financial and social inclusion issues more relevant. Many societies have been and will continue to be reshaped by profound transformations, such as the refugee crises and the influx of migrants. These transitions can lead to new forms of exclusion, but they can also create new opportunities for inclusion. They often have an effect on attitudes and perceptions, which in turn affect the way people act and feel. Feelings of being included and respected by others, or being heard by the government, are central to shaping people’s abilities, their sense of dignity, the opportunities they access, the way in which they take part in society, and the way the government engages the people and works toward equality and shared prosperity.

Notes 1. Robert J.  Barro, “Determinants of Economic Growth: A Cross-Country Empirical Study,” National Bureau of Economic Research, Working Paper No. 5698 (1996). See also Daron Acemoglu, Simon Johnson, and James A.  Robinson, “The Colonial Origins of Comparative Development,” American Economic Review, Vol. 91 (2001). Oliver C. Williamson, “The New Institutional Economics: Taking Stock, Looking Ahead,” Journal of Economic Literature, Vol. 38 (2000). 2. In economic theory, specifically Keynesian economics, transaction demand is one of the determinants of demand for money (and credit), the others being precautionary demand and speculative demand. The transaction demand for money refers specifically to money narrowly defined to include only its most liquid forms, especially cash and checking account balances.

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This form of money demand arises from the absence of perfect synchronization of payments and receipts. 3. Precautionary demand is the demand for financial assets, such as securities, money, or foreign currency; it is money people hold in case of emergency. The precautionary demand for money refers to real balances held for use in a contingency. As receipts and payments cannot be perfectly foreseen, p ­ eople hold precautionary balances to minimize the potential loss arising from a contingency. 4. ICF was officially endorsed by all 191 WHO member states in the Fifty-­ fourth World Health Assembly on 22 May 2001 (resolution WHA 54.21) as the international standard to describe and measure health and disability. 5. In Islamic markets during the Prophet’s time, Mirakhor (2010) reported that “prices were determined by fierce competition among suppliers, and every market was supervised by a person called muhtasib, a practice started by the Prophet himself. Supervisory were based on the rule-enforcement mechanism of ‘commanding the good and forbidding the evil’” in urging with compliance with the rules. 6. Based on oral historical reports of Tishti, Shinqiti, etc., tribe families by G. Lydon. 7. Former French president Nicolas Sarkozy commissioned leading economists, including Joseph Stiglitz and Amartya Sen, to look into better methodologies.

References Acemoglu, D., & Johnson, S. (2005, October). Unbundling Institutions. Journal of Political Economy, 113(5), 949–995. Asian Development Bank. (2014). ADB–OECD Study on Enhancing Financial Accessibility for SMEs: Lessons from Recent Crises. Mandaluyong, Philippines: Asian Development Bank. Badan Pusat Statistik (BPS). (2010). Profil Industri Mikro dan Kecil 2010 (Profile of Micro and Small Industry). Jakarta: Badan Pusat Statistik. Banerjee, A., & Duflo, E. (2007). The Economic Lives of the Poor. Journal of Economic Perspectives, 21(1), 141–167. Carton, R., Hofer, C., & Meeks M. (1998). The Entrepreneur and Entrepreneurship: Operational Definitions of their Role in Society. Annual International Council for Small Business. Conference, Singapore. Collins, D., et al. (2009). Portfolio of the Poor—How the World’s Poor Live on $2 a Day. Princeton University Press. Dana, L.  P. (2001). The Education and Training of Entrepreneurs in Asia. Education + Training, 43(8/9), 405–415.

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Deakins, D., & Freel, M. (2009). Entrepreneurship and Small Firms (5th ed.). London, UK: McGraw-Hill Companies. Dusuki, A.  W. (2008). Banking for the Poor: The Role of Islamic Banking in Microfinance Initiatives. Humanomics, 24(1), 49–66. European Bank for Reconstruction and Development. (2006). Annual Report 2006. London, UK. Formica, P. (2002). Entrepreneurial Universities—The Value of Education in Encouraging Entrepreneurship. Industry & Higher Education, 16, 167–175. Gambling, T., & Karim, R. (1991). Business and Accounting Ethics in Islam. London: Mansell. Gorman, G., Hanlon, D., & King, W. (1997). Some Research Perspectives on Entrepreneurship Education, Enterprise Education and Education for Small Business Management: A Ten-year Literature Review. International Small Business Journal, 15(3), 56–78. Grief, A. (1994). Cultural Beliefs and the Organization of Society: A Historical and Theoretical Reflection on Collectivist and Individualist Societie. Journal of Political Economy, 102(5), 912–950. Hannig, A., & Jansen, S. (2010). Financial Inclusion and Financial Stability: Current Policy Issues. ADBI Working Paper Series (No. 259). Tokyo. Hannon, P.  D. (2006). Teaching Pigeons to Dance : Sense and Meaning in Entrepreneurship Education. Education + Training, 48(5), 296–308. Henderson, R., & Robertson, M. (2000). Who Wants to be an Entrepreneur? Young Adult Attitudes to Entrepreneurship as a Career. Career Development International, 5(6), 279–287. Iqbal, Z., & Mirakhor, A. (Eds.). (2013). Economic Development and Islamic Finance (Directions in Development). Washington, DC: World Bank. Chapter 6. Lydon, G. (2008). On Trans-Saharan Trails : Islamic Law, Trade Networks, and Cross-Cultural Exchange in Nineteenth-Century Western Africa. Cambridge University Press. Mirakhor, A. (2009). Islamic Economics and Finance: An Institutional Perspective. IIUM Journal of Economics and Management, 17(1), 31–72. Mirakhor, A. (2010). Whither Islamic Finance? Risk Sharing in an Age of Crises. Morgan, P., & Pontines, V. (2014, July). Financial Stability and Financial Inclusion. ADBI Working Paper Series, No. 488. Navarro, M.  M., Iglesias, M.  P., & Torres, P.  R. (2009). Curricular Profile of University Graduates versus Business Demands. Education & Training, 5(1), 56–69. Nuri, M. R. P., Hoque, Md. T., Akand, M. K., & Waldron, S. M. (2012). Impact Assessment of a Vocational Training Programme for Persons with Disabilities in Bangladesh. Disability, CBR and Inclusive Development (formerly Asia Pacific Disability Rehabilitation Journal), 23(3), 76–89.

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Park, C., & Mercado, R.  V. (2015). Financial Inclusion, Poverty, and Income Inequality in Developing Asia. ADB Economics Working Paper Series (426). Rae, D. (2012). Action Learning in New Creative Ventures. International Journal of Entrepreneurial Behavior & Research, 18(5), 603–623. Roodman, D. (2012). Due Diligence—An Impertinent Inquiry into Microfinance. Washington, DC: Center for Global Development, Brookings Institution Press. Shefrin, H. (2002). Beyond Greed and Fear: Understanding Behavioural Finance and the Psychology of Investing. Oxford: Oxford University Press. Stiglitz, J., Sen, A., & Fitoussi, J. P. (2010). Mismeasuring Our Lives: Why GDP Doesn’t Add Up. New York: The New Press. Tambunan, T.  T. H. (2012). Indonesia: Building an Inclusive Development Model. In Z.  Yunling, F.  Kimura, & S.  Oum (Eds.), Moving Toward a New Development Model for East Asia: The Role of Domestic Policy and Regional Cooperation. Economic Research Institute for ASEAN and East Asia (ERIA) Research Project Report 10. Jakarta: ERIA. Tambunan, T.  T. H. (2015). Financial Inclusion, Financial Education, and Financial Regulation: A Story from Indonesia. ADBI Working Paper 535. Tokyo: Asian Development Bank Institute. World Bank. (2013). Inclusion Matters: The Foundation for Shared Prosperity (Advance ed.). Washington, DC: World Bank. World Bank. (2014). Global Financial Development Report 2014: Financial Inclusion. Washington, DC: World Bank. Young, J. E., & Sexton, D. L. (2003). What makes Entrepreneurs Learn and How Do They Do It? Journal of Entrepreneurship, 12, 155–182.

CHAPTER 3

Causes of Income and Wealth Inequalities: Perspectives of Economists from the Fields of Conventional and Islamic Economics Muhammad Imran Ejaz

3.1   Introduction The Prophet Muhammad  has brought the religion of Islam to humanity. In Islam the prohibition of riba (interest) is clear and undebatable. Over more than the thousand years that have passed since the times of the Prophet , Muslim thinkers have explicitly maintained that interest causes the concentration of wealth in the hands of a few people in the economy and sends the rest into poverty. The capitalist system has been around for some centuries now, and at the moment, it is at its pinnacle regarding the wealth that it has generated. Only recently have the Western economists begun to say it loud and clear that their system has generated huge income and wealth inequalities. Thomas Piketty with his book Capital in the Twenty-First Century has created an awareness and agitation regarding inequalities that exist in the capitalist world. But regarding the causes of

M. I. Ejaz (*) Lahore, Pakistan © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_3

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these inequalities, he comes to conclusions that appear to be in contradiction with the causes put forward by Muslim economists. Piketty blames inheritance and does not highlight interest as the primary cause. Joseph Stiglitz, a Nobel laureate economist, also fails to recognize interest as a major reason for this inequality. This research paper looks, in detail, at the views of these two economists and others from the world of conventional finance. An analysis of some Muslim scholars’ views regarding the ill effects of interest on the economy is also done in this chapter. The researcher feels that by the end of this chapter, it will become apparent that there is a wide gulf between the thinking of the economists from the realms of conventional and Islamic finance regarding the role of interest in generating inequalities within the economy.

3.2   The Views of Economists from Conventional Economics on Inequality 3.2.1  The Views of the French Economist Thomas Piketty Concerning Inequality According to Macat (2015), Piketty explains that for years most economists thought that capitalism reduced inequality between the richest and the poorest in the long run. For example, the Kuznets curve hypothesis proposes inequalities rise when countries industrialize but then decreases. Piketty disagrees. He maintains that capitalism generates more economic inequality. The Kuznets curve was created using data concerning wealth and income collected from the late nineteenth to early twentieth century, but Piketty profited from a whole century of extra data right into the early twenty-first century. Utilizing this broader pool of figures, Piketty does two things. He contends that Kuznets data is misleading because it was taken from what was a very uncommon period of history and it creates a theory he calls the central contradiction of capitalism. So what is this central contradiction of capitalism? Through history the annual rate of return on capital which means the profits or interest you earn from investing your money usually exceeds the annual growth rate of the overall economy. Return on capital has been quite constant at around 5% despite fundamental variations in who controls the capital. This is mostly the rich and individuals who inherit—whether it is held as gold, bonds, land, or in an investment portfolio. In contrast to this, the annual growth of an economy, or g, has almost always remained close to zero. Only in the last two centuries has it reached the level of 1–2% (Macat 2015).

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Cook, C. (2014) says that Piketty in his research found that in the eighteenth and nineteenth centuries the value of capital grew faster than the economy at large. So by 1900 the amount of wealth had grown to around seven times the national output in Britain, and since that wealth started out being owned by rich people, that means that the rich pulled away from the rest of the common people (Cook, C. 2014). Piketty bases his argument on a formula that relates the rate of return on capital (r) to economic growth (g), where r includes profits, dividends, interest, rents, and other income from capital and g is measured in income or output. He argues that when the rate of growth is low, then wealth tends to accumulate more quickly from r than from labor and tends to accumulate more among the top 10% and 1%, increasing inequality. Thus the fundamental force for divergence and greater wealth inequality can be summed up in the inequality, r > g. He analyzes inheritance from the perspective of the same formula. Cook, C. (2014) suggests that Piketty’s thesis is that inheritance has accounted for an increasing share of household wealth and it also exacerbates wealth inequality. So how important are inheritances relative to earnings from working? Piketty shows that in the nineteenth century inherited wealth offered riches simply unattainable by working and saving, a ratio of three-to-one as measured by lifetime resources. This ratio fell below one just after the world wars, and while trending upward, it is now only just above one. Thus in the nineteenth century, the richest French inherited their wealth, while nowadays the richest French are much more mixed between earning and inheriting. Piketty predicts that inheritances will become more concentrated in the future, perhaps leading to a return to a situation in which the richest people are those who inherited their wealth. It is in this increasing concentration of wealth by inheritance that Piketty sees the main role for r > g. r > g further allows for greater accumulation of assets over the lifetime, leading to higher ratios of assets at age of death to assets at age of receipt of inheritance, meaning a larger role for inheritance. This combination of an increasing role for inheritance, together with its increased concentration, is the channel by which r − g is proposed to drive increased inequality (Cook, C. 2014). According to Cook, C. (2014), Piketty has postulated that during the eighteenth and nineteenth centuries, the proportion of national wealth owned by the top 1% and 10% rose, but in the twentieth century, things were a little different. First of all, because of war. Between 1910 and 1950, the world wars and decolonization thumped the European rich. All that stuff that accumulated got blown up or given back to other people. Then

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after the war the recovery was historically unusual partly because it was all catch-up growth. The capital stock grew more slowly than the economy at large and was more heavily taxed, so owning all that stuff did not help the top 1% power ahead. The rest actually caught up a little bit. Since 1980, however, Piketty thinks that things have returned to the older pattern. Capital has been growing faster than the economy at large, and since the rich start off owning more stuff, inequality has increased. So far so undisputable but Piketty’s thesis is that this tendency might well endure, and if the rate at which capital grows remains faster than the growth of the economy at large, then the rich will keep pulling away and the world could look once again like a Victorian age. The rich will be rich because of who their parents are; not who they are and that is a major public policy challenge. Piketty’s analysis might trouble people but his remedy will make him even more adversaries. His suggested answer is a global wealth tax—a policy, he says, which is very improbable to be implemented (Cook, C. 2014). 3.2.2  The Views of Nobel Laureate Joseph Stiglitz Concerning Inequality Stiglitz (2015) puts the blame on bad economic theory for having contributed to the problem of inequality. For this situation he does blame the economists the same way they share the blame for the 2007–2008 great crisis. The economic models of that time said that markets were self-­ adjusting, the system was stable and could be relied on to be self-­regulating and therefore work well. Economists now know that it was all wrong. In the case of inequality, it is a little bit different. According to Stiglitz, there were a couple of ideas in economics that were particularly unhelpful. One of them was a very deep idea called the second welfare theorem of welfare economics—that the economist should focus on making the size of the economic pie as big as possible and then leave it to the political process to decide on how that pie is divided. So distribution was for some other areas. The second welfare theorem said that you could separate those two ideas—separate distribution from efficiency—meaning that you could achieve any distribution that you want through a market-friendly process. It has not worked out that way. It got so bad that one Noble Prize winner said that the most dangerous subject for economists to talk about was distribution. Why? Because he said that in worrying about how to divide the pie, you would lose attention on how to make the pie bigger, and the only way to enrich everybody was to make the pie bigger. A third idea that

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was very popular at that time which had no theory or idea behind was the theory of trickle-down economics. That was a very strongly held view, President Kennedy shared in that view. The crux of the idea was that make the economy bigger and everybody will benefit. So it was not only that a larger pie could benefit everybody but that a larger pie would benefit everybody. Today the economists have the evidence. In the USA, where the pie is getting bigger and bigger almost every year except in 2007–2008, at the time of the crisis the median income has gone down year after year. Median income today is lower than it was 25 years ago. The median income of a full-time worker is lower than it was 40 years ago—wages at the bottom are lower than they were half a century ago. According to Stiglitz, an economic system that does not raise the standard of living for most people is a failed economic system and in those terms the economic system of America is a failed economic system, and for this, he blames the economists because they thought that just getting the pie bigger—just get the GDP going and the system—would work for most Americans and this turned out to be not true (Stiglitz 2015). Stiglitz (2015) continues to suggest that all economists agree that inequality is a big issue, but the question is, what is causing it. One school of thought highlighted by Piketty says that it is capital in the twenty-first century. Piketty postulates that with the rate of return on capital greater than the rate of growth in the economy, the capital is going to grow faster and those who have capital will be reinvesting and therefore their wealth has and will be growing and growing at the expense of the rest. According to Stiglitz, this is not the big story. There is a grain of truth in it. An economist Nasser came up with a theory called abstinence theory. His theory was that the reason that the rich are rich is because they have sacrificed. They have sacrificed by not consuming—abstinence. That is what makes them wealthier and wealthier. All the rich were getting was a reward for their hard work—not consuming but being prudent and frugal. If what is happening in America is looked at in detail, we see that frugality is hard to see. A look at the saving rate of the economy and you cannot account for the increase in wealth that has occurred. What can be seen is that wealth has come especially from capital gains on land. An in-depth analysis shows that it is not just capital gains on rents. Land generates rent and there is a lack of work put into it. A person just owns a piece of land and he takes in money, but this aspect can be seen with those people who own oil or other natural resources. According to Stiglitz, they are not getting the return to hard work. They are just getting the return to their ownership claim (Stiglitz 2015).

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Stiglitz (2015) continues to suggest that a deeper look will show that a lot of the rents are what are called exploitation rents: rents associated with monopoly power—discrimination. There are all these kinds of rents in the system that don’t make the economy more efficient—they actually make the economy less efficient. Monopoly generates monopoly rents or what are called monopoly profits. Microsoft gets a monopoly in the operating system to get huge profits and the person holding this monopoly power becomes the richest person in the world. A look at the top hundred people in Forbes list shows that a lot of them at the top are there not from saving and saving but from monopoly rents. A lot of the people at the top are from the banks. If there is deregulation and a change of the rules of the game so that the bankers get bailed out by the public and they make more and more money but who is really paying for it—ordinary citizens with their taxes. The value of those bailout rents is capitalized in the value of the shares of the banks especially before the crisis, but on the other side, the taxpayers bear the burden. In France the value of the Riviera has gone way up as the Russian oligarchs and others want what we call positional goods, but the fact that the value of the land in the Riviera is up does not mean that France is more productive. It is the same amount of land, but what is really dangerous is that all the money is going into these fixed assets—less is going into productive capital and the result of all this is that the economy is less productive. The most important source of rents from the distribution point of view with regard to growing inequality is evidenced from the following. In the last 40 years the productivity of the real American workers (not the top 1% who are bankers and not workers) has doubled and the wages have stagnated and so a gap has opened up. This is a rent: an exploitation. Between the years 1945 and 1980, there was a conception in the middle-class society that if anyone played by the rules and worked hard, they were going to move up. They would be better than their parents and their children will be better off than them. This concept is obsolete now. Now the children are less well-off than their parents. America is no longer the land of opportunity. A young American’s prospects are more dependent on the income and education of the parents than in other European countries, which is least consistent with the American dream. France is more consistent with the American dream. This inequality has slowed down and lowered what would have been a higher growth rate. A dynamic economy cannot exist if people are not buying goods and people will not be buying goods if they do not have income (Stiglitz 2015).

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3.2.3  The Views of Positive Money Concerning Inequality Positive Money is a UK-based organization that campaigns against banking. It was founded by Ben Dyson in 2010. Its proposals are supported by the chief economist at the Financial Times, Martin Wolf. Positive Money (2016) writes that because almost all of our money is “on loan” from banks, someone has to pay interest on nearly every pound in the UK. This interest redistributes money from the bottom 90% of the population to the very top 10%. Meanwhile, inflated house prices and financial instability all lead to a growing gap between the poor and the rich. The system distributes money from the bottom 90% to the top 10%. Because 97% of the money in the UK is created by banks, someone must pay interest on nearly every pound in the UK. The bottom 90% of the UK pays more interest to banks than they ever receive from them, which results in a redistribution of income from the bottom 90% of the population to the top 10%. Collectively we pay £165 m every day in interest on personal loans alone (not including mortgages), and a total of £213 bn a year in interest on all our debts (Positive Money 2016).

3.3   The Views of Muslim Economists on Inequality 3.3.1  The Views of Al-Ghazali Concerning Inequality and the Role of Interest (Riba) Usmani, J. M. M. T. (2010) quotes Imam Al-Ghazali: The creation of dirhams and dinars (money) is one of the blessings of Allah. They are stones having no intrinsic usufruct or utility, but all human beings need them because everybody needs a large number of commodities for his eating, wearing etc., and often he does not have what he needs and does have what he needs not. Therefore, the transactions of exchange are inevitable. But there must be a measure on the basis of which price can be determined, because the exchanged commodities are neither of the same type, nor of the same measure which can determine how much quantity of one commodity is a just price for another. Therefore, all these commodities need a mediator to judge their exact value. Allah Almighty has, therefore, created dirhams and dinars (money) as judges and mediators between all commodities so that all objects of wealth are measured through them, and their being the measure of value of all commodities is based on the fact that they are not

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an objective in themselves. Had they been an objective in themselves, one could have a specific purpose for keeping them, which might have given them more importance according to his intention, while the one who had no such purpose would have not given them such importance, and thus the whole system would have been disturbed. That is why Allah has created them, so that they may be circulated between hands and act as a fair judge between different commodities and work as a medium to acquire other things. So, the one who owns them is as if he owns everything, unlike the one who owns a cloth, because he owns only a cloth, therefore, if he needs food, the owner of the food may not be interested in exchanging his food for cloth, because he may need an animal for example. Therefore, there was needed a thing which in its appearance is nothing, but in its essence is everything. The thing which has no particular form may have different forms in relation to other things like a mirror which has no color, but it reflects every color. The same is the case of money. It is not an objective in itself, but it is an instrument to lead to all objectives. So, the one who is using money in a manner contrary to its basic purpose is, in fact, disregarding the blessings of Allah. Consequently, whoever hoards money is doing injustice to it and is defeating its actual purpose. He is like the one who detains a ruler in a prison. And whoever effects the transactions of interest on money is, in fact, discarding the blessing of Allah, and is committing injustice, because money is created for some other things, not for itself. So, the one who has started trading in money itself has made it an objective, contrary to the original wisdom behind its creation, because it is injustice to use money for a purpose other than what it was created for. If it is allowed for him to trade in money itself, money will become his ultimate goal, and will remain detained with him like hoarded money. And imprisoning a ruler or restricting a postman from conveying messages is nothing but injustice.

Usmani, J. M. M. T. (2010) further quotes Al-Ghazali: Riba (interest) is prohibited because it prevents people from undertaking real economic activities. This is because when a person having money is allowed to earn more money on the basis of interest, either in spot or deferred transactions, it becomes easy for him to earn more money on the basis of interest without bothering himself to take pains in real economic activities. This leads to hampering the real interests of humanity, because the interests of humanity cannot be safeguarded without real trade skills, industry and construction.

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3.3.2  The Views of Mufti Taqi Usmani Concerning Inequality Usmani, J. M. M. T. (2010) writes in his paper presented at Davos: “The present position is that a very small faction of the society takes advantage of the bulk of the savings of the entire society. Taking the example of my own country (Pakistan), as of June 2008, 26,660 account holders out of 24.9 million (i.e. only 0.1% of total account holders) have utilized Rs.1.95 trillion which is 69% of total loans advanced” (Source: State Bank of Pakistan). It means that 0.1% people took advantage of 69% of the wealth deposited by millions of people in the banks. They have passed on a small proportion of their earnings to the savers in the form of interest, while making all the rest their own fortunes. Then, the entrepreneurs who used the money of the savers included the interest paid by them in their cost of production, raising the price of productions to that extent, and in turn claiming all the interest back from the payees through the increase in prices. It is neither logical nor equitable that the bulk of the profit generated by the money of millions of savers is secured only by a handful of entrepreneurs, and the depositors whose money generated these profits are given only a small amount of interest, which does not often match the rate of inflation and is claimed back from them in the form of increased prices. This is one of the basic causes that make the system of distribution unjust, uneven, and against the interests of common people. This aspect of interest has been criticized even by many modern economists. For example, James Robertson writes: The pervasive role of interest in the economic system results in the systematic transfer of money from those who have less to those who have more. Again, this transfer of resources from poor to rich has been made shockingly clear by the Third World debt crisis. But it applies universally. It is partly because those who have more money to lend, get more in interest than those who have less; it is partly because those who have less, often have to borrow more; and it is partly because the cost of interest repayments now forms a substantial element in the cost of all goods and services, and the necessary goods and services looms much larger in the finances of the rich. When we look at the money system that way and when we begin to think about how it should be redesigned to carry out its functions fairly and efficiently as part of an enabling and conserving economy, the arguments for an interest-free, inflation-free money system for the twenty-first century seems to be very strong. (Usmani, J. M. M. T. 2010)

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3.3.3  The Views of Mufti Muhammad Shafi Concerning Inequality Mufti Muhammad Shafi (late) is the father of Mufti Taqi Usmani and was the Grand Mufti of Pakistan. He had great stature within the world of Islam. Shafi, M. M. (1979) writes in his book: This mode of investment (the Islamic mode-Musharakah—which replaces Interest in an Islamic Economic System) to a great extent serves as an effective check on the concentration of wealth, which is the greatest evil of the Capitalist economy. Wealth, instead of becoming accumulated in the hands of a few, is so distributed over a very large number of individuals in the society that no injustice is done to anyone. Under the Capitalist system, economy being based on interest, Capitalists come not only to own the greater part of national wealth, but also to control the whole market and to run it in their own selfish interest.

3.4   Comparison of the Above Views Economists

of the Conventional and Islamic

The researcher has taken the views of Thomas Piketty and Joseph Stiglitz as they are two of the most influential and recognized economists of the current era. They have put forward their views on inequality in a very lucid way. None of them in their conclusions blame the rate of interest as a major contributing factor in generating inequality within the economy. Piketty derives from his study the argument that the principal culprit is the instrument of inheritance. This conclusion is in very contrast to the Islamic concept of inheritance being a remarkable tool in preventing the concentration of wealth. Hence the researcher feels the Muslim economists must carry our independent research which shows that riba (interest) is the culprit resulting in the concentration of wealth. This belief is not of the researcher alone, but as the above writing shows, Al-Ghazali understood that treating money as a commodity (and thereby allowing interest) would cause money’s hoarding (meaning its concentration in a few hands). Stiglitz highlights monopoly power as a culprit. Islamic teachings do support his view but he too fails to blame interest. In his arguments he blames the presence of inequality on the rents from land and natural resources that an individual may own. The reason he gives is that this rent is received without any hard work having been put in. The researcher is

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very surprised that he fails to apply the same argument to riba (interest) as there is the total absence of any work in attaining interest. Under the section of Al-Ghazali’s views, the researcher has quoted Imam Al-Ghazali where he explicitly condemns interest as it does not involve any work which may yield real economic activity. The world of Islam has been and is in consensus regarding the prohibition of interest. The researcher has quoted the views of Mufti Muhammad Shafi as he was considered an authority on Islamic studies during his life. The researcher feels quoting his position is essential as it is representative of the views of other Islamic scholars in the world. The organization Positive Money is heading in the right direction and seems to have already converged with Islamic economic thought with regard to interest. But Positive money is a small voice in the whole world of Western and conventional economic thought.

3.5   Conclusion and Recommendations The gulf between the worlds of conventional and Islamic economics is very wide and the fundamental difference between the two realms is the rate of interest. There have been attempts by Western economists and small organizations (such as Positive Money) to speak out against interest, but the most highly recognized economists (such as Stiglitz and Piketty) and institutions turn a deaf ear toward these voices arising from within them. After his tremendous empirical study, Piketty ends up blaming inheritance for the profound inequality in the Western economic system. On the contrary Islam looks at inheritance as a means of a just distribution of wealth. Stiglitz says that rents generated without any hard work are to blame and therefore even looks negatively at the rent an individual might get from a property or resource he has. At the same time Joseph Stiglitz fails to acknowledge that interest is bad for society given his reasoning that it is earned without any hard work. The Islamic scholars are firmly upholding the prohibition of interest and have done so ever since the Prophet Muhammad  declared interest as unlawful. The Western economists will have to open their minds and conscience to the ill effects of interest on the distribution of wealth and money in the economy. Convergence between the views of conventional and Islamic economists will only take place if prominent individuals and institutions in the Western world raise their voices against interest, and this convergence means that the Western world

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will have to traverse the gulf toward the teaching of the prohibition of interest. The researcher stresses that the need of the hour is for Muslim economists to carry out empirical research to prove what the Muslim economic thinkers have maintained for more than a thousand years.

Bibliography Cook, C. (2014, April 30). Thomas Piketty’s ‘Capital’ in 3 minutes. Newsnight. Retrieved from https://www.youtube.com/watch?v=HL-YUTFqtuI Inequality. (2016). Positive Money. Retrieved from http://positivemoney.org/ issues/inequality/ Macat. (2015, April 27). An Introduction to Thomas Piketty’s Capital in the 21st Century—A Macat Economics Analysis. Retrieved from https://www.youtube.com/watch?v=wpGG3_pBHUc&t=42s Shafi, M. M. (1979). Distribution of Wealth in Islam: Karachi, Dar ul Ishaat. Stiglitz, J. (2015, June 26). Joseph Stiglitz: It’s Time to Get Radical on Inequality. Retrieved from https://www.youtube.com/watch?v=2NsTeeb-87w&t=905s Usmani, J. M. M. T. (2010). Present Financial Crisis: Causes and Remedies from an Islamic Perspective. Paper presented at the World Economic Forum, Davos.

CHAPTER 4

Contribution of Islamic Microfinance Studies in Achieving Sustainable Development Goals Murniati Mukhlisin, Luqyan Tamanni, Toseef Azid, and Rifka Mustafida

4.1   Why Islamic Microfinance Studies Matter? Microfinance has become an important sector in many developing countries, where it is considered as an effective tool for poverty alleviation and improvement in financial inclusion. The World Bank publications including a recent Global Financial Development Report 2014 (World

M. Mukhlisin (*) Islamic Accounting Department, Institut Agama Islam Tazkia, Bogor, Indonesia e-mail: [email protected] L. Tamanni Islamic Economics Department, Institut Agama Islam Tazkia, Bogor, Indonesia e-mail: [email protected] T. Azid College of Business and Economics, Qassim University, Qassim, Saudi Arabia R. Mustafida LPPM Tazkia, Bogor, Indonesia e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_4

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Bank 2014) remain optimistic with microfinance and its promise to improve lives of the poor. Microfinance is also becoming one of the most of important research areas in finance and economics. There has been a surge in number of publication on the subject in the past decade from less than 100 titles in 1996 to more than 700 in 2010 (Fouillet et al. 2013). One of the reasons for this development is the success of Microcredit Summit in 1997 that showcased the emergence of microcredit institutions as the front-runner in poverty alleviation. This, among others, is attributed to the failure of commercial banks to provide the poor with access to capital due to their perception of the poor as risky or unbankable (Morduch and Armendariz 2005). Microfinance experiments such as Grameen Bank and Banco Sol are able to prove this is not the case and gradually able to fill the gaps in the market while remaining profitable and financially sound. Against this backdrop, Islamic microfinance is quietly evolving from an experiment into a niche industry in some Muslim countries, especially Indonesia, Bangladesh, Sudan, Lebanon, Pakistan and Yemen. According to a survey by the Consultative Group to Assist the Poor (CGAP), a nonprofit established by the World Bank and Western donors, there are at least 255 Islamic microfinance institutions in the Muslim world today serving more than 1.28 million clients (El-Zoghbi and Tarazi 2013). As an object of research, Islamic microfinance enjoys an increasing volume of publication and impact. That is because such research responds to emerging practices and at the same time stimulates innovation that help financial or economic system to evolve (Veugelers 2014). With these emerging researches, new understanding, new technologies and the potential for action are created (The Group of Eight 2013). The command to claim knowledge is mentioned in the Qur’an: Allah elevates those among you who believe and those given knowledge, many steps. Allah is aware of what you do (QS Al-Mujadalah (58): 11); seeking knowledge is also a part of worships: Read: in the Name of your Lord who created (QS Al-Alaq (96): 1). It indicates that every Muslim is required to seek for knowledge. Allah SWT in several verses of the Qur’an calls mankind as ulul albab, ulun nuha, that means people of intellect, people with full intelligence that should have natural tendency to seek knowledge and develop life on earth, hence contribute to the society. Islamic microfinance research has a concept to empower people and respond to economic problems in the society as well. Poverty issue is still the main concern of the world leaders. In 2015, 62 individual wealth was equal to 3.6 billion poor in the world; this is down from 388 individuals in 2010 (Oxfam 2016), or the

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world’s eight richest people have the same wealth of 50% poorest (Guardian 2017). The economic imbalances that occur will also affect the quality of education or public health. In 2000 the UN country members have made eight declarations called the Millennium Development Goals (MDGs). It focused on reducing extreme poverty by half, gender equality and mortality reduction (World Bank 2003). In 2015, MDGs were replaced by the Sustainable Development Goals (SDGs) as a new set of development target with 17 aspects to create a sustainable development for the whole countries in the world. It does not only talk about poverty but also education, health and well-being, gender equality, development and growth (World Development Indicators 2016). Islamic microfinance has the concept of justice in giving spiritual capital, capital and human resources appropriate for poverty reduction and human development (Riwajanti 2013). Islamic microfinance research publications either qualitative or quantitative are supposed to deliver impact for improving the quality of economic and financial system of the community. Hence, this study addresses the following questions: To what extent does research Islamic microfinance discuss the MDGs in the journals listed in ABS 2015? What has been offered by Islamic microfinance studies for achieving SDGs? The chapter is organized as follows. Section 4.2 presents an overview of studies on research mappings, while Sect. 4.3 offers literature review on MDGs and SDGs. Section 4.4 draws ‘What Is Going on Here?’ research methodology and method, followed by Sect. 4.5, which wraps discussion and draws conclusion, as well as offers recommendation for future research on the impact of global development agenda such as SDGs.

4.2   Studies on Research Mappings Brau and Woller (2004) review over 350 articles that address the issues of microfinance institution (MFI) sustainability, products, services, management practices, regulation, policy and impact assessment. The purpose of the study is to introduce the finance academic community to the discipline of microfinance institutions (MFIs). This study finds many of tools, models and framework in the existing finance literature can be brought to respond the problem of poverty. Microfinance offers the finance discipline a possible avenue to make a significant difference in the lives of the poor. In contrast, Duvendack et  al. (2014) report the findings of a meta-­ analysis to assess the impact of microcredit on women’s control over household spending based on 17 papers. The results state that effect of

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sizes is small. However, Rahman et  al. (2015) provide a peer-reviewed journal article on microfinance impact and sustainability over the period of 1997–2011. This study produced over 350 articles of which 302 articles were sorted by a skimming process based on relevance topic. The paper confirms microfinance institution extends financial and non-financial services to the bottom of the pyramid ignored by traditional financial institutions. The studies are examined very thoroughly and the recommendation is helpful for the concept of poverty alleviation and research future direction. In other studies, Mukhlisin and Komalasari (2018) summarize a multitude of 330 empirical studies in the area of Islamic banking and finance with the purpose of analysing the impact of Islamic banking and finance studies to practice. The study documents that the papers did not link directly to the future policy directions, for instance, to predict and prepare for financial crisis; rather they merely responded to the undergoing policies or themes of the journals. From the literature search above, it is clear that there is no evidence showing that a similar study has been conducted in the area of Islamic microfinance. Therefore, this is the motivation of the research.

4.3   MDGs and SDGs Millennium Development Goals (MDGs) are a set of eight measurable goals committed by 189 United Nations country members in September 2000. The focus is halving extreme poverty and hunger, promoting gender equality and reducing child mortality (World Bank 2003). The MDGs were revolutionary in providing a common language to reach global agenda. They are listed in Table 4.1. According to International Monetary Fund (2010, 2015), in achieving these objectives, there are some agenda policies, restoring sustainable global growth, building resilience to shocks, scaling up investment, expanding trade for the poorest country and helping fragile states. On 15 September 2015, MDGs were replaced by SDGs as a new set of development target adopted by the member countries of the United Nations. It contains 17 aspects focusing on five keys elements: people, planet, peace, prosperity and partnership. The 17 aspects of SDGs are: (1) no poverty; (2) zero hunger; (3) good health and well-being; (4) quality education; (5) gender equality; (6) clean water and sanitation; (7) affordable and clean energy; (8) productive employment and economic growth; (9)

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Table 4.1  List of the Millennium Development Goals (MDGs) Goal 1 Goal 2 Goal 3 Goal 4 Goal 5 Goal 6 Goal 7 Goal 8

Eradicate extreme poverty and hunger Achieve universal primary education Promote gender equality and empower women Reduce child mortality Improve maternal health Combating HIV/AIDS, malaria and other diseases Ensure environmental sustainability Develop a global partnership for development

Source: World Bank (2003)

industry, innovation and infrastructure; (10) reduced inequalities; (11) sustainable cities and communities; (12) responsible consumption and production; (13) climate action; (14) life below water; (15) life on land; (16) peace, justice and strong institution; and (17) partnership for global development. It is the guidance for global action over the next 15 years (WDI 2016). Given this approach, every country must overcome poverty and hunger and ensure that everyone can have respect and lives in a healthy environment. It is also important to guarantee everyone freedom from fear and violence through strong global cooperation. This agenda will end in 2030. There are several goals that are directly related to the economic field such as poverty, hunger, health, quality education, gender equality, infrastructure, consumption and production. To achieve these SDGs, it is necessary to access financial services for the whole community or financial inclusion (Klapper et al. 2016). According to Hassan (2015), Islamic microfinance products are suitable for empowering the poor. This service will help them to turn their savings and build small businesses.

4.4   ‘What Is Going on Here?’ Methodology The goal of this research is to learn ‘what is going on here?’ and to investigate social phenomena without explicit expectations (Schutt 2006, p. 19). Interpretive approach is referred by Lee (1991) as ethnography, hermeneutics, phenomenology and case studies. This research is concerned on the phenomenology type that relies on the way humans make sense of the world with a combination of critical approach that interprets the action of others that may lead to adjustment of the earlier meaning and actions.

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This research aims to prove whether research papers on Islamic microfinance contribute to achieving Sustainable Development Goals. The scope of this article covers research papers ranked in Academic Journal Guide, Association of Business School (ABS) 2015 version. The guide is specific on business school studies unlike Scopus List or Thomson Reuters that indexes and ranks papers from various disciplines. The ABS ranks journals through six steps: (1) assessing the need of business and management research community; (2) ranking from 1–4∗ (read: star/s) after consulting at least three out of five international journal listings; (3) classifying the journals through several reviews; (4) drawing comprehensive coverage of research; (5) finalizing process from editors; and (6) stating justification from editors on the methodology. The method of this research is first, the authors list down 1–4∗ journals published in ABS under the ‘Finance’ heading then search the subject with keywords: ‘Islamic microfinance’. There are 41 journals from 514 peer journals that have published papers on Islamic microfinance, including three Islamic journals (International Journal of Islamic and Middle Eastern Finance and Management [IJIMEFM], Journal of Islamic Accounting and Business Research [JIAB] and Journal of Islamic Economics, Banking and Finance [JIEBF]): 1. Journal of Economic Perspectives (JEP), 4∗, 1 paper 2. Journal of Human Resources (JHR), 3∗, 1 paper 3. Journal of Development Economics (JDE), 3∗, 4 papers 4. International Journal of Social Economics (IJSE), 1∗, 4 papers 5. Journal of Economic History (JEH), 3∗, 1 paper 6. International Journal of Economics and Finance (IJEF), 2∗, 1 paper 7. Accounting, Auditing & Accountability Journal (AAAJ), 3∗, 1 paper 8. The International Journal of Ethics and Systems (Humanomics), 1∗, 17 papers 9. International Journal of Islamic and Middle Eastern Finance and Management (IJIMEFM), 1∗, 8 papers 10. Journal of Business Venturing (JBV), 4∗, 2 papers 11. Journal of Business Ethics (JBE), 3∗, 1 paper 12. Social Enterprise Journal (SEJ), 1∗, 1 paper 13. Nonprofit and Voluntary Sector Quarterly (NVSQ), 1∗, 1 paper

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4. Development and Change (DC), 3∗, 3 papers 1 15. Management Research Review (MRR), 1∗, 1 paper 16. Asia Pacific Business Review (APBR), 2∗, 1 paper 17. Journal of International Development (JID), 2∗, 4 papers 18. Journal of Small Business & Entrepreneurship, 1∗, 2 papers 19. Journal of Economic Behavior and Organization (JEBO), 3∗, 4 papers 20. Economic Modelling (EM), 2∗, 3 papers 21. International Journal of Bank Marketing (IJBM), 1∗, 4 papers 22. Business Ethics Quarterly (BEQ), 4∗, 1 paper 23. Bulletin of Indonesian Economic Studies (BIES), 1∗, 1 paper 24. Qualitative Research in Financial Markets (QRFM), 1∗, 3 papers 25. Agricultural Finance Review (AFR), 1∗, 1 paper 26. Studies in Economics and Finance (SEF), 1∗, 1 paper 27. International Journal of Entrepreneurial Behavior & Research (IJEBR), 2∗, 1 paper 28. Journal of Islamic Accounting and Business Research (JIABR), 1∗, 2 papers 29. Journal of African Economies (JAE), 2∗, 1 paper 30. Entrepreneurship Theory and Practice (ETP), 4∗, 1 paper 31. Journal of Business Research (JBR), 3∗, 2 papers 32. Applied Economics Letters (AEL), 1∗, 1 paper 33. Energy Economics (EC), 3∗, 1 paper 34. Research in International Business and Finance (RIBF), 2∗, 1 paper 35. Entrepreneurship & Regional Development (ERD), 3∗, 1 paper 36. Journal of Islamic Economics. Banking and Finance (JIEBF), 1∗, 1 paper 37. Journal of Small Business Management (JSBM), 3∗, 1 paper 38. Atlantic Economic Journal (AEJ), 1∗, 1 paper 39. World Bank Research Observer (WBRO), 1∗, 1 paper 40. Brookings Papers on Economic Activity (BPEC), 3∗, 1 paper 41. Society and Business Review (SBR), 2∗, 1 paper Second, the authors examine and summarize the papers and group them into several constructs, as shown in Table 4.2, and finally, they discuss the constructs and conclude.

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Table 4.2  Number of empirical research papers on Islamic microfinance (1995–2017) Countries Bangladesh Malaysia Indonesia Pakistan Turkey Egypt MENA India Sri Lanka Brunei Darussalam Nigeria Iran Kenya UK Australia

Papers 15 14 9 6 4 3 3 2 2 2 2 2 2 1 1

Countries Muslim countries USA Zambia Senegal UAE Jordan Tanzania Mauritius Maldives Developing world Middle East South Asia Sudan Africa

Papers 1 1 1 1 1 1 1 1 1 1 1 1 1 1

4.5   Mapping of Islamic Microfinance Studies After selection, there are now 89 papers with major focus on Islamic microfinance, but in some parts, the papers discuss general Islamic finance issues. As for the countries being researched are mostly Bangladesh followed by Malaysia, Indonesia and other countries, see Tables 4.2 and 4.3. Table 4.2 indicates that Muslim countries are the majority countries discussed in the studies and Bangladesh is the most widely researched, with so far 15 research papers, followed by Malaysia with 14 papers. For Bangladesh, it deals with a successful microfinance institution that was initiated by Muhammad Yunus called Grameen Bank. The Grameen Bank is also related to gender equality, which encourages women to be independent and present in the economic undertakings. Table 4.3, however, shows that there are comparative empirical studies of Islamic microfinance associated with aspects of the SDGs. SDGs are used because it is more comprehensive towards human development. No poverty, reduced inequalities, peace, justice and strong institution are among the several aspects most widely discussed by Islamic microfinance studies. However, discussion of these aspects even has been raised prior to the agreement of the MDGs and SDGs.

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Table 4.3  Empirical studies of Islamic microfinance related to MDGs and SDGs (1995–2017) SDGs No poverty

Years

1995, 1996, 1999, 2002, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 Zero hunger 2009, 2010, 2011, 2012, 2015, 2016 Good health and 1999, 2002, well-being 2008, 2009, 2010, 2011, 2012, 2015, 2016, 2017 Quality 1995, 1996, education 2002, 2005, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 Gender equality 1996, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 Clean water and 2007, 2010, 2011 sanitation Productive 1995, 1996, employment and 2002, 2003, economic growth 2005, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 Industry, 1995, 2003, innovation and 2006, 2008, infrastructure 2009, 2010, 2011, 2015, 2016

Countries

Papers

Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Malaysia, Indonesia, Iran, Brunei, UAE, UK, Africa, Turkey, Senegal, Nigeria, Jordan, South Asia, Egypt, Kenya, India, Brunei, Sudan, Mauritius, Maldives, Sri Lanka, Iran

89

Australia, Malaysia, Bangladesh, Indonesia, Nigeria, Brunei, Pakistan, Sudan Pakistan, Bangladesh, Malaysia, Indonesia, Iran, Brunei, UEA, UK, Africa, Australia, Senegal, Nigeria, Africa, Sri Lanka, Iran

18

Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Malaysia, Indonesia, Brunei, UEA, UK, Africa, Turkey, Australia, Nigeria, Jordan, Egypt, Kenya, India, Brunei, Mauritius, Maldives, Sri Lanka, Iran Pakistan, Bangladesh, Turkey, Nigeria, Indonesia, Egypt, MENA, Kenya, Malaysia, Africa, Sri Lanka, developing world

63

Malaysia, Bangladesh, Tanzania

42

38

5

Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Malaysia, Indonesia, Brunei, UEA, UK, Africa, Turkey, Australia, Senegal, Nigeria, Jordan, South Asia, Egypt, Kenya, India, Brunei, Sudan, Mauritius, Maldives, Sri Lanka, Iran Arab world, Turkey, Pakistan, Middle East, North Africa, Tanzania, Iran, Brunei, UEA, UK, Africa, Senegal, Nigeria, Nigeria

89

35

(continued)

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Table 4.3 (continued) SDGs Reduced inequalities

Years

1995, 1996, 1999, 2002, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 Sustainable cities 1995, 1999, and communities 2002, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2014, 2015, 2016, 2017 Peace, justice and 1995, 1996, strong institution 1999, 2002, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017

Countries

Papers

Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Malaysia, Indonesia, Iran, Brunei, UAE, UK, Africa, Turkey, Australia, Senegal, Nigeria, Jordan, South Asia, Egypt, Kenya, India, Brunei, Sudan, Mauritius, Maldives, Iran

89

Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Tanzania, Malaysia, Indonesia, Brunei, UEA, UK, Africa, Turkey, Australia, Senegal, Nigeria, Jordan, Egypt, Kenya, India, Brunei, Sudan, Sri Lanka, developing world, Iran Arab world, Turkey, Pakistan, Bangladesh, Middle East, North Africa, Tanzania, Malaysia, Indonesia, Iran, Brunei, UEA, UK, Africa, Turkey, Australia, Senegal, Nigeria, Jordan, South Asia, Egypt, Kenya, India, Sudan, Mauritius, Maldives, Sri Lanka, Iran

76

89

Research papers published between 1995 and 1999 show that no poverty, gender equality and strong institution have been discussed by the researchers even before the existence of the MDGs (see Table 4.4). That is because Islamic finance system strongly calls for eradicating poverty in every community. Table 4.5 informs that after the implementation of the MDGs by the United Nations member countries, Islamic microfinance research direction is moving towards the study case of Islamic microfinance institution in Bangladesh, Malaysia and the Middle East as an effort to combat poverty. Table 4.6 documents that after nine years since MDG targets were declared until the final year before SDGs were announced, research on the support to Islamic microfinance addressed problem analysis of IMFIs in channelling the financing, in strengthening the institutions, and in

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Table 4.4  Empirical studies in Islamic microfinance (1995–1999) before implementation of MDGs Year/author: journal

Country, sample, method, paradigm

Findings

1995, Kuran: JEP

Arab world, Turkey, Pakistan, literature review, interpretivism

1996, Alderman, Behrman, Ross and Sabot: JHR

Pakistan, 7000 individuals, dummy regression, positivism

1999, Ghatak and Guinnane: JDE

Bangladesh, Europe, literature review, interpretivism

The Islamic sub-economy is providing palpable benefits that secular economic agencies and institutions are failing to provide To reduce gender gaps will require policies that focus on the market. The response to modest changes in incentives may be high This risk of IMFIs is inherent in the system and needs to be viewed as a potential cost

improving the role of women in enhancing the family economy. It seems that the issues discussed by the academia are not fully tally with the goals set by the MDGs. The issues on environmental sustainability and global partnership for development are almost missing from the focus of the research papers during the period. Table 4.7 shows that Islamic microfinance research papers after the implementation of the SDGs lead to Islamic financial instruments for poverty reduction such as zakat and waqf. In addition, the discussion about social infrastructure, gender equality and strengthening of the institution through Islamic finance scheme are among the favourite topics.

4.6   Conclusion and Recommendation After examining 89 papers from 41 high-ranking journals, the answers to the research questions—To what extent does research Islamic microfinance discuss the MDGs in the journals listed in ABS 2015? What has been offered by Islamic Microfinance studies for achieving SDGs?— are as follows: 1. Islamic microfinance studies offer unique solution in the form of Islamic financial instruments for the eradication of poverty and hunger, increasing the role of women in the economy and improvement of infrastructure.

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Table 4.5  Empirical studies on Islamic microfinance (2002–2008) after implementation of MDGs Year/author: journal

Country, sample, method, paradigm

Findings

2002, Choudhury: IJSE 2003, Kuran: JEH

Bangladesh, literature review, interpretivism

The social well-being objective becomes the principal one for the microenterprise

2005, Eid: IJEF

2006, Dixon, Ritchie and Siwale: AAAJ

2008, Dusuki: Humanomics

2008, Torkestani and Ahadi: IJIMEFM

Middle East, Europe, comparative, critical

Given the important role that Islamic law played in the economic life of the pre-modern in the Middle East, it is hardly surprising to find that it contributed to the region’s economic frustration MENA, literature review, Larger macroeconomic and governance interpretivism` reforms are essential, but this research points to the importance of sectorial strategies, even if their efficacy is only fully optimized when all other reforms are carried out Zambia, the client-loan The findings show that tensions between officer, live observation, vertical and horizontal accountability in poststructuralism practice can be directly translated into heightened pressure and stresses on both the non-governmental organization (NGO) and its loan officers, which constrain overall accountabilities to other stakeholders and disguise other potential dysfunctions Bangladesh, Malaysia, Microfinance requires innovative Indonesia, Grameen Bank, approaches beyond the traditional financial Amanah Ikhtiar Malaysia, intermediary role Bank Rakyat Indonesia, literature review, interpretivism Iran, 30 experts working First, Iranian MFIs have enough readiness as top managers in 15 to introduce micro-insurance as a new selected Iranian MFIs, product. Second, the collaborative nature Likert scales ranging, of Iranian culture (score: 84.67) and the positivism government’s supports (score: 88) are the most important strengths of Iran, in respect to the development of micro-insurance

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Table 4.6  Empirical studies on Islamic microfinance (2009–2014) after implementation of MDGs Year/author: journal

Country, sample, method, paradigm

2009, Hassan and Latiff: Humanomics

Brunei, Malaysia, UAE, UK, A collective approach of businesses, literature review, interpretivism IFIs and awqaf/charitable foundations would increase the flow of corporate resources into the social sector/ microfinance Bangladesh, the programme of BRAC has been able to build a raft of BRAC, literature review, institutional arrangements by interpretivism innovatively combining and redeploying the resources it had at hand and thus enabling social and economic inclusion for the poorest in Bangladesh Australia, Muslim Community The signs for the Islamic financial Co-operative (Australia) Ltd, institutions operating continued Islamic Co-operative Finance growth appear positive Australia Limited, literature review, interpretivism Turkey, 32 Turkish business The findings of this research imply people, in-depth interviews, that the Turkish entrepreneurship has poststructuralism its own characteristics MENA, literature review, This paper finds that it is possible to interpretivism combine the two practices and to convince Islamic religious leaders that Islamic banking could be applied to microfinancing. Senegal, interviews and focus Socio-religious networks in West groups, critical Africa like Mouridism have actually created a non-capitalist spirit of commerce, and to some degree entrepreneurialism, among Senegalese Mourids who are majority Wolof Turkey, 139 questionnaires, The most serious problem faced by surveys, poststructuralism entrepreneurs in Turkey is the complex and confusing tax structure. Other important problems include unreliable employees, the inability to maintain good records and a weak economy

2009, Mair and Marti: JBV

2009, Ahmad and Ahmad: Humanomics

2009, Uygur: JBE 2009, Shahinpoor: IJSE

2009, Minard: SEJ

2009, Benzing, Chu and Kara: JSBM

Findings

(continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

2010, Kaleem, and Ahmed: NVSQ 2010, Buğra and Cakar: DC

Pakistan, microfinance model MFIs in Pakistan mostly seek technical literature review, interpretivism and financial assistance from foreign donor agencies Turkey, comparative analysis, The role women assume in interpretivism contributing to household income is defined in the realm of social assistance and not in the labour market Bangladesh, 1020 clients Clients’ socio-economic factors like working across country, logit age, number of family members in model, positivism farming, total land size and clients’ ethics and morals had a positive and significant influence on household income Indonesia, literature review, The implementation of Islamic interpretivism microfinancing, which was preceded by selection process of microenterprises and also accompanied by business control, incentive system and construct good relationship, is effective in developing microenterprises and improving the household income Malaysia, 1800 AIM members The results of this study indicate that from the states of Kelantan AIM, through its microcredit and and Perak, correlation, training activities, has been able to positivism alleviate poverty, improve health condition of its members, as well as enable its members to improve the education level of their children Nigeria, 62 practising Nigerian Female entrepreneurship in Nigeria is female entrepreneurs, driven by microfinancing as well as interviews, poststructuralism family dynamics that work to shape and influence the birth of a business

2010, Rahman and Ahmad: IJIMEFM

2010, Hadisumarto and Ismail: Humanomics

2010, Saad: JIEBF

2011, Halkias, Nwajiuba, Harkiolakis and Caracatsanis: MRR 2011, Shubber: IJIMEFM

Literature review, interpretivism

Findings

All this represents one of the challenges facing the well-established and still-growing sector of Islamic finance and banking. Clearly, the leaders of this global sector will need to deal with the challenge sooner or later (continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2011, Kabeer: DC

Bangladesh, organizational staff, qualitative exploration, interview, poststructuralism

2011, Al-Azzam, Hill and Sarangi: JDE

Jordan, 160 urban borrowing groups, regression, positivism

The study has noted that in many cases, men’s initial resistance to women’s membership of the NGOs subsequently gave way to active support, particularly in those cases where both had participated side by side in the struggle for their land rights, but also more generally through a better understanding of what these organizations were about This research suggests some potential means to improve repayment, i.e., lenders should focus on encouraging group pressure, monitoring and aspects of social ties that increase repayment rates The study concludes that microfinance is an empowering tool in vulnerable remote areas

2011, Chan and Malaysia, three villages under Ghani: APBR the Sarikei Branch of AIM Office in Sarawak, survey interviews, interpretivism 2011, Kroessin: Bangladesh, Islamic Bank The development truths constructed JID Bangladesh Limited Practice, by the IBBL, in response to their literature review, interpretivism construction of ‘Western’ development as purely material, are therefore a recasting of development as a holistic process that is both material and spiritual with an ultimately higher transcendental goal 2011, Gosh: Literature review, The hard and challenging work of DC interpretivism structural transformation, asset redistribution and systemic change still has to be done, if we really want to eradicate, rather than just continue to deal with, poverty (continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2012, Ahmed: JDE

Bangladesh, 3000 households in 91 villages spread evenly throughout the country (in 1997–1998, 1998–1999, 1999–2000 and 2004–2005), panel data, positivism

2012, Wardiwiyono: IJIMEFM

30 questioners were distributed to 30 BMTs, descriptive statistic and qualitative analysis, poststructuralism Bangladesh, literature review, interpretivism

Microcredit can help in two ways. In the short run, it helps insure consumption. In the long run the change in the value of livestock in response to health shocks is lower for households with access to microcredit, and thus insurance does not come at the cost of production efficiency BMTs in Indonesia have implemented an internal control system for their financing activities

2012, Spiegel: JID

2012, Chowdhury: JSBE

Bangladesh, the Household Income and Expenditure Survey 2005 dataset (N = 10,080), probit regression, positivism

2012, Farre: WBRO

Literature review, critical

2013, Kunt and 148 countries, more than Klapper: BPEA 150,000 adults in 148 countries, regression, positivism

Microfinance is far from a panacea; several studies conclude in that fashion, and certainly the preceding analysis has suggested that microfinance strategies are susceptible to a multitude of risks in the artisanal mining context It is found that the probability that a household will own a business in the CHT region is 11% lower in comparison to that of a household elsewhere in Bangladesh. Moreover, starting a business in the CHT region requires more capital, and violent conflict and geo-cultural characteristics are particularly discouraging for entrepreneurship The main implication is that policies meant to achieve gender equality should focus on men rather than exclusively target women The data show wide gaps in account penetration between income and developing countries and between the poor and within countries (continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2013, El-Komi and Croson: JEBO

USA, 44 participants, logit regression, positivism

2013, Sahoo and Dash: EM

South Asia, annual data spanning 1975 to 2010: SR, M2Y, inflation rate, GDP growth rate (GY), real per capita income (PCI), current account deficit as ratio of GDP (FSY), bank credit to domestic sector (BCR), age dependency ratio (DEP) and the share of agriculture in GDP (AGY), panel data, positivism Egypt, 144 slum dwellers from the various districts of Manshiet Nasser, dummy regression, positivism

This study finds significantly higher compliance rates for the Islamic-­ compliant contracts (profit sharing and joint venture) than for the traditional contract (interest-based) Study finds that financial sector development positively affects total and private savings in South Asia along with per capita income, share of agriculture and foreign savings. Results also support the humped-­shaped relationship between financial development and savings. The causality results support that financial development leads to higher savings mobilization in South Asia Study finds that an increase in trust following a decrease in social distance is related to the principal belief: the expectation that an agent will choose trustworthy is associated with a greater probability to choose trust among friends but not among strangers An essential strategic implication for the MENA microfinance industry is that they need to pursue a technological progress in order to meet the dual objectives of reaching many poor people and financial sustainability The use of Al-Tawhid principles of contract suggested practices that are fair and free from elements of riba and gharar. Cash waqf is suggested as a source of fund for Islamic MFI for sustainability

2013, Binzel and Fehr: JDE

2014, Bassem: EM

2014, Abdullah and Ismail: Humanomics

MENA, dataset of 198 observations from 33 Middle East and North Africa microfinance institutions over the period of 2006–2011, panel data, Malmquist index, positivism Literature review, interpretivism

(continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2014, El-Gamala, El-Komib, Karlanc and Osmanc: JEBO

Egypt, three villages of Cairo, also among the poorest, experimental model, poststructuralism

2014, Salleha, Jaafarb and Ebrahim: JEBO 2014, Wahyudi: IJIMEFM

Malaysia, literature review, interpretivism

2014, Katwalo and Muhanji: IJBM

Kenya, 293 questionnaires of banks in Nakuru and Kericho Counties, regression, critical

2014, Tolba, Seoudi and Fahmy: JSBE

Egypt, 125 firms, in-depth interviews and a focus group, ANOVA, positivism

2014, Syed, Buren: BEQ

Literature review, interpretivism

2014, Samad: Humanomics

India, 300 Muslim lower- and middle-class respondents in 2011, observation, poststructuralism

Empirically, bank-insured RoSCA model generated significantly higher take-up and repayment rates than the Grameen model. This suggests that this model, by overcoming the religious barriers to credit, can be a useful alternative to Grameen-style microfinance Results of study support the policy direction of the FDIC’s small-dollar loan programme This research shows that commitment contributes positively in achieving the financial goals of an alliance. Coordination and initial agreement has a positive and significant influence in forming commitment from BMT and trust from Islamic banks The success in the unbanked segment largely lies in banks developing the ‘software’ for directly addressing the specific needs of the traditionally unbanked The results show that intentions to take a commercial bank loan are low in Egypt and SME owner-managers have negative perceptions on the service quality of loan providers A dialectical approach to understanding the relationships among religion, culture and business provides a better guide to responsible business action in Muslim-majority countries than does the capability approach IMF can play a very critical role in providing deliverance from financial slavery

Indonesia, 131 BMT spread throughout Central Java and Yogyakarta, survey, poststructuralism

(continued)

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Table 4.6 (continued) Year/author: journal

Country, sample, method, paradigm

2014, Indonesia, 348 questionnaires Riwajanti: BIES from BMT or BMRS and 22 interviews with the directors or managers of these institutions, survey interviews, correlation, positivism 2014, Malaysia, 6 Amanah Ikhtiar Kazemian, Malaysia (AIM) medium-level Rahman and managers, interviews, Ibrahim: poststructuralism QRFM 2014, Ashraf, Muslim countries, 2138 Hassan and rm-years for 754 different Hippler III: MFIs across 83 countries, 33 Humanomics Organization of the Islamic Conference (OIC) member Muslim countries and 50 non-member countries, a pooled ordinary least squares regression, positivism 2014, Hassan: India, Islamic microfinance Humanomics group members, survey, interpretivism

Findings The findings suggest that microenterprises in Indonesia face challenges in gaining access to finance, despite their large numbers, their potential and their important role in the macro-economy Based on the findings of this study, AIM has a high level of customer orientation and inter-function coordination and a middle level in competitor orientation Results show that country gross domestic product size is positively related with profitability, and the percentage of women borrowers is also significant in driving loan recovery and profitability in the OIC sample, but they are otherwise not significant for the rest of the world sample This study found that collective action through Islamic microfinance groups actually helps to increase environmental awareness, economic betterment of the members and fruitful management of LCRs through Islamic microfinance

2. Instruments offered in reaching SDG targets include zakat and waqf for financing of micro and medium enterprises, as well the use of partnership or musharakah and mudharabah schemes. 3. Beaver (1996) documents that trend in research papers is influenced by several factors, among others, exogenous and endogenous factors. From a 25-year study, he concludes that factors such as data availability, environment, theory and academic research are significant. This research finds that environment such as the introduction of MDGs and SDGs influence direction of research papers that was campaigned in the conferences during the period. Academic research is also another dominant factor that leads to normative understanding of the MDGs and SDGs.

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Table 4.7  Empirical studies on Islamic microfinance (2015–2017) after SDGs Year/author: journal

Country, sample, method, paradigm

2015, Salleh: IJIMEFM

Brunei, structured interviews (215 welfare recipients and 216 non-welfare recipients), semi-structured (39 welfare recipients), interviews, positivism

Findings

This paper highlights the need for bank accounts and credit facilities that meet the needs of welfare recipients, to fulfil their daily needs, as well as saving for children/ grandchildren’s education, and for welfare recipients who save 2015, Wahyudi: Indonesia, 89 BMT, SEM, Empirically, conflict, coordination Humanomics positivism and trust are a positive and significant contributor in the success of transfer of knowledge. Trust and transfer of knowledge is significantly influenced positively by the building of coordination, agreement, interdependence and social capital 2015, Htay, Malaysia, questionnaire, Micro-health takaful will be viable if Sadzali and interview, interpretivism and only if TOs collectively offer it as Amin: QRFM a part of their corporate social responsibility, and it must be subsidized by the zakat or waqf authorities 2015, Indonesia, Pakistan, Sudan, Case studies of successful initiatives Obaidullah: AFR literature review, interpretivism reveal that composite models involving the integration of philanthropy-based, not-for-profit as well as for-profit components may provide ideal solutions 2015, Saeed and Pakistan, 368 listed Pakistani It was found that small and Sameer: SEF non-financial firms over the medium-sized enterprises (SMEs) are period of 2001–2009, panel financially constrained in the credit data, positivism market. The main finding indicates that reduction in bank concentration eases financing constraints, and this effect is more pronounced for SMEs (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2015, Hassan: Humanomics

Literature review, interpretivism

2015, Sambajee and Dhomun: IJEBR

Maldives and Mauritius, 6 government officials, 8 SME owner/managers, 1 private bank owner, 1 academic and one resort owner, interviews, poststructuralism

2015, Haneef, Pramanik, Mohammed, Amin and Muhammad: IJIMEFM

Bangladesh, 381 respondents, SEM, positivism

2015, Aydin: IJIMEFM

Literature review, interpretivism

2015, Alam, Hassan and Said: Humanomics

Malaysia, 393 microcredit borrowers from Amanah Ikhtiar Malaysia (AIM), survey, poststructuralism

The paper finds that there are some opportunities capable of improving the economic condition of the poor Muslim communities through some innovative approaches. To illustrate this finding, the paper emphasizes on designing and delivering Islamic microfinancial products suitable for the poor based on the principle of Islamic solidarity The Maldivian government is less proactive in supporting its SMEs compared to the Mauritian government. Its failure to facilitate access to finance and provide business support services has led the Maldivian SMEs to use multiple methods of bootstrapping to sustain existing businesses and/or start new ones The results show that there are significant relationships between IsMF and takaful, waqf resources and human resource development, takaful and human resource development, IsMF and human resource development, and waqf resources and project financing The paper suggests that Muslim countries should embrace the social business model for sustainable development and greater subjective well-being Results indicate that the microcredit program of AIM has a positive and enhancing effect on the livelihood of clients. This effect is reflected in the assessment of their well-being, especially in the context of maqasid al-Shariah (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2015, Adnan and Indonesia, 20 respondents Ajija: from each selected branch, Humanomics 200 clients, descriptive statistics, poststructuralism

2015, Abbas and Shirazi: JIABR

2015, Klapper and Singer: JAE

2015, Neubert, Bradley, Ardianti and Simiyu: ETP

2015, Meagher: JID

This paper reveals that BMT financing is effective in reducing poverty. Most of respondents can increase their income after receiving BMT financing. Products of BMT, especially BBA and mudarabah, to empower the poor in various productive businesses have been able to reduce the extent and severity of poverty Pakistan, 270 micro-­ The study found the strong opinions entrepreneurs and petty traders of the respondents speak in favour of in three major cities of Islamic microfinance under a system Pakistan, 100 people from of profit and loss sharing. Conversely, middle and top management, the majority of the clients also feel reliability and descriptive that Islamic banks do not encourage analysis, poststructuralism lower-income micro-entrepreneurs Africa, 33,000 observations Unbanked adults in Africa cite the from the 33 African countries, lack of money to use an account, regression, positivism high costs of opening an account, distance and documentation requirements as some of the reasons behind not having formal accounts 4000 clients with 9 credit Results from microcredit officers (a microcredit bank, entrepreneurs in Kenya and Kenya) and 168 Indonesian Indonesia indicate significant and Kenyan respondents, relationships between entrepreneurs’ regression, positivism spiritual capital and business innovation and performance, even after accounting for other forms of capital Nigeria, 18 leadership of Fieldwork in northern Nigeria shows relevant enterprise associations, that inclusive initiatives are as well as 35 interviews and 8 intensifying competitive struggles focus group discussions with within the informal economy in Muslim informal enterprise which stronger actors are crowding operators, interview and FGD, out poorer, less educated and poststructuralism migrant actors, exacerbating disaffection and vulnerability to radicalization (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

2015, Haile, Osman, Shuib and Oon: JID

Malaysia, 20 female borrowers of Amanah Ikhtiar Malaysia (AIM) and TEKUN Nasional, in-depth interviews, poststructuralism

Findings

Results show that most of the borrowers are empowered. However, it is inconclusive whether economic empowerment achieved by borrowers could be entirely attributed to the services of the studied MFIs, given the prevalence of cross-borrowing 2016, Rozzani, Malaysia, clients of the Islamic It was found that clients are quite Mohamed and microfinance institution, satisfied with the disbursement Yusuf: IJSE interview, poststructuralism process through a mobile solution. However, the same cannot be said with the repayment process. The difficulties in using the mobile solution pose a major threat to its success 2016, Zhao and 891 MFOs, 244 public funders This study finds that strong market Lounsbury: and 990 commercial funders, logic enhances both commercial and Journal of regression, positivism public capital acquired by MFOs, Business whereas religious diversity decreases Venturing the amount of commercial capital flowing to MFOs. Religious diversity also mitigates the positive impact of the market logic on capital flows into MFOs 2016, Zhao and 891 MFOs, 244 public funders This study finds that strong market Lounsbury: JBV and 990 commercial funders, logic enhances both commercial and regression, positivism public capital acquired by MFOs, whereas religious diversity decreases the amount of commercial capital flowing to MFOs. Religious diversity also mitigates the positive impact of the market logic on capital flows into MFOs 2016, Thaker, Malaysia, literature review, The findings of this paper will Mohammed, interpretivism provide microenterprises with an Duasa and alternative source of financing to Abdullah: JIABR start or expand their business by using cash waqf fund (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

2016, Hyun and Uddin: EM

Bangladesh, 10 state-owned banks, 31 private domestic banks, 9 foreign banks and 8 Islamic banks from 2001:Q1 to 2014:Q2 (2572 observations), VAR, positivism

Findings

The Bangladesh financial markets are still considered underdeveloped and constrained; the lending behaviours of Bangladeshi domestic banks resemble those of banks in the USA and South Korea, as indicated by the results of volatility and cyclicality 2016, Aziz and Literature review, The study identifies the inefficiency Mohamad: IJSE interpretivism in the current practices and makes some propositions that are in conformance with Islamic principles and implementable by Islamic institutions all over the world. The authors propose a theoretical framework and operational propositions for ISB 2016, Wulandari Indonesia, chairman and staff The findings show that the Central and Kassim: of the Central BMT (Induk BMT has built specific products and IJBM Koperasi Syariah) and Central empowerment mechanisms for the BMT (Pusat Koperasi Syariah), poor and has an ideal product to be structured interviews, applied in 382 BMT in Indonesia. poststructuralism There are two schemes of financing source in BMT, namely, social ministry (Kelompok Usaha Bersama) and private financing (national and international donor) 2016, Bangladesh, 430 players The paper finds significant evidence Chowdhury: AEJ forming 215 groups sampling, supporting theoretical hypotheses in (OLS) regressions and joint-liability microcredit lending. maximum likelihood Nevertheless whether joint liability is estimation (MLE) binary the optimal lending model for estimation, positivism alleviating world poverty remains undetermined 2016, Sri Lanka, 1250 youth aged Positive affect, subjective norms, Jebarajakirthy 18–27 selected from the entrepreneurial desire and self-­ and Thaichon: Northern Province of Sri identity enhanced intentions of IJBM Lanka, confirmatory factor obtaining microcredit, whereas analysis (CFA), positivism perceived deterrents reduced those intentions (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2016, Rahman, Muhammad, Ahmed and Amin: Humanomics

Bangladesh, 207 divisions of Bangladesh, SEM, positivism

The findings of this study show that, overall, the model fits the data and can be used to advance Islamic MF in Bangladesh, which implies that the IMIM is applicable for use in this country The findings show that the higher the SI (social impact), the higher the FP (financial performance) in the microfinance sector The results provide empirical evidences that indicate that management sustainability is significantly influenced by customer orientation and inter-function coordination. However, only customer orientation affects the financial sustainability of AIM The proposed model incorporates the peculiarities of the poor people in pre-financing, financing and post-financing activities of microfinancing products to serve as a reference for policymakers. The paper also found that each region has unique product preferences depending on the poor’s characteristics The main result of this study shows that growth in women’s revenue and resources played an important role in improving women’s financial freedom and sense of self-possession

2016, Oliver, Dieguez, and Alvarado: JBR

Information for 563 MFIs around the world for the year 2012, PLS path modelling, positivism 2016, Kazemian, Malaysia, 190 management Rahman, Sanusi staff of AIM across Malaysia, and Adewale: the partial least square-­ Humanomics structural equation modelling, positivism

2016, Wulandari, Kassim, Sulung, and Putri: Humanomics

Indonesia, representatives of BMTs for the (JABODETABEK), Sulawesi Selatan, Yogyakarta and Nusa Tenggara Barat, in-depth interview, poststructuralism

2017, Hassan and Saleem: Humanomics

Bangladesh, 700 women, customers of sample Islamic microfinance programme, regression, positivism

(continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

Findings

2017, Sinhaa and Literature review, Sheth: JBR interpretivism

This study proposes eight marketing strategies rooted in the 4 A’s framework: affordability through democratizing and upscaling the offer, accessibility through managing and reinventing reach, acceptability through cultural and functional fusion and awareness through building brand identity and engaging stakeholders 2017, Ahamed 2635 commercial banks, The results highlight that the and Mallick: cooperative banks and Islamic importance of ensuring inclusive JEBO banks in 86 countries over the financial system is not only a time period 2004–2012, development goal but also an issue regression, positivism that should be prioritized by banks, as such a policy drive is good for their stability 2017, Zhang and Developing world, The study finds macroeconomic Posso: AEL macroeconomic variables of 64 evidence of a negative relationship developing economies over the between women’s participation in period 2003–2014, panel data, microfinance and GI positivism 2017, Shaikh: The model of Holmstrom and The study suggests a framework in JIABR Tirole (1997), mathematical which equity financing could be used model, interpretivism to fund microenterprises that will employ poor people with related skills 2007, Iran, 140,000 individuals, The analysis shows that the resource Farzanegan and which include more than dividend policy with a subsequent Habibpour: EE 36,000 Iranian urban and rural direct income tax has a significant households in 2009, the decreasing effect on the household bootstrap, positivism Gini index, while targeted policies are more effective in reducing number of households under the poverty line (continued)

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Table 4.7 (continued) Year/author: journal

Country, sample, method, paradigm

2017, Rozzani, Mohamed and Yusuf: RIBF

Malaysia, staffs of Risk Management Department in Institution A and Institution B, in-depth interviews, poststructuralism

Findings

It was found that both Institution A and Institution B are both exposed to Shariah risk, operational risk and credit risk. In addition to that, as Institution B is an established and reputable financial institution in Malaysia, it is also exposed to reputational risk 2017, Lindvert, Pakistan, 21 women Results also show that although Patel and entrepreneurs, semi-structured women do get some selective access Wincent: ERD interviews, poststructuralism to resources from family members, they are restricted by limited access to social capital outside of family members 2017, Abdullah Literature Review, To ensure the perpetuity of the waqf, and Ismail: IJSE interpretivism it is suggested that only revenue from the waqf property should be used for microfinance fund 2017, Patel: SBR Sri Lanka, Amana Takaful, Islamic finance had to be put to observation, poststructuralism many complex tasks, one of which was to delicately finesse political capital and build trust through that capital

4.6.1  Recommendation By performing research, new understanding, new technologies and the potential for action are created (The Group of Eight 2013). That means Islamic microfinance studies orientation would give innovation for achieving SDGs, especially no poverty; zero hunger; good health and well-being; quality education; clean water and sanitation; gender equality; productive employment and economic growth; industry, innovation and infrastructure; reduced inequalities; sustainable cities and communities; and peace, justice and strong institution. Future research in the Islamic microfinance areas could draw the importance of “Clean water and sanitation and Affordable and clean energy, Sustainable cities and communities, Responsible Consumption and

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Production, Climate action, Life below water, Life on land” as big themes in achieving SDGs. This is in the same vein with the objectives of shariah (Maqasid Shariah) that one of them is to promote protection of the environment (hifdzul bi’ah or hifdzul ‘alam1), see Al-Qardhawi (2001). One way to ensure timely researchers’ contributions with high impact, researchers are encouraged to publish in international-ranking journals and IRTIIDB could help the publication through IRTI-IDB’s own international journal. Researchers are encouraged to co-author with regulators in journal publications for a thorough policy recommendation.

Note 1. The notion of hifdzul ‘alam is mentioned by Yusuf al-Qardhawi in Yùsuf al-Qardhàwi, Ri‘àyah al-Bì’ah fì Syarì‘ah al-Islàm, First Edition (Cairo: Dàr asy-Syurùq, 1421 H/2001 M), 47.

References Al-Qardhawi, Y. (2001). Ri‘àyah al-Bì’ah fì Syarì‘ah al-Islàm (1st ed.). Cairo: Dàr asy-Syurùq, 1421 H/2001 M, p. 47. Beaver, W.  H. (1996). Directions in Accounting Research: NEAR and FAR, Accounting Horizons; June 1996; 10, 2; ABI/INFORM Global, p. 113. Brau, J. C., & Woller, G. M. (2004). Microfinance: A Comprehensive Review of the Existing Literature. Journal of Entrepreneurial Finance, 9(1), 1–28. Duvendack, M., Jones, R. P., & Vaessen, J. (2014). Meta-Analysis of the Impact of Microcredit on Women’s Control Over Household Decisions: Methodological Issues and Substantive Findings. Journal of Development Effectiveness, 6(2), 73–96. El-Zoghbi, M., & Tarazi, M. (2013). Trends in Sharia-compliant Financial Inclusion. Brief. Washington, DC: CGAP. Fouillet, C., Hudon, M., Harriss-White, B., & Copestake, J. (2013). Microfinance Studies: Introduction and Overview. Oxford Development Studies, 41(sup1), S1–S16. Guardian. (2017, January 16). World’s Eight Richest People have Same Wealth as Poorest 50%. Retrieved from https://www.theguardian.com/global-development/2017/jan/16/worlds-eight-richest-people-have-same-wealth-aspoorest-50 Hassan, A. (2015). Financial Inclusion of the Poor: From Microcredit to Islamic Microfinancial Services. Humanomics, 31(3), 354–371.

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Holmstrom, B., & Tirole, J. (1997). Financial Intermediation, Loanable Funds, and the Real Sector. The Quarterly Journal of Economics, 112(3), 663–691. IMF. (2010). Reaching the MDGs: Macroeconomic Prospects and Challenges in Low-Income Countries. Background Note by IMF Staff for the United Nations MDG Summit September 2010. IMF. (2015). The IMF and the Millennium Development Goals. International Monetary Fund Factsheet. Klapper, L., El-Zoghbi, M., & Hess, J. (2016). Achieving the Sustainable Development Goals: The Role of Financial Inclusion. Working paper of United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development. Lee, A. S. (1991). Integrating positivist and interpretive approaches to organizational research. Organization Science, 2(4), 342–365. Morduch, J., & Armendariz, B. (2005). The Economics of Microfinance. MIT Press. Mukhlisin, M., & Komalasari, R. (2018). Do You Capture Financial Crisis? Journal of Islamic Monetary Economics and Finance, 3(2), 245–292. https://doi. org/10.21098/jimf.v3i2.781. Oxfam. (2016). An Economy for the 1%. Briefing Paper 18, January 2016. United Kingdom. Rahman, M. W., Luo, J., Hafeez, A. S. M., & Sun, T. (2015). A Comprehensive Review of Microfinance Impacts, Sustainability and Outreach. Asian Journal of Agricultural Extension, Economics & Sociology, 6(2), 64–76. Riwajanti, N. I. (2013, Spring & Fall). Islamic Microfinance as an Alternative for Poverty Alleviation: A Survey. Afro Eurasian Studies, 2(1&2), 254–271. Schutt, R. K. (2006). Investigating the Social World: The Process and Practice of Research. CA, Sage Publications. The Group of Eight. (2013). The Role and Importance Research Intensive Universities in the Contemporary World. Discussion Paper April 2013. Veugelers, R. (2014). The Contribution of Academic Research to Innovation and Growth. Working Paper No. 71 of the WWWforEurope Project. World Bank. (2014). Global Financial Development Report 2014 : Financial Inclusion. Available at: https://openknowledge.worldbank.org/handle/ 10986/16238. Accessed on 13 September 2019. World Bank Group. (2003). ICT and MDGs. The World Bank. World Development Indicators. (2016). Highlights: Featuring the Sustainable Development Goals. International Bank for Reconstruction and Development. The World Bank.

CHAPTER 5

Islamic Finance and Its Impact on Financial Inclusion Wissal Msellek

5.1   Introduction Despite the global economic and financial challenges, Islamic finance has once again demonstrated its resilience by continuing to grow at double-­ digit rates across all sectors. But even though the growth is fast, there is further progress need to be made to support the socioeconomic aspects that still face some issues. Poverty, financial capability, and financial exclusion are some of the problems that are present in Islamic finance field today, and trying to deal with one of them will lead you to the others. Governments around the world are increasingly viewing financial inclusion as an important part to economic development as it is important for a sustainable economy. To achieve a desirable socioeconomic outcome, financial inclusion has become an increasingly important concern for a vast number of countries worldwide. This leads over 90 developing countries, representing more than 75% of the world’s unbanked population, to sign the Maya Declaration since 2011. And the World Bank’s 2014 Global Financial Development Report (GFDR) reported on financial inclusion

W. Msellek (*) Universiti Malaysia Sarawak (Unimas), Kota Samarahan, Malaysia © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_5

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that more than two-thirds of regulatory and supervisory agencies have been tasked with encouraging financial inclusion, and more than 50 countries have set formal targets and ambitious goals for financial inclusion. So what is a financial inclusion? And how is it related to the financial capability of the poor in Islamic finance?

5.2   Poverty and Financial Capability When talking about poverty and people attained by it, it means that their financial capability is very low leading them to a total financial exclusion. So for the financial inclusion of these people, their financial capability must be enhanced. And as defined by the World Bank, financial capability is the internal capacity to act in one’s best financial interest, given socioeconomic and environmental conditions. It encompasses knowledge (literacy), attitudes, skills, and behavior of consumers with respect to understanding, selecting, and using financial services, and the ability to access financial services that fit their needs.

5.3   Financial Inclusion Financial inclusion has many pillars, which are presented in Table 5.1.

5.4   Financial Inclusion Through Risk-Sharing 5.4.1  Small-Medium Enterprises According to the Core Conventional Tools to Enhance Financial Access in Islamic Economic Studies (Vol. 20, No. 2, p. 68), SMEs have functioned as the engine of growth for both developed and developing economies by being the largest providers of new jobs and major source of technological innovation in most countries. As for poverty

Table 5.1  Pillars of financial inclusion Risk-sharing/assets-linked financing Small-medium enterprises

Microfinance

Redistribution institutions Micro-­ takaful

Sadaqah

Zakat

Qard al-hasan

Waqf

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reduction, SMEs are more likely to employ poor and low-income workers then larger firms; sometimes, SMEs are the only source of employment in poor regions and rural areas. However, market failures may cause biases against SMEs. For example, high risks for cost-searching and coordination failure across sectors always prevent start-ups from entering a new market. Thus, industry policies favouring SMEs, such as credit subsidies and tax credits, are recommended for developing countries.

Islamic finance highlights the significance of profit-sharing finance, which can have positive economic effects similar to direct investment leading to strong economic development. Promotion of entrepreneurship and risk-sharing are two key features of Islamic finance, and given that small-­ medium enterprises (SMEs) require both encouragement to entrepreneurship and risk-sharing, there is a natural fit for Islamic finance and SME financing. Islamic SME finance concepts can be seen to provide a comprehensive asset-based economic and equitable model that fulfills expectations such as social justice and human-centered sustainable development. Financing modes that best suit SMEs include mudarabah (principle/ agent) and musharakah (equity partnership). Both forms serve a useful purpose: they provide investors with high liquidity at low risk. However, Shariahcompliant SME finance is not limited to these instruments; innovative approaches tend to involve more comprehensive financing schemes that mix the aforementioned saving as a tool for insurance hedging against future turbulence. Ijarah has been one of the most widely used forms of financing SMEs as it reduces the startup cost in addition to providing security to lenders. 5.4.2  Microfinance Microfinance can be defined as “the provision of financial services to low-­ income clients, including self-employed, low-income entrepreneurs in both urban and rural areas” (Ledgerwood 1999). The microfinance adopts market-oriented and enterprise development approach. It emphasizes institutional and program innovations to reduce costs and risks and has greater potential to expand the financial frontier to the poor in sustainable manner (Littlefield et al. 2003). Microfinance can be featured under several aspects such as: • Integrating social intermediation: It is defined as “a process in which investments are made in the development of both human resources and institutional capital, with the aim of increasing self-reliance of

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marginalised groups, preparing them to engage in formal financial intermediation” (Bennett et al. 1996; Pitt and Khandker 1996). • Group-based financial services: It is a group-based approach that normally involves the formation of groups of people who have a common objective to access financial services. This service use pressure as a substitute to collateral. And it has the potential to reduce transaction costs in credit delivery and disbursements (searching, monitoring, and enforcement) of the lender by shifting onto the groups. • Savings mobilization: This can strengthen microfinance institutions and reduce their dependence on government subsidies and donors for loanable funds (Gurgad et  al. 1994; Von Pischke et  al. 1986; Rhyne and Otero 1992, 1994). • Overdependence on subsidies: Which debate on the need for microfinance institutions to be independent from subsidy or self-sufficient. Subsidies can cause a lack of financial discipline on the part of both lender and borrower. While the lenders may have less concern about repayment rates, borrowers on the hand perceived loan as grants which may reduce their sense of obligation to repay their debts (Bennett et  al. 1996). Low and subsidized interest rates also have been empirically proven to result in regressive income distribution, credit rationing, and non-sustainable institution (Gurgad et al. 1994). Furthermore, the infusions of subsidies may induce entry and lead to perverse effects to borrowers’ welfare in the face of stiff competition among the unregulated moneylenders (Hoff and Stiglitz 1998).

5.4.3  Micro-Takaful Micro-takaful can be defined as takaful accessed by the low-income market. As such, micro-takaful is not just a scaled-down version of regular takaful; the product and processes need to be completely reengineered to meet the characteristics and preferences of the low-income market, such as farmers, blue-collar workers, and small traders. The main argument is that micro-takaful can play an important role in poverty alleviation through risk-sharing among low-income individuals. This means that micro-takaful has unique product features in line with the income and other realities of the target market. It also requires innovative and cost-effective approaches to reach masses of people who may not be formally employed or have a bank account.

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Micro-takaful has a great role to play to promote financial inclusion. Besides being shariah compliant, takaful helps individuals and businesses to reduce their exposure to risks by promoting social and economic values. Micro-takaful is still limited compared to micro-insurance, but it has great potential in growing demand for shariah-compliant microfinance. Now, financial institutions are promoting the use of takaful as a guarantee for credit which is important in developing countries, where the poor have low liquidity in general and low capacity to pledge other types of guarantees that might be acceptable to formal banking standards. Micro-takaful is a socially responsible tool that aims to reduce poverty, help the vulnerable, and assist the underserved population through financial inclusion and practices such as pooling risks and assets within villages or communities. Microtakaful benefit packages can be designed in close partnership with the target population to ensure a higher participation rate. That is why micro-takaful has the capacity to reach groups excluded from statutory social insurance, especially where the workers are in the rural and informal economy. Micro-takaful covering family and health benefits and crop, livestock, and property damages can be implemented through a community-based model, a cooperative-based model, a wakalah partner model, or even a provider-driven model. People who participate in a microlevel health insurance scheme will be able to reduce their out-of-pocket expenditures and increase their use of health-care services (Panda et al. 2015).

5.5   Financial Inclusion Through Redistribution Institutions Redistribution institutions have four relevant tools for financial inclusion, which are presented. 5.5.1  Sadaqah Philanthropy and benevolence occupy a central position in the Islamic scheme of poverty alleviation and redistributive justice. The broad instrument of Islamic philanthropy is sadaqah. When made compulsory on well-­ to-­do Muslims, sadaqah is called zakat. When sadaqah results in flows of benefits that are expected to be stable and permanent (such as through endowment of a physical property), it is called sadaqah jariyah or waqf. Contemporary Islamic economists emphasize that a philanthropy-based

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intervention inherent in the institutions of zakat and sadaqah could potentially take care of the basic needs of the extremely poor and create a social safety net (Chapra 2008). 5.5.2  Zakat The concept of zakat could be expanded to provide a sustainable source of income for the poor. It is seen as a significant tool for promoting financial inclusion and economic growth. If “zakat” funds are managed properly, pooling these funds and encouraging the poor/beneficiaries to direct the funds toward starting a micro/small business would contribute to a more conducive developmental impact and help reduce disparities within the economy. “Zakat” is also perceived as an important tool for continually circulating liquidity in the system. Imposing it on aggregate wealth, including gold and silver and idle balances, benefits the system from unutilized resources and induces more investment and employment. This in turn paves the way for innovations to introduce alternative financial products that would achieve both effective accommodations to the nature of micro and small businesses in addition to poverty alleviation. Practical examples could include mudarabah agreements with institutional investors and facilitating access to dedicated zakat funds. No doubt, introducing such financial instruments to direct “zakat” resources promotes more social equity and equality in a sustainable and productive manner and could maximize the value added of such resources. 5.5.3  Qard al-Hasan Qard al-hasan (QH henceforth) is defined in Shariah as an interest-free loan. It is usually granted from well-off lenders to poor borrowers. It can also be directed from borrowers to intermediaries that can redirect it on their behalf to poor borrowers. QH is therefore a non-rewarding loan (with no expected return), and the borrower is under obligation to repay the loan depending on the borrower’s financial capacity to do so. Loan procedures are usually informal, and social capital is the basic collateral for this instrument.

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5.5.4  Waqf Awqaf are basically real nonperishable properties that are voluntarily donated for philanthropic purposes. Awqaf are dominated by fixed property mainly land or buildings, but can be applicable also to cash, shares, stocks, and other assets. The concept of awqaf is a well-practiced phenomenon in recent times in both the Muslim and non-Muslim world. Awqaf are usually named endowments in non-Muslim countries and are providing a wide range of services especially in education and community services. Awqaf by definition need an institutional setup to ensure perpetuity and good governance (for more information, see Islamic Social Finance, in Islamic Finance: A catalyst for shared prosperity? Global Report on Islamic Finance, World Bank & IRTI 2016, pp. 153–180).

5.6   Relation Between Financial Inclusion and Financial Capability People who save and borrow from formal sources are more aware of various financial institutions and their products than those who tap into informal sources, or those who do not save or borrow at all. If formal financial providers offer services of higher quality, this pattern may suggest that respondents with more information about the financial sector select better products and institutions than those with less information. Whereas people without formal financial products are less likely to know about the services offered by formal financial institutions, their awareness levels of financial concepts are comparable to those of users of financial products and services. On the one hand, this result suggests that a substantial proportion of people that are not being reached by financial products have a similar understanding of financial concepts as respondents with established relations with financial institutions. On the other hand, it suggests that both financially excluded people and those who are included deserve policy attention. This means customers are well-educated and have more knowledge in banking products and demand for more innovative products and services (Aslam et al. 2011). Zainol et al. (2008) argue that the bankers had limited knowledge in this area prior to working with the banks. In addition, the Islamic bankers themselves do not quite understand the difference between Islamic and conventional banking system. This is because most of the Islamic banking staff are from conventional banking system; hence,

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the process of transferring knowledge requires a lot of effort and vigorous implementation (Haniffa et al. 2006). As a solution to this matter, the Board of Directors, which is the highest level of management in a corporation, must have enough capability in the field of Islamic finance and the products and services offered. The capability of the boards depends on how much the education, experience, expertise, networking, and potential they have. Then they must provide more infrastructure and provisions to Islamic banking employees and provide them with sufficient knowledge to enable them to perform their duties in accordance with the Shariah principles through many education programs. Because it is important that the Islamic banking players have a deep understanding of Islamic banking industry themselves, and in order for financial products to provide maximum benefits, their users need to know and understand how to use them which suggests a stronger role for financial institutions in providing financial education programs to their clients as well.

5.7   Propositions To improve the financial inclusion and enhance the financial capability of the poor, I would like to present the following propositions: • Ensure a level playing field for Islamic microfinance, SME, and micro-takaful. • Institutionalize the Islamic redistributive instruments. • Promote the sustainable provision of a wide range of financial services for the poor. • Refine the financial education strategy for the employees first, and for the clients as well, allowing banks to expand access through agents and use of technology (e.g., mobile phones). • Use a wide range of programs, including mass media, social media, comic books, trusted intermediaries, and so on, to enhance financial knowledge, financial product awareness, and change attitudes and behavior. • Keep in contact with the people through digital communication, making it easier for the new generation and the youth for information access. • Combine financial capability-enhancing programs with available financial products, which most people can access, to promote responsible participations in the financial markets.

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• Share knowledge with financial institutions to develop products with design features tailored to help their clients to meet their long-term savings goals. • Explore opportunities for school-based financial education. • Analyze data on consumer complaints submitted by financial institutions periodically and use this information as input to supervisory and regulatory activities.

5.8   Conclusion Islamic banking needs to enhance its current operating model to attract depositors and expand credit services by tailoring its instruments to the specific needs of the market. Islamic finance advocates risk-sharing and equity finance while prohibiting debt financing and leveraging. Given the emphasis on social and economic justice and the eradication of poverty, we would expect Islamic instruments that targeted to address inequity, such as zakat, sadaqah, waqf, and qard al-hasan, to play an important role if the required institutional structures are developed. Therefore, there is a need to formalize or institutionalize Islamic redistributive mechanisms designed to empower the economically weak segments of the society, and also provide a Shariah-compliant finance company model for microfinance and micro-takaful, as well as remove interest rate caps for microcredit for SMEs and strengthen customer protection laws. In sum, revamping the current model of Islamic banking, by improving and expanding the use of Shariah-compliant instruments, could play a key role in strengthening financial inclusion, alleviation of poverty and improving higher and more inclusive growth in the social economies of Islamic finance.

References Aslam, N., Mohsan, F., Nawaz, M. M., Khan, M. S., & Shaukat, Z. (2011). Impact of Customer Satisfaction on Customer Loyalty and Intentions to Switch: Evidence from Banking Sector of Pakistan. International Journal of Business and Social Science, 2(16), 263–270. Bennett, L., & Cuevas, C. E. (1996). Sustainable Banking with the Poor. Journal of International Development, 8(2), 145–152. Bennett, L., Goldberg, M., & Hunte, P. (1996), Ownership and Sustainability: Lessons on Group‐Based Financial Services from South Asia. Journal of International Development, 8(2), 271–88.

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Chapra, U. (2008). The global financial crisis: can Islamic finance help minimize the severity and frequency of such a crisis in the future? A paper prepared for presentation at the Forum on the Global Financial Crisis to be held at the Islamic Development Bank on 25 October 2008. Enhancing Financial Capability and Inclusion in Morocco. A Demand-Side Assessment. (2014). The World Bank. Gurgad, M., Pederson, G., & Yaron, J. (1994). Outreach and Sustainability of Six Rural Finance Institutions in Sub-Saharan Africa. Washington, DC: The World Bank. Haniffa, R., Abdul Rahman, R., & Haneem Mohamed Ali, F. (2006). Board, Audit Committee, Culture and Earnings Management: Malaysian Evidence. Managerial Auditing Journal, 21(7), 783–804. Hoff, K., & Stiglitz, J.  E. (1998). Moneylenders and Bankers: Price-Increasing Subsidies in a Monopolistically Competitive Market. Journal of Development Economics, 55, 485–518. Islamic Finance a Catalyst for Shared Prosperity? Global Report of Islamic Finance World Bank Group, IRTI. (2016). pp. 158–180. Ledgerwood, J. (1999). Microfinance Handbook: An Institutional and Financial Perspective (Sustainable Banking with the Poor). Washington: The World Bank. Littlefield. E., Murduch. J., & Hashemi S. (2003). Is Microfinance an Effective Strategy to Reach the Millennium Development Goals?. Panda, P., Chakraborty, A., & Dror, D. M. (2015). Building Awareness to Health Insurance Among the Target Population of Community‐Based Health Insurance Schemes in Rural India. Pitt, M. M., & Khandker, S. R. (1996), Household and intrahousehold impact of the Grameen Bank and similar targeted credit programs in Bangladesh, World Bank Discussion Papers no. 320, The World Bank, Washington, DC. Rhyne, E. H., & Otero, M. (1992), Financial Services for Microenterprises: Principles and Institutions. World Development, 20 (11), 1561–71. Rhyne, E. H., & Otero, M. (1994), The New World of Microenterprise Finance: Building Healthy Financial Institutions for the Poor. Kumarian Press Inc., West Hartford, CT. Von Pischke, J. D., Turtiainen, T., & Mundial, B. (1986). Investment and Finance in Agricultural Service Cooperatives. World Bank. Zainol, A., Nair, M. & Kasipillai, J. (2008). R&D Reporting Practice: Case of a Developing Economy, Journal of Intellectual Capital, 9(1), 122–132. http://www.irti.org/English/Research/Documents/IES/034.pdf http://www.mifc.com/index.php?ch=28&pg=72&ac=134&bb=uploadpdf http://www.imf.org/external/np/blog/nafida/081015.pdf

CHAPTER 6

A Critical Review of Takaful Companies’ Contributions to Economic Developments in Fulfilment of Maqasid al-Sharı̄ʿah: Evidence from Malaysia Abu Umar Faruq Ahmad and Rashedul Hasan

6.1   Introduction The concept of Islamic insurance (Takaful) is based on the principles of cooperation, shared responsibility and collaboration. It allows its participant members under the insurance scheme to enjoy mutual protection (Ali 2006). The term takaful represents the mutual agreement of sharing

A. U. F. Ahmad Islamic Economics Institute, King Abdulaziz University, Jeddah, Saudi Arabia Islamic Cooperative Finance Australia Ltd., Parramatta, Australia Islamic Bank of Australia Project, Sydney, Australia R. Hasan (*) Faculty of Business, Communication and Law, INTI International University, Kuala Lumpur, Malaysia © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_6

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6.2   Literature Review and Hypothesis Development The past studies relating to takaful mentioned the significance of Maqasid al-Sharı̄‘ah in risk management realm focusing on takaful. Management of risk in takaful has to fulfil the objectives of Sharı̄‘ah, commonly protection of life, wealth and human dignity (Matsawali et al. 2012). Based on the statistics provided by these researchers on the occurrences of violence in Malaysia, it clearly shows that rape, incest, child abuse and molestation cases have risen over the ten-year period from 2000 to 2010. Therefore, upon incorporation of the protection of human dignity, takaful will have its path to not only flourish as an Islamic financial institution but with a high degree of noble values and Sharı̄‘ah influence. As for the present study, we aim to look at filling the gap of takaful operators’ responsibility in fulfilling three basic objectives of Sharı̄’ah, namely, daruriyyat, hajiyyat and tahsiniyyat. Islamic financial institutions are assumed to have failed to promote such objectives of Sharı̄‘ah through their corporate social responsibility (CSR) schemes (Cebeci 2012), and this creates a need to explore alternatives. Daruriyyat are a must and basic for the establishment of people’s welfare in this world and in the hereafter. This falls under the necessities since every Muslim needs to protect its five basic necessities such as faith, life, posterity, property and its intellect. Deficiency in daruriyyat brings deficiency in hajiyyat and tahsiniyyat, but not the other way around (Khan and Ghifari 1992). For takaful companies within the scope of the tenets of Sharı̄’ah, where the subject matter and intended objectives should be fully compliant with the Sharı̄ʿah, their contracts must be free from riba (interest and/or usury), gharar (uncertainty and excessive risk) and maysir (games of chance). Also, their contracts must not be aimed at deriving personal gain to merely one participant and loss to others; rather, participants must agree to cooperate and agree to pay a contribution to help those in need (Fauzi et al. 2016) and so on. In essence, takaful is an agreement between a group of participants and investors to guarantee the protection of loss, damage or disaster if it occurred to any participant in the scheme. There are several ways that takaful should achieve Maqasid al-Sharı̄‘ah. According to Abdul Aziz and Mohamad (2013), the achievement of Maqasid can be confirmed through the protection of self, family, asset and investment. In the process, the Islamic economic system promotes the

Total TOs Agents employed by TOs  Family takaful  General takaful Total number of offices Total number of employees Total NCI Total contributions as percentage of GNI  Family takaful contribution as a percentage of GNI  General takaful contribution as a percentage of GNI  Family takaful contribution  General takaful contribution Total benefits in RM million

8.00 43,843 32,987 10,856 154 2863 2565.00 0.40 0.30

0.10

73.30 21.30 753.30

11,188 4006 151

2967

1720.90 0.30

0.20

0.10

46.30

17.90

557.90

2007

8.00 15,194

2006

Table 6.1  Growth of takaful in Malaysia

866.10

23.50

85.70

0.10

0.30

3025.10 0.40

2411

44,222 15,975 157

8.00 60,197

2008

2185.40

39.84

127.27

0.25

0.13

4863.00 0.56

2846

66,338 33,970 207

11.00 100,308

2011

2263.40

44.51

155.08

0.18

0.25

5887.80 0.65

2758

68,009 37,543 213

12.00 105,552

2012

2706.80

46.84

160.78

0.07

0.21

6207.90 0.65

3162

58,984 18,820 215

12.00 77,804

2013

2699.00

50.77

157.47

0.06

0.06

6330.60 0.61

2720

50,529 13,577 129

11.00 64,106

2014

3200.20

55.20

164.65

0.07

0.22

6815.60 0.61

2896

50,334 15,053 112

11.00 65,387

2015

(continued)

3521.20

56.49

181.20

0.07

0.22

7534.60 0.63

3766

49,836 14,364 87

11.00 64,200

2016 6  A CRITICAL REVIEW OF TAKAFUL COMPANIES’ CONTRIBUTIONS… 

93

534.70

218.60

8818.30 7445.20 1373.10 1.60 6.70

157.10

6899.00

5800.90

1098.10

1.20 5.90

2007

400.80

Source: Bank Negara Malaysia

Key takaful indicators

 Net benefits and claims (family takaful)  Net benefits and claims (general takaful) Total takaful fund assets  Family takaful fund assets  General takaful fund assets  Total % of GNI  % of total assets of the insurance and takaful industry

2006

Table 6.1 (continued)

525.10

1660.40

2011

1.50 7.50

1669.30

8900.10

1.96 7.79

2571.00

14,377.20

10,569.40 16,948.20

234.10

632.00

2008

2.10 8.15

2755.90

16,289.80

19,045.60

627.50

1635.90

2012

671.40

2027.60

2014

750.40

2449.90

2015

854.90

2666.30

2016

2.21 8.96

2982.00

2.19 9.11

3127.00

2.20 9.37

3322.00

2.24 12.06

3593.00

17,952.00 19,619.00 21,389.00 23,200.00

20,934.00 22,746.00 24,711.00 26,792.00

707.50

1999.20

2013

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loss or damage among members of a community. The concept of takaful has existed in early Muslim history, but the developments of the concept into an Islamic financial vehicle begun in Sudan in 1979 which received its boost in Malaysia in 1984 (Lim et al. 2010). The takaful industry started with only one operator in 1985, which has increased to eleven in 2016. The takaful sector in Malaysia represents a small 17% of the combined insurance and takaful segment’s total premiums and contributions. At the end of June 2018, the combined general and family takaful sector’s capital adequacy ratio stood at 227.5%, comfortably above the minimum regulatory requirement of 130%. Table 6.1 provides key indicators of takaful industry developments in Malaysia. As mentioned earlier, the total number of takaful operators has increased significantly. Takaful industry in Malaysia offers both family and general takaful. There has been a 322% growth in the total number of the agent in 2016 compared to the number of agents in 2006. Net contribution income for the industry has also seen a growth of 337% in 2016 as compared to 2006. Therefore, we have aimed to explore the contribution of the takaful industry growth towards the economic development of Malaysia. Yusuf (2012) explored the prospect of takaful’s contribution to the Nigerian economy and highlights the invaluable contributions that takaful can make towards economic development. Chen et  al. (2012) confirmed the positive impact of the developments of the life insurance industry on economic development. Rahman et al. (2008) found that the inception of Takaful Malaysia and Takaful Nasional has made positive impact on the socio-economic development in Malaysia. The growth of the Malaysian takaful industry indicates that Malaysian Muslims have a high level of awareness of the importance of takaful, especially family takaful in their daily lives. Such awareness is translated into the exponential growth in takaful fund assets (see Table 6.1). Nevertheless, empirical evidences validating the impact of takaful industry growth towards Malaysian economic development are rare. Therefore, the authors seek to provide empirical evidences in this context and reduce the gap in Islamic finance literature. The rest of the chapter is divided into six segments. In the next section, a review of past literature on takaful has been provided. The hypothesis has also been developed in the same section. In Sect. 6.3, the theoretical perspective is discussed, followed by the methodological issues. Section 6.4 provides the results and discussion, and the study concludes in Sect. 6.5, highlighting the contributions and directions for future research.

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importance of a transparent contract. Abdul Aziz and Mohamad (2013) indicate that takaful operators should concentrate on the charitable aspect inherent in the core principles of the Sharı̄‘ah that promotes a good cause. Such charitable feature has been prevalent in the product offerings of takaful industry operating in both developed and developing countries. Bank Negara Malaysia has indicated that takaful operation in Malaysia has paid around RM 525 million in 2003 from takaful surplus funds to takaful participants. However, the amount has a decrease in recent years (RM 339 million in 2011) due to the economic downturn resulting from the global financial crisis (Abdul Aziz and Mohamad 2013). Nevertheless, it is important to channel such contribution to activities relevant to reducing poverty and improving the economic conditions of the poor and needy. Successful integration of takaful contribution in the government-administered development programmes may bring sustainable changes to the poverty-stricken economies and ensure achievement of the objectives of the Sharı̄‘ah. Maqasid al-Sharı̄‘ah can be translated as the objectives of Islamic law. They comprise all the benefits which indirectly ward off bad things and other forms of evil from the ummah. Furthermore, Maqasid al-Sharı̄‘ah allow a higher degree of appreciation towards Islam and Allah’s rules and regulations (Matsawali et al. 2012). The objectives of Islamic law are divided into four dimensions: needs, rulings, individuals and the purposes. Modern scholars, however, classify Maqasid into three different levels: general, specific and partial objectives (Auda 2008). There are some studies that focus on Maqasid al-Sharı̄‘ah. The element of wealth must be circulated throughout every segment of community level and not circulated among the rich in the society only (Al-Qura’n, 59:7). It is of paramount importance that financial institutions, namely, Islamic financial institutions, ensure fair and equitable mobilization and distribution of wealth. This study attempts to further test on an Islamic financial institution on the elements of wealth circulation with regard to reducing poverty. Therefore, the study focuses mainly on takaful operators and the mechanics of fulfilling Maqasid al-Sharı̄‘ah. Ratnawati and Sutopo (2014) suggest implementing Islamic microfinance as an alternative to alleviate the level of poverty. Microfinance is a provision of financial services to the poor, low-income people and the non-bankable. Through microfinance facilities, these kinds of people receive various financial services such as savings, credit, money transfers, insurance and so on (Armendáriz and Morduch 2010; Ledgerwood

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1999). Microfinance has achieved incredible success after primarily initiated by Grameen Bank in Bangladesh. However, it has also been criticized for causing more cost to customers (Armendáriz and Morduch 2010). This study aims to examine Islamic financial service providers in Malaysia, specifically takaful operators, to determine whether they are able to fulfil their obligations to alleviate poverty and improvise social welfare. It is supported by a study undertaken by Dusuki and Abdullah (2006) on the implications of the Maqasid on CSR where a corporation should be responsible to Allah in the manner of handling and managing their resources. Regardless of financial conditions, every individual let alone corporation is liable to assist the unfortunates and the poor. It does not mean that Islam discourages profit-making, rather it emphasizes that making profit should not be the sole purpose of a business. Also, according to Islamic principles of business and commerce, both rewards and risks should go together. Islam introduced several charitable vehicles that promote income equalities, and these have been utilized as a practical tool for poverty alleviation. Zakah is one such mechanism in Islam which has the inbuilt mechanism to eliminate poverty if implemented properly (Raimi et  al. 2010; Shirazi 2006; Ali and Hatta 2014). Malaysia has always been a shining example of implementation and effective administration of Zakah fund. It was found that the state with a high collection of Zakah appears to have a low incidence of poverty and vice versa. Nonetheless, in order to make a real impact on the economy, Zakah payers need to comply with the basic principles of Zakah which is laid down in the Qur’an as the payment is still voluntary in Bangladesh. The main objective of Zakah is to alleviate poverty (Sadeq 1997). Muslim economists have focused on the utilization of human capital generated by mosques and searched for the validity in investing this fund in financing various Islamic projects. Focusing on the issues of Zakah, the Sharı̄‘ah permits the investment of Zakah for the purposes of maslaha or public interest. However, controversies relating to investing Zakah fund have shifted the discussion towards the possibilities of investing those funds in a way that is grounded on waqf perspectives. Raimi et al. (2010) explored the ability of Zakah in alleviating poverty through a faith-based model and concluded that the amount of Zakah collected from the year 2009 to 2015 could significantly contribute towards poverty alleviation and actualization of United Nations’ Millennium Development Goals (MDGs) in Nigeria. While most of the previous studies examined the

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relationship between total tax revenue (both individual and corporate) and economic growth  (Gale and Samwick 2014; Lee and Gordon 2004; Ogbonna and Ebimobowei 2012), only a handful of studies have focused on the impact of Islamic charitable instruments on economic growth. Majority of the past studies that were conducted to explore the impact of Islamic finance industry on economic growth focused primarily on the Islamic banking industry (Gheeraert and Weill 2015; Kassim 2016; Khaliq and Thaker 2017; Yüksel and Canöz 2017). Only a few past studies explored the relationship between takaful industry growth and economic development (Ismail and Shaikh 2018; Muye and Hassan 2016). Muye and Hassan (2016) investigated the impact of Islamic insurance development on economic growth based on the dataset of twenty-two countries. Their study found a positive and significant relationship between the Islamic insurance industry developments and economic growth. However, results provided by Muye and Hassan (2016) may not be generalizable for all countries as the study has not incorporated some commonly used indicators of economic development. Lack of available studies exploring the impact of takaful insurance industry growth on economic development has led to the current study in the Malaysian context, the country being one of the market leaders in the global takaful industry. We have developed the following hypothesis based on earlier discussions: H1  Takaful industry growth has a positive impact on economic development.

6.3   Methodology The Malaysian economy has also suffered from the European debt crisis, and the economic indicators have turned around starting from 2012. As a result, we chose a pre- and post-crisis period to study the impact of the growth of the takaful industry on economic development. The data for the empirical analysis are extracted from various databases, including Bank Negara Malaysia and the World Bank. We have collected takaful statistics from Bank Negara Malaysia website and information relating to economic indicators are collected from the World Bank database. Data for the control variables are collected from the World Governance Indicators

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provided by the World Bank. Our data range between 2006 and 2016, covering eleven years. According to the information provided on the Bank Negara Malaysia website, during the time of our study eleven takaful operators were operating in Malaysia. To test the effects of the growth of takaful industry and its impact on Malaysian economic development, we chose the following baseline model:



Economic Development it = a 0 + b1Takaful Industry Development it + b 2 Controlsit + e it

(1)

where Economic Developmentit represents the dependent variable and is measured by gross domestic product (GDP) growth, employment ratio and inflation. β1Takaful Industry Developmentit is a vector of independent variables and is measured by several takaful industry development indicators. Details of the indicators are provided in Table 6.2. Finally, Controlsit is the vector of control variables for firm i at time t. α and β are intercept and parameters to be estimated, respectively, and εit is the error term. The full model is presented in Eq. (2):



LGDPit = a 0 + b1MSit + b 2 NBCit + b 3 NCI1it + b 4 NCI2it + b 5 TFA it + b 6 CCit + b 7 VA it e it LEMPit = a 0 + b1MSit + b 2 NBCit + b 3 NCI1it + b 4 NCI2it + b 5 TFA it + b 6 CCit + b 7 VA it e it INFit = a 0 + b1MSit + b 2 NBCit + b 3 NCI1it + b 4 NCI2it + b 5 TFA it + b 6 CCit + b 7 VA it e it

(2) (3) (4)

6.4   Results and Discussion Table 6.3 represents descriptive statistics for independent and control variables for the entire sample in the period during 2006–2016. The growth of the takaful industry is measured using market structure (MS), net benefits and claims (NBC), net contribution income (NCI) and Takaful fund assets (TFA). Market structure is measured by a number of total takaful

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Table 6.2  Variable definitions Sl

Variables Full form

Definition

Independent variables 1 MS Market structure 2 NBC Net benefits and claims payment 3 NCI1 Net contribution income 1 4 NCI2 Net contribution income 2 5 TFA Takaful fund assets Control variables 1 CC Control of corruption 2

VA

Voice and accountability

Dependent variables 1 LDGP Economic development 2 3

LEMP INF

Employment Inflation

Natural log of a total number of takaful agent Natural log of benefits and claims paid by both family and general takaful operators Combined contribution as a percentage of gross national income Per capita contribution by takaful operators Takaful fund assets as a percentage of gross national income This is a measure of the extent of the use of public power to achieve personal gain. We have used the scores published in the World Governance Indicators This is a measure of the extent of the ability of a country’s citizen to participate in the selection of their government. We have used the scores published in the World Governance Indicators The log converted gross domestic product (GDP) measures of national income and output for a Malaysia Employment-to-population ratio Annual inflation as a percentage of consumer prices

Table 6.3  Descriptive statistics Mean MS NBC NCI1 NCI2 TFA CC VA EMP GDP INF

4.77 3.18 0.51 2.16 1.84 0.16 −0.45 1.78 4.34 2.51

Maximum 5.02 3.54 0.65 2.37 2.24 0.19 −0.33 1.79 4.40 5.44

Minimum 4.18 2.74 0.30 1.80 1.20 −0.06 −0.56 1.76 4.28 0.58

Std. dev. 0.22 0.29 0.13 0.18 0.38 0.15 0.82 0.01 0.04 1.29

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operators in Malaysia. The mean score of market structure is 4.77. Net benefits and claims payment is measured with the natural log of benefits and claims paid by both family and general takaful operators in Malaysia. It has a mean score of 3.18 and a standard deviation of 0.29. Net contribution income is measured by the natural log of contribution income as a percentage of gross national income. We have used the second measure of net contribution income by introducing per capita contribution by takaful operators. Mean scores for both proxies of net contribution income are 0.51 and 2.16, respectively. The final independent variable used to determine the growth of the Takaful industry in Malaysia is Takaful fund assets. The mean and standard deviation for Takaful fund assets are 1.84 and 0.38, respectively. The results of the Pearson correlation coefficients are presented in Table 6.4 for all variables included in the study. It is expected that inflation will have a negative correlation with takaful industry growth. Similar findings are evident from the correlation statistics. We have also found a positive correlation between GDP, employment and independent variables. Table 6.5 provides a detailed analysis of the impact of takaful industry growth on economic development in Malaysia. OLS regression results indicating the impact of each independent variable on economic development are provided. We have conducted the analysis for each of the three equations specified earlier. We found a positive significant impact of net contribution income of takaful industry on the gross domestic product. However, other proxies of takaful industry growth were not found to have a significant impact on GDP. Adjusted r-square for model 1 is 96% and is statistically significant. In the case of model 2, we find a positive impact of net contribution income on employment. This model is statistically significant with an adjusted r-square of 99%. The final model includes inflation as the dependent variable and is not found statistically significant. Such results conform to the findings of Muye and Hassan (2016). Therefore, we accept H1 and conclude that takaful industry growth has a positive impact on the Malaysian economic development.

CC EMP GDP INF MS NBC NCI1 NCI2 RI TFA VA

1.00 0.68 0.40 −0.06 −0.08 0.40 0.45 0.38 0.08 0.47 0.68

CC 1.00 0.92 −0.12 0.31 0.90 0.85 0.84 0.19 0.89 0.86

EMP

Table 6.4  Pearson correlation analysis

1.00 −0.14 0.53 0.94 0.88 0.93 0.64 0.92 0.78

GDP

1.00 −0.24 −0.16 −0.21 −0.22 −0.70 −0.20 −0.35

INF

1.00 0.65 0.72 0.75 0.02 0.68 0.56

MS

1.00 0.97 0.98 0.14 0.98 0,85

NBC

1.00 0.97 0.15 0.98 0.92

NCI1

1.00 0.14 0.98 0.86

NCI2

1.00 0.14 0.32

RI

1.00 0.89

TFA

1.00

VA

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Table 6.5  Regression statistics Variables

MS NBC NCI1 NCI2 TFA CC VA C Adjusted R2 F-statistics Durbin-Watson stat

Model 1: GDP

Model 2: employment

Model 3: inflation

β

t-stat

β

t-stat

β

t-stat

−0.08 −0.03 −0.09 0.56 −0.05 0.06 −0.21 3.65 0.96 33.68∗ 2.38

−2.09 −0.33 −0.43 3.14∗∗ −0.59 1.05 −1.14 12.19∗∗

−0.03 0.01 −0.03 0.04 0.02 0.01 0.02 1.76 0.99 240.34∗ 2.92

−6.48∗∗ 1.18 −1.47 2.41∗ 1.59 1.85 0.69 52.0∗∗

−1.76 −1.96 58.30 35.33 −24.23 19.90 −76.85 −82.33 0.52 2.52 2.146

−0.44 −0.21 2.55∗∗ 1.91 −2.72∗∗ 3.17∗∗ −3.88∗∗ −2.63∗∗

Notes: ∗∗Significant at 1 percent level, ∗significant at 5 percent level; the table represents OLS regression results

6.5   Conclusion The Islamic finance industry is built on the concept of ethical investments, a principle that differentiates the industry from their conventional counterparts. The inherent objective of Islamic financial institutions to contribute to human development has shaped their product offerings. As such, the Islamic finance industry is expected to contribute more towards community developments. There have been numerous studies that highlighted the importance of Islamic banking for economic development in Muslim countries. The current study, however, is unique as it focuses on emphasizing the importance of Islamic insurance (takaful) industry for economic development. We have provided empirical evidence for the Malaysian takaful industry. The rationale for selecting Malaysia for the study is twofold. First, Malaysia is one of the market leaders and has the majority of the global market share in the takaful sector. Second, the Malaysian takaful industry has responded to the changes in the global economic development by introducing innovative products such as investment-­linked takaful. As such, we are able to explore the impact of such innovation on the growth of the sector and whether the growth of takaful industry has any significant impact on the economic development of Malaysia. We have used several measures for economic development which include GDP growth, employment ratio and inflation. Empirical results indicate that the

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growth in net contribution income can improve GDP growth and increase employment. In addition, net contribution income is found to have a negative impact on the level of inflation. Takaful operations need to understand the importance of fund asset utilization as it can also bring positive changes in the economy by reducing inflation. Such findings provide a clear indication that regulators are required to review the contribution of takaful industry to the economy and revisit the existing regulation and develop investor-friendly environment that could promote takaful to a wider community and ensure sustainable growth of the industry.

References Abdul Aziz, A. F., & Mohamad, S. (2013). Fulfillment of Maqasid Al-Shari’ah via Takaful. MPRA paper 4477. Ali, I., & Hatta, Z. A. (2014). Zakat as a Poverty Reduction Mechanism Among the Muslim Community: Case Study of Bangladesh, Malaysia, and Indonesia. Asian Social Work and Policy Review, 8(1), 59–70. Ali, K. M. M. (2006). Present Scenario and Future Potentials of Takaful. Islamic Economics, Banking and Finance, 2(2), 1–14. Armendáriz, B., & Morduch, J. (2010). The Economics of Microfinance. Cambridge, MA: MIT Press. Auda, J. (2008).  Maqasid Al-Shariah as Philosophy of Islamic Law: A Systems Approach. London; Washington: International Institute of Islamic Thought. Retrieved March 24, 2020, from www.jstor.org/stable/j.ctvkc67tg Cebeci, I. (2012). Integrating the Social Maslaha Into Islamic Finance. Accounting Research Journal, 25(3), 166–184. Chen, P. F., Lee, C. C., & Lee, C. F. (2012). How Does the Development of the Life Insurance Market Affect Economic Growth? Some International Evidence. Journal of International Development, 24(7), 865–893. Dusuki, A., & Abdullah, N. (2006). Customers’ Perceptions of Islamic Hire-­ Purchase Facility in Malaysia: An Empirical Analysis. IIUM Journal of Economics and Management, 14(2), 177–204. Retrieved December 11, 2016, from http://irep.iium.edu.my/3029/ Fauzi, P.  N., Rashid, K.  A., Sharkawi, A.  A., Hasan, S.  F., Aripin, S., & Arifin, M. A. (2016). Takaful: A Review on Performance, Issues and Challenges in Malaysia. Journal of Scientific Research and Development, 3, 71–76. Gale, W.  G., & Samwick, A.  A. (2014). Effects of Income Tax Changes on Economic Growth. Economic Studies, September, pp. 1–15.

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Gheeraert, L., & Weill, L. (2015). Does Islamic Banking Development Favour Macroeconomic Efficiency? Evidence on the Islamic Finance-Growth Nexus. Economic Modelling, 47, 32–39. Ismail, A. G., & Shaikh, S. A. (2018). Role of Islamic Economics and Finance in Sustainable Development Goals. Islamic Economic Studies and Thoughts Centre (IESTC), 1(1), 1–16. Kassim, S. (2016). Islamic Finance and Economic Growth: The Malaysian Experience. Global Finance Journal, 30, 66–76. Khaliq, A., & Thaker, H.  M. T. (2017). Dynamic Causal Relationship between Islamic Banking and Economic Growth: Malaysian Evidence. European Journal of Islamic Finance, 8, 1–11. Khan, F. M., & Ghifari, N. M. (1992). Shatibi’s Objectives of Shari’ah and Some Implications for Consumer Theory. Readings in Islamic Economic Thought, p. 176. Ledgerwood, J. (1999). Sustainable Banking with the Poor Microfinance Handbook. Washington:  The International Bank for Reconstruction and Development/ The World Bank. Lee, Y., & Gordon, R. H. (2004). Tax Structure and Economic Growth. Journal of Public Economics, 89, 1027–1043. Lim, J., Idris, M. F., & Carissa, Y. (2010). History, Progress and Future Challenge of Islamic Insurance (Takaful) in Malaysia. In Oxford Business & Economics Conference Program, pp. 1–26. Matsawali, M. S., Abdullah, M. F., Yeo, C. P., Abidin, S. Y., Zaini, M. M., Hardi, M., Ali, F. A., & Yaacob, H. (2012). A Study on Takaful and Conventional Insurance Preferences: The Case of Brunei. International Journal of Business and Social Science, 3(22), 1–14. Muye, I.  M., & Hassan, A.  F. S. (2016). Does Islamic Insurance Development Promote Economic Growth? A Panel Data Analysis. Procedia Economics and Finance, 35, 368–373. Ogbonna, G., & Ebimobowei, A. (2012). Impact of Tax Reforms and Economic Growth of Nigeria: A Time Series Analysis. Current Research Journal of Social Sciences, 4(1), 62–68. Rahman, Z. A., Yusof, R., & Bakar, F. A. (2008). Family Takaful: Its Role in Social Economic Development and as A Savings and Investment Instrument in Malaysia—An Extension. Shari’ah Journal, 16(1), 89–105. Raimi, L., Bello, M. A., & Mobolaji, H. (2010). Faith-based Model as a Policy Response to the Actualisation of the Millennium Development Goals in Nigeria. Humanomics, 26(2), 124–138. Ratnawati, S., & Sutopo, H. H. (2014). The Development of Model Empowerment Poor Society in Coastal Area Through Net Marketing Fishery Product in East Java. Academic Research International, 5(1), 237.

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Sadeq, A. M. (1997). Poverty Alleviation: An Islamic Perspective. Humanomics, 13(3), 110–134. Shirazi, N. S. (2006). Providing for the Resource Shortfall for Poverty Elimination Through the Institution of. IIUM Journal of Economics and Management, 1(1), 1–27. Yüksel, S., & Canöz, I.̇ (2017). Does Islamic Banking Contribute to Economic Growth and Industrial Development in Turkey. Ikonomika, 2(1), 93–102. Yusuf, T. O. (2012). Prospects of Takaful’s (Islamic Insurance) Contributions to the Nigerian Economy. Journal of Finance and Investment Analysis, 1(3), 223–224.

PART II

Islamic Financial Inclusion: Cases and Modeling

CHAPTER 7

Making Islamic Finance a Vehicle for Social Inclusion: A Case for Revisiting the Liquidity Management Practices by Islamic Banks Muhammad Ayub

7.1   Introduction The students of economics at Panthéon-Sorbonne Paris revolted in June 2000 arguing that the economics texts they are made to read focus only on mainstream economics; the neoclassical school and other schools are sidelined. The similar wake-up calls against the conventional economics and finance gathered further momentum with financial crash in 2008 and crises that followed. Ha-Joon Chang and Jonathan Aldred (2014) and the Nobel laureate Paul Krugman raised voices against the failure. The phrase used since about the past decade “Economics is dead; long live economics” and the slogan “The world has changed, the syllabus hasn’t” reveal the fact that the economists condemn the tools of mainstream economics but use the same tools as they attempt to resolve the issues facing the global economy and the human beings. The regulatory

M. Ayub (*) Riphah International University, Islamabad, Pakistan e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_7

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measures announced after the 2008 crisis have not been able to lead the national and global economies to sustainable and balanced growth. Amidst the persistent crises in the global economy and finance, the gap between the rich and the poor is widening and all theories currently applied have failed. Islamic economics emerged half a century ago with the objective that the economic theories and institutions must be humancentered for the development and welfare of all. But the way Islamic finance developed as a part of modern economics totally ignored the objective and disappointed its pioneers. Islamic banking and finance (IBF), which has the capacity of providing the framework for achieving the objective of sustainable socioeconomic growth, witnessed a rapid growth over the last two decades. In an overview of the conceptual bases of Islamic finance, it has been observed that Islamic finance promotes risk sharing, connects the financial sector with the real economy, and emphasizes financial inclusion and social welfare. Even the 2030 agenda of the World Bank for sustainable development that seeks to eradicate poverty in all its forms, promote sustained and inclusive economic growth, and ensure social development emphasized Islamic finance that promotes responsible and risk sharing–based finance. It highlights the global acceptance of the core principles of Islamic finance providing mechanisms for redistribution to address the imbalances and advocating for the just, fair, and equitable distribution of income and wealth during the production cycle.1 The policymakers, the Shari‘ah scholars, and the practitioners in Islamic finance need to jointly adopt a fresh approach to enable Islamic banking and finance achieving the Sustainable Development Goals (SDGs) with the ultimate focus on SDG 10—reducing inequalities within and among the countries. Islamic finance industry spread over 110 countries and 50 million customers grew from US$200 billion in 2003 to an estimated US$2 trillion of assets worldwide in 2016 is expected to surpass US$3 trillion by 2020 (TR 2016/2017). However, the practical journey of Islamic finance institutions (IFIs) portrays a totally different scenario. They did not enter the micro, SMEs, and the agriculture sector, which are vital for the prosperity of people at large and have played a crucial role in the development of the respective economies (Katua 2014). A little use has been made of shirkah-­ based modes in financing and investment, and whatever done culminated mainly to replication of debt-based financing. Debt-based financing in the form of credit and forward (salam) trading, or leasing, is permissible, but the way IFIs have been using it could create worse results than that of

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conventional finance even. According to The Economist (January 2013), the fundamental causes of failure of microfinance movement and the crisis had been tradition of (ab)using debt as a tool of social policy. The neoliberal market-based economics and “social legitimatization of vices like greed and pride in the societies have resulted in failure of economics and finance.”2 Islamic banks and financial institutions, however, are abusing the institution of debt and following almost the same approach and path. As the IFIs are focusing on treasury and liquidity management only, they may face deceleration in growth as they might not be in position to compete with the conventional institutions due to prohibition of transactions based on riba and short selling with its minimum bearing. According to the IFN Guide 2017, the drop in Islamic finance growth rate that was witnessed in 2016 was likely to continue in 2017. In the overall industry, however, capital market is flourishing by dint of sukuk issuances and innovative structured products, including Forex forwards, profit rate swaps, and as a whole the organized tawarruq that may ultimately lead to the same fate as experienced in recent crises. This chapter analyzes such products/practices, particularly with regard to liquidity management, and suggests a new approach enabling Islamic finance to serve the cause of humanity by enhancing socioeconomic inclusion. We shall discuss the strengths of Islamic finance, what is meant by liquidity management, what Islamic banks and financial institutions are currently doing for liquidity management, and what policy changes have to be introduced to evolve a real, stable, and sustainable Islamic system of finance and to turn the tables on the conventional system.

7.2   Learning the Lesson? Responding to the failure of capitalist and socialist economic development, the creation of Islamic banking and finance (IBF) was initiated with the hope of providing a financial base through which economic development could be achieved with human well-being and social justice (Asutay 2007). Islam encourages economic endeavor and the maximization of profit, but this must be within the bounds of the divine and business ethics. Islamic banks and financial institutions belong to a new wave of institutions whose social goals are at least (if not more) as important as making profit. In Islamic finance, parties to the contract should have perfect knowledge of the counter values intended to be exchanged and cannot predetermine a guaranteed profit (Hannifa and Hudaib 2007).

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The IFIs need to learn lessons from the failure of conventional economics and finance in terms of stable and equitable growth of wealth and its fair distribution among various members of the society. In the conventional system, “money does not exist without debt, debt does not exist without interest, and interest drives us to earn more and more money” (Eisenstein 2007). No one, particularly those sitting at the helm of affairs, is ready to accept that the risk shifting instead of risk sharing, and creating interest-­bearing money and credit without taking notice of its impact on income distribution, is the fundamental cause of exploitation of the poor by the rich and the recurring economic and financial crises in the world. For sustainable growth and welfare of the communities at large, development has to be on both social and economic fronts. The term ‘financial inclusion’ being used for the last many years both in developing and in developed economies referring to the efforts to combat the issue of ‘exclusion’ of the people of small means from the formal financial services needs to be transformed into ‘social inclusion’ and to promote community reinvestment (Ayub 2015). The targets-based pay packages and career path of Islamic bankers are leading to compromises on Shari‘ah principles by the practitioners and even the Shari‘ah scholars. Rafee Haneef, a KL-based senior Islamic banking practitioner, says in this regard, “Islamic banks today are compensating their sales team based on the amount of financing closed, not dissimilar to conventional banks. This has led to various mischiefs, including mis-­ selling, predatory lending and other abusive practices. Islamic banks need to lead the market by compensating the sales team based on the quality of advice given to the customer and customer satisfaction results” (ISRA/TR 2016, pp. 159–161).

7.3   Strengths of Islamic Finance System Islamic finance is more about facilitating the real sector including commodity producing, commerce, and business sectors. The challenging socioeconomic conditions both in developed and developing economies provide an opportunity to Islamic finance scholars and practitioners to come with real and long-term solution to the current problems as envisaged in the theory of Islamic economics, banking, and finance. As per requirements of Islamic law of contracts, the IFIs have to create a close link between financial flows and productivity because Islamic finance is driven by production and trade. In other words, finance must not be made a tool for illegitimate gains through interest, short selling, gambling, and unethical practices.

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Main features of the system of Islamic banking and finance are: 1. Complete ban on riba/interest (return without taking business risk or making any value addition). 2. Avoidance from gharar (lacking information certainty, ownership, or ineffective control of the parties over the counter values). 3. One cannot sell what he/she does not own. 4. Exchange of real assets or papers representing the real assets—not notional/virtual/fictitious assets. 5. Prohibition of sale of debts except at face value with recourse. 6. The owner of an asset has both risk and reward of that asset—risk must not be separated from real economic activities. Sadiq and Black (2012) summarize the features of Islamic finance as “the ban on interest, the ban on speculation, the ban on financing certain economic sectors, the profit and loss sharing principle and the asset-­ backing principle.” Islamic finance does not approve the complex deals in the financial markets—“the layers upon layers of debt and interest, side bets and speculation built on tenuous tangible assets, which are completely detached from reality.” Professor Michael Skully, of the faculty of Business and Economics at Monash University, agrees, saying, “The things that killed us were the financials. When we talk about the Islamic funds doing better, it was a function of them not being exposed to financials and highly levered companies.” Professor Constant Mews of the Monash University confesses with regard to Islamic finance: “The interesting thing about Islam is that it was a much more commercial culture from the outset than Christianity.” It was by dint of this culture that from around the middle of the eighth century to the middle of the thirteenth, the Islamic world enjoyed a golden age, while European Christians were struggling through the Dark Ages.

7.4   Islamic Finance as in Vogue—The Issue of Approach and Mindset Islamic banking and finance practitioners, on the other hand, normally believe and always wish that every conventional product must have an Islamic alternative for profitability in the competitive market and complain about the lack of liquidity management tools. Accordingly, liquidity

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management is considered to be the most serious issue hampering the growth of Islamic finance. This is despite the fact that Islamic banks have made many compromises to prepare Shari‘ah-compliant versions for conventional products. It’s a right time, therefore, to conduct self-check and analysis of the performance of IFIs in order to sustain the growth in the future. We plan here to analyze the performance so far and the potential role of Islamic finance in serving the cause of humanity by enhancing socioeconomic inclusion. Islamic banks are holding public money as a trust and they are accountable both to the public and to the Almighty. Islamic bankers in general and product developers and the policymakers, in particular, need to look at building alternatives based on the divine principles to resolve the problems created by the conventional system. Despite rapid growth as indicated above, Islamic finance is yet only 1% of global financial assets implying to the fact that it might never be able to bring any change in the values-free conventional system of finance. Its reason, according to Mabid Ali Al-Jarhi, former director of IRTI, Islamic Development Bank (IDB), Jeddah, and currently professor at the INCEIF, Malaysia, is that Islamic finance has crossed the threshold of convergence to conventional finance and is losing its meaning and rationale. Shari‘ah compliance is increasingly becoming a misnomer as the conventional finance is being practiced boldly in the name of Islam. The convergence to conventional finance by way of replication has to be rolled back to realize the macroeconomic benefits that justify the switch from conventional to Islamic finance (Al-Jarhi 2016). This is why Islamic banks seem to be failing to create meaningful difference through promotion of social justice (Balala 2010). They focus on profit maximization and competition but have little concern for social responsibility. With such tool kit of Islamic financial institutions, Islamic economics has diverted from value-based system to the capitalist system based on wealth maximization at any cost. Islamic banking and finance does share the aspirations of Islamic economics (Asutay 2007).

7.5   The Way to Achieving Social Inclusion through Islamic Finance Social harmony and risk sharing are the basic elements of social inclusion, in addition to developing the sense of group belongingness in a society. In the light of the injunctions of Islam, it would imply sharing of benefits and

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possible risks/losses through mutual efforts and cooperative partnership. As ordained by the Qur’ān [5:2] (O you who have believed …cooperate in righteousness/justice and piety, but do not cooperate in sin and aggression), Muslims have to help one another in all matters of common concern. However, the very first measure in this context would be to stop the conversion of social capital into financial capital as presently is the case of all finance-related approaches. As per Islamic principles, the capital and the talent/expertise have to be combined by way of sharing the risks as well as rewards instead of interest charge and the credit transactions for that purpose (Ayub 2015). According to UNESCO (2013), an inclusive society is built on the fundamental values of fairness, equality, social justice, human rights and freedoms, and participation in decision-making, as well as on the principles of tolerance and recognition of the diversity. Hence, IFIs must aim at social inclusion which may inter alia imply “full and fair access to collective resources and activities; the maintenance of social relationships with the family, friends and acquaintances, and the developing of the sense of group belongingness” (Cobigo, cf. R. Aparicio 2013). Social inclusion is a natural enemy of poverty, which hinders the satisfaction of basic needs, prevents exercising human rights, and limits the horizon of people’s participation in society, either as an individual or as a social group (R. Aparicio 2013). For generating large-scale prosperity and welfare of the society as a whole, the State and the regulators have to intervene to ensure that the poor are not deprived of the benefits of growth simply because of their poverty. In addition to ensuring that all segments are provided with equal opportunities to prosper, some special schemes and arrangements are needed both in the public and the mutual/cooperative sectors to enable those who are not able to fulfil their basic needs to live a healthy and respectable life. The efforts at achieving higher growth rates of economies without caring for the widening gap between the rich and the poor can never lead to sustainable prosperity even of the selected groups. Similarly, initiating ever new schemes with limited objectives of providing funds to the ‘financially excluded’ or facilitating the banks to finance such segments without taking care of other issues might not be really fruitful. To make any measures or schemes really useful, the target needs to be broad-based social inclusion by reviving the risk-sharing and community-based cooperative institutions.

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7.6   Liquidity Risk, Liquidity Management, and Its Tools Liquidity management has been one of the greatest concerns of both conventional and Islamic banks aiming at avoiding liquidity shortage, the assassin of banks, on the one hand, and investing it for benefiting even from a single penny overnight, the colossal source of earnings for them, on the other hand. Liquidity management refers to the ability of banks for matching the maturity of assets and liabilities daily and coping with short-­ term pressures that may arise in the process of ensuring that the assets are fully funded (Mark Largan and Colley 2000). From the regulators’ point of view, liquidity risk is defined as a “risk to a bank’s earnings and capital arising from its inability to timely meet obligations when they become due without incurring unacceptable losses” (Syed Ali 2006). Experiences show that liquidity risk mainly emanates from overexposures taken due to false assumptions and incorrect judgments for higher earnings, abnormal behavior of financial markets and contagion impact, flaws in contractual structures, and breakdown of payments system due to lack of credibility and mismanagement. Basel III liquidity rules and related measures in some jurisdictions like that of England require banks to hold a liquid asset buffer (LAB) of unencumbered and high-quality liquid assets (HQLA) at all times. The assets in this buffer should be readily accessible and easy to convert into cash in private markets to meet any sudden demands for liquidity the firm may face, especially during periods of firm-specific stress or more general market disruption. The Basel rules allow Islamic banks to use a wider range of assets for their buffer, which are subject to haircutting to avoid favorable treatment over conventional firms (BoE 2017). Both the shortage and the excess of liquidity have implications for the banks and so cause serious concerns for the managers chasing the higher and higher targets of earnings. The shortage may create stability and solvency problems, while excess liquidity may lead to loss of earnings. A number of risks culminate in liquidity risk. Although most of Islamic banks at global level have generally surplus cash, a few had suffered with liquidity ̇ crunch. Turkey-based Ihlas Finans was closed down in 2001 due to the liquidity crisis (Syed Ali 2006). Islamic banks also have a mismatch risk as their main funding is from short-term deposits, while their financing and investments are long term, for example, ijara, sukuk, stocks, and mutual funds. It implies that the main issue of liquidity is on investment and

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financing side requiring the banks to place when they are surplus and withdraw or disinvest in case of demand by the investors/depositors. According to the International Islamic Financial Market (IIFM), key issues in liquidity management by the IFIs include (i) small number of participants, (ii) slow development in Islamic financial instruments, (iii) absence of Islamic secondary market, (iv) absence of an active Islamic interbank market, (v) different Shari‘ah interpretations, and (vi) absence of lender of last resort. With regard to the level of liquidity with Islamic banks, a study revealed that Islamic financial institutions are almost 50% more liquid as compared to conventional financial institutions.3 Excess liquidity results in business risk by affecting the competitiveness of IFIs due to no return or very low returns. Banking failures, on the other hand, are due to liquidity shortages ̇ at the time of crisis as happened in the case of Ihlas Finans in Turkey. Due to lack of Islamic interbank market, the IFIs have no real ability to tap short-term funds to meet cash flow requirements. It requires a Muradababased “lender of last resort” (LOLR) window by the central bank/ regulator.

7.7   The Myth of Excess Liquidity with Islamic Banking Institutions We need to analyze as to how Islamic banks’ funding is short term as in the case of the conventional banks and why they are generally surplus. Firstly, they pursue an aggressive marketing for current accounts (C/As) on which they earn profit, but pass on nothing or little to the depositors. Secondly, they market for short-run fixed return deposits (FD) of the corporate sector and finance/invest again in fixed return avenues. Hence, Islamic banking institutions (IBIs) are becoming increasingly liquid, maybe because they are getting fixed rate deposits based on tawarruq (e.g., as the case of Malaysia and the UAE) or even mudaraba with some tactics to allure ‘priority depositors’ (as the case of Pakistan). They are shy of going to the real sector for financing and are fond of the public sector deficit financing, thus getting small risk-free returns. In Pakistan, for example, IBIs emphasize on targets-based deposits mobilization through current accounts (C/As) and investment accounts by the priority depositors by creating unreasonably large number of special pools. Remunerative4 and non-remunerative C/As of the IBIs increased by

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50% and 28.2%, respectively, during 2016. A huge part of deposits so collected is provided to interest-based banks by way of tawarruq-clean and collateralized lending. At the end of December 2016, IBIs’ placements with conventional banks (mainly consisting of interbank tawarruq, bai muajjal with State Bank of Pakistan (SBP), and mudaraba-based deposits) stood at Rs 111 billion out of total deposits of Rs 1.5 trillion. According to Meezan Bank’s Report (2016), Rs 129 billion were placed with other banks—Rs 77.8 billion on basis of secured murabaha of sukuk, Rs 20 billion through clean lending, and Rs 31.4 billion by way bai muajjal of sukuk with the SBP. It implies that surplus is not an issue per se; it’s rather a case of profit maximization even by compromising on the Shari‘ah principles. Further, it provides conventional banks opportunity to arbitrage. This is why, due to tawarruq-based placements by Islamic banks, the collateralized rate is higher in Pakistan than the clean rate, while globally, the call money market rates are generally higher than the collateralized rates. In the UAE, tawarruq is resorted both for deposits and for investing liquidity by way of ‘LME Murabaha,’ ‘Shares Murabaha,’ and Nasdaq Murabaha (Siddiqi, Y.A. 2017), all of which are transactions for the sake of transactions, without any contribution to real business and production activities. In Malaysia, prior to the introduction of IFSA 2013, a healthy ratio was maintained between CASA (current and savings accounts), FD (fixed deposits), and capital at 40%:30%:30% respectively, but now the ratio is around CASA 20, FD 50–60 due to more focus on FD based on commodity murabaha—implying that overall cost of deposits increased owing to the higher proportion of ‘expensive’ FDs. The same is the case of the UAE, where the central bank itself launched debt-based commodity murabaha (tawarruq) Islamic certificates of deposits (CDs) with maturities of one week to a year; almost 50% of Islamic banks’ deposits are raised and invested by way of tawarruq. Thus, Islamic banks have become just money managers like conventional banks chasing the targets for their perks and benefits, and as such, the authors like Volker Nienhaus, renowned Western writer on Islamic finance, term the trend as conventionalization of Islamic banking and finance. With this LM focus, Islamic banking can never be a driver for socioeconomic growth. Client-wise financing in Pakistan shows that corporate sector accounted for 77.5% share in overall financing, followed by consumer financing having 10.5%. Finance provided by IBIs to real sectors like SMEs and agriculture remained lower at 3.4% and 0.8%, respectively, even less than the overall banking industry’s financing at 7.1% and 5.3%,

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respectively. To be the real competitors, IBIs could lower the financing rates to the commodities and business sectors, rather than becoming a conduit for transfer of liquidity to the conventional system. As indicated in a published study of the COMCEC of the Organisation of Islamic Cooperation (OIC) on Islamic finance infrastructure, the supply of instruments that fulfil the Basel III liquidity requirements is small relative to the demand. Furthermore, the Islamic Financial Services Board (IFSB) and International Islamic Financial Market (IIFM) need to develop guidelines and templates to strengthen money markets, secondary markets for Islamic securities, and LOLR facilities for Islamic banks. The study suggests that IFSB and IIFM should develop guidelines and templates to strengthen money markets, secondary markets for Islamic securities, and LOLR facilities for Islamic banks. There is also needed an international Shari‘ah-compliant LOLR facility, maybe by establishing an Islamic Monetary Fund (IsMF), that could either provide Shari‘ah-compliant liquidity at the global level or coordinate arranging liquidity from other central banks. As the Islamic financial industry grows, there may be a need to establish an entity similar to IMF that can provide Shari‘ah-compliant liquidity in times of need. Islamic infrastructure institutions like IDB, IFSB, IIFM, IILM, and LM may coordinate to establish such Islamic Monetary Fund. Some quarters have been indicating even the Bitcoin or other virtual currencies, not having any regulatory control, as potential tool for liquidity management. The blockchain technology is used for mining Bitcoins that is also being used for dice betting and running mobile gambling platform.5 Here, the issue is not whether Bitcoins and other cryptocurrencies are Islamic or un-Islamic; the issue is, how they are created and exchanged. Islam accepts any homogeneous commodity acceptable by public as money as a medium of exchange. Islamic law tends to create discipline by asserting how it is issued, exchanged, and traded that affects the parties to exchange as also the whole economy/society, and in case of reserve currencies, even the humanity at large. In the past, centuries ago, various commodities served as money; supply and demand of the goods used to determine the relative value of currencies. Since the advent of ‘fiat money,’ it’s the State authority that manages the value of money based on supply and demand of goods available in the market. Amount of money and its value in an economy have to be based upon the value of goods and services in the economy and its precisely determined potential (under the conditions of bai al-salam). Trading in money has to be subjected to rules

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of bai al sarf—hand to hand to avoid injustice with any of the parties and loss to the society that uses any currency for exchange purposes. Any cryptocurrencies, or even the ‘ledger money’ that is exchanged/controlled by the central banks through ledger, can serve the purpose, but the issue is how to exchange and control such currencies. Currently, all cryptocurrencies are being used as a tool for hundi, black marketing, gambling, lucrative payments as at ‘night clubs’, or big stores to expand their businesses. Also, they are being used as ‘Ponzi game,’ in which case the buyers are forced to find new buyers. Their creation and exchange have no link with the goods and services used by human beings. As there is no link with real business and economy, it is a means to earn money from money through blockchain-based cheating by those who are technically sound and through exchange methods not fulfilling the rules of bai al sarf. Hence the IFIs need to totally avoid dealing in cryptocurrencies as long as the same lack any regulatory controls by monetary authorities, do not have legal and monetary properties such as indemnity, and do not have legal status equivalent to money.

7.8   Islamic Banks’ Practices for Liquidity Management The prime tools for liquidity management by Islamic banks are tawarruq, also called ‘commodity murabaha’/sukuk murabaha and hedging through derivatives, although the latter category is basically a part of risk management, not the LM technique. Tawarruq is being used in varying degrees in all countries where Islamic banking is practiced except Sudan and Oman. In many parts of the world, Islamic banks mobilize deposits against fixed returns through tawarruq and/or commodity platforms and then deploy the funds again on the basis of tawarruq, or so-called hedging through financial derivatives. Oman, which started Islamic banking in 2013, outrightly banned the organized tawarruq (even then it was ranked at number 3 in terms of growth of Islamic banking during 2015 as per Thomson Reuters’ report for the year). In Pakistan, SBP allows IBIs’ exposure in bai muajjal of sukuk with GOP to be eligible for Statutory Liquidity Ratio (SLR) (for details of this transaction, see JIBM, Dec. 15). As such, sukuk cannot be sold before maturity due to being receivables; their SLR eligibility has significantly increased the stability risk of IBIs and the industry.

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We discuss below these tools (tawarruq and hedging) to analyze their processes, level of Shari‘ah compliance, and implications for IBF. 7.8.1  Tawarruq/Commodity Murabaha/Sukuk Murabaha Tawarruq, the most commonly used toll for liquidity management, can be defined as to get cash or to invest cash by way of trading as a contrivance while the subject of the exchange is not the objective—it’s just to circumvent the prohibition of riba. Almost all contemporary jurists allowed juristic tawarruq in unavoidable cases where a person may buy a commodity on deferred payment basis and sell it in spot market to get (less) cash while all conditions pertaining to transfer of ownership and possession are fulfilled. (In case the commodity sold is bought back by the seller, it is ‘eenah—the exact product [‘ayn al-sal‘ah] goes back to the first seller, prohibited by vast majority of the jurists.) But, what Islamic banks do is ‘organized tawarruq’ in which they buy and sell any commodities or instruments like ijara sukuk through broker(s) without fully observing the trade-related Shari‘ah essentials. A number of well-known contemporary jurists, namely Khaalid al-Mushayqih (Majallat al-Buhooth al-Islamiyyah 73/234–237), Ali al-Saloos, Saami Suwaylim, and ‘Abd-Allaah ibn Hasan al-Sa’eedi, ‘Abd al-Rahmaan al-‘Uthmaan, Muhammad ibn ‘Abd-Allaah al-Shabaani, and many others, have conducted detailed studies according to which organized tawarruq is not valid due to being riba. It is against economic logic, because it employs artificial sale contract as a façade to camouflage the conventional nature of transactions (Al-Jarhi 2016). According to an estimate, such tawarruq, secured murabaha, commodity/sukuk murabaha, and so on represents around 60% of the Islamic banks’ financing services around the world. Mufti Ismail Desai contended with regard to tawarruq, “What is often begrudgingly allowed for by some scholars for extreme, case-by-case situations, banks often turn that into a retail product for ordinary customers to use. This is not the spirit of Islamic finance. And it is often not even the letter of Islamic finance” (Yurizk n.d.). Jeddah (as also Makkah)-based Islamic Fiqh Council(s) (IFC) allowed tawarruq in the beginning, but took back its pronouncement of allowing tawarruq in 2009 on the solid ground that it was neither practiced with the conditions as required by Islamic law nor there was any possibility of observing the conditions required for permissibility of tawarruq (19/5: Resolution 179).

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Tawarruq causes capital flight from Muslim societies and Islamic countries. In many cases, the subject matter practically goes back to the first seller thus rendering it prohibited bai al ‘eenah. For example, what is currently being done in the name of interbank bai muajjal of sukuk in Pakistan is practically ‘eenah. A broker facilitates an Islamic bank and two conventional banks; sukuk are purchased by Islamic bank from conventional bank ‘A’ on spot payment, then sold instantly to any conventional bank ‘B’ on deferred murabaha, which practically sells back to the bank ‘A’. But, just to satisfy the Shari‘ah scholar, a note is written that ‘B’ can hold or sell the sukuk at its discretion (see Fig. 7.2 in the Appendix; dotted line shows actual process). The bank ‘B’ used the fund so received for arbitrage by investing in government debt securities carrying higher rates. It is invalid according to Islamic Fiqh Council (IFC, Resolution in 2000) Jeddah, AAOIFI, and almost all Shari‘ah bodies except a few. ‘Commodity murabaha’/secured commodity murabaha, both commonly known as organized tawarruq (see Fig. 7.1 in the Appendix) as in the UAE, Malaysia, Bahrain, and other parts of the world, is used both for deposits taking and for investment. For placement of excess liquidity in the international market, there are currently three operational international commodity murabaha platforms including Bursa Malaysia, DMCC Dubai, and London Metal Exchange. In other jurisdictions, it is used through non-standardized procedures involving broker(s). It also involves heavy cost of commodity or sukuk brokerage without adding any real value whatsoever except for the risk-free return to both Islamic and conventional banks involved. Bursa Suq Al-Sila’ (BSAS) launched in Malaysia in 2009 is specifically dedicated to facilitate Islamic interbank placements, Islamic deposit taking, financing, Islamic profit rate swap, Islamic cross-currency swap, sukuk issuance, as well as debt trading with commodity (Bai’ Dayn Bi Sala’) using the concept of murabaha for tawarruq. ‘Commodity murabaha’ through ‘platform’ like BSAS results in (i) funds raised for the purpose of Islamic business from mainly the Muslims are flowing from Muslim economies; (ii) does not contribute in any growth or developmentoriented economic activity; (iii) low return and limited scope for liquidity management while the conventional counterparties apply limits and earn huge income on account of arbitrage; and (iv) always back to back murabaha is needed for maintaining liquidity making Islamic finance increasingly away from its spirit and principles.

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In Pakistan, the Shari‘ah board of the Meezan Bank approved the guidelines for developing a commodity murabaha platform at Pakistan Mercantile Exchange (PMEX).6 It is important to observe that the proposed process of commodity murabaha at the PMEX has not been approved, so far, by the Shari‘ah boards of the SECP and the SBP. It seems that now the responsibility has been shifted to the premier Islamic bank of the country that once practically involved will automatically be followed by the market.7 Why Tawarruq to Be Excluded from IBIs’ Kitty? Not only the apex Shari‘ah bodies like Jeddah- and Makkah-based Islamic Fiqh Councils and overwhelming majority of the Shari‘ah scholars have disapproved the organized tawarruq due to being replication of the conventional interest- and gharar-based products, but also the practitioners have warned about its seriously negative effects. Salman H. Khan (2010) indicated that fulfilling the conditions for valid tawarruq as allowed by AAOIFI is almost impossible. Sohaib Umar, a senior Islamic finance professional working with the Central Bank of Bahrain, has discussed in detail as to why the regulators must stop the use of commodity murabaha/tawarruq by the Islamic banks (TR/ISRA Report 2016, pp. 81–85). He concluded this on the basis of the following: 1. Tawarruq creates a disconnect between the real and the financial economy—it is simply a conduit for monetization. 2. It means debt accumulation without economic growth. 3. It is identical to the interest-based system in terms of consequences— unfair, inequitable and eventually leading to instability in the system. 4. It increases systemic risk due to unhealthy financial innovation difficult to be regulated due to being more complicated than the conventional system even. 5. It is a parasite in the system caused by the debt created without commensurate growth in the economy. 6. It is hindering the genuine growth of Islamic finance as already happened—in some countries, tawarruq was initially used by Islamic banks for interbank transactions, then increasingly used for assetside transactions (e.g., personal finance, auto finance, working capital finance), and eventually used in liability-side products as well (savings and investment accounts based on commodity murabaha).

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7. It is immoral activity, whereby Islamic banks end up collecting the liquidity for Islamic business and placing it with conventional banks for arbitration at their end—anyone who approaches an Islamic bank for Shari‘ah grounds would not allow it to collect savings in the name of Shari‘ah compliance only to place it with conventional banks where it is used to expand the conventional banking business. 8. The above negative effects hold true even if the proper commodity murabaha structure is followed as per principles of valid trade. But practically, the abuse is commonplace in such transactions. Constructive or actual possession of the commodity is rarely obtained by the customer. Sohaib Umar has rejected the argument by some proponents of tawarruq that commodity murabaha is the ideal tool of liquidity management and the key to profit maximization of any modern Islamic bank and cited the example of Oman—closing the door to commodity murabaha compelled them to think about other modes, such as interbank wakalah, for their short-term liquidity needs. 7.8.2  Shari‘ah-Compliant Derivatives as Liquidity Management Tools In some jurisdictions like Malaysia and the UAE or in the case of mega Western finance groups offering Islamic windows, financial derivatives are being used for profit taking and liquidity management, although the main objectives of derivatives are said to be hedging or risk management. The so-called ‘Islamic hedge funds’ are increasingly taking the market by reconciling the religion’s ban on speculation with hedge fund techniques involving short selling on the rationale that “the religion’s rules do not constrain profitability” (see Reuters Market Report, March 11, 2010). Some writers allowed options on the basis of arbun, but the argument was not convincing legalizing short selling as Sheikh Muddassir Siddiqui, a member of the Shari’ah Standards Committee of AAOIFI, Dubai-based lawyer, who also served as internal Shari‘ah supervisor and Shari‘ah coordinator of the IDB Jeddah, disagreed to the idea that the use of arbun rendered short selling Shari‘ah compliant. “The payment of arbun does not transfer title to the buyer. The principle of the sharia is that you are not allowed to sell something that you don’t own,” he said. Similarly, AAOIFI in its Sharia’a Standard 21, Clause 3/11, has specifically disallowed the use of salam contracts to sell stocks. The common futures and forward

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contracts violate Islamic rules as the payment and goods delivery both are deferred. Further, both parties involved in futures contract have an option either to hold the contract until maturity or to liquidate it before maturity. This leads to gharar. Those who allow hedging allow on the condition that it is not used for speculation and the conditions for Forex trading are fulfilled. In standard Forex trading, Forex accounts either receive or are charged interest when a trader holds a position overnight. This practice of charging overnight swaps is in breach of Shari‘ah principle and this is why standard Forex accounts aren’t strictly compliant with the Shari‘ah principles. The Jeddah-based Islamic Fiqh Academy in its resolution (No. 107 (1/12) 23–28 September 2000) held the following in its rejection of the conventional forward contracts in commodities even: If the subject matter in the forward contract is a commodity that needs manufacturing, transaction must fulfill the conditions of istisnā‘. If manufacturing not needed, price must be paid on spot and the transaction must fulfill the conditions of salam. However, if the price is not paid at the spot, the transaction will be illegal because it is a kind of bai‘ al-kālı̄ bil kālı̄. On the other hand, if the transaction is just a promise and not binding upon either parties or at least one of them, it will be permissible.

The International Swaps and Derivatives Association (ISDA) and International Islamic Financial Market (IIFM) have published template documentation for some Shari‘ah-compliant derivatives. But the market still continued to use bespoke documentation as that best suits their earnings maximization motive. Hedging for risk and liquidity management is conducted generally through derivatives. While some futures and options are traded on organized exchanges, forward contracts/options and swaps are traded in over-the-counter (OTC) markets. According to the BIS, less than 20% of the notional amount outstanding is traded on exchanges, and the magnitude and scope of OTC transactions are far greater than the exchange-traded transactions. This is why the bespoke documentation is used despite the templates issued by the IIFM and ISDA. Profit rate swaps/total return swap, repo, and FX forwards comprised the main Islamic derivatives market, but quite recently, more structured transactions like structured FX options and commodity derivatives have also been targeted (Yusuf Battiwala, IFN Guide 2017). Islamic Fiqh Academy of the OIC, AAOIFI, and some other Shari‘ah bodies have acknowledged the need for hedging while emphasizing that

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hedging strategies must be in line with Islamic finance principles and subject to certain conditions like: 1. Hedging mechanism is not to be used for speculation and gambling. (It’s difficult to draw the line between hedging and speculation as it tends to get blurry. Further, there are many issues of ownership and contract settlement in hedging contracts entered into by the IFIs [Laldin8].) 2. The hedging transaction is to be carried out based on actual underlying risk arising from an investment which adds value to the real economy. 3. The strategy or technique involved in hedging risk does not sever the risk from its underlying assets. 4. The hedging contract and its underlying assets must be Shari‘ah compliant. The IIFM guidelines for Islamic hedging include, inter alia, similar conditions, as the following: 1. The purpose must be a real hedge against unexpected risks to both sides of the transaction. 2. It should not be for the purpose of speculation. 3. A cash settlement without the actual transaction involving delivery and receipt of assets is not permitted. 4. Delay in receipt and delivery in case of cross-currency and FX forward transactions causes non-Shariah compliance (Ijlal Alvi 2016). Against the permission given by abovementioned apex bodies, the practice of Islamic banks in the use of conventional hedging techniques is different and ‘shows otherwise’ (IRP No: 88/2016-Noor Suhaida et al.9). The following issues have been identified in the ISRA Research Paper: superficial use of commodity murabaha for hedging, compensation for breach of wa’ad that is not based on the actual loss (amount charged in the form of a percentage of the financing amount serves merely as a mechanism for profiteering (istirbah)), and mark-to-market gain/loss in Islamic profit rate swap and Islamic forward with mark-to-market netting off. The study further found that execution of promises and tawarruq to facilitate mark-to-market gain/loss does not represent a genuine exchange in Shari‘ah, and hence the resultant profit could not be considered a lawful gain. Shari‘ah does not allow one party to gain when the payment of gain

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is given not on the basis of holding a commodity, but on the basis of mark-­ to-­market, as this would trigger the element of gambling. The study also concludes that the impact on the economy and society may also be taken into account while revising the resolutions already issued by the various Shari‘ah bodies who allowed such products. The lust for competitive gains is the hurdle to limit the hedging, once allowed, to the real requirements for genuine forward cover that could be allowed if payments are to be made in the future for imports or for services availed. Shari‘ah compliance becomes impossible in complicated processes with a series of tawarruq and multiple wa‘ad, as we discuss in the following paragraph. In ‘Islamic Profit Rate Swap’ (IPRS), for example, each of the contracting parties undertakes the swapping of fixed and floating profit payments at all times when profits accrue in the future and a series of reverse murabaha are used to generate profits in specific currency. Ijlal Alvi adds, “Unlike conventional derivatives where both risk mitigation and speculative activity take place simultaneously Islamic hedging is very much a requirement-based activity.” But, practically, hedging would be extremely difficult or even impossible without speculation (Imran Iqbal and Wajdi, IRP: 46/2012). The separation between the physical commodity market prices and futures prices has created an opportunity to make a speculation in futures trading. Thus, the function of futures as a hedging instrument has turned into the arena of mere speculation, which is loaded with gambling and gharar transactions. It causes instability and failure to the whole system, even to the hedge funds themselves. According to The Washington Post (May 29, 2017) and eVestment, an institutional investor data firm, more than 1000 funds were closed during 2016, while the investors pulled $111 billion out of the industry. Hedge funds are losing favor among some of their most important clients like pension funds. The $51bn New York City Employees’ Retirement System withdrew from hedge funds on account that they are too expensive and complex. The high fees were eating away at meager profits (a 2% management fee and 20% of the profits earned, known in the industry as ‘2 and 20’. Fees for investing in passive index funds can be much cheaper, generally a tiny fraction, as low as 0.1% in some cases).

7.9   What Islamic Banks Need to Do for Liquidity Management? Islamic banking is not just ‘banking.’ It entails real business and economic activities and needs risk-based/risk-sharing products with potentially higher sharing of returns reflecting the risk level and detailed disclosure on

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performance to mitigate the risk. It is hence envisioned to be more ‘participative’ in nature facilitating the real business. While conventional banks keep on taking risk positions to realize the above dual objectives, Islamic banks have to face some real constraints as they cannot earn money on money without first converting it to the real assets and then taking commodity, market, and credit risks. But the IFIs have focused only on the liquidity management for maximizing the risk-free earnings and compete in the money market. Reliance on tawarruq and other replications of conventional liquidity management techniques may potentially inflict a reputation damage to the nascent Islamic finance industry (Syed Ali 2006). Effective liquidity management framework for Islamic banks would base on the orderly development of Islamic domestic Shari‘ah-compliant interbank and sovereign sukuk markets at national levels. This, in turn, would happen with strong commitment of the government/states, the central banks, and the fiscal authorities as well as a proactive regulatory framework. Islamic banks and financial institutions, in order to provide a real alternative to the present corrupt system, have to take the lead to be innovative for proper linkage between the real and the finance sectors of the economy, not for replicating the conventional products. This can be accomplished only if the Shari‘ah fraternity firmly resolves not to approve any products that are not Shari‘ah compliant both in letter and spirit. Here comes the role of AAOIFI or Islamic Fiqh Council. For generating large-­ scale prosperity and welfare of the society as a whole, the State and the regulators have to intervene to ensure that the poor are not deprived of the benefits of growth simply because of their poverty. In addition to ensuring that all segments are provided with equal opportunities to prosper, some special schemes and arrangements are needed both in the public and the mutual/cooperative sectors to enable those who are not able to fulfil their basic needs to live a healthy and respectable life. Model of direct funding by the investors/savers also needs to be used to deploy deposits directly to the investments where investors will be taking direct risk on performance of the investment. It may automatically lead to promotion of equity-based financing. ‘Fund before lending’ is the old way of thinking. Islamic banks need to first identify the projects, maybe via the Investment Account Platform (IAP), and then arrange financiers to associate the depositors with real business and economy on the basis of mudaraba or musharaka. Financing portfolios could be funded directly by the customers, thus removing the contractual burden and the financial

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costs associated with deposit building (Islamic Bankers, November 2016). This arrangement is nearer to the concept of venture capital, a potential business area that Islamic finance has not explored so far. It will also save the banks from the problem of mismatch. Mudaraba as the basis of deposits may be applied genuinely while ensuring prudent risk management and just profit distribution. An Investment Account Platform (IAP) may be developed to help the depositors to participate in the trading business directly giving the banks mudarib share or wakalah fee. Malaysia has already introduced such musharaka-­ based platform to the public. It is similar to the concept of crowdfunding where the investors come together and place equity in a business as direct investors.10 The IAP would finance the internal or external trading of such goods that are available in bulk in any market. As the clients will themselves choose the investment, their investment will remain till completion of the trade activity. On assets side, Islamic banks need to go in equity-related areas like stocks market, venture capital, private equity, partnership, and companies. Even those involved in structuring Islamic finance products suggest that the approach and manner of offering products and services, even in case of replication or adaptation, have to be materially differentiated from the conventional products (Rafe Haneef, ISRA/TR 2016, pp. 159–161). In economies like that of OIC countries, a great potential lies in venture capital area particularly in infrastructure and renewable energy, specialized health care, agriculture and agro-based industry, food processing, infrastructure, low-cost housing, livestock and dairy, and education. Individual investors and small investors may be enabled to invest in asset-based Shari‘ah-compliant retail ijara and mudaraba-based sukuk through the banking and nonbanking financial institutions. Active trading of the retail sukuk like that of stocks could be an effective tool of liquidity management by the IBIs. Islamic banks may manage the liquidity risk by inter-Islamic bank placements, prudent deposit mix for maturity matching, gap analysis prior to financing, proper choice of contracts for finance, proper reserves and provisions like profit equalization reserve (PER) and investment risk reserve (IRR), deposit takaful and secondary market dealing in sukuk, and redeemable equity instruments like participation term certificates (PTCs) and mutual funds. Contractual risks leading to liquidity problems can be managed by careful documentations, parallel contracts, and securitization

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of the underlying assets particularly in the cases of ijara, salam, and istisna, and trading in secondary market where possible. Securitization of physical assets into tradable securities would be generating stable flows of income under ijara and musharaka. Its examples are sukuk and other certificates issued by the government and the Central Bank in Sudan. This securitization must base on new assets each time to provide real boost to the economy. The IDB Jeddah and the UNDP have established the Global ‘Islamic Finance and Impact Investing Platform’ (GIFIIP) to promote market-­ based solutions to sustainable development challenges. Its strategies include developing appropriate investing tools and instruments and improving access of impact enterprises to Islamic funding.11 Issuance of short-term sovereign sukuk would also be helpful for proper liquidity management by the banks. Salam sukuk, although not tradable in the secondary market, can serve for parking excess liquidity and for SLR as in the case of Bahrain’s salam sukuk. In Sudan, where the whole banking system is Islamic, the banks are allowed to keep liquid assets of a maximum of 20% of the financing portfolio in a form of any of Central Bank of Sudan or CBOS’s ijara-, musharaka-, or mudaraba-based certificates, the instruments that are also used to manage liquidity at the macro-economy level through open market operations (Central Bank of Sudan 2015). For interbank market, CBOS encourages banks to cooperate and coordinate together to unify their financing and exchange rate policies, establish monetary funds for liquidity management, and securitize their capital assets. Lender of last resort (LOLR) facility is provided by using the Liquidity Deficit Window (LDW) and the Investment Financing Window (IFW) on mudaraba or musharaka bases. At LDW, if the receiving bank repays the finance within seven days, it is exempted from paying any profit to CBOS.  But if it exceeds the seven days, profit is distributed between rabbulmal and mudarib based on 90% to rabbulmal and 10% to mudarib. At IFW, the CBOS raises tender for banks that are awarded to banks based on the percentage of musharaka or profit percentage of mudaraba. Further, a Liquidity Management Fund (LMF) was established in September 2014 as SPV jointly owned by Sudanese banks and managed by the Financial Investment Bank. Thus, the central bank is no longer involved in the daily liquidity requirements of the banks except as a lender of last resort. Member banks are requested to put in capital a combination of a minimum 40% cash contribution and 60% in a form of investment securities or sukuk as mentioned above.

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Efforts have also been made to develop solutions based on wakalah, unrestricted wakalah, and securitization of assets. In wakalah, the agent/ wakeel invests the Muwakil’s (that of the principal) funds in pre-agreed asset classes; for the period of wakalah, the risk is transferred to the Muwakil. The product of unrestricted wakalah is to provide funding to the treasury pool which in turn invests in any of the assets on the balance sheet. Central banks may offer Islamic interbank securities, for example, certificates of deposit (CDs), as offered to conventional banks in the UAE. They may also invest in, and support the development of, secondary market of long-term Islamic investments like sukuk, mutual funds certificates, mudaraba certificates, and so on. However, the Shari‘ah scholars associated with the IFIs have to play a leading role for the change. The issue is as to why banks would wish to take business risk if the Shari‘ah scholars themselves allow them replication of all conventional tools of money minting through techniques like organized tawarruq, wa’ad, netting off, total return swaps, and all kind of Forex derivatives. It is pertinent to observe that such products are strongly condemned by Shari‘ah academics, while easily accepted by the majority of IFIs’ Shari‘ah board members (Al-Jarhi 2016). Shari‘ah boards/scholars in the banks behave in many cases like an authoritative Fiqh Academy. There has to be standardization of Islamic modes of business contracts, and AAOIFI’s Shari‘ah standards principally based on resolutions of the Jeddah-based Islamic Fiqh Council (IFC) are the best standards for the purpose. Shari‘ah boards in Islamic banks need to advise the policymakers and product developers to abide by the AAOIFI’s standards. They also need to be extremely careful while approving any structured products. Ijlal Alvi, the head of IIFM, suggests to the Shari‘ah scholars, with regard to permitting or otherwise the financial swaps mechanisms, that for analyzing the mechanisms and their contravention with Shari‘ah principles, they must carefully study and examine the whole transaction processes before passing any ruling on them (ISRA/TR 2016, pp. 152–158).

7.10   Conclusion Islamic finance is fundamentally about “the efficient and effective distribution of capital for the benefit of the real economy.” Islamic banking is based on Shari‘ah rules and the Shari‘ah is concerned with promoting justice and welfare in society (al-adl and al-ihsan) and seeking Allah’s blessings, with the ultimate aim of achieving success in this world and

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hereafter (Hannifa and Hudaib 2007). SDGs ultimately intend to achieve stable growth of economies benefitting all segments of the societies. For achieving the objective, Islamic finance institutions could have set an example to the whole world, had they applied the Islamic finance paradigm to the letter and spirit. Following the Shari‘ah principles in letter and spirit for all banking products and services is the most critical factor that would shape the future of Islamic banking and finance, and Islamic banks need to adhere to those principles. Otherwise, the people will be increasingly losing interest in Islamic banking and finance institutions. Hence, we reiterate that liquidity management instruments, Shari‘ah compliant in letter and spirit, need to be developed. Islamic banks’ practices, particularly the so-called liquidity management products, have diverted Islamic economics and finance from value based to capitalists system (Asutay 2007). Having crossed the milestone of 40 years, Islamic bankers need to say goodbye to all such devices like organized tawarruq and derivatives-related investment/funding products that could not get general acceptance from the infrastructural Shari‘ah bodies, Shari‘ah scholars in general, academia, and the researchers on Islamic finance. Regulators have to play role for disciplining the IFIs. It is because the failure of Islamic finance to live up to its paradigm owes a great deal to the inactive role of the central bank. “If regulators were aware of the macroeconomic advantages emanating from an honest application of Islamic finance, they must not had allowed any products like Tawarruq,” says Mabid Ali Al-Jarhi (2016). Mabid has proposed a social dialogue in every country where Islamic finance is part of the regulators’ policy to resolve the problems in money creation and liquidity management. The dialogue has to be among the legislators, monetary and financial authorities, bankers and finance executives, Shari‘ah board members, and representatives from the Islamic Fiqh Academy, AAOIFI, IFSB, the Islamic Development Bank, the International Association for Islamic economics, the IMF, and the World Bank. Banks may focus on direct funding like mutual funds to raise deposits; it will have lesser pressure on banks’ capital, will be more transparent and more risk spreading, and will also lead to systemic stability. Daud Vicary Abdullah very rightly says, “Islamic finance has many challenges ahead, not least of which is steering practitioners, regulators and academics towards the benefits of Risk Sharing and rediscovering the real economy. Such an equity-based financial system, where risk sharing takes place, will reduce the over-reliance on debt funding and will therefore avoid the

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excessive debt and speculation which becomes part of the nexus of the crisis” (ISRA TR 2016, pp. 152–158, p. 162). The use of fintech for promoting mudaraba-based money and capital market also using the concepts like crowdfunding could be helpful in achieving the objective (Ali S. Nazim 2017). Fintech could help Islamic banks become more efficient and scale up their operations, according to the BNM, which started last year the process of reviewing regulations to address fintech firms. In February this year, a group of six Islamic finance institutions launched an internet-based investment platform to serve as a central marketplace to finance small and medium-sized businesses. Last but not the least, Islamic finance industry needs integrated support from IRTI, standard-setting bodies including AAOIFI and IFSB, and regulators for ensuring adoption of standards and harmonization of pronouncements on structured products for liquidity management and business.

Appendix 1. Sell Sukuk

Isl. Bank

Con. Bank A 2. Payment (Spot)

5. Payment on due date

3. Sukuk’s Deferred Sale on Profit

Back to A 4.

Broker

Con. Bank B

Fig. 7.1  Process flow—interbank bai muajjal of sukuk (organized tawarruq) in Pakistan. (Source: Author’s own)

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3. Buys Commodity for Rs. 100 m, Jan 01

Conventional Bank (Agent)

Broker B

2. Pay (Spot Jan, 01)

5. Agent receives sales proceeds (April 30, Rs. 105m) 6. Settles Investor (Pay Rs. 104.5m) (Broker‘s fee Rs. 0.5m) Funds Flow

Broker A

1. Agent Receives Funds from Investor (Rs. 100m Jan, 01) (To pay to Broker A)

Islamic Bank (Investor) Principal

Commodity Flow

Fig. 7.2  Structured flow of secured commodity murabaha

Notes 1. http://www.theborneopost.com/2017/03/05/islamic-finance-theunconventional-but-nascent-financial-system/ 2. Vision in Action (ViA) Advisory Group, Report on Christian-Muslim Interfaith Dialogue on “Engaging Structural Greed Today” in Kota Kinabalu, Sabah, Malaysia; September 25–30, 2011. 3. The then CEO, HSBC Amanah; Liquidity Management of Islamic Financial Institutions in the UAE, December 10, 2005. 4. Banks pay a very low profit to remunerative C/As, the category introduced recently to circumvent the prohibition of paying any return/hibah to C/A holders depositing money as a loan, but to offer them various benefits to allure cheap money. 5. Blockchain system first emerged to facilitate digital currencies like Bitcoin. It involves a shared electronic ledger that allows all parties to track information through a secure network, removing the need for third-party verification. 6. http://www.brecorder.com/2017/03/09/338790/guidelines-forpmex-commodity-murabaha-approved/. No further detail has been shared about the structure and process flow of the product. 7. It has already happened that the premier bank in Pakistan pioneered the excessive use of clean and collateralized tawarruq and then ‘Running Musharaka’ as replica of conventional OD, obliging the other IBIs in the country to be involved in such prohibited practices, maybe on the basis of ‘Maslahah’ or ‘Umum Balwa’ (‘a common plight’ or ‘fasad al zaman’)

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principle as adopted by the Shari‘ah boards of the Securities Commission and that of BNM, Malaysia, in order to escape from the losses/harm from bad practices that prevailed in the society/economy. 8. M. Akram Laldin, ED, ISRA, Malaysia; see https://fb.com/EthisCrowd/ videos/1094018484035944. 9. IRP, ISRA, 2016 http://ifikr.isra.my/publication/-/publication/ getPublicationDetail/8001 10. Islamic Bankers : Resource Centre Nov. 2016; https://islamicbankers. me/2016/11/16/deposit-paradigm-shift/; also see https://www.iaplatform.com/. 11. http://www.huffingtonpost.com/entry/islamic-finance-an-innovativeavenue-for-financing_us_58b97c82e4b02eac8876cd83

References Al-Jarhi, M. A. (2016). Islamic Finance at the Crossroads. Paper presented in the 11th ICIEF, KL, Malaysia. Ali, S. N. (2017). Moving Towards Community Driven Islamic Finance. Journal of Islamic Business and Management (JIBM), 7(1), 11–27. Aparicio, R. (2013). Paper for workshop on “Measuring Social Public Policies: Inclusiveness and Impact” UNESCO, Paris, 25, 26 March. Retrieved from http://www.unesco.org/new/fileadmin/MULTIMEDIA/HQ/SHS/pdf/ Workshop-Social-Inclusion_CONEVAL.pdf Asutay, M. (2007). Conceptualisation of the Second Best Solution in Overcoming the Social Failure of Islamic Banking and Finance. IIUM Journal of Economics and Management, 15(2), 167–195. Ayub, M. (2015). Financial Inclusion: Social Inclusion has to be the Target. Journal of Islamic Business and Management, 5(1), 5–16. Balala, M. H. (2010). Islamic Finance and Law Theory and Practice in a Globalized World (pp. 177–178). London, UK: I.B. Tauris. Bank of England (BoE). (2017). Consultation Paper. Shari’ah Compliant Liquidity Facilities: Establishing a Fund Based Deposit Facility, April 2017. Chang, H.-J., & Aldred, J. (2014). After the Crash, We Need a Revolution in the Way We Teach Economics. Retrieved from https://www.theguardian.com/ business/2014/may/11/after-crash-need-revolution-in-economicsteaching-chang-aldred Eisenstein, C. (2007). The Ascent of Humanity. Harrisburg, PA: Panenthea Press. Retrieved from http://lust-for-life.org/Lust-For-Life/_Textual/Charles Eisenstein_TheAscentOfHumanity_2007_604pp/CharlesEisenstein_ TheAscentOfHumanity_2007_604pp.pdf

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Hannifa, R., & Hudaib, M. (2007). Exploring the Ethical Identity of Islamic Banks via Communication in Annual Reports. Journal of Business Ethics, 76, 97–116. https://doi.org/10.1007/s10551-006-9272-5. Ijlal, A. (2016). The IIFM Islamic Hedging Master Agreement: A Shariah Perspective. ISRA/TR, pp. 152–158. Islamic Bankers, Resource Centre. (2016). Deposit Paradigm Shift. Retrieved from https://islamicbankers.me/2016/11/16/deposit-paradigm-shift/ Islamic Fiqh Council. (2000). Resolutions and Recommendations (1985–2000). IRTI, IDB, Jeddah. Retrieved from http://www.isra.my/index. php?option=com_content&view=article&id=355:oic-fiqh-academy-ruledorganised-tawarruq-impermissible&catid=11:tawarruq&Itemid=15 ISRA & Thomson Reuters. (2016). Islamic Commercial Law Report. ISRA, Malaysia. Katua, N. T. (2014). The Role of SMEs in Employment Creation and Economic Growth in Selected Countries. International Journal of Education and Research, 2(12), 461–472. Khan, S. H. (2010). Organised Tawarruq in Practice: A Sharı̄´ah Non-compliant and Unjustified Transaction. New Horizon. Largan, M., & Colley, A. (2000). Banking Operations: Regulation, Practice and Treasury Management. Chartered Institute of Bankers. Sadiq, K., & Black, A. (2012). Embracing Sharia-Compliant Products through Regulatory Amendment to Achieve Parity of Treatment. Sydney Law Review, 34, 189. Retrieved from http://www.austlii.edu.au/au/journals/ SydLRev/2012/9.pdf Siddiqi, Y.  A. (2017). Introducing Islamic Banking in New Markets. India: Darul Safwah. Syed Ali, S. (2006). Financial Distress and banking failure: Lessons from Closure of ̇ Ihlas Finans in Turkey. Jeddah: IRTI, IDB. Thomson Reuters (TR). (2016/2017). State of the Global Islamic Economy Report. Yurizk (U.S. based online source of global Islamic Finance education). (n.d.) The Problem with Tawarruq. Retrieved from http://dir.yurizk.com/blogyurizk/7-blog/399-the-problem-with-tawarruq.html

CHAPTER 8

Improving Access to Financial Services: Theory and Practice Around the Globe Muhammad Azeem Qureshi and Toseef Azid

8.1   Introduction Access to financial services is a genuine global policy concern (Arun and Kamath 2015). Considering the socio-economic dimensions of this policy concern, its scope extends well beyond financial inclusion to provide an enabling environment to the people to attain their full potential. Since the 1990s, education is at the core of development agenda that have significantly contributed to empower the people. However, access to financial services to these educated young entrepreneurs enables them to realize their full potential (Beck and De La Torre 2007). The policy frameworks considerate of financial inclusion are likely to help bring in all-inclusive human-centred sustainable development. Despite the benefits of finance, the data show that the use of financial

M. A. Qureshi (*) Oslo Business School, Oslo Metropolitan University, Oslo, Norway e-mail: [email protected] T. Azid College of Business and Economics, Qassim University, Qassim, Saudi Arabia © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_8

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services is far from universal in many countries, especially developing countries (Claessens 2006). Lack of access to finance is often a critical factor in generating persistent income inequality, as well as slower economic growth. Hence expanding access remains an important challenge across the world (Beck et al. 2009). However, higher cost of financial inclusion especially in micro loans has resulted in human miseries in many parts of the world, especially in India1 and Bangladesh (Ahmad 2007). We observe prevalence of financial exclusion and its socio-economic consequences in the Islamic world. A review of the relevant literature suggests different forms and tools to enhance financial inclusion. However, considering the negative outcomes of these practices around the globe, the researchers consider it important for the benefits of the poor households to have a strategy that goes well beyond credit (Beck et al. 2009). We therefore, argue to incorporate the quality of life in both the worlds (see our postulation in Sect. 8.2) in the agenda for financial inclusion in the Muslim world. For this purpose, we propose venture philanthropy as a tool to achieve financial inclusion that promotes equity, brotherhood and harmony in the society to realize quality of life in both the worlds. Along with introduction in this section, we organize this chapter as follows. In Sect. 8.2, we build a theory to postulate the relationship of financial inclusion to the quality of life in both the worlds by using systems theory to map the organic relationships found in relevant development theories. In Sect. 8.3, we review the practices around the globe to enhance financial inclusion to enlist their pros and cons. We present our proposed framework in Sect. 8.4 and we present conclusions in Sect. 8.5. We provide references at the end.

8.2   Causal Mapping of Theories of Economic Development In complex systems, cause and effect are distant in time and space (Sterman 2006) and intertwined in a two-way cause-and-effect feedback processes. The policy makers, however, tend to focus their attention to the problem indicators rather than their underlying structure that causes the problem. Further, we find many evidences suggesting that financial development and inclusion reduce income inequality and poverty. However, we are far from a complete understanding of the channels through which this effect

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operates (Beck et al. 2009). It is, therefore, imperative to present a holistic map of two-way feedback processes that link all relevant elements of a system structure. We draw our inspiration of this work from Verse 97, Surah 16 of the Holy Quran. َ ً ‫صا ِل ًحـا ِ ّم ۡن ذَك ٍَر ا َ ۡو ا ُ ۡن ٰثى َوه َُو ُم ۡؤمِ نٌ فَلَـنُ ۡحيِيَنَّهٗ َحيٰ وة‬ َ‫س ِن َما كَانُ ۡوا يَعۡ َملُ ۡون‬ َ ‫​ ولَـن َۡج ِزيَـنَّ ُهمۡ ا َ ۡج َر ُهمۡ بِا َ ۡح‬ َ ‫َم ۡن عَمِ َل‬ َ ً‫طيِّبَة‬ Whosoever acts righteously—whether a man or a woman—and embraces belief, We will surely grant him a good life; and will surely grant such persons their reward according to the best of their deeds.

We understand from this verse that whosoever acts righteously will surely get a good life here and a reward hereafter. We translate this promise of Allah (SWT) as falah in both the worlds. To portray this concept of falah, we present causal mapping2 of various theories of economic growth. Optimum accumulation and utilization of the factors of production, capital and labour, has remained as the core policy objective for quite a long time to create and maximize economic value. We present this process in Fig. 8.1. Since the 1990s, researchers and policy makers have recognized the intertwined nexus of human and physical capital to affect economic growth suggesting that human development (HD) and economic growth are interdependent in feedback processes suggesting that both are mutually reinforcing either leading towards an upward spiral of development or a poverty trap (Qureshi 2008, 2009). These processes at an aggregate level also help develop social capital. We present in Fig. 8.2 the causal mapping of this stratum of development theories that put the people at the centre stage of all aspects of the development process. However, the vicious cycle of capital accumulation and concentration challenging the prophecies of trickle-down (Qureshi 2008) is empirically observed in a recent report by Oxfam3 (Oxfam 2017) clearly suggesting

Fig. 8.1  Causal structure of theories of economic growth

Labour

+

GDP

Physical Capital

+

+ PC income after taxes

+ +

Investments

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+

Social Capital

Human Capital

+

+

+

Access to education and health

+

GDP

Physical Capital

+

+

PC income after taxes

+ +

Investments

Fig. 8.2  Causal structure of people-centred theories of economic development

+

Social Capital by group

Human Capital by group

+

+

+

GDP

Physical Capital by group

+

+

+

Access to PC income education after taxes and health by group by group

+

Investments by group

Fig. 8.3  Causal structure of socio-economic groups–centred theories of economic development

that prevailing systems promote a society of the elite where the state and market facilitate exploitation, wealth accumulation and concentration for the owners of capital (Hussain 1997, Pedercini and Qureshi 2010). The persistent poverty across the globe particularly in developing countries requires consideration of the implications of the development policies on income distribution (Essama-Nssah 2005). Consequently, we observe a variety of methods and policies to positively affect growth and income distribution for the welfare of the people (Pedercini and Qureshi 2010). We extend the causal structure of an earlier work (Pedercini and Qureshi 2010) in Fig. 8.3. We argue that these theories do promote ‘equity’ among the socioeconomic groups in a society; however, ‘quality of life’ is not their policy objective. As such, shifting the policy objective from economic development, human development and income distribution, the theories of social

8  IMPROVING ACCESS TO FINANCIAL SERVICES: THEORY AND PRACTICE… 

+ +

Quality of life

+

Level of information symmetry

+

Social Capital by group

+ + Level of equity and justice

+

141

+

Access to finances

+

Human Capital by group

+

Access to education and health by group

+ +

GDP

Physical Capital by group

+

+

+ +

PC income after taxes by group

+

Investments + by group

Fig. 8.4  Causal structure of theories of social justice and economic development

justice consider the quality of life as the objective of development policies. These theories advocate transparency, information symmetry, and equity and justice in the society as governance mechanisms that should ensure the economic as well as human development along with equitable income distribution while improving the quality of life of the individuals. In Fig. 8.4, we present the causal mapping of the theories of social justice that consider access to financial/physical capital or financial inclusion as the policy tool to realize the economic potential of available human capital (Naceur et al. 2015). However, high cost of financial inclusion especially in micro loans has resulted in human miseries in many parts of the world, especially in India4 and Bangladesh (Ahmad 2007). Individuals have their own choices, emotions and moral values while making any exchange. Islam provides the basic rules for exchange with the policy objective of falah (success) in both the worlds. Islam seeks equity and justice in exchange governed by taqwah to create value-based economy and society. The ultimate objective of the Muslim and the market of

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Islamic society is to attain welfare of both the worlds (al-Ghazali) where all the market agents follow the teachings of the Qur’an and Sunnah of prophet (SAW). Islam provides a set of principles for business to its followers. Trading is permitted but without interest, and also Islam appreciates charity for purification of wealth,5 injustice is not allowed in business transactions,6 adulteration and exploitation of others are not allowed,7 business should be with mutual consent of parties, and one should not use the property of others without permission.8 If believers follow the abovementioned shariah principles, this will not only help to improve their business and quality of life in this world, but they will also get the reward in the life hereafter. Islam forbids injustice, greediness, cheating, adulteration, corruption, dishonesty, lying, untrustworthy and fraud. Integration of this life and the life hereafter shapes shariah-compliant behaviour of individuals. It is a well-known phenomenon that exchange in this life is dependent on the choices of the people. Similarly, the exchange in the life hereafter is dependent on their choices, as mentioned in Qur’an (2:16).9 Here the exchange is not in terms of material goods rather in terms of human behaviour. An exchange following the true guidance will benefit (falah) the believers; otherwise they will be punished which is a pure loss.10 It is very interesting to note that the concept of purchasing is not similar to worldly concept. Here no need to purchase with money or using the wealth; exchange or purchase is based on the right or wrong choice. It all depends upon the behaviour of the believers. If choice is not on the right direction, then they will be punished, as explained in Qur’an (2:86).11 Allah (SWT) in chapter al-Saf guides the believers about the trade which is beneficial for them.12 It is worthwhile to note that Islam teaches about spending in the way of Allah (SWT) that is in real terms a trade in between Allah (SWT) and the believers. Qur’an informs the believers about the benefits of this trade that has no chances of loss.13 There is a guarantee from Allah (SWT) that this trade will increase the standard and quality of life in the life hereafter.14 Financial inclusion, in Fig. 8.5, has backward linkages with zakat, waqf and qarz-e-hassan, physical/financial capital, level of information symmetry and level equity and justice in the society, whereas it has the forward linkage with investment by group. This is our postulation of financial inclusion in an Islamic framework that clearly suggests policy framework to ensure financial inclusion to make the marginalized groups effective

8  IMPROVING ACCESS TO FINANCIAL SERVICES: THEORY AND PRACTICE… 

Perceived quality of life hereafter

+ + Religious Capital

+ Shariah compliant individual practices

+

+

+

Quality of life

+

Zakat Qarz-e-hassan Waqf

+

Level of equity and justice

+

Social Capital by group

+

+ +

Level of information symmetry

+

+

+

+

143

+

Access to finances

+ +

Human Capital by group

+

Physical Capital by group

+

+

+ Access to education and health by group

GDP

+ +

PC income after taxes by group

+

Investments by group

+

Fig. 8.5  Causal structure of Islamic moral economy

members of the society who realize their full potential to enjoy the quality of life in this world and expect falah in the life hereafter. In the following paragraphs, we will first review the practice of financial inclusion in different parts of the world. With the help of our postulation and the synthesis of these practices, we will suggest an integrated policy framework for Muslim countries to promote financial inclusion in society, which helps facilitate a harmonious society based on injunctions of Islam.

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8.3   Understanding the Dynamics of Financial Inclusion—Practices from Different Parts of the World The financial landscape, in Fig. 8.6, that we adopt from Rabobank (2006), of developing or emerging economies (most of the Muslim countries fall under these categories), suggests that the marginalized segments of the society are neglected by the formal financial institutions. Their financial needs are only catered by specialized institutions, NGOs or governments in the form of microcredit or grants. We have already noted exorbitant cost of financial inclusion especially in micro loans that has resulted in human miseries in many parts of the world, especially in India15 and Bangladesh (Ahmad 2007). Figure 8.6 is a depiction of financial inclusion at the macro level.

More sophisticated financial services for MCEs Standard financial services for MCEs

Microfinance for MCEs

High

Commercial banks

Mi Low Income

Economically Active Poor

Official Poverty Line Grants

Extremely Poor

Fig. 8.6  Financial landscape in developing and emerging economies. MSE, micro and small enterprises; MCE, medium size corporate enterprise. (Adapted from Rabobank 2006)

8  IMPROVING ACCESS TO FINANCIAL SERVICES: THEORY AND PRACTICE… 

A

Current consumers of financial servicers

B

C

Voluntary exclusion

Involuntary exclusion

No need No awareness?

B1

Assumed rejection use due to price /income?

Rejected High risk Bad credit No access

Rejected Discrimin ation No access

B2

C1

C2

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Population

Excluded due to price, product, income or Respondent features No access

C3

Fig. 8.7  Difference between access and use of financial services. (Source: Adapted from Claessens 2006)

At micro level a researcher (Claessens 2006) uses a standard demandsupply framework to explain access to financial services, wherein access refers to supply and use in the intersection of the supply and demand schedules. In Fig  8.7, Claessens categorizes the entire population into three groups. Group A has access and use of financial services; Group B has access but does not want to use financial services (voluntary exclusion); and Group C has no access and thus does not use financial services (involuntary exclusion) (Claessens 2006). Recently researchers have broadened the definition of financial development and financial depth to include financial outreach and inclusion (Beck and Demirgüç-Kunt 2008). Considering the benefits of financial inclusion, different stakeholders across the globe are trying to move the population from the right-hand side to the left-hand side of Fig. 8.7. We provide here some of the examples from across the globe to identify their key characteristics. 8.3.1  The Farmers’ Cooperatives The objective of these cooperatives is to harness the human capital (agricultural skills and labour) found in the farmers and provide them small loans as well as education and training in developing business systems and financial management to enable them to realize their full potential. Usually, the farmers are also the shareholders of these cooperatives, for example, in Indonesia and Kenya (Rabobank 2006).

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8.3.2  Microfinance Institutions/Banks We observe proliferation of microfinance institutions and banks across the globe. They have provided financial inclusion to many. Nevertheless, stories of miseries (even leading to suicides) of the marginalized at the hands of their so-called saviours are also well known (Ahmad 2007). Some of these banks are also using technology to outreach their customers and reduce the costs (Cracknell 2012). 8.3.3  Interest-Free Loans (Qarz-e-Hassan) There are two products introduced in two different contexts with two different objectives but one common thread—interest-free loans. First, Akhuwat based on Islamic concept of muakhawat provides qarz-e-hassan for poverty alleviation in Pakistan since 2001. Second, JAK Members Bank (operational since 1997 in Sweden, and now it operates in Denmark, Germany and Italy as well) does not charge or pay interest on its loans provided to its members for house finance. 8.3.4  Social Networks at Work for Financial Inclusion in the UK Information failure is a significant market failure that may have economic consequences especially for the marginalized members of a society. A study in the UK uses two different data sources to find that non-consumers of financial services are distinguishable from consumers only by belonging to social networks where financial services usage is relatively low. The study concludes that social networks play a key role in transmitting information and financial inclusion (Meadows et al. 2004). 8.3.5  Financial Inclusion in India—Impact of Social Banking and Pro-market Reforms Considering the supply-side policy as a tool to improve financial inclusion, India adopted the social-banking policy that mandated the banks to open branches in four unbanked locations in order to get licence to open a branch in already banked locations. Using panel data techniques over a large dataset, the study finds that the social-banking policy has played crucial role to foster financial inclusion in India during 1977–1990. However,

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pro-market financial sector reforms in the 1990s have adversely affected the pace of financial inclusion. The study identifies proximity and credit availability as two policy targets to foster financial inclusion in India (Chakravarty and Pal 2013). 8.3.6  Financial Literacy in South Africa A study in South Africa finds that financial education brings customers into the financial system. However, increasing the level of financial literacy alone does not take them further up on the financial access ladder, but aspirations and skills move households up on the financial access ladder and probably out of poverty (Kostov et al. 2015). 8.3.7  Education and Income Improve Financial Inclusion in Africa Another study using the Global Findex database of the World Bank on 37 African countries finds that financially inclusive people have relatively higher education and income (Zins and Weill 2016). 8.3.8  Financial Inclusion and Country Characteristics A study of over 160 countries suggests that a deeper financial system and access to information are some key tools to provide access to financial services. Improved access to financial services helps improve the overall national income of the country; however, its impact on poverty reduction is still elusive (Honohan 2008). Another study of 140 countries suggests two-dimensional determinants of financial inclusion. At macro level, the study finds that greater financial inclusion is associated with lower account costs, greater proximity to financial intermediaries, stronger legal rights and more politically stable environments. On the other hand, at micro level the effectiveness of policies to promote inclusion varies depending on the characteristics of the individuals considered. Further, the study finds rural population as financially excluded (Allen et al. 2016). 8.3.9  Financial System Structure Using data of 54 countries from Financial Sector Assessment Program (FSAP) reports of the IMF and the World Bank, and the firm-level data

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from the Enterprise Surveys of the World Bank, a study concludes that dominance of the financial system by banks discourages use of financial services by firms of all sizes, whereas low-end financial institutions and specialized lenders seem particularly suited to ease access to finance in lowincome countries. Further, there is no evidence that smaller institutions are better in providing access to finance (Beck et al. 2013). A multi-region study suggests that the depth and quality of regulation and supervision help improve financial inclusion (Arun and Kamath 2015). We provide a summary of the tools from the review of the relevant literature that help improve access to financial services and reduce poverty: • Creating ownership stake • Enhanced supply of low-cost products • Literacy and access to information • Social networks • Interest-free products • Access to finance not only to individuals and micro businesses but also to SMEs • Improved regulatory and supervision frameworks • Specialized institutions • Strong legal rights and stable environment

8.4   Islamic Sharing Institution: A Tool to Enhance Financial Inclusion The above review of the relevant literature suggests different forms and tools to enhance financial inclusion. However, considering the negative outcomes of these practices around the globe, the researchers consider it important for the benefits of the poor households to have a strategy that goes well beyond credit (Beck et al. 2009). We, therefore, argue to incorporate the quality of life in both the worlds (see our postulation in Sect. 8.2) in the agenda for financial inclusion in the Muslim world. For this purpose, we propose a two-tier policy framework. At country level, an improved governance mechanism that ensures strong legal rights and provides effective and robust regulatory supervision; and specialized financial institutions based on the concept of venture philanthropy as a tool to achieve financial inclusion that promotes equity, brotherhood and harmony in society to realize the quality of life in both the worlds. To

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operationalize this conception, we propose proliferation of Islamic sharing institutions (ISIs) that collect zakat (levied on stock of wealth which is physical capital), charity (given from income that we assume in our model) and waqf as well as provide investment capital (please see Fig. 8.5). In our conception, we entrust a relatively wider scope to our proposed ISIs by assigning them the role of IFIs as well. As such, in our conceptualization ISI is an institution that maintains a pool of funds (endowment from zakat, charity, waqf and investment capital through equity capital and mudharabah, etc.) and has the capability to: • Collect zakat and charity from givers of the society • Collect investment capital through equity capital and mudharabah and so on from haves of the society • Identify the potential receivers of the society • Identify the available skill set and resources and provide training • Provide potential business ideas, business plan, its implementation, monitoring and control • Identify and provide (as qard-e-hasan or mudharabah, musharakah, etc.) the needed resources for effective implementation of business plan • Recover the invested capital and motivate the takers to contribute in the endowment fund Our proposed ISI facilitates sharing to promote compassion and brotherhood. In Islamic context, generation of capital is based on taqwah, a God-fearing behaviour. A God-fearing person (muttaqi) spends (zakat and charity) in the way of Allah (SWT) and expects reward from Allah (SWT) in the life hereafter. Therefore, the foremost capital generated is religious capital that promotes virtuous behaviour (good intention, honesty, kindness, moral attitude, honour for others, brotherhood among the members of the society, etc.) and discourages immoral behaviour (dishonesty, cheating, theft, jealousy, backbiting, dishonour to others, etc.). This boosts the psychological state of the charity giver, and interconnectedness of human societies channels this positive energy from givers to receivers. In this way, religious capital helps build psychological capital that further lays the foundation for social capital. As depicted in Table 8.1, we maintain that religious capital generates psychological capital, whereas social and human capitals are beyond psychological capital. Further, social capital based on the trust, association and the network among the members of

What you have

Finance Tangible assets (plant, equipment, patents, data)

Philanthropy

Profit

Traits

Nature of capital

Change

Expected return

Reward in the life hereafter

Happiness

Generation of resources

Confidence Hope Optimism Resilience

Belief Intentions Practice Rituals

Generation of resources

What you are

Psychological capital

What you believe

Religious capital

Satisfaction

Generation of resources

Relationship Network of contacts Friends (brotherhood)

What you know

Social capital

Motivation to maximize gains (compassion, or some kind of inner fulfilment) while minimizing the losses Source: Azid et al. (2016)

Traditional economic capital

Type of capital

Table 8.1  Formation of intangible capital from tangible capital in moral economy

Utility

Experience Education Skills Knowledge Ideas Healthcare Generation of resources

What you have

Human capital

Falah in both of the lives

New resources

Incremental change in capital through moral economy

Development of the personality

∑ (end result)

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the society is likely to be strong where religious societies exist. Moreover, social capital has a positive influence on human capital and the organizational structure and has continuous impact on the success, efficiency and productivity of the firms (Adler and Kwon 2002). In Islamic traditions, taqwah (fear of Allah SWT) is the basis of degree of piousness that shapes the desired behaviour while utilizing social capital. As such, the pious members of an Islamic society shall have good relationships with their network of contacts in an environment of brotherhood sharing and helping each other without selfish behaviour. Intrinsically, the three intangible capitals, that is, religious, psychological and social capitals, generate the human capital. In an Islamic system, moral attitude comes from religious capital; hope, resilience, optimism and efficiency come from psychological capital; and positive relationship networks of brotherhood come from social capital on top of education, training and healthcare to emerge as human capital. Concisely, an environment that appreciates knowledge, skills, expertise, ethics, optimism and positive social networks and imparts effective training to enhance the human capabilities is a key factor for the sustainable development of a society that thrives on compassion and brotherhood generating utility of both the worlds for its members. We understand that transformation of these intangible capitals is entirely different from the physical/traditional capital. Transformation of these intangibles cannot be purchased and is irreversible, robust and resilient. Further, it is inherently volatile and random in its nature and as such there is no symmetry in the process of transformation. Consequently, it has different impact on different members of a society and on the different societies. A reproductive process creates more than the process inputs and over time changes the understanding of the participants. We can easily extend this framework of transformation when we consider the impact of philanthropy on the above intangible capitals. The term ‘venture philanthropy’ was first coined in 1969 (by John D.  Rockefeller III) as “an adventurous approach to funding unpopular social causes”. It resurfaced in the mid-1990s associated with a growing community seeking to apply their wealth and their business wisdom to the most pressing social problems. Venture philanthropy is “a field of philanthropic activity where private equity/venture capital models are applied in the not-for-profit and charitable sectors” with the overall objective to maximize social impact. It is characterized by six main features: engaged partnership, tailored financing, multi-year support, provision of nonfinancial services, assistance to build organizational capacity and performance measurement (see Table 8.2).

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Table 8.2  Traditional vs. ISI venture philanthropy Features

Traditional philanthropy

High engagement Investors: not engaged, gift givers, not involved beyond the grant and not in the process, want to know how resources are used, least concerned with effectiveness Tailored financing Finance: conservative, form of a grant/gift, no pay back

Multi-year support

Non-financial support

Organizational capacity-building

Performance-­ based measurement

ISIs as venture philanthropists Committed to taking an active role in the development of the project and/ or person whom they are supporting

Flexible, revenue-generating social enterprises, funds for infrastructure, project delivery with growth, scale and quality May commit to a multi-year Venture philanthropists engage on a project funding, no concern multi-year basis with the view towards beyond that point, long-term the project becoming self-sufficient project ‘dependent on grant funding’, tested and proven projects may end prematurely Non-profit leaders and An engaged partnership with a organizations are usually venture philanthropist means the responsible for finding their delivery of non-financial support and own service providers on an services along with financial services, as-needed basis e.g., musharakah or mudharabah Supporting organizations Needs to succeed to deliver its that ‘do good’, focus is on services in the most effective way the reach and delivery possible, support for organizational setup In traditional philanthropy, To work closely with the person the evaluation stage leading the project to develop targets, concentrates on the initial metrics and tracking methods, not project proposal screening. only for internal performance but also Performance-based for impact assessment measurement goes beyond reporting and compares the achieved outcomes with the intended outcomes

Source: Constructed by authors based on information from Ochs

Venture philanthropists work with a range of organizations—not solely with charities and not-­for-­profits. These include social enterprises, trading charities and socially driven commercial organizations. In particular, they have filled a gap between traditional grants for not-for-profits and commercial market rate equity and loans. Capital investments made by venture

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philanthropists also aim to address issues of sustainability and scale. Venture philanthropy seeks to use many of the tools of venture capital funding to promote start-up, growth and risk-taking social ventures. The main elements of venture philanthropy are building operating capacity, close engagement between donors and recipients, and clear performance expectations. Along with long-term funding, venture philanthropists often provide skills and expertise that small organizations cannot afford. We emphasize the key word venture that has capacity and flexibility to focus on drive and creativity needed for a start-up venture to succeed. Traditional capital providers seek minimizing the risk and distancing themselves from operations. Instead, venture philanthropists readily shoulder some of the risk and responsibility for the success of the venture and are quite prepared to get engaged and play a role on the board as their main objective is social return on investment and secondary objective may or may not be financial return on investment. Reciprocally, the social organizations learn from the venturing skills and imagination of the venture capital community. Consequently, such engagements in social issues become source of new ideas, reputation and recruitment that help grow brand equity (through association with well-known charities or social enterprises), attract talent (particularly younger people who want to believe that their employer has a social conscience) and stimulate cultures of innovation in the mainstream business through engagement with different types of organization. Most of the developing countries and particularly Muslim countries are suffering from ‘brain drain’ considered one of the reasons for their poor economic development. The bulk of their human capital is working outside of the country of origin. To mitigate this problem, we argue that ISIs (venture philanthropists) have the structural elements and resources to engage the labour force available in the community to make them productive entrepreneurs and workers. Further, these ISIs bring social capital and networks to the projects and regions in which they work. Consequently, empathy and their interaction within the local context shall help develop brotherhood. We propose that Islamic venture philanthropy shall use conventional models of venture philanthropy. To elaborate further, we give one example from Pakistan—Akhuwat.16 Inspired by the historical event of Muakhaat-­e-­Madinah, Akhuwat was established in 2001 with the objective to provide interest-free microfinance to the poor to enable them to enhance their standard of living. To finance this programme, Akhuwat outreaches to the givers of the society who donate their zakat and charity to Akhuwat (an ISI in our definition).

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Akhuwat provides a system based on mutual support and ‘akhuwat’ (brotherhood) in the society that helps build religious, psychological and social capitals in society. While doing so, Akhuwat identifies the skills (human capital) of the recipients and provides the supplementary training and microfinance as qarz-e-hassan to initiate value-added economic exchange in the community. In this way, Akhuwat helps build and enhance human and physical capital not only to alleviate poverty but also to help build a ‘sharing and caring’ society. The relationship between Akhuwat and recipients not only enables them to earn a reasonable living for their families but also inspires them to become donors over time. Our example ISI (Akhuwat) raises funds from charity and donations and has qarz-e-hassan as the only instrument of capital provision as microfinance to micro-entrepreneurships. However, our suggested ISI would raise funds from zakat, waqf, charity and investment capital and shall have qarz-e-hassan and other Islamic financing instruments, for example, mudharabah, musharakah and so on along with providing capital and financial/consultancy services not only to micro-­entrepreneurships but also to small and medium enterprises.

8.5   Conclusion Lack of access to formal financial services for poor segments of the society and its potential consequences is well documented. However, researchers argue that it is not only the poor that lack access to formal financial services, but limited access to financial services by non-poor entrepreneurs is likely to be even more important for growth and overall poverty reduction (Beck et al. 2009). We therefore broaden the definitional scope of financial inclusion to include poor as well as non-poor entrepreneurs. We then use systems thinking to present causal mapping of the organic relationships found in the development theories to locate financial inclusion as a development tool to materialize the quality of life in both the worlds. To improve the operationalization of our conceptualization, we take a stock of the practices around the globe by reviewing the relevant literature and present our framework to address this issue. The conventional economy has profit maximization as the economic motive, whereas the participants of Islamic sharing economy seek Pleasure of Allah (SWT). Many verses of the Qur’an motivate the believers to promote the environment of brotherhood based on caring and sharing for the Pleasure of Allah (SWT). A classic example of Islamic sharing economy is

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Muakhaat-e-Madinah, which is brotherhood based on caring and sharing. Further, sharing of the economic resources is mandatory (zakat) as well as optional (charity). We observe that due to lack of formal institutions, these resources are utilized suboptimally. We, therefore, propose formalization of sharing economy via proliferation of Islamic sharing institutions (ISIs) that collect the zakat, charity and waqf from haves and pool in an endowment fund. Further, ISIs also raise investment capital through equity capital and mudharabah and so on. Then ISIs identify the have-nots and SMEs to provide the consultancy, training and the required capital (as qard-ehasan or mudharabah, musharakah, etc.) to start/expand their entrepreneurships followed by monitoring and recovery. We elaborate that through this process the society will observe increase in religious, psychological, social, human and physical capital. Increase in the first three capitals will harness harmony, compassion and brotherhood that will also help increase human capital that is likely to increase total factor productivity. Further, increase in human and physical capital will increase economic output transforming takers into givers over time. Based on this conclusion, our policy suggestion is to create ISIs and empower them to collect zakat, charity and waqf along with investment capital. These ISIs will then have a pool of funds, and to better utilize these funds, ISIs can utilize Islamic financial instruments (qarz-e-hassan, mudharabah, musharakah, etc.). These funds will enable them to not only earn profit from mudharabah, musharakah and other transactions for their shareholders but also provide financial stability by risk-sharing and promote moral/social/cultural values by not financing those products/services that are haram/harmful. Consequently, it is expected that through this process the society will earn falah—in this world an environment of compassion and brotherhood that takes care of have-nots and Pleasure of Allah (SWT) in the life hereafter.

Notes 1. http://www.businessinsider.com/hundreds-of-suicides-in-indialinked-to-microfinance-organizations-2012-2?r=US&IR=T&IR=T 2. The box represents the stock of some resource. For example, physical capital. The arrows represent the causal links showing polarity (±) on the arrow/arrowhead. The equal sign on arrow indicates delayed effect. 3. https://www.oxfam.org/en/pressroom/pressreleases/2017-01-16/ just-8-men-own-same-wealth-half-world

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4. http://www.businessinsider.com/hundreds-of-suicides-in-india-linked-tomicrofinance-organizations-2012-2?r=US&IR=T&IR=T 5. “But those who devour riba become like the one whom Shaitaan has bewitched and maddened by his touch. They have been condemned to this condition because they say, ‘Trade is just like riba’, whereas Allah has made trade halaal and riba haraam. Henceforth, if one abstains from taking riba after receiving this admonition from his Lord, no legal action shall be taken against him regarding the riba he had devoured before: his case shall ultimately go to Allah. But if one repeats the same crime even after this, he shall go to Hell, where he shall abide forever! Allah deprives riba of all blessing and develops charity, and Allah does not like an ungrateful, sinful person.” (2:274–276) 6. “Do not usurp one another’s property by unjust means, nor offer it to the judges (as bribe) so that you may devour knowingly and unjustly a portion of the goods of others.” (2:188) 7. “Woe to those that deal in fraud. Those who, when they have to receive by measure from men, exact full measure. But when they have to give by measure or weight to men, give less than due. Do they not think that they will be called to account? On a Mighty Day. A Day when (all) mankind will stand before the Lord of the Worlds?” (83:1–6) and “Give full measure when ye measure and weigh with a balance that is straight: that is the most fitting and the most advantageous in the final determination” (17:35) and “And O my people! Give just measure and weight, nor withhold from the people the things that are their due: commit not evil in the land with intent to do mischief.” (11:85) 8. “O you who have believed! Do not devour one another’s property by unlawful ways; but do business with mutual consent” (4:29) and “Come not nigh to the orphan’s property, except to improve it until he attains the age of full strength; and fulfill (every) pledge, for (every) pledge will be enquired into (on the Day of Reckoning).” (17:34) 9. “These are people who bartered true guidance for waywardness. Their commerce did not profit them, nor are they rightly guided.” (2:16) 10. “Indeed, mankind is in loss, except for those who have believed and done righteous deeds and advised each other to truth and advised each other to patience.” (103:2–3) 11. “Those who have purchased the present life in exchange for the afterlife, for them punishment shall not be lightened, nor shall they find any to help them.” (2:86) 12. “O believers, shall I point you to a commerce that will save you from a painful torment? That you believe in God and His Messenger; that you exert yourselves with your wealth and persons. This would be best for you, if only you knew.” (61:10)

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13. “Those who recite the Book of God, who perform the prayer, who expend of what We provided them, secretly and in the open—these can expect a commerce that will never fail. He shall pay them their wages in full and increase His favors upon them. He is All-forgiving, All-praiseworthy.” (35:29–30) 14. “God has purchased from the believers their souls and their wealth and, in exchange, the Garden shall be theirs. They fight in the cause of God, they kill and are killed—a true promise from Him in the Torah, the Evangel and the Qur’an. Who is more truthful to his promise than God? So be of good cheer regarding that business deal you transact. That is the greatest of triumphs.” (9:111) 15. http://www.businessinsider.com/hundreds-of-suicides-in-india-linkedto-microfinance-organizations-2012-2?r=US&IR=T&IR=T 16. http://www.akhuwat.org.pk/

References Adler, P. S., & Kwon, S.-W. (2002). Social Capital: Prospects for a New Concept. The Academy of Management Review, 27(1), 17–40. Ahmad, Q. K. (2007). Socio-Economic and Indebtedness-Related Impact of MicroCredit in Bangladesh. Bangladesh Unnayan Parishad (BUP). Allen, F., et al. (2016). The Foundations of Financial Inclusion: Understanding Ownership and Use of Formal Accounts. Journal of Financial Intermediation, 27, 1–30. Arun, T., & Kamath, R. (2015). Financial Inclusion: Policies and Practices. IIMB Management Review, 27(4), 267–287. Azid, T., Al Rawashdeh, O. H., & Chaudhry, M. O. (2016). Social Justice, Market, Society and Government: An Islamic Perspective. In T. Azid & L. Sunar (Eds.), Social Justice and Islamic Economics: Theory, Issues and Practice. Routledge. ISBN 9781138558816. Beck, T., & De La Torre, A. (2007). The Basic Analytics of Access to Financial Services. Financial Markets, Institutions & Instruments, 16(2), 79–117. Beck, T., & Demirgüç-Kunt, A. (2008). Access to Finance: An Unfinished Agenda. The World Bank Economic Review, 22(3), 383–396. Beck, T., et al. (2009). Access to Financial Services: Measurement, Impact, and Policies. The World Bank Research Observer, 24(1), 119–145. Beck, T., et al. (2013). Is Small Beautiful? Financial Structure, Size and Access to Finance. World Development, 52(Supplement C), 19–33. Chakravarty, S. R., & Pal, R. (2013). Financial Inclusion in India: An Axiomatic Approach. Journal of Policy Modeling, 35, 813–837. Claessens, S. (2006). Access to Financial Services: A Review of the Issues and Public Policy Objectives. The World Bank Research Observer, 21(2), 207–240.

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Cracknell, D. (2012). Policy Innovations to Improve Access to Financial Services in Developing Countries: Learning from Case Studies in Kenya. Center for Global Development. Essama-Nssah, B. (2005). The Poverty and Distributional Impact of Macroeconomic Shocks and Policies: A Review of Modeling Approaches. Policy Research Working Paper No. 3682. Washington, DC: World Bank, p. 77. Honohan, P. (2008). Cross-country Variation in Household Access to Financial Services. Journal of Banking & Finance, 32(11), 2493–2500. Hussain, I. (1997). Pakistan: The Economy of an Elitist State. Pakistan: Oxford University Press. Kostov, P., et al. (2015). Access to Financial Services: The Case of the ‘Mzansi’ Account in South Africa. Review of Development Finance, 5(1), 34–42. Meadows, P., et  al. (2004). Social Networks: Their Role in Access to Financial Services in Britain. National Institute Economic Review, 189(1), 99–109. Naceur, B., et al. (2015). Can Islamic Banking Increase Financial Inclusion? IMF Working Paper WP/15/31. Middle East and Central Asia. Oxfam. (2017). An Economy for the 99%. Pedercini, M., & Qureshi, M.  A. (2010). A Resource-based Approach to the Modeling and Simulation of Income Distribution: The Case of Pakistan. Journal of Income Distribution, 19(3–4), 65–87. Qureshi, M.  A. (2008). Challenging Trickle-Down Approach: Modelling and Simulation of Public Expenditure and Human Development—The Case of Pakistan. International Journal of Social Economics, 35(4), 269–282. Qureshi, M. A. (2009). Human Development, Public Expenditure and Economic Growth: A System Dynamics Approach. International Journal of Social Economics, 36(1/2), 93–104. Rabobank. (2006). Access to Financial Services in Developing Countries. Sterman, J. D. (2006). Learning from Evidence in a Complex World. American Journal of Public Health, 96(3), 505–514. Zins, A., & Weill, L. (2016). The Determinants of Financial Inclusion in Africa. Review of Development Finance, 6(1), 46–57.

CHAPTER 9

Fintech and Financial Inclusion in Pakistan: An Exploratory Study Hassnian Ali and Rose Abdullah

9.1   Introduction Financial inclusion is an important element and motive of sustainable and inclusive growth which could unleash the wide and unseen potential of formal savings, investment propensities, proper household consumption, and investment inclination of the poorer strata of society. Financial inclusion is a process of conformity of access to efficient and reliable financial products and services, which include bank account, formal savings, insurance, and cheaper credit facility needed by unserved and underprivileged segments such as low-income groups and weaker sections at an affordable cost in a transparent and fair way by mainstream formal institutional entities (Raza et  al. 2015). There is clear evidence that financial inclusion

H. Ali (*) ICRIE, Minhaj University Lahore, Lahore, Pakistan R. Abdullah Faculty of Islamic Economics and Finance, Centre for Research and Publication, Universiti Islam Sultan Sharif Ali, Bandar Seri Begawan, Brunei Darussalam e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_9

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results in the reduction in poverty and inequality and thus it is vital for inclusive financial and economic growth (Clarke et  al. 2003). Financial system in developed countries is more inclusive as compared to less developed countries. Kendall et al. (2010) found that 81% of adults living in developed countries have formal bank accounts as compared to only 28% in less developed countries. Demirgüç-Kunt and Klapper (2013) mentioned in their study’s findings that seven countries, namely, the Philippines, China, Bangladesh, Pakistan, Vietnam, India, and Indonesia, encompass approximately 92% of the 1.5 billion unbanked people in emerging economies in developing Asia. The digital revolution that started and has been occurring since the middle of the last century is typified by a fusion of technologies and cyber-­ physical systems that are blurring the lines between the economic, financial, physical, biological, and digital spheres. During the last five years, terms like digital finance, including digital payments, digital and mobile wallets, Fintech, and so on, and digital financial inclusion have been introduced and have gained attraction and have become important topic of discussion among stakeholders, financial industry experts, policymakers, governments, regulators, and also customers as well. A global firm McKinsey & Co published a report on digital finance and digital financial inclusion that explains the definition of both terms. Digital finance means “financial services delivered via digital channels including mobile and internet with rare use of cash and traditional bank branches.” The report also defines digital financial inclusion: “digital financial inclusion to mean offering people with digital financial services. This can be providing services to those who are currently unbanked as well as giving currently underprivileged and underserved individuals and businesses access to a wider and more appropriate set of digital finance products” (Manyika et  al. 2016). Digital financial inclusion can also be defined as “digital access to and use of formal financial services by excluded and underserved populations. Such services should be suited to the customers’ needs and delivered responsibly, at a cost both affordable to customers and sustainable for providers” (CGAP 2015). Fintech has become one of the most dynamic, engaging, and energetic segments of the financial services marketplace. Fintech in the etymological and general perspective is the compound of two independent words finance and technology; it is not a buzzword. “Fintech is used to describe a variety of new and innovative business models and emerging and advanced technologies that have the potential to transform the financial

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services industry.” New and innovative Fintech business models exclusively offer one or more specific financial products or services in an automated way through the use of the Internet and digital channels. By adopting digital channels, they unleash the various financial products and services traditionally served by service providers formal incumbent banks, brokers, or investment managers. Here, for example, robo-advisers offer automated investment advice; equity crowdfunding platforms intermediate share placements; peer-to-peer lending platforms intermediate loans; and social trading platforms offer brokerage and investing services. Emerging and advanced technologies such as machine learning, artificial intelligence, cognitive computing, and distributed ledger technologies (DLT) can be used to supplement both Fintech new entrants and traditional incumbents and have the potential to materially change the financial services industry (International Organization of Securities Commissions (IOSCO) 2017). Freedman (2006) describes financial technology as being concerned with building systems that model, value, and process financial products such as stocks, money, bonds, and contracts. This new and recent term is given to those companies, start-ups, and firms that are providing highly innovative and pioneering financial services or products with the combination of IT ventures or by using the latest technology itself. The basic difference between Fintechs and the bulk of regulatory financial institutions, including banks and other financial institutions, is the use of advanced, innovative, and digital technologies. The regulatory financial industry has large built-in information technology (IT) infrastructures, and the industry is spending a big part of revenues on IT. But, surprisingly the emerging Fintechs are the ones using more advanced technologies such as mobile phones, the Internet, Internet of Things (IoTs), blockchain, high-speed computing, and machine learning. By deploying these technologies, Fintechs are providing cheap and easy-to-access services, from transfers and trading to crowdfunding and so on, and operating largely outside of the banking regulations. Fintech has also great potential and importance for the Islamic finance industry due to its unique characteristics of low-cost, secured, and transparent operations, and so on. The Islamic Financial Services Board (IFSB) (2017) in their latest report on Islamic finance industry made a valuable addition and discussed Fintech and shariah compatibility and application to Islamic finance industry, regulatory issues, and financial inclusion. The report also claimed that Islamic Fintech could grow and develop rapidly in

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the jurisdictions where Islamic banking has attained systematic and reasonable importance. The level of financial inclusion is very low in Pakistan and it is considered among the least financially inclusive countries in the world. A larger proportion of the population is unbanked, having no access to formal or informal financial services. Given the high percentage (85%) of the population lacking access to formal financial services, financial inclusion is a dominant problem in Pakistan. The high cost of banking infrastructure prevents the dissemination of financial services beyond a small portion of the population. However, digital financial services offer a promising potential to overcome problems of reach and scale. Fintechs not only offer the means for digitization but also have a significant role to play in emerging markets with low financial inclusion as agreed by 92% of senior executives and 80% of middle managers in the FinTech Survey 2016 (Karandaaz Pakistan & FinSurgents 2017). Raza et  al. (2015) provided an overview of financial inclusion in Pakistan. Zulfiqar et  al. (2016) explained the determinants of financial inclusion and perceived barriers to financial inclusion and their implications for inclusive growth in Pakistan. Some studies in terms of digital financial inclusion also available on branchless banking, agent banking, and mobile banking and G2P payments and inclusive growth in Pakistan (see Kemal 2016; Zahid et al. 2017). There are vast theoretical and empirical studies available especially in context of Pakistan which do not discuss the financial inclusion directly, but these studies discussed subtopics which are somehow relevant with financial inclusion like the role of economic development to speed up the reduction of income disparities, poverty elimination, and economic stability (see Akhtar and Hussain 2015; Nenova et  al. 2009; Shahbaz and Islam 2011). Consequently, the aims of this chapter are to provide an overview of financial inclusion in Pakistan, to give a comparative analysis of Pakistan’s performance in information and communication technologies (ICT), and finally to explore the potential of Fintech applications and propose a pragmatic scheme to develop a Fintech ecosystem in Pakistan to achieve the goal of financial inclusion in the country. Therefore, the rest of this chapter will highlight the overview of financial inclusion in Pakistan and then discuss the current status of Pakistan’s performance in ICT and highlight the drawbacks. The next section will elucidate the concept of Fintech and its applications. The discussion will

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lead to exploration of the potential of Fintech applications and propose a pragmatic scheme to develop a Fintech ecosystem in Pakistan to achieve the goal of financial inclusion in the country before conclusion. The researcher has adopted mixed method which involves simple quantitative and comprehensive qualitative method within the exploratory studies to explore a concept and problematic phenomenon and finally to suggest a scheme as a solution of the existing problem. The qualitative research method is related to the gathering and collection of information about a concept, events, and things which are continuingly occurring or existing recently (Sandelowski 2000). The secondary data for this study has been taken from various sources such as Global Findex database, Global Competitiveness reports and Networked Readiness reports by World Economic Forum, research surveys and reports by different research organizations and centers such as World Bank, Bill & Melinda Gates Foundation, G20, McKinsey, IOSCO, PWC, Deloitte, and KPMG. Moreover, data for Pakistan has been retrieved from reports, strategies and surveys produced by national authorities including Pakistan Telecommunication Authority (PTA), Ministry of IT (MOIT) and Ministry of Finance (MOF) and State Bank of Pakistan (SBP).

9.2   Overview of Financial Inclusion in Pakistan Pakistan has a very low level of financial inclusion where only one-fifth of adult population has access to formal bank accounts. Table 9.1 provides the indicators of financial inclusion for Pakistan. It also explains the comparison score of each indicator with respect to South Asia and lower middle-­income countries. The first indicator shows that just 13% of adults have formal bank account in Pakistan in comparison with South Asia and middle-income countries, that is, 46.4% and 42.7%, respectively. A very low percentage of females (4.8%) in Pakistan have a bank account as compared to an average of 37.4% in South Asia. In Pakistan, only 11.2% of the poorest quartile have a bank account as compared to 38.1% in South Asia and 33.2% for lower middle-income countries. Merely 12.4% of the rural population have an account as compared to overall 43.5% in South Asia. Just 2.9% of adults in Pakistan use debit cards, compared to overall 18% in South Asia and 21.2% in lower middle-income countries. Only 3.3% of Pakistani adults continued saving at a financial institution during the previous year, while the percentage of individuals saving at a saving club or person outside family is 11.4%. The percentage of adults saving at a

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Table 9.1  Indicators of financial inclusion in Pakistan Pakistan

South Asia

Lower MYC∗

Bank account (% age 15 years +) All adult Women Adults belonging to the poorest 40% Young adults (% ages 15–24) Adults living in rural areas Access to financial institution account (% age 15+) Has debit card ATM is the mean mode of withdrawal Use of account in the past year (% age 15+) Used an account to receive wages Used an account to receive government transfers Used a financial institution to pay utility bills Other digital payments in the past year (% age 15+) Used a debit card to make payments Used a credit card to make payment Domestic remittances in the past year (% age 15+) Sent remittances Received remittances Saving in the past year (% age 15+) Saved at a financial institution Saved in savings club or person outside family Credit in the past year (% age 15+) Borrowed from a financial institution Borrowed from a family or friend Borrowed from an informal lender

13.0 4.8 11.2 13.2 12.4

46.4 37.4 38.1 36.7 43.5

42.7 36.3 33.2 34.7 40.0

2.9

18.0 31.1

21.2 42.4

1.4 1.8 0.4

3.5 3.1 2.7

5.6 3.3 3.1

1.0 0.1

8.5 2.6

9.6 2.8

15.7 24.8

10.7 12.2

14.2 17.8

3.3 11.4

12.7 8.8

14.8 12.4

1.5 34.0 5.3

6.4 31.4 10.9

7.5 33.1 8.5

Source: World Bank (2015) Inclusion database. ∗Lower MICs, lower middle-income countries

financial institution in South Asia and the lower middle-income countries is 12.7% and 14.8%, respectively; however, saving at informal sources is larger in Pakistan in comparison to South Asia (8.8%), pointing toward the existence of a large informal sector. Family or friends are a major source of borrowing, and the percentage of Pakistani adults borrowing from informal sources (34%) is greater than in South Asia (31.4%) and the average of lower middle-income countries (33.1%). Only 1.5% of Pakistani adults borrowed from a formal financial institution compared to 6.4% for overall

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South Asia. This shows Pakistan is lagging far behind other countries and South Asian region in relation to numerous dimensions of financial inclusion. The gaps are huge and demand immediate policy responses from the country leadership and policymakers (Zulfiqar et al. 2016). The available data shows the gaps and disparities among varied demographic groups regarding financial inclusion in Pakistan. Youth (aged 15–24) are the least financially encircled age group as only 5% of them are financially included. Financial inclusion is greater for urban population compared to population in rural areas. If we look at gender, males have higher financial inclusion as compared to females. Education appears to be an important factor in determining financial inclusion of individuals as 15% of individuals having secondary or higher level of education are financially included as compared to just 3% for people with primary or less level of education. The percentage of employed persons who are financially included is almost three times higher than those who are unemployed. Similarly, 11% of people above poverty line are financially included as compared to 6% of those who are below poverty line (SBP 2014). Table 9.2 summarizes the status of digital financial inclusion in Pakistan. This table provides the details of active digital stored-value account ownership among different demographics in Pakistan. This also highlights that there is very low level of digital financial inclusion in Pakistan. These tables clearly highlight that Pakistan is at critical stage regarding financial inclusion. People usage of digital channels is also cynical. The barriers in the way of financial inclusion highlighted in different studies are lack of awareness, lack of money, excessive informal economy, lack of products that cater the needs of consumers, distance, and already built trust on agents for financial transactions. The data also shows that gender disparities regarding financial inclusion in Pakistan are detracted because of male dominance in families, contemptuous culture within society, religious constraints, lack of opportunities of employment, and unavailability of safe environment in the market; unethical mental approach also prevails in society. It is no doubt, Fintech has been proven as a viable solution for majority of the abovementioned barriers and issues like distance problem, religious constraints, undesired products, and gender discrimination, lack of financing and funding for businesses, and so on in different regions, for example, China and India. In the context of Pakistan, Fintech can be a practicable solution to promote financial inclusion in Pakistan. But it demands true will of government leadership, policymakers, and regulatory bodies which

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Table 9.2  Active digital stored-value account ownership among demographics Main FSP indicator

Adults (15+) who have active digital stored-value accounts Poor adults (15+) who have active digital stored-­ value accounts Rural women (15+) who have active digital stored-value accounts Poor women (15+) who have active digital stored-­ value accounts Adults (15+) who have active digital stored-value accounts and use them to other financial services (beyond basic wallet, P2P, and bill pay) Poor adults (15+) who have active digital stored-­ value accounts and use them to other financial services (beyond basic wallet, P2P, and bill pay) Poor women (15+) who have active digital stored-­ value accounts and use them to access other financial services (beyond basic wallet, P2P, and bill pay) Rural women (15+) who have active digital stored-value accounts and use them to access other financial services (beyond basic wallet, P2P, and bill pay)

%

%

Base definition

Base n

Base n

8% 6000 5% 3074 3% 1745 3% 1426 3% 6000

8% 6000 4% 2893 3% 1829 2% 1426 3% 6000

2% 3074

4% 3102

All poor

0.7% 1426

0.4% 1426

All poor females

0.7% 1745

2% 1760

All rural females

All adults All poor All rural females All poor females All adults

Note: Digital stored-value accounts: accounts in which a monetary value is represented in a digital electronic format and can be retrieved/transferred by the account owner remotely. For this particular study, DSVAs include a bank account or NBFI account with digital access (a card, online access, or a mobile phone application) and a mobile money account Source: Intermedia (2016)

leads to the development of strong and better ecosystem for Fintech in the country. Fintech sector is purely based on digital channels, digital infrastructure, and high availability of ICT and the skills regarding ICT.  So, before explaining the potential of Fintech applications to promote the Financial inclusion in Pakistan and a pragmatic scheme to develop Fintech ecosystem in the country, it is important to provide an overview of digitization and ICT environment and comparative analysis of Pakistan’s performance in ICT.

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9.3   Information and Communication Technologies Environment in Pakistan Pakistan Telecommunication Authority (PTA) has recently reported that annual cellular subscribers by March 2017 are more than 139 million (70% of population) (Pakistan Telecommunication Authority PTA 2017). According to the GSMA report, Pakistan will have 17 million new unique subscribers by 2020 (GSMA 2017). The mobile broadband penetration has also improved from 3% to 16% (PTA 2016), but this is not satisfactory because approximately 84% of the population don’t have broadband subscription. This division of 16% and 84% among the population is not good for knowledge economy and it draws a big gap between innovation and economy (Team 2017). According to a Pakistan economy survey (2016–2017), which was published by the Ministry of Finance of Pakistan, telecom sector depicted positive growth during the first two quarters of FY 2016–2017. The survey also highlighted that the total teledensity had reached 72.36% by the end of March 2017 as compared to 70.81% at the end of last fiscal year. The reported Foreign Direct Investment (FDI) inflow in the ICT sector during the period of July 2016–March 2017 reached to USD 55 million. The subscribers of 3G and 4G LTE had expanded to 39.88 million by March 2017, registering 10.3 million new subscriptions to 3G and 4G LTE networks during July 2016–March 2017 (Govt of Pakistan 2017). According to the Ministry of Information Technology in Pakistan, there are more than 2000 IT companies and call centers in the country and the number is expanding each year. Pakistan has 300,000 English-­ speaking IT professionals having expertise in existing and emerging IT technologies and products. There are approximately 20,000 IT graduates and engineers being produced every year. Pakistan also has 14 software technology parks covering an area of one million square feet (Ministry of Information Technology MOIT 2017).

9.4   Comparison of Pakistan Performance in ICT in the Years 2015 and 2016 The numbers mentioned in the above section mostly are taken from the reports and policies published by national institutions, including the State Bank of Pakistan, Ministry of Finance, Ministry of IT, and Pakistan Telecommunication Authority. In this section comparison has been made

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by using data of two years (2015–2016) to evaluate the real performance of Pakistan in ICT. For this data has been taken from the World Economic Forum’s Networked Readiness Index (NRI) that measures the performance of the country in ICT based on four indices: the environment for ICT, the readiness of a society to use ICT, the actual usage by all main stakeholders, and the impact that ICT generate in the economy and in society. Table 9.3 gives a comparison for the years 2015 and 2016 of networking readiness and status of ICT indicators for Pakistan. First, the table shows the overall rank and value for the four main subindexes, that is, environment subindex which comprises two pillars, readiness subindex which comprises three pillars, usage subindex which has also three pillars, and last impact subindex which comprises two pillars. Pakistan has moved to rank 110 out of 138 in 2016 from 112 out of 143 in 2015. It means Pakistan is still lagging behind in ICT developments and needs huge improvements in different segments. The table shows the first subindex which addresses the environment of ICT in two perspectives: political and regulatory environment and business and innovation environment. In this Table 9.3  The current networked readiness for growth and jobs Rank (out of 138) Score (1–7) Networked Readiness Index 2016 (out of 138) Networked Readiness Index 2015 (out of 143) Networked Readiness Index 2014 (out of 148) A. Environment subindex 1st pillar: Political and regulatory environment 2nd pillar: Business and innovation environment B. Readiness subindex 3rd pillar: Infrastructure and digital content 4th pillar: Affordability 5th pillar: Skills C. Usage subindex 6th pillar: Individual usage 7th pillar: Business usage 8th pillar: Government usage D. Impact subindex 9th pillar: Economic impacts 10th pillar: Social impacts

110 112 111 2016 115 128 98 104 126 1 127 118 123 110 103 105 105 106

2015 117 121 97 109 119 49 133 118 123 94 110 105 102 108

3.4 3.3 3.3 2016 3.4 3.0 3.9 4.0 2.1 6.9 2.8 2.9 2.1 3.2 3.3 3.1 2.8 3.4

Source: The Global Information Technology Report 2016, World Economic Forum

2015 3.4 3.0 3.9 3.6 2.5 5.7 2.6 2.9 2.0 3.4 3.3 3.1 2.9 3.4

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subindex and its two pillars, the most critical is political and regulatory environment in which Pakistan stands at 128 out of 138. The details of this pillar show the reasons of this critical position; as in the section of Laws under the pillar of political and regulatory environment relating to ICT, Pakistan’s rank moves down to 117 from 114; in the section of efficiency of legal system in settlings disputes, its rank has moved down to 107 from 100, and  in judicial independence, it has  moved down to 82 from 67. This shows that Pakistan’s regulatory and political environment had not improve in 2016, and it is still not suitable and good for ICT. In business and innovation environment, Pakistan has made progress, and the numbers also show the improvements. Among other pillars, three need high attention: the first pillar is infrastructure and digital content, in which Pakistan lost 7 points in 2016 and stood at 126 out of 138; the second is skills, in which Pakistan gained 6 points in 2016 but still stood at 127th place out of 138; and the third is individual usage of ICT, in which Pakistan ranked 123 among 138 countries without gaining or losing any points in 2016. In other pillars Pakistan’s performance is not very satisfactory, and in most pillars Pakistan ranks between 105 and 110 out of 138 (World Economic Forum WEF 2015a, 2016a, b). These results are also supported by a recent report entitled “Digital Planet 2017” which provides the digital evolution index 2017 score for 60 countries, and Pakistan is one of them. This report evaluated the progress of digital economy in these countries across four main derivers: demand conditions, supply conditions, institutional environment, and innovation and change. Pakistan was in the fourth quadrant of watch-out countries who scored 1.69/4.0 and stood at the 56th position among the 60 countries (Chakrvorti and Chaturvedi 2017). This comparison shows that Pakistan is still in the red zone with respect to ICT developments. Pakistan does not show satisfactory progress and improvement in the year 2016. The numbers highlight the dire need of effective legislation and regulations regarding ICT and more regulatory authorities should focus on the real implementation of the policies and laws. There is also need of consumer protection laws and act which will enhance the adoption and usage of ICT tools and instruments for individuals and businesses as well. The numbers also show that there is high demand of new skilled IT professional for Pakistan which also correlate with the demand for better digital infrastructure especially in the case of latest technologies. There is also a big gap between documentations, that is, policies and strategies and implementation. The government also failed

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in achieving targets mentioned in policies and strategies. These points are also highlighted in different studies which support the above results (see AdeelAnjum et al. 2012; Fraz 2015; ICMA 2015; Kanwal 2017; Naqvi and Bashir 2015; Shaukat et al. 2009; Team 2017).

9.5   Fintech and Its Applications and Financial Inclusion Fintech is a new and emerging industry, but it has gained importance in recent years. So, many countries, including developed and developing or emerged countries, started to adopt and embrace Fintech according to their strategies and goals. But one goal is common, that is, to promote financial inclusion through Fintech. The most active areas of Fintech are data and analytics, artificial intelligence, digital payments, digital currencies, crowdfunding, and other forms of peer-to-peer (P2P) financing. The market intelligence platform VB Profiles, based in San Francisco, found that over 1200 Fintech companies raised over USD 105 billion in total funding and having worth of nearly USD  870 billion in current value. According to the VB Profiles’ report, the major global hubs leading the Fintech growth are California having 219 companies, the UK (133), New York (95), and France (55) (VB Profiles 2016). The Fintech sector in Asia is also growing speedily, India with 49 as a leader and China with 31 due to their big population size and a fast-rising middle class. Australia is also a growing hub for the growth of Fintech companies (24) because of its friendly regulatory environment (FintechNews 2016). New entrants and emerging Fintechs will not only unbundle new innovations leading in a series of large-scale behavioral changes but also reinvent the linkage individuals have with their money. It is observed that this change will be most pronounced in new and emerging markets (Karandaaz Pakistan & FinSurgents 2017). The potential of Fintech to use current technology due to the presence of fewer legacy systems, combined with the potential to bring about greater financial inclusion, access to capital, and economic growth, has led many emerging markets to place significant emphasis on efforts to spur developments in this area (International Organization of Securities Commissions [IOSCO] 2017). The following section discusses the applications of Fintech and their potential to promote financial inclusion and also highlights the opportunities for Pakistan.

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9.5.1  Digital Payments Digital payments can be defined as noncash transactions processed through digital channels and include digital commerce, mobile payments, and P2P money transfers. Among the different regions, the US accounted for 29% of the global digital payment, followed by China, which led mobile payment transaction value with USD 467.7 billion in 2016. Statista forecasted that the US mobile payments will grow at an annual rate of 62% between 2016 and 2021. Digital payments were one of the main derivers of all Fintech transaction values that accounted 85% in 2016 (Statista 2016). The PwC Market Research Centre forecasts that the number of noncash transactions will also grow by 69% from 2013 to 2020 and that the transaction value in one minute will be one million (PricewaterhouseCoopers 2016). An empirical study in rural Niger elucidated that payments done by digital means saved an average time of one-hour travel time and more than three hours of waiting time per transfer (Aker et al. 2016). Digital payments provide mental relaxation to the daily workers like teachers and health workers; for example, an empirical study in India shows that the rate of attendance of teachers is 90% in states having reliable and efficient digital salary payment facility, but only 60 to 80% in other states (McKinsey & Co 2010). Digital payments also provide an opportunity to governments of potential cost savings at larger scale. A case study of Mexico conducted by a firm named “Better Than Cash” shows that the Mexican government’s transformation to digital payments (started in 1997) trimmed its spending on pensions, wages, and social welfare by 3.3% annually, or nearly $1.3 billion (Babatz 2013). In a comprehensive report with the title “The Opportunities of Digitizing Payments” prepared by a collective effort of the World Bank, Bill and Melinda Gates Foundation, Better Than Cash Alliance, and Global Partnership for Financial Inclusion (CPFI) of G20, dozens of empirical studies have been cited as evidence that prove the benefits of digital payments for governments and formal financial industry including banks, nonbank, and so on and also for end customers. This report elucidates that digital payment is a first entry point for unserved, unbanked, and poor people to enter into the formal financial system (Global Partnership for Financial Inclusion (CPFI) et al. 2014). In Pakistan the digital payment infrastructure is expanding continuously with the number of plastic cards reached at 37.1 million from 36.2 million which depicted a growth of 2.5% compared to previous quarter.

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Out of these cards, 47%, 28%, 21%, 3%, and 1% are debit cards, social welfare cards, propriety/ATMs only cards, credit cards, and prepaid cards, respectively. Banks have started issuing PayPak (Pakistan’s first domestic payment scheme) cards to their customers. Point-of-sale (POS) machines’ network has also expanded from 52,062 to 52,854, depicting a growth of 1.5% as compared to the previous quarter, and for every 100,000 adults in Pakistan, there are 40 POS in the country (SBP 2014). Table 9.2 shows that just 8% Pakistanis have active digital stored accounts; thus, the volume of digital is also minute. The Fintech sector can foster the trend of digital payments which leads to addition of more people in the mainstream of financial services. 9.5.2  Crowdfunding and P2P Lending Crowdfunding and P2P lending are vigorous and interesting segments of Fintech for lenders due to the potentially high returns, simplified application process, and quick lending decisions, but these are linked with high risks because of limited guarantee of the amount repaid. According to Morgan Stanley, it is expected that marketplace lending will be accounted to $290 billion by 2020, averaging 51% growth per year (Coraggio 2017). Schweitzer and Barkley (2017) analyze the characteristics and attributes of businesses that take loans from online lending platforms, based on the 2015 survey. The authors conclude that these borrowers have the same attributes and characteristics to those businesses that were not served for credit from a formal bank, and their findings are connected with the argument that the unserved businesses turned from formal banks and went to Fintechs providing online lending services to arrange credits for businesses. Jagtiani and Lemieux (2017) conclude their study that there are many evidences which show that Fintech lenders are filling the credit gaps by providing risk-priced loans to the businesses who were not served by the formal banks. Crowdfunding and P2P lending include conventional crowdfunding and P2P lending having inherent character of interest and fixed profit and also Islamic crowdfunding and P2P lending having inbuilt attributes of risk sharing or charity and donations including mudharabah, musharakah, Qard-e-Hassan, cash waqf, and temporary cash waqf. Ethis Crowd is the world’s first real estate Islamic crowdfunding platform that facilitates funds to real estate projects. Now, the platform has a community of 17,000 private investors that fund and invest in business, entrepreneurial, and real

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estate activities in Asia. The platform has completed the real estate project of building houses in Indonesia which has been crowdfunded USD 2.2 million in its first 20 months (Ethis Crowd 2016). In Pakistan the situation of lending and credit growth from formal financial institutions is not just staggering but it has slowed down. According to SBP, credit to private segment has reduced significantly during the last five years; this leads to decline in contribution of private sector to GDP from 22% in 2009 to only 14.7% in June 2014. The SMEs lending from banks also fell from 16% in 2008 to only 7% in June 2014. The biggest sector of agriculture accounted for only 6% of the total lending; the same trend was seen in housing loans and other sectors (SBP 2014). According to the Global Competitiveness Report (2016–2017) published by the World Economic Forum, access to finance is one of the most problematic factors in Pakistan, and it stood fourth in the list of problematic factors, with a high score of 8.4 as compared to last year, which was 7.9 (World Economic Forum WEF 2015b, 2016a). P2P lending platforms offer financing to SMEs and start-ups that are traditionally not or less served by formal banks, as well as consumers (Milne and Parboteeah 2016). This shows the great potential of alternative platforms, including crowdfunding, Islamic crowdfunding, and P2P lending Fintechs in Pakistan. 9.5.3  InsureTech InsureTech is one the segments of Fintech addressing existing insurance and takaful opportunities, potential, and challenges. PWC’s survey shows that insurance companies are likely very much aware of the Fintech revolution: 74% of survey’s respondents deem Fintech innovations as a threat for their industry. PWC’s global survey in 2016 also depicts that 68% of insurance industry players are dealing with Fintech and have taken concrete steps to tackle the upcoming challenges and/or embrace opportunities. However, only the players that are most innovative ones have Fintech at heart and wanted to explore more active ways to participate in the ecosystem, such as incubators and venture funds (PricewaterhouseCoopers PWC 2016). Insurers are introducing lifestyle apps that give additional consumer value on a continuing and constant basis. The constant consumer involvement will begin to reshape price as the key buying criterion. By deploying smart contracts powered by blockchain customers and insurers

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can manage claims in a more transparent, responsive, and irrefutable manner. Some start-ups such as Blockstream, Everledger, and Tierion are working in this direction. Several companies such as insPeer, PeerCover, Friendsurance, and Lemonade are effectively using social media. Domotz as an Internet of Things solution for the connected home offers a platform for home insurers to rate risk and manage claims (Let’s Talk Payments 2016). In Pakistan the insurance coverage is only 7%, and the sector contributes merely less than 1% to national GDP. More than half of the uninsured population in the country has never bought insurance because they precepted it unaffordable and unbeneficial (Karandaaz Pakistan & FinSurgents 2017). This shows that InsureTech and TakafulTech can provide affordable and easy-to-use insurance products to the uninsured population of Pakistan by using digital channels. 9.5.4  Big Data Analysis and Cloud Computing Cloud computing has become an emerging, dynamic, and most discussable topic in both academia and industry. The US National Institute of Standards and Technology (NIST) has defined it as “as a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources that can be rapidly provisioned and released with minimal management efforts” (Hawes 2010). There are three major categories of cloud computing as services: infrastructure as a service (IaaS), platform as a service (PaaS), and software as a service (SaaS). These cloud services offer on-demand data access and ubiquitous communications. Cisco forecasted that cloud service providers (CSPs) will process more than three-quarters (78%) of workloads by 2018 (Cisco 2016). In TechTarget’s forecast, 80% of the financial services institutions will run on hybrid cloud architecture by 2018 (TechTarget 2016). Mobile cloud computing (MCC) is a new type of cloud computing which is basically a converged technology of mobile computing, cloud computing, and wireless technologies. By stepping into the era of 5G, mobile cloud computing (MCC) becomes a perfect match to further leverage the limitations of resources and locations for advanced networking services (Yan et al. 2017). A research firm International Data Corp (IDC) defines big data as “the intelligent economy produces a constant stream of data that is being monitored and analyzed. Social interactions, simulations, mobile devices, facilities, equipment, R&D, and physical infrastructure all contribute to the

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flow. In aggregate, this is what is called Big Data” (International Data Corporation (IDC) 2012). According to a report issued by a research firm International Data Corp (IDC), the market for big data technology and services will grow at a CAGR of 23% by 2019. The IDC further predicted that annual spending will also reach $48.6 billion in 2019 (Olavsrud 2015). The volume of data is growing exponentially, and it is expected that by 2020 there will be more than 16 zettabytes (16 trillion GB) of useful data (Turner et  al. 2014). The White House published a report on big data which explores that big data can be used to reveal or possibly reduce employment discrimination by promoting efficiency, ethics, and mechanisms for mitigating discrimination in employment opportunity. The White House’s report further shows that by using big data educational opportunities can be increased. Data and algorithms can potentially help law enforcement become more effective, transparent, and efficient (The White House 2016). The potential for big data is expected to impact all sectors, from healthcare to media, from energy to retail (Manyika et al. 2016). Banks can take potentially benefit from the alternative data sources and big data by making partnership with online Fintech lenders (Jagtiani and Lemieux 2017). There are many ways for financial services industry to achieve business advantages by mining and analyzing data. These include enhanced detection of fraud, retail customer service, and improvement of operational efficiencies. Many Fintechs are leveraging big data to provide more customer-­centric services. 9.5.5  Blockchain and Smart Contracts Blockchain is also called distribute ledger technology. It is a public ledger of business transactions. A blockchain network works as an intermediator in a decentralized system for the exchange of assets and information (Mainelli and Milne 2016). There are different kinds of potential, and existing activities in the blockchain revolution are broken down into three categories: blockchain 1.0, 2.0, and 3.0. Blockchain 1.0 is referred to currency, which involves the deployment of cryptocurrencies in applications related to cash, such as remittance, currency transfer, and digital payment systems. Blockchain 2.0 is referred to contracts, the economic, financial, and market applications using the blockchain technology that is more extensive than simple cash transactions, including stocks, bonds, futures,

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smart property, loans, titles, mortgages, and smart contracts. Blockchain 3.0 is referred to blockchain applications beyond finance, currency, and markets particularly in the areas of government, literacy, science, health, art, and culture (Swan 2015). According to Accenture report, blockchain is one of the most talked about topics in the present financial services industry. Ninety percent of banks’ executives are interested in blockchain, and currently their banks are exploring the use of blockchain in the payments’ industry. Moreover, this report also highlights the benefits of using this technology in payment industry; these are lower frictionless cost, shorter settlement time, reduce errors, new revenue opportunity, and lower administrative cost (Accenture 2016). More than 50 banks, including Barclays and JPMorgan Chase, have joined the R3 consortium (Kharif 2016). Santander, UniCredit, Reisebank, UBS, ATB Financial, CIBC, and the National Bank of Abu Dhabi all are working with Ripple’s technology, which deploys a distributed ledger of the sort that also underpins bitcoin. HSBC and State Street have successfully tested out blockchain in bond transactions in 2016, while the Bank of America announced a partnership with Microsoft to experiment with the system (Shen 2016). Fintech start-ups such as Chainalysis and IdentityMind Global are helping banks comply with KYC (Know Your Customer) and AML (anti-money laundering) regulations in the deployment of blockchain for banking services (Deloitte 2016a). The blockchain technology has a big potential beyond bitcoin such as in payment industry, trade finance, capital markets, insurance, and investment management. 9.5.6   Artificial Intelligence, Internet of Things and Robo-Advisors These emerging firms called Fintechs are leveraging client algorithms and information to develop automated portfolio allocation and investment recommendations tailored to the individual customers. They have coined the term “robo-advisors.” Clients can easily access robo-advice through digital user channels for low fees and sometimes free (Deloitte 2016b). Robo-advisors have the ability to eliminate behavioral biases and handle routine account maintenance without human involvement. Robo-advisors quickly attained market traction, overseeing $19 billion by the end of 2014. KPMG and CGI forecast that the number will hit to $2 trillion in

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assets by 2020 (patpatia & Association 2016). In addition, KPMG’s survey forecasts that 75% of survey’s respondents are interested in robo-­ advisor services (KPMG 2016). My Private Banking, a research firm, estimated that hybrid robo-services will rise by 2020 to a size of USD 3700 billion assets worldwide; by 2025 the total market size will be accounted to USD 16,300 billion (MyPrivateBanking 2016). A Japanese insurance company, Fukoku Mutual Life Insurance, is replacing more than 30 staff by using IBM Watson cognitive computing software robot known as Amelia which has the ability to understand the semantics of the language and can answer business queries like a human. The Japanese company has a plan to use Amelia to read medical documents that are used to assess payments. The robots will only calculate payment amounts but final decisions will continue to be made by a human (computerWeekly 2017). Artificial intelligence (AI) can help banks in their anti-money laundering or employee misconduct detection efforts by replacing costly functions that are currently done manually by humans (Arslanian 2016). According to the European Commission, the Internet of Things involves “[t]hings having identities and virtual personalities operating in smart spaces using intelligent interfaces to connect and communicate within social, environmental, and user contexts” (Atzori et al. 2010). IoTs in the last years has become a reality which allows people and things to be connected anytime, anyplace, with anything and anyone, ideally using any network/path and any service. The Internet of Things has a great impact on societies (Papadokostaki et al. 2017). The number of objects able to record and transmit data to other objects is continually growing. It is forecasted that the number of devices connected to the Internet will increase from 10 billion today to 50 billion by 2020 (Payvision 2016). The IoT could give retailers, sellers, and their banks access to real-time detail they need regarding things and goods in transit (Santander 2015). The above discussions and large number of studies show that Fintech has big potential in terms of providing immediate and secured digital payments, financing, and also investments to unserved or less served businesses, start-ups, and also unbanked segment and also can include more people in the ambit of insurance segment through InsureTech. Fintech sector is deploying and using latest technologies including big data analytics, clouds, IoTs, blockchain, and artificial intelligence to provide highly secured, instant, easy-to-access, easy-to-use, low-cost, and finally more customer-centric financial services and products. These technologies also promise protection of business and consumers alike by establishing secured

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and strong KYC and AML environment in accordance with the regulations of the targeted country and territory. Due to these characteristics, these technologies have great potential in Islamic finance industry to promote Islamic financial inclusion. Studies and reports also show that the central banks, regulators, and governments, around the globe, are embracing Fintech continuously to achieve the goal of financial inclusion which will be digital financial inclusion. But to gain these potential advantages of Fintech, there is a dire need and demand of well-established Fintech ecosystem in the region. The following section discusses the challenges in the way of building Fintech ecosystem in Pakistan and steps need to be taken by Pakistan to make a foundation of better Fintech ecosystem which finally leads to achieve the goal of Financial inclusion in Pakistan.

9.6   A Pragmatic Scheme “Five Points Agenda” for Pakistan Manyika et al. (2016) published a comprehensive report on digital financial inclusion in emerging markets. The report targeted seven emerging countries as case studies including Pakistan. This report highlights that digital finance has potential to provide access and add newly 93 million people in the ambit of financial inclusion in Pakistan, which will increase USD 263 billion and USD 23 billion in terms of new deposits and credit, respectively. It will also provide an opportunity to Pakistani government to save USD  7 billion by preventing leakage of tax and stopping illicit activities. It also has potential to create 7 million jobs in Pakistan and also can boost the percentage of GDP by 7% ($36 billion) until 2025. These benefits of digital finance look very big and optimal but can be gained by the joint effort of different entities in the country. Fintech can also play vital role to harness the abovementioned benefits of digital finance because of inherent digital nature of Fintech. The above report of McKinsey & Co categorically explained and declared that these expected benefits of digital finance can only be enjoyed by the emerging country where the leadership have true vision and will to deliver the nation and make the country economically stable and financially inclusive (Manyika et al. 2016). After reviewing and analyzing the wide literature including reports, surveys, working papers, strategic documents, policy papers, books, research papers, articles, and other available resources, it is concluded that

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the following five points or steps are most necessary and have great importance in establishing reliable and efficient and effective ecosystem of Fintech in particular and digital financial system in general in Pakistan. These points if implemented in practical sense can lead to financial, economic stability in Pakistan. The country can become a new hub of Fintech on the world map and finally can achieve the goal of financial inclusion. 9.6.1  Leadership with True Vision and Will Rotberg (2012) in his book Transformative Political Leadership writes, “Accomplished political leaders have a clear strategy for turning political visions into reality. Through well-honed analytical, political, and emotional intelligence, leaders chart paths to promising futures that include economic growth, material prosperity, and human well-being. Alas, such leaders are rare in the developing world, where often institutions are weak and greed and corruption strong.” The World Economic Forum’s Global Competitiveness Report (2016–2017) identifies corruption as the first out of five most problematic factors for doing business in Pakistan, followed by crime and theft, tax rates, access to financing, and government instability (World Economic Forum WEF 2016a). According to Corruption Perceptions Index (CPI) 2016 of Transparency International, Pakistan with the score of 32 is still among the countries with the most perceived corruption every year. Pakistan is facing a lot of political, economic, and social problems. The foremost reason for the grim situation of Pakistan is that its leadership has suffered from lack of true vision, long-term planning, and right strategy, making the country a hub of problems and issues (Beg 2015; Bhargava 1971; Hoor-Ul-Ain and Wajidi 2016; JAVAID 2010; Khan 2007; Latif 2013; Masood and Shah 2012; Nasr 1992; Shafqat 1999). There is the urgent need of leadership with true vision, strong will, and capability to deliver the nation and to solve the problems. Without the true leadership, the big vision can never be achieved and the country will continue being plagued with problems. The State Bank of Pakistan also categorically mentioned in National Financial Inclusion Strategy (2014) that industry cannot get benefits and achieve any target unless some fundamental issues are discussed and addressed. Among those major issues, SBP states that “[a]bsence of a clear mandate, leadership, technical expertise and resources at public insurance entities, and the weak technical

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capacity at the Ministry of Commerce that is responsible for industry policy and oversight of public entities” (see GPFI 2016; ICMA 2015; SBP 2014; World Bank 2014). There are 22 educational policies that have been introduced in Pakistan in different regimes from 1946 to present date, but none of them has achieved the documented targets. Still, Pakistan literacy rate is 58% and this is static at this point from the last four years (H.  Qadri 2017). To make any policy successful, and attaining the targeted goals, implementation and then monitoring, supervision, and accountability are important and necessary. Financial inclusion is a multifaceted and big target which has great impact on economic development and also on society at micro and macro level. Fintech ecosystem can play a vital role in bringing financial inclusion in Pakistan, but it cannot be done without the deliberate leadership who has really interest in the prosperity and progress of Pakistani nation. 9.6.2  Regulatory Sandbox for Fintech Policymakers have to promote and support innovation to get those benefits it enables, especially for financially excluded and underserved groups. They have also to identify new risks that will be an inevitable element of new innovations. These risks have to be addressed and mitigated. In this environment of digitization and Fintech, global policymakers are focusing on building strong cyber resilience in the financial markets to make them safeguard from illicit and unauthorized activities. Global regulatory authorities, bodies, and central banks have issued, some of them have proposed, regulatory sandboxes to give opportunities to incumbents, new entrants, start-ups, Fintechs, and innovators of testing and making trial of their products and services in the limited environment. These regulatory sandboxes are a step to minimize the legal uncertainty for incumbents and new Fintech start-ups and innovators that also will foster the adaptation to test and learn approach which finally leads to set rules for new products and business models. For Islamic Fintechs to provide shariah-compliant financial products, it is clearly mentioned in sandbox especially issued in Malaysia and Brunei that they have to fulfil the strong criteria of shariah compliance while using innovative business models and emerging technologies. Eleven countries, including the UK, Canada, Singapore, have live regulatory sandboxes for Fintech, and other countries like Dubai, India, Russia, and Switzerland have proposed form

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of regulatory sandboxes for Fintech (see Autoriti Monetary Brunei Darussalam AMBD 2017; Bank Negara Malaysia BNM 2016; Banking Technology 2016; Deloitte 2017; Ernst & Young EY 2016; Financial.net 2017; GPFI 2016). This shows that regulatory bodies, and central banks in the list of countries, understand the importance and need of the present era, which is the era of digitization and Fintech. They have issued regulatory sandboxes to create the environment of innovation that supports the adaptation of new business models and innovative products by using latest technologies. Pakistani policymakers should also take step and has to issue a sandbox for Fintech to create and build an ecosystem of Fintech that will support the incumbents and new innovators, start-ups, and Fintechs in testing the new products and business models. This will also be a big catalyst for the development of strong economy and financial industry and finally lead to the achievement of goal of digital financial inclusion in the country by providing access of formal financial services to 85% excluded population. The Ministry of IT issued a policy entitled “Digital Pakistan Policy” in which they mention about establishing the innovation centers for Fintech in major cities of the country (Ministry of Information Technology MOIT 2017). The issuance of regulatory sandbox exclusively for Fintech will be the milestone to achieve this target. 9.6.3  Digital Infrastructure and Latest Technologies Infrastructure is a backbone of any system including Fintech. The infrastructure that is needed includes availability of digital technologies, digital content, high-level penetration of mobile technology, access of the Internet, existence of proper electronic and digital payment system at large scale, and telecommunications. Big data, artificial intelligence, and clouds support information system in financial industry which is also the demand of digital financial inclusion (International Trade Administration ITA 2016). In Pakistan banks and mobile money providers are embracing and going toward the usage of digital technologies and channels to bring more efficiency in their operations and products. Meezan Bank Limited, which is one of the Islamic banks of Pakistan and has the largest network in the country, signed an agreement with VMware.inc, a global leader in cloud infrastructure and business mobility to meet the growing demands through IT (Business Recorder 2017). Pakistan has also very experienced

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and genius IT experts who have won big international awards in IT. Recently, Dr. Saeed Ul Hassan, an IT scientist and director of ITU’s Scientometrics Lab, has been decorated with Global Eugene Garfield Honorable Mention Award for Innovation in Citation Analysis (MIT Technology Review Pakistan 2017). But these numbers of activities and scientists are still very small in the population of 200 million people (for details, see World Economic Forum WEF 2016b). Pakistani government, authorities, and policymakers need to come up with suitable plans and policies with implementation of them. Otherwise, all things will remain in documents and none of the targets can be achieved. They have to equip the country with organized digital infrastructure and latest technologies. There must be need of providing access to digital technologies to the grossroot levels by establishing digital labs in schools, colleges, and universities. To harness the real benefits of Fintech and to achieve the target of financial inclusion, it is indispensable to develop the ICT infrastructure and fill the skills gap in the region. 9.6.4  Interoperability, Coordination, and Collaboration Interoperability, coordination, and collaboration are the important elements of any developed and successful ecosystem around the globe. This involves different governments and public and private sectors indigenously and outside the region. Public and private sectors can establish safe, secure, reliable, and affordable open and shared platform for digital payments, banking services, and other financial alternatives by converging themselves via digital channels especially by using blockchain-based shared ledger. This will work as the catalyst of financial inclusion and will also enhance the adoption of basic and primary financial services at a larger scale. This trend of interoperability, coordination, and collaboration is prevailing in the world. For example, the Postal Savings Bank of China (PSBC), China’s largest lender having branch network of 40,000 branches, has deepen cooperation with Ant Financial and Tencent in the Internet and mobile finance. Moreover, the online-only banks also align with Chinese Government’s policy by providing access of financial services to unbanked Chinese to promote financial inclusion (Duflos 2015). P2P lenders Jimubox, RenRenDai, and Minshengyidai and China Minsheng Bank are helping each other to manage and safeguard funds of investors (Ernst & Young EY 2016). The Dianrong.com and the Regional Bank of

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Suzhou set up collaboration agreement in 2014 in targeting small enterprises (Finextra 2014). There are numerous examples of this type that can be found around the globe. Currently, there are 12 players in Pakistan that have branchless banking licenses. These include UBL, MCB, HBL, JS Bank, Bank of Punjab, Meezan Bank, Tameer Microfinance with Telenor, Waseela Microfinance with Mobilink, U Microfinance with Ufone, Askari Bank with Zong, Bank Alfalah with Warid, and FINCA with Finja. But unfortunately, none has interoperability among their services and wallets (Karandaaz Pakistan & FinSurgents 2017). The government of Pakistan, policymakers, financial and ICT government authorities, Securities and Exchange Commission of Pakistan (SECP), banks including conventional and Islamic banks, nonbanks, banking agents, mobile money providers, and other public and private entities have to set a reliable, secure, and shared platform by using digital channels like blockchain, big data, and mobile and Internet technologies. 9.6.5   Awareness of ICT and Financial Literacy Many studies have one common conclusion that financial literacy plays a vital role in the economic development of the country and also has a huge impact on consumers’ behavior of managing savings, budget, income, investment, funds, and pensions (Gulati 2010; Hastings et  al. 2012; Kharchenko 2011; Landerretche and Martínez 2013; Lusardi and Mitchell 2013; Taft et al. 2013; Xu and Zia 2012). Some of them also shed light on financial literacy with the relation of financial inclusion. Their studies highlight that financial literacy and financial education affect the level and speed of financial inclusion in the region. Higher financial literacy boosts the depth of financial services among the people (Ramakrishnan 2011; Zulkhibri 2016). There are a number of studies that focused on financial literacy in Pakistan. These studies conclude that Pakistan is among those countries where the gap of financial literacy and usage of ICT is huge and acts as a big hindrance in the way of financial decision-making among household individuals, nonbusiness students, and institutions’ staff in the country. Studies also found that this is also a big determinant and works as an impediment in the way of financial inclusion in Pakistan. The lack of awareness of the usage of digital technologies or digital channels among households, females, and other individuals leads to the extreme low level

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of digital financial inclusion (see Table  9.3) in Pakistan (Aftab 1994; Ameen and Gorman 2009; Awais et al. 2016; Choudhry 2006; Ghaffar and Sharif 2016; Intermedia 2016; Zulfiqar et al. 2016). The above discussions categorically demonstrate that government leadership, policymakers, and financial institutions and educational institutions have to make strong and joint effort to promote financial literacy and awareness of ICT to achieve the target of establishing Fintech ecosystem and financial inclusion in the country. There is the need of suitable financial educational programs that should be organized for all segments of society. To promote awareness of ICT, the government can engage graduates in IT, software engineering, and computer science in different programs to educate the non-IT students in schools, colleges, and universities and also to educate general public about the usage of ICT.

9.7   Conclusions and Implications The gist of the whole discussion is that financial inclusion is an important element and has great impact at the micro and macro level of inclusive economic growth. It plays the vital role in the reduction of poverty, income inequalities, gender disparities, and informal economy in the poor stratum of community. The global economic and financial scenario is changing rapidly due to the influence of emerging technologies and innovative business models that leads to the emergence of a sector named Fintech. In terms of financial inclusion, Pakistan is one of the least financially inclusive countries in the world. It is also lagging behind the other countries of the same income level in the Asian region and outside. The barriers in the way of financial inclusion highlighted in different studies are lack of awareness, lack of money, excessive informal economy, lack of products that cater to the needs of consumers, distance, and already built trust on agents for financial transactions. The data also shows that gender disparities regarding financial inclusion in Pakistan are also detracted because of male dominance in families, the contemptuous culture within society, religious constraints, lack of opportunities for employment, and unavailability of safe environment in the market; an unethical mental approach also prevails in society. Studies show that Fintech has big potential to promote financial inclusion in terms of providing immediate and secured digital payments, financing, and also investments through crowdfunding and P2P lending to unserved or less served businesses, start-ups, and also unbanked segment

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and also can include more people in the ambit of insurance segment through InsureTech. Fintech sector is deploying and using latest technologies including big data analytics, clouds, IoTs, blockchain, and artificial intelligence to provide highly secured, instant, easy-to-access, easy-to-use, low-cost, and finally more customer-centric financial services and products. The central banks, regulators, and governments, around the globe, are embracing Fintech continuously to achieve the goal of financial inclusion which will be digital financial inclusion. Fintech has also great potential and importance for the Islamic finance industry due to its unique characteristics of low-cost, secured, and transparent operations, and so on. But elements like shariah compatibility and applications to Islamic finance industry, and regulatory issues, have to be focused. Islamic Fintech can grow and develop rapidly in the jurisdictions where Islamic banking has attained systematic and reasonable importance. Fintech ecosystem is developed with the availability of digital infrastructure, digital content, the latest and emerging technologies, and professional and skilled talent in ICT. A comparison of Pakistan’s performance in ICT shows that Pakistan is still in the red zone with respect to ICT developments. Pakistan does not show satisfactory progress and improvement in the year 2016. The numbers highlight the dire need for effective legislation and regulations regarding ICT and more regulatory authorities should focus on the real implementation of the policies and laws. There is also need of consumer protection laws and act which will enhance the adoption and usage of ICT tools and instruments for individuals and businesses as well. The numbers also show that there is high demand of new skilled IT professional for Pakistan which also correlate with the demand for better digital infrastructure especially in the case of latest technologies. There is also a big gap between documentations, that is, policies and strategies and implementation. The government also failed in achieving targets mentioned in policies and strategies. The cynical status of digital finance in Pakistan also supports the above results. It is no doubt that Fintech can boost the access of formal conventional and Islamic financial services alike to the unserved and ignored segment of the society in Pakistan. But to harness the potential advantages of Fintech, there is a dire need and demand of well-established Fintech ecosystem in the region. Firstly, Pakistan has to eliminate or reduce the most problematic factors of doing business, corruption is at the top of the list, in the country. Based on the findings and vast literature review, this study

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proposed a pragmatic scheme that encompasses a five-point agenda consisting of leadership with true vision; the regulatory sandbox for Fintech; digital infrastructure and latest technologies; interoperability, coordination, and collaboration; and awareness of ICT and financial literacy. This pragmatic scheme can be a milestone to make the foundation of a better Fintech ecosystem which finally leads the goal of financial inclusion in Pakistan.

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Milne, A., & Parboteeah, P. (2016). The Business Models and Economics of Peer-to-­ Peer Lending (No. 17). European Credit Research Institute ECRI. Ministry of Information Technology MOIT. (2017). Digital Pakistan Policy 2017. MIT Technology Review Pakistan. (2017). ITU Scientometrics Lab Director Wins Global Award. MIT Technology Review Pakistan. MyPrivateBanking. (2016). Robo Advisors are Gaining Popularity with High-­ Net-­Worth Investors. Naqvi, S.  M. M.  R., & Bashir, S. (2015). IT-Expert Retention Through Organizational Commitment: A Study of Public Sector Information Technology Professionals in Pakistan. Applied Computing and Informatics, 11, 60–75. https://doi.org/10.1016/j.aci.2011.11.001. Nasr, S.  V. R. (1992). Democracy and the Crisis of Governability in Pakistan. Asian Survey, 32, 521–537. Nenova, T., Ahmad, A., & Thioro Niang, C. (2009). Bringing finance to Pakistan’s Poor: A Study on Access to Finance for the Underserved and Small Enterprises (No. 48672). The World Bank. Olavsrud, T. (2015). IDC Says Big Data Spending to Hit $48.6 Billion in 2019 [WWW Document]. CIO. Pakistan Telecommunication Authority PTA. (2017). Telecom Indicators [WWW Document]. Retrieved October 1, 2017, from https://www.pta.gov.pk/index. php?Itemid=599 Papadokostaki, K., Mastorakis, G., Panagiotakis, S., Mavromoustakis, C.  X., Dobre, C., & Batalla, J. M. (2017). Handling Big Data in the Era of Internet of Things (IoT). InAdvances in Mobile Cloud Computing and Big Data in the 5G Era (pp. 3–22). Springer. patpatia & Association, C. (2016). Beyond Robo-Advisors: Using Technology to Power New Methods of Client Advice and Interaction. Patpatia & Associates, Inc. Payvision. (2016). The Mobile Payments Report 2016. Retrieved from https://www.payvision.com/the-mobile-payments-repor t-2016-anomnichannel-evolution PricewaterhouseCoopers. (2016). Payments in the Wild Tech World: Digitisation and Changing Customer Expectations. PTA. (2016). Annual Report: Pakistan Telecommunication Authority. Qadri, H. M.-D. (2017). Country Facing Leadership Crisis: Qadri. In The Nation. https://nation.com.pk/lahore/06-Jun-2011/Country-facing-leadershipcrisis-Qadri Ramakrishnan, D. (2011). Financial Literacy—The Demand Side of Financial Inclusion. Social Science Research Network. h ­ttps://papers.ssrn.com/ abstract=1958417 Raza, M. S., Fayyaz, M., & Syed, N. (2015). Overview of Financial Inclusion in Pakistan. International Journal of Management Science, 6, 572–581.

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Rotberg, R. I. (2012). Transformative Political Leadership: Making a Difference in the Developing World. University of Chicago Press. Sandelowski, M. (2000). Focus on Research Methods-Whatever Happened to Qualitative Description? Research in Nursing & Health, 23, 334–340. Santander. (2015). The Fintech 2.0 Paper: Rebooting Financial Services. SBP. (2014). Pakistan National Financial Inclusion Strategy. State Bank of Pakistan SBP. Schweitzer, M.  E., & Barkley, B. (2017). Is ‘Fintech’ Good for Small Business Borrowers? Impacts on Firm Growth and Customer Satisfaction. Shafqat, S. (1999). Pakistani Bureaucracy: Crisis of Governance and Prospects of Reform. Pakistan Development Review, 38, 995–1017. Shahbaz, M., & Islam, F. (2011). Financial Development and Income Inequality in Pakistan: An Application of ARDL Approach. Journal of Economic Development, 36, 35. Shaukat, M., Zafarullah, M., & Wajid, R. A. (2009). Information Technology in Pakistan: An Analysis of Problems Faced in IT Implementation by Pakistan’s Banking and Manufacturing Companies. Pakistan Journal of Social Sciences, PJSS, 29, 13–22. Shen, L. (2016). Blockchain Could Start Making Some Real Waves the Banking Industry Next Year [WWW Document]. Fortune. Retrieved February 6, 2017, from https://fortune.com/2016/09/28/blockchain-banks-2017/ Statista. (2016). FinTech: Digital Payments. Swan, M. (2015). Blockchain: Blueprint for a New Economy. O’Reilly Media, Inc. Taft, M. K., Hosein, Z. Z., & Mehrizi, S. M. T. (2013). The Relation between Financial Literacy, Financial Wellbeing and Financial Concerns. International Journal of Business and Management, 8(11), 63. http://www.ccsenet.org/ journal/index.php/ijbm/article/viewFile/24940/16664 Team, M. (2017). Challenges of IT Sector in Pakistan; Comparing National and Punjab IT Policy Drafts 2016. More News. TechTarget, C. (2016). What Does Cloud Computing Look Like in 2016? (E-guide). The White House. (2016). Big Data: A Report on Algorithmic Systems, Opportunity, and Civil Rights. Washington, DC: White House Office. Turner, V., Gantz, J. F., Reinsel, D., & Minton, S. (2014). The Digital Universe of Opportunities: Rich Data and the Increasing Value of the Internet of Things. IDC Analyze the Future, 5. VB Profiles. (2016). FinTech Landscape [WWW Document]. VB Profiles. Retrieved August 28, 2017, from https://www.vbprofiles.com/l/fintech World Bank. (2014). Global Financial Development Report 2014: Financial Inclusion. World Bank. World Bank. (2015). The Little Data Book on Financial Inclusion 2015. World Bank Publications.

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CHAPTER 10

Financial Inclusion for Farmers Through Appropriate Financing Products: Analytic Network Process Approach Dika Megantara and Anita Priantina

10.1   Introduction The agricultural sector has an important role in the economic process in Indonesia. When the economic crisis in 1998 destroyed various business sectors, agriculture was a sustainable sector and still made a significant contribution in the national development (Arifin 2004). Agriculture was a lifesaver when the Indonesian economy suffered from a prolonged economic crisis. Indonesia is an agrarian country with a population of 265 million people in 2017 (US Census Bureau 2017). Most of the population are farmers. Based on the Central Bureau of Statistics data, almost as many as 37.75 million people (roughly 33% of the population) work as farmers (Badan Pusat Statistik 2015).

D. Megantara PT BPRS Al Salaam Amal Salman, Bogor, Indonesia A. Priantina (*) Institut Agama Islam Tazkia, Bogor, Indonesia e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_10

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However, most farmers in Indonesia are still constrained in accessing capital sources. Banks are less interested in financing the agricultural sector. The agricultural sector is deemed as highly risky, because of its dependency on natural factors such as climate and the high exposure to natural disasters such as floods, droughts, pest attacks, and other rice diseases or rice price uncertainty itself. On the other side, the total financing portfolio of Islamic bank has always been increasing. However, compared to other sectors, the agricultural sector only gets 4% of the total amount of financing. Together with forestry and agricultural facilities, the composition of financing from Islamic bank constituted only 5.56% in 2015 (Fig. 10.1). The access to financing for farmers is significantly low despite having a very strategic role in the national economic development. Ashari and Friyanto (2006) adds that agriculture has been a labor absorber and has significant contribution to gross domestic product, foreign exchange, industrial raw materials, food and nutrition sources, and drivers of other real sectors of the economy. The very limited access to financing has threatened the food security. The agricultural sector has been increasingly displaced by other sectors, with higher agricultural land conversion. Hendrastomo (2011) argues that the impartiality of industrialization in the agricultural sector is exacerbated by the implementation of land transfer for the construction of factories for the acceleration of the manufacturing industry. Various Financing Composition of Islamic Bank others social services business services transport, cargo storage and Communication trade,restaurants, and hotels construction water,gas, and electricity manufacturing mining Agriculture, forestry, and agricultural facilities

42.53% 9.37% 9.21% 1.39% 24.62% 6.18% 0.13% 0.90% 0.12% 5.56%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Fig. 10.1  Financing composition of Islamic bank in November 2015. (Adapted from OJK 2015)

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labor-­intensive projects are underway to build infrastructure to promote industrial growth. Other than causing food security problem, conversion of agricultural land followed by the establishment of new factories and real estate raises new problems of water resources. Access to water needs more struggle; the river is no longer able to provide for the need for agriculture irrigation in the dry season. Land use for nonagricultural purpose reaches 110,000 hectares annually (BPS 1998–2002). It decreases agricultural production. Programs initiated by the government such as rice self-sufficiency become very expensive and the agricultural productivity is decreasing due to land conversion (Hendrastomo 2011). There is one extraordinary Baitul Maal Wat Tamwill in Demak, one regency in Central Java, Indonesia, which offers a financing mode which is to be paid after harvest. Ninety percent of the financing portfolio is channeled to the agricultural sector. BMT As Salam offers mode of financing which is to be paid after harvest. Farmers who are eligible to receive the financing will return the principal after harvest, while margin can be paid after harvest or monthly. The various repayment systems applied by BMT As Salam are adjusted to the condition of the local farmers. The total members of BMT As Salam in 2016 amounted to 4982 people, spread across one head office and four branches. This unique feature of financing could be the appropriate solution for the food security problem in Indonesia. To be adopted in other Islamic financial institutions (IFIs), this research will analyze the benefit, opportunity, cost, and risk (BOCR) elements of the financing to be paid after harvest.

10.2   Research Objectives The objectives of this study are as follows: 1. To analyze the benefits, opportunities, costs, and risk of financing to be paid after harvest. 2. To analyze the priority of each element of the benefits, opportunities, costs, and risk of financing to be paid after harvest. 3. To analyze the priority of alternative strategy to increase the financing to be paid after harvest in the short and long term.

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10.3   Sharia Financial Institutions 10.3.1  Theory and Concepts of Sharia Financial Institutions Islamic financial institutions (IFIs) are financial institutions that work according to the concept of sharia with the principle of profit and loss sharing as the main method (Amalia 2009). The structure of IFIs is classified into Islamic commercial bank, Islamic rural bank, and Baitul Maal Wat Tamwill. Each type may have different products and market share. However, the principle and instruments used in any sharia financial institutions should have no fundamental difference; the difference locates in the area of ​​operation only. The principles of IFIs in running their business are (Ridwan 2004): . Prohibition against riba (interest rate). 1 2. Because of the prohibition of interest, the depositors are investors. Therefore, there are uncertainty factors in the business, so the depositors and financing customers must share the business risk and at the agreed rate of return based on the profit, not the principal. 3. Money is not capital but will become capital if it has been exchanged with resources to carry out productive activities, so that money will have flow concept. 4. Prohibition against the behavior of speculation. 5. The principle of ta’awun, the principle of helping one another to improve living standards through economic and business cooperation mechanisms. 6. The principle of tijaroh (business), the principle of seeking profit in a manner justified by sharia. IFIs should be managed professionally, so as to achieve effective and efficient principles. 7. Besides being a business institution, Islamic financial institutions also perform the function of a social institution.

10.4   The Role of Sharia Financial Institutions in the Agricultural Sector The system of conventional financial institutions has several rules applicable (Antonio 2001): (1) Interest is determined in advance with the assumption that the activities funded should be profitable. (2) The

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percentage of profit is determined based on the loaned capital. (3) Interest payments shall remain valid without consideration of any reason. (4) Although profits increase, the amount of interest payments does not increase. The use of the interest system established at the start of the agreement makes this system highly avoidable for funding activities due to very high risks, so financing agricultural activities is not a primary target for optimizing the profitability. The agricultural sector requires a specific support institution. According to Arifin (2004), the recovery of the national economy can be done well if the agricultural sector is made as the leading sector with the improvement of financial institution operation as one of the most important supporting institutions. The agricultural sector is strongly influenced by natural factors that are beyond human control, and the output produced has perishable characteristics, various quantity and quality, and fluctuating prices. Therefore, Wulandari and Suroso (2004) propose that to help develop the agricultural sector, financial institutions should have three main principles: 1. Fair risk and profit sharing system, by taking the likelihood of profit and loss into account 2. Avoiding setting the amount of profit at the beginning of the agreement 3. Setting the profit share based on the amount of profit gained, not from the capital According to Ashari and Saptana (2005), to ensure a sense of justice for the agricultural business, it is necessary to create a discourse of alternative financing model that matches the characteristics of the business in the agricultural sector. There are several considerations for Islamic banks to give sharia financing to the agricultural sector: 1. Characteristics of financing in IFIs are in accordance with the conditions of the agricultural sector. Sharia financing scheme gives more sense of justice because profit and loss are shared. 2. Sharia financing scheme has been widely practiced by Indonesian farmers. Culturally, many farmers are familiar with systems such as maro1 and mertelu.2 These systems are in line with the principles of sharia (profit sharing). So with more intensive socialization, farmers will more easily understand the concept of Islamic financing.

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3. Agricultural business has a wide range. Enterprises in the agribusiness sector include several subsystems that are very wide, ranging from subsystem procurement facilities, cultivation, harvesting, postharvest, food processing to marketing the products. In all these subsystems, it is possible to use the sharia mode of financing. 4. Sharia financing products are quite diverse. The wide scope of business and commodities in the agricultural sector could be anticipated with sharia financing products that are also quite diverse. This allows customers to choose the type of sharia financing products according to the conditions and characteristics of their business. 5. Compliance level of farmers. Farming business is still mostly cultivated by some small farmers in the countryside, and generally they are very respectful of customs and rules of religion in everyday life. The existence of financing scheme in accordance with the teachings of religion is expected to emotionally facilitate farmers in accepting the system of Islamic finance. 6. Commitment of sharia banks to micro, small, and medium enterprises (MSMEs). Based on the data published by BI at the end of 2012, the share of MSMEs that get the funding of Islamic full-­ fledged bank and Islamic business unit has reached 72.3%. This indicates that sharia banks are more focused on financing the real sector (UMKM). 7. Business in the agricultural sector is a real business. This is in accordance with the principle of sharia financing that focuses on financing the real sector and avoiding the financing of a speculative nature.

10.5   Research Methodology 10.5.1  Profile of BMT as Salam BMT As Salam has the cooperative as the legal entity established after the Decree of Ministry of Cooperative No, 68/BH. Kop.11-03/X/2004. It was established on May 10, 2004, and was inaugurated as a cooperative legal entity on October 28, 2004. BMT As Salam expanded its network by establishing branch offices in Kramat Village, Dempet Village, and Demak. The capital of BMT As Salam comes from its own capital, from the principal savings of the members and mandatory savings, as well as from capital participation derived from the board of managers, supervisors, and staffs.

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BMT As Salaam also gets loaned capital from Revolving Fund Management Institution (Lembaga Pengelola Dana Bergulir; LPDB), the holding of the sharia cooperative (Induk Koperasi Syariah; Inkopsyah), and Islamic banks. 10.5.2  Data Source and Data Collection The data used in this study are primary data and secondary data. The study obtained secondary data from official websites such as the Bank Indonesia, the Financial Services Authority (Otoritas Jasa Keuangan: OJK), the Central Bureau of Statistics (BPS), and the Ministry of Agriculture. The primary data is obtained through: 1. In-depth interview to collect detailed information about the objects discussed in this study. 2. Expert and practitioner survey, which is data collection focused on the benefit, opportunity, cost, and risk aspects of the products. From the survey results, the authors obtained data for quantitative analysis in the framework of analysis formed from the results of in-depth interview. Table 10.1 is a list of experts and professionals who became respondents in this study. The data and information presented by experts and practitioners are then organized into a model. The data will be then analyzed using the analytic network process (ANP) utilizing the software “Super Decisions.” Table 10.1  Experts and practitioner respondents Respondents No. Name

Position

1 2 3 4 5 6 7

Subbranch Manager of Bank Jateng Jatibarang Former Head of Research and Development Division of BPPT Manager KSU (Koperasi Serba Usaha) BMT As Salam, Demak Farmer in Ciapus Branch Manager of BMT As Salam, Kramat Member of Farmers Cooperation in Ciapus Director of PBMT Ventura

Akhmad Farikhi Edi Santoso Hanafi Wanda Nur Salim Parman Saat Suharto Amjad

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10.5.3  ANP Method Saaty (2005) defines ANP as “[a] multicriteria theory of measurement used to derive relative priority scales of the absolute numbers from the individual judgments that also belong to a fundamental scale of absolute numbers. The analytic network process is a mathematical theory in decision-­making that is capable of analyzing the influence of an analytical process through assumptions to solve various forms of problems. This method is used in the form of completing pairwise comparisons between elements of the decomposition accompanied by a priority scale that produces the greatest priority influence. ANP is also able to explain the model of dependence factors and its feedback systematically. Decision-making in the ANP application is to consider and validate the empirical experience. The network structure used is benefit, opportunity, cost, and risk (BOCR), which makes it possible to identify and compile all the factors that influence the output or the resulting decision (Saaty and Vargas 2006). 10.5.4  BOCR Analysis According to Saaty and Vargas (2006), the relationship between benefit, opportunity, cost, and risk is influenced by common factors. The analysis of benefit, opportunity, cost, and risk (BOCR) is a priority analysis based on the result of the desired criteria calculation as the benefit and the unwanted criterion as the cost. In addition, there are also criteria based on future events, which may occur as a positive (opportunity) and things that can lead to risk (negative). According to Saaty (2001), in order to perform the analysis, the calculation is done by using the pairwise comparison method. The resulting decisions are divided into three parts: the scoring system, the merits of BOCR’s decision as a decision-making consideration, and the linkage network—the fact (objective) that makes an alternative decision more desirable than others (Fig. 10.2). BOCR network structure can also be divided into two clusters, namely, the positive and negative effects of the problems we examine. It can be seen in Fig. 10.3.

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Goals

Benefit

Opportunity

Cost

Risk

Fig. 10.2  ANP BOCR network structure. (Adapted from Ascarya 2012) Fig. 10.3  BOCR network structure. (Adapted from Ascarya 2012)

Goal

Criteria

Sub-Criteria

Alternative

This study uses the BOCR approach which is an analysis of the present and future conditions, and allowing the circumstances to occur. Therefore, the definition of aspect/solution/strategy criteria based on BOCR analysis are as follows: 1. Benefit (B), all aspects that can provide benefits or advantages for farmers and Islamic financial institutions from the financing to be paid after harvest 2. Opportunity (O), all aspects that are intended as a profitable opportunity in the future for farmers and Islamic financial institutions, especially Baitul Maal Wat Tamwill (BMT), the financing to be paid after harvest 3. Cost (C), any aspect that can cause burden or loss for farmers and sharia financial institutions, especially Baytul Maal Wat Tamwil (BMT), the financing to be paid after harvest 4. Risk (R), any aspect that is intended as a future adverse risk for farmers and sharia financial institutions, especially BMT, the financing to be paid after harvest

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Saaty and Vargas (2006) describe the results of some prioritized alternatives, derived from three outcomes: standard conditions obtained from B divided by C, pessimistic B divided by the product of cost and risk (C × R), and realistic (B × O) divided by (C × R) calculations. The best alternative is chosen with a high realistic value and the chosen alternative is considered as a decision determined from other alternatives. This realistic value is also similar to other Saaty (2001) theories where there are two types of calculation produced by BOCR: A. Additive negative formula: This formula is usually used to determine long-term priorities. The formula is: bB + oO − cC − rR. B. Multiplicative formula: This is equivalent to marginal cost/benefit analysis and commonly used to determine short-term priorities. Its formula is: BO divided by CR. Decision-making could use formula created by Emanuel and Cefalu (2002) which is typically used to determine short term and long-term priorities. The formula is: bB + oO + c(1 − C) + r(1 − R). 10.5.5  ANP Research Stages The ANP framework that will be designed can only be completed after the data as well as information about the preferences/comments/opinions are represented by experts/practitioners/regulators. The data used in this study is primary and secondary data. Primary data is obtained from in-­ depth interviews, while secondary data is extracted from previous studies. There are two phases of data collection. The initial phase is gathering both primary data which is obtained from in-depth interviews and secondary data which is extracted from previous studies. After the initial stage, data will be clustered in order to composea questionnaire. This questionnaire is designed to measure preferences/comments/opinions which are represented by experts/practitioners/regulators using the ratio scale from 1 to 9, as in Table 10.2. The research stages of ANP are depicted in Fig. 10.4.

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Table 10.2  ANP scale. (Adapted from Ascarya 2012) Verbal scale

Numerical scale

Extreme importance Very strong or demonstrated importance Strong or essential importance Moderate importance of one over another Equal importance

9 8 7 6 5 4 3 2 1

Data collection is done separately for each respondent

10.6   Analysis and Discussion 10.6.1  Problem Decomposition This stage of ANP method consist of identifying, analyzing, and simplifying the elements complexity into BOCR network. After conducting the literature review process and conducting interviews with several respondents in this study, the authors perform cluster division grouped into four clusters, namely, benefit, opportunity, cost, and risk (BOCR). The following is a list of explanation of aspects and clusters that the authors formulated:

1 Benefit (a) For IFIs/BMT • Generating Profit Sharing As any other mode of financing, this mode of financing generates profit sharing for the IFIs/BMT (Hanafi 2016). The difference is that the profit sharing generated does not harm the customers, in this case, the farmers. • Increasing Financing Portfolio The disbursement of this mode of financing will also increase the IFIs/BMT financing portfolio. As the number of farmers is significant, the increase will also be significant (Mançka 2012, Wulandari and Suroso 2004). • Minimizing Financing Default

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Preliminary Research Identifying problems

Literature Review and Indepths Interview

Research Questions What are benefit, opportunities, cost, and risk from financing to be paid after harvest?

How is the priority of the benefit, opportunities, cost, and risk from financing to be paid after harvest?

How is the priority of short term and long term alternative strategies?

Data Collection Constructing Model

Decomposing elements of benefit, opportunities, cost, and risk

Constructing Questionnaire

Validating Questionnaire

Distributing Questionnaires to Expert

Data Interpretation Pairwise Comparison

Constructing ANP Model

• Checking Consistency • Re-compare if there is inconsistency

Result Priority of benefit, opportunities, cost, and risk

Priority of each element under benefit, opportunities, cost, and risk

Priority of Short term and long term alternative strategies

Fig. 10.4  Stage of research using ANP. (Adapted from Ascarya 2012)

When the financing is installed monthly, while the farmers’ business do not yield return monthly, there are possible reasons for default (Thohari 2014). It could be because of lack of capital (other than added by financing from the IFIs/BMT), asset, or cash flow problem. When the financing repayment is due after harvest, the default could be minimized.

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(b) For Farmers and Society • Suitability to Farmers’ Need Several crop harvests are due in several months. Financing with monthly installments is not suitable with farmers’ mode of business. Financing to be paid after harvest is suitable for their needs (Nurmanaf 2006, Ashari and Saptana 2005). • Regressive Margin System BMT As Salaam has regressive margin system (Salim 2016). The bigger the financing amount, the less the profit sharing for the BMT. • Simplified Financing Mode Since the payment is due after harvest, not to be installed monthly, this system is simplified for farmers (Hanafi 2016). Even for those who do not have sufficient accounting ability, they can engage in this kind of financing. 2 Opportunity (a) For IFIs/BMT • Product Innovation When this kind of custom financing is implemented, there is possibility for other kind of custom financing (Ashari and Saptana 2005). For example, financing for fishermen as they also have daily and several days business process, not monthly as well. • Increasing Potential Customers The number of farmers in Indonesia is highly significant. From Sabang in Aceh until Merauke in Papua, farmers are everywhere. The potential to increase customers is also significant (Putra 2016). • Increasing Branch Offices As the number of farmers is significant, the success in this mode of financing could be duplicated in other area as well (Ashari and Saptana 2005). (b) For Farmers and Society • Alleviating Poverty According to the data of BPS, 33% of the population in Indonesia are farmers. With the additional data of change in land use, this kind of financing has potential role to alleviate poverty among farmers (Wulandari and Suroso 2004). • Increasing Infrastructure Some of the farmers are still having problems with irrigation system in Indonesia. They have to bear the cost by themselves. This is one of the significant costs they have to consider when finally choosing to sell their land. If access to finance is easy,

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farmers are confident to do farming business. Infrastructure will be then the next priority in order to be built (Mançka 2012). • Food Security When farmers are confident that agricultural business is promising, access to financing is easy, and infrastructure problems are settled, there will be no problem such as less supply compared to demand (Ratih and Prabatmodjo 2013). 3 Cost (a) For IFIs/BMT • Operational Cost IFIs/BMT faces problems in cash flow management if they distribute financing to be paid after harvest (Ashari and Saptana 2005). They will not get income monthly. Their routine monthly expense will be replaced by only once payment in the end of the financing duration. When they have routine monthly expenses, they will have to do extraordinary financial management. • Cost for IT IT is needed to operate the information management system of the institution, to execute the accounting system, and to monitor the progress of the financing process (Wulandari and Suroso 2004, Mastur 2006). • Less of Government Support So far, the government of Indonesia has distributed low rate credit to small and medium enterprises, farmers, and other low-­income communities. However, most financial aid was channeled to conventional banks which are considered as having more experience and more capital. (b) For Farmers and Society • Providing Collateral To anticipate moral hazard, the Islamic financial institutions still request collateral from the farmers (Nurmanaf 2006, Mastur 2006). • Less of Production Factor To be able to access the financing, farmers are required to have production factors to be in part submitted as the collateral (Mastur 2006, Wulandari and Suroso 2004). • Access to Financing For villagers, with limited infrastructure, such as transportation and railroad, to access the formal financial institutions is a separated problem (Wulandari and Suroso 2004, Nurmanaf

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2006). The number of Islamic financial institution is also limited compared to the conventional counterpart.

4 Risk (a) For IFIs/BMT • Financing Default The IFIs are exposed to financing default. It could be due to harvest default or moral hazard from the customers/farmers. To liquidate the collateral may take some time (Mançka 2012, Mastur 2006). • Capital Lost If default happen, the IFIs will lose the capital to equalize the lost born from the financing deposit (Wijayanti and Sumekar 2009). • Business Competition The IFIs have also business competition with other IFIs or with conventional counterpart (Mastur 2006). (b) For Farmers and Society • Losing Collateral/Harvest Default When the harvest defaults, the farmer will not be able to repay the financing, and if they do not have other assets in possession to be sold, they will have to lose their collateral (Wijayanti 2013). • Price Volatility Prices of several commodities such as paddy are set by the government. There is a minimum price set for this commodity (Ashari and Saptana 2005). • Market Risk Farmers are also exposed to market risk. It is related to competition with other competitor in the same field nationally and globally (Mastur 2006). Because of lack of supply, there are other international players in the market.

Overall, the ANP decomposition of this study is depicted in Fig. 10.5.

10.7   Geometric Mean Results of the BOCR Model The geometric mean shows that the ranking of the BOCR are (1) opportunity, (2) benefit, (3) risk, and (4) cost. The benefit and opportunity aspects each share the same weight, which is 0.385. The third priority is risk aspect with a value of 0.143 and the fourth priority is cost aspect with a value of 0.087.

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Financing to be Paid after Harvest

Benefit

Benefit

1. 2. 3.

1. Generating Profit Sharing 2. Increasing Financing Portfolio 3. Anticipating Moral Hazard.

Suitability to Farmers need Regressive Margin System Simplified Financing Access

Opportunity

Opportunity 1. Product Innovation 2. Increasing Potential Customers 3. Increasing Branch Offices

1. 2. 3.

IFIs/ BMT

Farmer/ Society

Cost

Cost 1. 2. 3.

1. Operational Cost 2. IT Cost 3. Less of Government Support

Alleviating Poverty Increasing Infrastructure Food Security

Providing Collateral Less of Production Factor Access to Financing

Risk

Risk

1.Losing Collateral 2.Price Volatility 3.Market Risk

1. Financing Default 2. Capital Lost 3. Business Competition

Alternative Strategies

1.

Agriculture Bank

2.

Optimizing Marketing Strategy

Fig. 10.5  ANP-BOCR network framework

3.

Linkage

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Overall, it can be concluded that the program is good because the benefit and the opportunity elements have more significant weight compared to the cost and risk elements. This implies that the program is recommended and it could be adopted in other Islamic financial institutions (Fig. 10.6). To see the weight of each node inside the aspect of the BOCR, all nodes from the BOCR for both IFIs and farmers are also ranked. Overall, the top priority is node ‘generating profit sharing’ which comes from benefit for IFIs/BMT aspect with a value of 0.188. The second priority with a value of 0.179 is node ‘suitability to farmers’ need’ which comes from benefit for farmers’ aspect. The third priority is node ‘operational cost’ which comes from cost for IFIs/BMT aspect (Fig. 10.7).

Priority of Benefit, Opportunity, Cost, and Risk W=0.27 0.143 0.087

4.RISK 3.COST

0.385 0.385

2.OPPORTUNITY 1.BENEFIT

0

0.1

0.2

0.3

0.5

0.4

Fig. 10.6  Priority of benefit, opportunity, cost, and risk elements 2.Price Volatility 3.Harvest Default

0.088

1.Capital Lost

0.106 0.113 0.114 0.119 0.127

0.085

2.Access to Market 3.IT Cost

0.094 0.086

1.Less of Support

0.092

2.Alleviating Poverty

0.154 0.155 0.113

0.070

3.Increasing Potential Customers

0.081

1.Product Innovation 2.Regressive Margin System

0.109

0.046

3.Increasing Financing Portfolio

0.150

0.117 0.135 0.179

0.100

1.Anticipating Moral Hazard

0.188

0.045 0

0.02

0.04

0.06

Fig. 10.7  Priority of all BOCR elements

0.08

0.1

0.12

0.14

0.16

0.18

0.2

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D. MEGANTARA AND A. PRIANTINA

Interestingly, the two lowest ranking overall also come from benefit aspect. They are anticipating moral hazard from benefit for IFIs/BMT and regressive margin system from benefit for farmers. Each value is 0.045 and 0.046. 10.7.1  Geometric Mean of Cluster Benefit For IFIs/BMT, the most important benefit is generating profit sharing. As the population of farmers is significant, the profit and potential profit generated are also significant. For farmers, the most important benefit is the suitability of the financing mode to their needs and to their mode of business (Fig. 10.8). The second and third priority of benefit aspect for IFIs/BMT are increasing financing portfolio and anticipating moral hazard. For farmers, the second and third priority of benefit are simplified financing access and regressive margin system (Fig. 10.8). Overall ranked from the cluster of benefit, the node ‘generating profit sharing’ is the top priority, which comes from benefit for IFIs/BMT. The second priority is suitability to farmers’ need and the third priority is simplified financing access; both come from benefit for farmers (Fig. 10.9). 10.7.2  Geometric Mean of Cluster Opportunity For IFIs/BMT, the most important opportunity generated from this mode of the financing is attracting more product innovation. The weight is 0.406. This kind of product is very unique and rare. Financing products are dominated by monthly instalment–based financing. It is understandable Priority of Benefit Elements for IFIs/BMT 0.565

0.6 0.2 0

W= 0.33 0.6 0.301

0.4 0.134 1.Anticipating Moral Hazard

Priority of Benefit Elements for Farmers/Society

3.Increasing Financing Portfolio

0.326

0.4 0.2

2.Generating Profit Sharing

W= 0.33

0.537

0

0.137 1.Suitability to 2.Regressive 3.Simplified farmers need Margin System Financing Access

Fig. 10.8  Priority of benefit elements for IFIs/BMT (left) and farmers (right)

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Priority of Overall Benefit 0.188

0.2

0.179

0.15 0.109

0.100 0.1 0.05 0

0.046

0.045

1.Anticipating 2.Generating Moral Hazard Profit Sharing

3.Increasing Financing Portfolio

1.Suitability to 2.Regressive farmers need Margin System

3.Simplified Financing Access

Fig. 10.9  Priority of overall benefit elements

since the money in the financial institution comes from the stakeholder and the depositors. The financial institutions have to also consider that they need to share the profit to the third party mostly in monthly basis. The success of this product will give another insight to bankers that nonmonthly instalment–based financing could also contribute to the profit generating. For farmers and the society overall, the most important priority is alleviating poverty. The weight is 0.451. In Indonesia, the number of farmers is significant; and whom are deemed as farmers are not only those who have land, but also those who do not have land and can only work for other bigger farmers with land. If those considered as bigger farmer sell their land because they do not have capital to manage the farming, they also close the job opportunity for those who do not have land (Fig. 10.10). The second and third priority of opportunity elements for IFIs/BMT are increasing potential customers and increasing branch offices. This implies that the financing to be paid after harvest could bring better financial inclusion in the future, especially for farmers (Fig. 10.10). On the other hand, the second and third priority of opportunity elements for farmers and society overall are food security and increasing infrastructure. When farmers get proper attention and get access to financing, the danger of food security problem will also be solved in the short,

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Priority of Opportunity Elements for Farmers/Society

Priority of Opportunity Elements for IFIs/BMT W= 0.18 0.6 0.4 0.2 0

0.406

0.350

0.244

W= 0.18 0.6

0.451

0.4

1.Product Innovation

2.Increasing Branch Offices

3.Increasing Potential Customers

0

0.338

0.211

0.2 1.Alleviating Poverty

2.Increasing Infrastructure

3.Food Security

Fig. 10.10  Priority of opportunity elements for IFIs/BMT (left) and farmers (right)

Priority of overall Opportunity 0.2 0.150 0.15

0.135 0.117

0.1

0.081

0.113 0.070

0.05

0

1.Product Innovation

2.Increasing Branch Offices

3.Increasing Potential Customers

1. Increasing Infrastructure

2.Alleviating Poverty

3.Decreasing Change in Land Use

Fig. 10.11  Priority of overall opportunity elements

medium, and long run. Furthermore, Indonesia is a big country—ranked the fourth most populated country after China, India, the United States.3 If there is any problem related to food security, the degree of severity could be very devastating. Overall, the most important opportunity is alleviating poverty, which comes from opportunity for farmers. The second and third priority are triggering more product innovation and increasing potential customers, both of which come from opportunity for IFIs/BMT (Fig. 10.11).

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10.7.3  Geometric Mean of Cluster Cost Operational cost is deemed as the most significant cost for the financier in conducting the financing to be paid after harvest. The IFIs/BMT has to bear additional cost which is monitoring of the financing. For rice farming, for instance, the monitoring of the financing should be done in three months, equal to the duration needed for the rice to ripe. To determine the eligibility of the customer, the banker should also conduct proper analysis process, as the payment is due to several months ahead. More interestingly, providing collateral is not deemed as the most important cost for farmers, but instead, it is access to financing. Most of the farming field and the houses of the farmers are relatively far from the banks and far from the center of economic transaction. This is also why traditional loan sharks still have their significant position among the villagers (Fig. 10.12). The second and third priority of the cost element for IFIs/BMT are less support from the government and IT cost. The second and third priority of the cost element for farmers/society are providing collateral and less of production factor (Fig. 10.12). Overall, the most important cost is operational cost, which comes from cost for IFIs/BMT. The second and third priority are access to financing and providing collateral, both of which come from cost for farmers/society (Fig. 10.13). 10.7.4  Geometric Mean of Cluster Risk From Fig. 10.14, it can be seen that the weight of each node in the cluster risk for both IFIs/BMT and farmers/society is quite similar. For IFIs/ BMT, the most important risk is capital lost, while for farmers the most important risk is losing collateral (Fig. 10.14). Priority of Cost Elements for IFIs/BMT 0.6

0.466

0.4

0.259

0.275

2.IT Cost

3.Less of Govt Support

0.2 0

0.6 0.4

0.463 0.281

0.256

1.Providing Collateral

2.Less of Production Factor

0.2 0

1.Operational Cost

Priority of Cost Elements for Farmers/Society

3.Access to Financing

Fig. 10.12  Priority of cost element for IFIs/BMT (left) and farmers (right)

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D. MEGANTARA AND A. PRIANTINA

Priority of overall Cost 0.2 0.155

0.154

0.15 0.094

0.092

0.086

0.1

0.085

0.05 0

1.Operational Cost

2.Cost for IT

3.Less of Govt Support

1.Providing Collateral

2.Less of Production Factor

3.Access to Financing

Fig. 10.13  Priority of overall cost elements

Priority of Risk Elements for IFIs/BMT 0.6 0.4

0.263

0.380

0.357

1.Financing Default

0.6 0.4

0.343

0.338

0.319

0.2

0.2 0

Priority of Risk Elements for Farmers/Society

2.Capital Lost

3.Business Competition

0 1.Losing Collateral 2.Price Volatility 3.Market Risk

Fig. 10.14  Priority of risk element for IFIs/BMT (left) and farmers (right)

The second and third priority of risk elements for IFIs/BMT are business competition and financing default, while the second and third priority of risk elements for farmers/society are price volatility and other market risk (Fig. 10.14). Overall, the most important risk is capital lost, which comes from risk for IFIs/BMT.  The second and third priority are business competition and losing collateral, each comes from risk for IFIs/BMT and risk for farmers/society (Fig. 10.15).

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Priority of overall Risk 0.2 0.127

0.15 0.1

0.119

0.114

0.113

0.106

1.Losing Collateral

2.Price Volatility

3.Market Risk

0.088

0.05 0

1.Financing 2.Capital Lost 3.Business Default Competition

Fig. 10.15  Priority of overall risk elements

10.7.5  BOCR Synthesis Results After the assessment stage of aspect criteria is done, then the next calculation is to determine the priority of alternative strategy. The results of the pairwise comparison for the strategy can be seen from the following graphs. In the short term, the most important strategy is linkage. The weight is 0.517. IFIs/BMT has not been able to play an active role in meeting the needs of the agricultural sector. It is expected that the linkage with government institution will be able to fulfill and expand the financing for agricultural needs. The second priority is optimizing the marketing strategy with a value of 0.387. The third priority is establishing a special agricultural bank, with a weight up to 0.096 (Fig. 10.16). Surprisingly, the priority for long-term strategy has the same ranking, with difference only in their weight (Fig. 10.17). The top priority is still linkage with government institution, with now a bigger weight of 0.622. As the market share of Islamic bank has not increased during the last five years, the role of government is still deemed as the most important. The second priority is optimizing marketing strategy and the third priority is establishing special banks for agricultural purpose, with a bigger weight of 0.128.

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D. MEGANTARA AND A. PRIANTINA

0.8 0.6 0.4 0.2 0

0.387

0.517

0.096

1. Agricultural Bank

2.Marketing Strategy

3.Linkage

Fig. 10.16  Priority of short-term alternative strategies

0.8

0.622

0.6 0.4 0.2 0

0.128 1. Agricultural Bank

0.250

2.Marketing Strategy

3.Linkage

Fig. 10.17  Priority of long-term alternative strategies

10.8   Conclusions The role of the agricultural sector is crucial for economic growth; it is important in meeting the resilience and food security for the entire community. The agricultural sector requires a specific supportive institution. Considering that the activities of the agricultural sector are very risky, financing with appropriate mode to the characteristics of farmers is needed. Financing to be paid after harvest offers solution to the above-discussed problem. Decomposition process from in-depth interview and previous research conclude that the benefit of this product for IFIs/BMT according to priority ranking are (1) generating profit sharing, (2) increasing

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financing portfolio, and (3) minimizing financing default. The benefit for farmers according to priority ranking are (1) suitability to farmers need, (2) simplified financing mode, and (3) regressive margin system. The opportunity from this product in the future for IFIs/BMT according to priority ranking are (1) product innovation, (2) increasing potential customers, and (3) increasing branch offices. The opportunities for farmers according to priority ranking are (1) alleviating poverty, (2) food security, and (3) increasing infrastructure. The cost for IFIs/BMT according to priority ranking are (1) operational cost, (2) less of government support, and IT development cost. The cost for farmers and society according to priority ranking are (1) access to financing, (2) providing collateral, and (3) less of production factor. The risk for IFIs/BMT according to priority ranking are (1) capital lost, (2) business competition, and (3) financing default. The risk for farmers and society according to priority ranking are (1) losing collateral, (2) price volatility, and (3) market risk. Alternative strategy that becomes a priority to be implemented according to respondents both in short and long term is cooperation with government institution. Then the second priority strategy is the marketing strategy, and the last priority is the agricultural bank.

Notes 1. Profit sharing in which the profit is shared each 50% for the two partners. 2. Profit sharing in which the profit is shared each one third of the three partners. 3. According to United States Census Bureau, data retrieved from https:// www.census.gov/popclock/print.php?component=counter per October 15, 2017.

References Amalia, E. (2009). Keadilan Distributif Dalam Ekonomi Islam. Jakarta: Rajawali Press. Antonio, M. S. (2001). Bank Syariah: Dari Teori ke Praktik. Jakarta: Gema Insani. Arifin, B. (2004). Analisis Ekonomi Pertanian Indonesia. Jakarta: Kompas. Ascarya. (2012). Analytic Network Process (ANP): Pendekatan Baru dalam Penelitian Kualitatif. Jakarta: Pusat Pendidikan dan Studi Kebanksentralan Bank Indonesia.

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Ashari and Saptana. (2005). Peran Perbankan Nasional Dalam Pembiayaan Sektor Pertanian. Pusat Analisis Sosial Ekonomi dan Kebijakan Pertanian. Forum Penelitian Agroekonomi, 23, 132–147. Ashari, & Friyanto, S. (2006). Prespektif pendirian Bank Pertanian di Indonesia. Forum Penelitian Agro Ekonomi, 24(2), 107–122. Badan Pusat Statistik. (2015). Berita Resmi Statistik 2015. Retrieved from h t t p s : / / w w w. b p s . g o . i d / w e b s i t e / p d f _ p u b l i k a s i / S t a t i s t i k Indonesia-2015_rev.pdf Emanuel, J., & Cefalu, P. (2002). Drilling for oil in the Artic National Wildlife Refuge, Project in a Graduate Class: Decision Making in Complex Environments. Katz Graduate School of Business, University of Pittsburgh. Hendrastomo, G. (2011). Keterpurukan Sektor Pertanian Sebagai Potret Kegagalan Industrialisasi Di Indonesia. DIMENSIA, 5(1), 71–83. Mançka, A. (2012). Lending Problems of Agriculture and Agro-Industry in Albania. Ontario International Development Agency. International Journal Of Sustainable Development, 3, 4. Mastur, A. A. (2006). Penataan Kelembagaan dan Permodalan bagi Pengembangan Industri Berbasis Pertanian. In Prosiding Seminar Nasional Teknologi Inovatif Pascapanen untuk Pengembangan Industri Berbasis Pertanian, pp. 36–41 Michael, T. (2000). Pembangunan Ekonomi 2. Jakarta: Bumi Aksara. Nurmanaf, A.  R. (2006). Analisis Sistem Pembiayaan Mikro dalam Mendukung Usaha Pertanian di Pedesaan. Pusat Analisis Sosial Ekonomi dan Kebijakan Pertanian. Nuswantoro, B. (2002). Prospek Bank Pertanian Di Indonesia. Paper Falsafah Sains. Program Pascasarjana IPB Otoritas Jasa Keuangan. (2015). Statistik Perbankan Indonesia November 2015. Retrieved from http://www.ojk.go.id/id/kanal/perbankan/data-dan-statistik/statistik-perbankan-indonesia/Documents/Pages/Statistik-PerbankanIndonesia-November-2015/SPI%20November%202015.pdf Otoritas Jasa Keuangan Syariah. (2015). Statistik Perbankan Indonesia December 2015. Retrieved from http://www.ojk.go.id/id/kanal/syariah/data-danstatistik/statistik-perbankan-syariah/Documents/Pages/statistik-perbankansyariah-desember-2015/New%20SPS%20Des%2015.pdf Rambat, L. (2006). Manajemen Pemasaran Jasa (2nd ed.). Jakarta: Salemba Empat. Ratih, R., & Prabatmodjo, H. (2013). Tanggapan Petani Terhadap Kebijakan Perlindungan Lahan Pertanian Pangan Berkelanjutan di Kabupaten Bandung. Jurnal Perencanaan Wilayah dan Kota. Sekolah Arsitektur Perencanaan dan Pengenbangan Kebijakan ITB, 3. Ridwan, M. (2004). Manajemen Baitul Mal Wa Tamwil (BMT). Yogyakarta: UII Press. Rodiana, N. (2014). Efektivitas Penerapan Bayar Pasca Panen Pada Pengembalian Akad Murabahah Pertanian Padi di BMT As Salam, Kramat, Demak. Bogor: Skripsi PS IPB.

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Saaty, T.  L. (2001). Theory and Applications of the Analytic Network Process. Pittsburgh: University of Pittsburg. Saaty, T. L., & Vargas, L. G. (2006). Decision Making with the Analytic Network Process: Benefits, Opportunities, Costs and Risk. Pittsburgh: Springer. Sukirno, S. (2002). Pengantar Teori Ekonomi. Raja Grafindo: Jakarta. Thohari, E. (2014). Sumber-Sumber Pembiayaan Untuk Agribisnis. Retrieved from http://peternakan.litbang.pertanian.go.id/fullteks/lokakarya/probklu03-3.pdf Tjiptono, F. (2007). Manajemen Penjualan Produk (First Printing). Yogyakarta: Kanisius. Wijayanti, M. (2013). Pola Penyelesaian Sengketa Pembiayaan Bermasalah Di Kalangan Pegiat Ekonomi Syariah Kota Metro. Jurnal Adzkiya: STAIN Metro, 1, 111–125. Wijayanti, R.  Y., & Sumekar, K. (2009). Pengaruh Bauran Pemasaran Jasa Terhadap Loyalitas Anggota Pada KJKS BMT Bina Ummat Sejahtera Lasem Kudus. Analisis Manajemen, Muria Kudus. Wulandari, S., & Suroso, A.  I. (2004). Lembaga Keuangan Syariah Alternatif Strategis Memajukan Sektor Agribisnis. Agrimedia, 9(1), 40–53.

Transcripts

of

Interview

Transcript of Interview with Bapak H.  Hanafi (Manager KSU BMT As Salam Demak about Pembiayaan Bayar Pasca Panen “Yarnen”) 2016. Transcript of Interview with Bapak Mubai (Client of KSU BMT As Salam Demak) 2016. Transcript of Interview with Bapak Musyafa (Client of KSU BMT As Salam Demak) 2016. Transcript of Interview with Bapak Nur Salim (Head Branch of KSU BMT As Salam Demak about Pembiayaan Bayar Pasca Panen “Yarnen”) 2016. United States Census Bureau. (2017). U.S. Census Bureau Current Population. Data retrieved from https://www.census.gov/popclock/print. php?component=counterper October 15, 2017.

CHAPTER 11

Skill-Based and Interest-Free Microfinance Model of Entrepreneurship as the More Sustainable Model Farhat Mahmood and Adeeba Ishaq

11.1   Introduction Many people believe that modern economy cannot function very well with a prohibition on interest rate payments for entrepreneurship loans. In fact, we will demonstrate below that more economic welfare could be generated with the prohibition on interest payments against entrepreneurship loans. However, such initiatives taken by microfinance banks (MFBs) are getting failed in Pakistan despite its lots of efforts. The main cause behind the failure is lack of earnest efforts from all intellectual, practical, political, constitutional and legal fronts (Mansoor and Bhatti 2006). Furthermore, since the element of interest payment over the original amount of loan is attached with entrepreneurship loans from microfinance banks, it would be difficult for newly entrant youth to take loans which would be financed out of future revenues.

F. Mahmood (*) • A. Ishaq PIDE, Islamabad, Pakistan e-mail: [email protected] © The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1_11

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Besides banking sector, various other organizations (such as NGOs and training centers) are involved in providing entrepreneurship loans to promote entrepreneurship in Pakistan. Entrepreneurship leads to innovation and job creation in the economy and so can play a critical role in the economic welfare of a country. Pakistan, having more youth-based economy, has a huge scope for entrepreneurship. With a population of more than 11.5 million and a heavy youth bulge (60% of population less than 30 years of age), thousands of jobs need to be created every year. The rural youth has a great tendency to move to the main cities to pursue careers in low-paid and semiskilled jobs. Research suggests that most entrepreneurs avoid the traditional, predictive approach of decision-making. However, every entrepreneur shares a similar pattern, identified as five principles by Sarasvathy (2004).1 These entrepreneurs are considered expert entrepreneurs by Sarasvathy (2004) and hence they are more successful and able to run a sustainable business. Keeping in view entrepreneurship initiatives of various organizations (i.e., microfinance banks, NGOs and training centers) of Pakistan, the objective of this study is to analyze and compare the performance of these organizations using descriptive statistics. The study will further focus on finding the impact of all three types of entrepreneurship initiatives on economic welfare in Pakistan. Hence, the hypothesis of the study is that skill-­based and interest-free entrepreneurship loans are more sustainable than unskilled with and without interest entrepreneurship loans. The organization of this chapter is as follows: Sect. 11.2 presents Pakistan’s microfinance industry performance with statistics. In Sect. 11.3, relevant literature review is presented, and Sect. 11.4 presents the research methodology along with data sources used for carrying out this study. The results are discussed in Sect. 11.5. Finally, Sect. 11.6 provides conclusions and policy implications.

11.2   Pakistan’s Microfinance Industry Interest is prohibited in Islam because of its exploitative nature. Yet in Pakistan, the number of active borrowers from interest-based institutions is increasing day by day (see Table 11.1). The fragile economy of Pakistan does not provide favorable grounds for the institutional development of interest-free organizations. The huge burden of domestic and international loans on the economy and other constraints, such as nonperforming loans, unsatisfactory level of investment and saving, mounting budgetary

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Table 11.1  Microfinance industry performance snapshot (2010–2014) Year

2010

2011

2012

2013

2014

Active borrowers (in millions) Gross loan portfolio (PKR in billions) Active women borrowers (percentage) Average loan size (PKR in thousands) Branches Total staff Total assets (PKR in billions)

1.9 25.1 56 18.5 1.405 12,005 35.8

2 27.4 59 20.2 1.55 14,202 48.6

2.2 33.8 59 22.3 1.46 14,648 61.9

2.6 46.6 58 26 1.606 17,456 81.5

2.8 61 52 28 1.747 100

Source: Pakistan Microfinance Network (PMN) 2020 report

deficits, inefficient tax system, extravagant style of living of politicians and bureaucrats, lack of proper infrastructure, abject poverty, unsatisfactory level of literacy and the deteriorating moral standards of the polity did not allow the interest-free system to take its roots in Pakistan (Mansoor and Bhatti 2006). In 1998, Pakistan Microfinance Network (PMN) was established to represent the emerging microfinance institutions (MFIs). Later in 2000, Pakistan Poverty Alleviation Fund (PPAF) was set up as a top organization, with the support of the World Bank, to provide wholesale refinancing to MFIs. Currently, as the sector reaches 2.8 million active borrowers with a gross loan portfolio of PKR 61.1 billion, deposits of MFBs stand at PKR 42.7 billion (see Table 11.2). Moreover, microfinance industry witnessed continued growth and expansion in outreach in the year 2015. At present, microfinance providers (MFPs) can be categorized into three peer groups, namely, microfinance banks, microfinance institutions and rural support programs. However, only MFBs are regulated and supervised by the State Bank of Pakistan. The microfinance sector in Pakistan started off with complete reliance on grants, international lenders and subsidized debt to meet its funding requirements. In order to fund future accelerated growth and reach up to 10 million active borrowers, the industry would require additional debt for on-lending of up to PKR 300 billion keeping in view the prevailing growth in loan sizes and outreach (see PMN Report 2020). The new entity, the Pakistan Micro Investment Company (PMIC), which will be created through the PPAF spin-off, would be better placed to attract financing from diverse sources and meet the increased borrowing need of MFPs. It is projected that more than PKR 40 billion of additional debt for

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Table 11.2  List of all MFBs, CED and NGOs of Pakistan MFBs NGOs

Training centers

Apna, Finca, Khushhali, NRSP, Pak-Oman, Tameer, The First MF, The Punjab Provincial Cooperative, U MF and Waseela MF Kashf Foundation, Orangi, Akhuwat, Community Support Concern, Damen, Asasah, Orangi Charitable Trust, Deep Foundation, Jinnah Welfare Society, Rural Community Development Society, Buksh Foundation, Naymet, Heal Pakistan and Wasil Foundation Microsoft Innovation Center, Social Innovation Lab, CED, IBA, Telenor Velocity, Revolt, Plan9, The Nest I/O, Invest2Innovate, LUMS Center for Entrepreneurship, PlanX, Serendipity, The Incubator, Technology Incubation Center, NUST, Arpatech Hatchery, The Founder Institute, Peracha Organization, SMEDA, SEED Incubation and BIC COMSATS

Sources: https://www.techjuice.pk/incubators/, http://www.ngos.org.pk/poverty/micro-credit-ngos. htm, http://www.pmn.org.pk/microfinanceproviders/banks

on-lending will be routed through the PMIC by 2020. Despite having immense growth potential, MFBs face some challenges, that is, managing profitability, rising competition, the quality of credit portfolio and ensuring liquidity. As a case study we have picked Khushhali Microfinance Bank, Akhuwat Foundation (AF) and Center for Entrepreneurial Development (CED) entrepreneurship training center from Table  11.2. The following is the detail of all three selected organizations. In 2000, the first microfinance bank, that is, Khushhali Bank (KB), was established as part of government’s poverty reduction strategy with a loan of US$150 million from ADB. Khushhali Microfinance Bank is a leading microfinance bank providing financial services to micro, small and medium enterprises and low-­ income households across Pakistan with an average 30% markup rate (following non-Islamic mode of microfinancing). On average KB disburses 25% loans to female entrepreneurs and 75% for male entrepreneurs. Lending procedure requires an age limit of 20–60 years. Loan tenure ranges from 3–36 months, with options of repaying lump sum amount at the end of loan period or in equal monthly installments. The minimum loan is Rs 150,000 and maximum loan amount is Rs 500,000. Moreover, minimum business experience of 2 years is required to obtain a KB loan. Recovery ratio is around 98%. Besides microfinance banks and institutions, specialized and multipurpose NGOs also extend microfinance services to the poor segment of the population. One of them is Akhuwat Foundation (AF),2 which was

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established in 2001 with the objective of providing interest-free microfinance in the form of Qarz-e-Hassana (following Islamic mode of financing) to the poor so as to enhance their standard of living. AF uses local religious places for loan disbursements, and encourages its borrowers to donate to Akhuwat’s program to help their brethren once the borrowers themselves have gained enough economic stability. The transformation of borrowers into donors is one indicator of the change Akhuwat had envisaged. The lending methodology of AF is as follows. Individual loans are marketed through awareness campaign in poor localities, market places and through previous borrowers. For individual selection, the loan process starts with the submission of applications. The Loan Officer then evaluates the application, that is, whether the individual lives below the poverty line, has a reliable social capital, is not involved in any illegal business and possesses entrepreneurial abilities. Through the preparation of business plans, the business idea of the intended loanee is evaluated. After the initial appraisal by the Unit Manager, the application is forwarded to the Branch Manager. Finally, the case is referred to the Loan Approval Committee. If the committee approves the case, loan is disbursed. The whole process takes almost three weeks. Every borrower also provides two individual guarantors. Disbursement takes place two to three times a month, and 100–150 loans are disbursed at one event usually held at branch office/ mosque or church. The recovery rate of loans is 99%, and on average 40% of loans are disbursed to females, while 60% to males, and its markup is 0%. In Pakistan recently another mode of microfinance entrepreneurship has emerged, that is, training centers for entrepreneurship loans. One such example is the Center for Entrepreneurial Development (CED) at the Institute of Business Administration (IBA), Karachi, Pakistan (see Table 11.2), which conducts a six-month fast-track entrepreneurship program as a pilot test to train the rural youth to pursue agriculture-based business opportunities in their own villages to spur innovation and growth in agriculture. The entrepreneurship program is based on the effectual principles of entrepreneurship. The training of CED has a few stages. The first stage lasts for two months. This starts with the “know yourself” module (i.e., the individual explores his interests). Various exercises developed at IBA-CED and that of Sarasvathy (2004) are used in this module. After this the opportunity recognition module starts. The students are exposed to idea generation and creativity exercises. They are encouraged to come up with a business idea based on the “know yourself” exercise and the pain or need in their surrounding or community. The effectuation theory3 is

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introduced with relevant case studies and readings. Various experiential activities like interview with an entrepreneur, guest speaker sessions and field visits are conducted to reinforce the concepts. Each student has to pitch his idea in front of an audience of experts, bankers, angel investors, faculty and students. In the second stage (two months), the students are exposed to functional knowledge of marketing, accounting, finance, people management and operations management. The students are exposed to the applications of this knowledge in an entrepreneurial context and raising money from inaccessible and hidden sources. The students are asked to relate their own experiences and networks while reflecting on the agriculture-based opportunities. Various guest speakers from industry are invited to share their stories of failure and success. The students are also taken on field trips to agro-based and other entrepreneurial businesses. In the third phase the students go out to their respective places to launch their businesses. The students are required to start a venture based on their bird in hand (whatever resources they have in their hand). It has to be within their affordable loss with as less money as possible. Faculty and alumni mentors are available to students and they are free to seek help from available expert pools. The participants are called back biweekly for feedback and mentoring sessions. Based on the hands-on learning, the students are allowed to change and modify their business ideas. The students keep track of the start-up activities and apply the effectual principles learned during the program. The students are called back in the sixth month. A debriefing session is conducted to consolidate the learning in the launch phase. The students discuss their success and failure stories with the faculty and mentors. Based on the above model, 120 students underwent a six months’ program on agriculture entrepreneurship at the Center for Entrepreneurial Development at IBA Karachi.

11.3   Literature Review In the twentieth century, innovations in financial services have been the center of attention in financial sector across the world. Microfinance is a significant development in financial sector that specifically impacts marginalized population. This concept is derived from microcredit. Moneylenders, credit cooperatives and credit unions are engaged in microcredit since the nineteenth century (Rahman et al. 2015). During the 1970s the modern concept of microfinance was formally introduced with the establishment of Grameen Bank by Professor Muhammad Yunus. It is a bank dedicated

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for the poor only. Microfinance programs include both financial and nonfinancial services for the marginalized groups. It offers microcredit, savings, remittance, health, education, insurance, skill training and social awareness to the poor, unbanked, underbanked and underserved population. Conventional financial institutions mostly serve rich. Heavy collateral and markup requirements limit borrowing ability of the poor in conventional financial institutions. Microfinance institutions relax financial constraints on poor and help them in becoming entrepreneurs, generating income, wealth and self-sufficiency (Rahman et  al. 2015). In this way it has emerged an effective developmental approach that helps the poor getting rid of poverty trap (Rahman et al. 2015). However, a debate regarding welfare impacts, outreach and sustainability issues of microfinance industry is going on in different academic, policy and research circles. Rahman et al. (2015) report these issues as the most challenging for MFIs. Studies conducted at regional and global level report mixed impacts of MFIs. Morduch (1999), Dunford (2006), Pitt and Khandker (1998) and Ahmed et al. (2011) report positive impacts, and Simanowitz (2011) and Kondo et  al. (2008) report no impact or negative impacts of microfinance programs. However, the most agreed-­ upon view is that rising microfinance industry has changed established ideas about the poor that they are mere consumers of financial services and, hence, not bankable (Brau and Woller 2004). MFIs has introduced variety of cost-effective lending services and mobilized social investment of millions for the ignored poor (Mutua, et al. 1996). In short microfinance has immense potential for poverty alleviation, not only paying for itself but turning profit. Brau and Woller (2004) conclude that it is doing well by doing good. According to Attanasio et al. (2015), MFIs cut down wage work, increase self-employment, generate profits and, hence, promote microcredit idea of increasing entrepreneurship. Tarozzi et  al. (2015) find an increase in school attendance and overall borrowing with expansion of microcredit services in Ethiopia. Though conventional microfinance has earned enormous fame across the world, its acceptance is limited in Muslim countries for religious reasons (Khan 2010). The main reason for this self-exclusion of Muslim world is that conventional microfinance services are interest based, which is prohibited in Islam. The Holy Quran says, “And GOD has permitted trade and forbidden interest.”4 The Quran says, “O believers! Be mindful of ALLHA and give up what remains of Al-Riba, if you are believers. Look out if u do not obey this order then ALLAHA declare war against you

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from him and from His Prophet peace be upon him, but if you give up your interest then you can claim your principal amount. Neither should you impose harm (Due to interest), nor other should harm you.”5 The Prophet (PBUH) said, “In any society, when Riba becomes common, it causes hunger and poverty in it. In any society, when bribery becomes common, it makes it depressed.” Karim et al. (2008) report that almost 72% citizens of Muslim countries do not use interest-based financial services. Religious scholars propose interest-free microfinancing system (called Islamic microfinance system) in accordance with the Islamic Sharia’h. Thus, combining the Islamic social principle, that is, caring for marginalized/less fortune, with microfinance’s power to include the financially excluded poor population into financial services can significantly add to its outreach in Muslim-majority countries as well (Akhter et  al. 2009). IRTI (2016)’s report explains that Islamic social finance advocates sharing economy and promotes redistribution. So, adopting it can help to achieve the twin development goals, that is, (1) ending extreme poverty globally by 2030 and (2) promoting inclusive prosperity by raising the incomes of the bottom 40% of the population. Population size of the Islamic world is almost over 1.2 billion. Incidence of poverty is quite high in most Muslim countries except a few in the Middle East and Southeast Asia. Prevalence of high inequality and low productivity in these countries is sound reason of high poverty rates (Akhter et al. 2009). Over 470 million Muslims in four largely populated countries, Pakistan, Bangladesh, Indonesia and India, are living below US$2 per day. According to the World Bank’s estimates, over 7000 MFIs are serving around 16 million poor persons in developing world. Their total cash turnover is approximately US$2.5 billion across the world. Estimates of the Microcredit Summit suggest that US$21.6 billion is required for the provision of microfinance to 100 million of the world’s poorest families (Akhter et al. 2009). Microcredit borrowers are estimated around 13 million, with outstanding loans of US$7 billion, and the repayment rates are almost 97% with significant (30%) annual growth. Despite all this, access to financial services is still limited to less than 18% of the world’s poorest families (Grameen Foundation 2007). In this situation, Islamic microfinance has great potential to fight against poverty and fulfill financial needs of Muslims in these countries. Doing so, it can also develop a valuable human capital base and boost economic growth in these countries (Ahmad 2007). While discussing competitiveness of Islamic microfinance, Frasca (2008) declares Islamic finance a potential “heaven” for victims of recent global credit crisis to get rid of speculative excess of the conventional financial system.

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Microfinance is still underdeveloped in the Middle Eastern and North Africa (MENA) region compared to Asia, Africa or Latin America. Particularly in Saudi Arabia and the UAE, it is still at the stage of infancy (IDLO Report 2009). CGAP’s survey results reveal that almost 80% outreach of Islamic MFIs is confined to three countries, that is, Afghanistan, Indonesia and Bangladesh. Frasca (2008) reports that Islamic MFIs have potential to compete and even outperform conventional MFIs in the MENA region, by satisfying religiously tailored demand for financial services for the poor. Among Muslim countries, in Pakistan as well poverty statistics are alarming, with 39% population still living under poverty line.6 According to Malik and Whitney (2014), persistent increase in poverty is observed, when measured using headcount ratios during recent decade. Few NGOs are taking Islamic microfinance initiatives in Pakistan (Shirazi et al. 2015). The most prominent among these are Akhuwat, Asasah, Wasil Foundation, Namet, Helping Hand and National Rural Support Program and Karakoram Cooperative Bank (KCBL). According to the microfinance growth strategy 2020 prepared by PMN,7 currently microfinance industry of Pakistan has 3.1 million active borrowers and its gross loan portfolio is PKR 61.1 billion.8 Over time as MFIs are increasing in number and getting maturity, outreach of microfinance industry in terms of active borrowers is growing steadily. From business environment and policy perspective, microfinance sector in Pakistan appears among the best-rated microfinance sectors of the world. However, still there exists a gap between its potential (27 million clients) and actual (current penetration rate 11.5% of potential size)9 market size for microfinance despite significant positive developments. Projection for 2020 by PMN is of 6 million clients approximately; that is again far below compared to potential.10 Non participation in microfinance can be for two reasons: people are either not interested in it or they have religious reservations about interest-based financing (Goud 2007). In the face of all this, Islamic MFIs (both bank and nonbank) have great potential to serve the needs of the lower-income strata in Pakistan. Aslam (2014) reports that several microfinance banks, public and private institutions, nonprofit organizations and NGOs are actively producing and pooling resources in various forms like individual and group loans, micro loans, micro leasing, micro insurance and funds transfer in Pakistan. Their objective is to help the conventionally excluded poor become entrepreneurs and protect them against exceptional emergencies. In Pakistan, a critical threat to economy is ignorance

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of government from major share (almost 90%) of business that lies in small and medium sectors. If Islamic MFIs are directed toward this sector, it has great potential to generate employment for unemployed youth (Aslam 2014). Though still limited in outreach, both conventional (interest-­ based) and Islamic (interest-free) modes of microfinance are available in Pakistan nowadays and are growing at a steady pace. Studies report repayment rate is higher (approximately 97%) for the latter. Under Islamic microfinance there are two categories: one providing loans without any training/skill development, like Akhuwat Foundation, and second providing microcredit complementary with skill development, for instance, the Center for Entrepreneurial Development (for a detailed list, see Table 11.2).

11.4   Research Methodology In the chapter we are comparing three different microfinancing models (see Fig. 11.1) prevailing in Pakistan. As a representation of these models, we have picked up one sample from each model, that is, KB (Model A), AF (Model B) and CED (Model C). We have analyzed the performance of these three models using descriptive statistics (2011–2014) over time. Also using multiple case studies chosen from samples, we have shown the impact of these models on entrepreneurial ventures (qualitative analysis).

11.5   Results and Discussion We have analyzed our hypothesis using descriptive statistics and qualitative analysis of selected cases from chosen sample of all three models. 11.5.1  Descriptive Statistics Figure 11.2 shows plots for incremental loans of Khushhali Bank (KB) and Akhuwat Foundation (AF). It’s clear that microfinance borrowing and, hence, financial inclusion are increasing over time. Data for 2010–2015 shows that incremental microfinance loans from both KB (Khushhali Bank, conventional11) and AF (Akhuwat Foundation, Islamic) have an upward trend. However, the curve for AF incremental loans lies almost up compared to KB incremental loans for the study period. It appears that demand for Islamic microfinance (AF) is greater than conventional microfinance (KB). People are showing more willingness toward Islamic microfinance and, hence,

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Model A

With Interest nonskilled based financial Investment (KB) Model B Interest free nonskilled based financial Investment (AF)

Model C Interest free skilled based financial Investment (CED)

To promote Entrepreneurship Activities in Pakistan

Fig. 11.1  Comparison of entrepreneurship models

getting out of the state of financial self-exclusion in Pakistan. A prominent reason here is the borrowing cost differential in the two systems. Interest-­ free lending actually targets the bottom income quartiles and helps them establish businesses without charging interest cost. Conventional system too although helps entrepreneurial activities for the poor yet it rations its customers with collateral requirements and further decreases profits by the amount of interest it charges on micro loans. So, apart from religious reasons, it is not serving the poorest of the poor. Moreover, KB incremental loans show greater fluctuations compared to AF incremental loans. So, it can be inferred that Islamic microfinance system is more stable compared to conventional system. Figure 11.3 shows that net borrowing trends for both male and female under conventional (KB) and Islamic (AF) microfinance systems. Here again the borrowing pattern for AF is more stable compared to KB. Also the curve for AF female borrowers lies above that for the KB female borrowers during 2011–2015. It is showing strong preference among females

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incremental loans in PKR

140,000 120,000 100,000 80,000 60,000 40,000 20,000 0

2011

2012

2013

2014

2015

years KB incremental loans

AF incremental loans

Fig. 11.2  Incremental loans trend during 2011–2015. (Source: Authors’ compilation from annual reports of KB and AF)

Yearly Increment to loans in PKR

250,000 200,000 150,000 100,000 50,000 0

2011

2012

2013

2014

KB Male borrowers

KB Female borrowers

AF Male borrowers

AF Female borrowers

2015

Fig. 11.3  Incremental loans trend with male/female loan distribution during 2011–2015. (Source: Authors’ compilation from annual reports of KB and AF)

for Islamic microfinance. In case of males although KB at some point overlaps AF male borrowers, we can see a decreasing trend in KB curve toward the end of the study period. On the other hand, during the same period there is a sharply increasing trend in AF male borrowers. So, it is implied that over time demand for Islamic microfinance is increasing in males also.

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11.6   Case Studies The real-life application of the abovementioned entrepreneurship development program led to very interesting results. Tables 11.3, 11.4 and 11.5 describe three case studies of each model for the purpose of comparison of all the three models. Table 11.3  Khushhali Microfinance Bank case studies Case 1: Wonder Women of Khushhali—Shaheen Munawar Case The unexpected death of Shaheen’s husband made her a widow with five background children to support. She was unprepared to take on the entire responsibility of supporting her family, but she had no other choice. Shaheen realized she couldn’t rely on unstable jobs to sustain her family; that’s why she was determined to become an entrepreneur. She planned to take an interest-­ based loan from Khushhali Microfinance Bank. Business Private children school type Business Rural Sindh location Loaned Rs 150,000 with 30% markup amount Economic 300 students enrolled in school (positive impact on rural literacy figure) welfare Shaheen owned 60 lac worth land of school (positive poverty reduction impact) 12 teachers hired in the school (unemployment figure dropped) Case 2: Shoemaker—Govind Case Govind, father of three, was one among the millions of Pakistanis living in background poverty. A native of Sindh, his life had been spent struggling to provide three meals a day for his family. Coming from a minority community didn’t help him much. He was certain that his children would face the same fate of grinding poverty without access to education if he didn’t act and act fast. Govind’s father worked very hard throughout his life. Despite working for 35 years in a shoe-manufacturing shop, he was not able to save anything for his family. While relocating from the village, Govind’s family only had 70 rupees and his father’s shoemaking skills. Initially, a few relatives supported them but they were also not financially strong enough. Govind decided to start his own business of making shoes and convinced his father to help him. His biggest constraint was lack of funds. Business Shoemaking venture type Business Sindh location (continued)

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Table 11.3 (continued) Loaned amount

Rs 10,000 with 30% markup, but timely payments have enabled him to maintain a good customer relationship with the bank. As a result, his loan ceiling was increased and he has recently received a Rs 125,000 bank loan. Economic Increase in productivity (positive impact on output of economy) welfare Purchased machine (positive impact on Govind’s asset possession) Employed two workers (positive unemployment reduction effect) His children are getting education (positive impact on literacy figure) Case 3: Wazeeran Bibi Poultry and Goat Farm Case Wazeeran Bibi lost her right hand in a fire accident in her childhood. Ever background since childhood, she had experienced poverty. Getting married to a man who cultivated crops on leased lands did not change her prospects either. Her husband’s work had limited scope and the income was nominal, barely enough for bread and milk. With four daughters and two sons, making ends meet was always a challenge. Sick of financial restrains, she stood up one day to venture forth and avail assistance from Khushhali Bank. She says, “The reason I took this step is because I never wanted my children to have a similar life like her.” Business Goat farmhouse and later on poultry farm type Business Punjab location Loaned Rs 8500 with 30% markup amount Economic Monthly income of Rs 12,000 (positive impact on poverty reduction) welfare Savings of Rs 10,000–12,000 monthly (expansion of business, i.e., addition of poultry farm) Source: www.khushhalibank.com.pk

Table 11.4  Akhuwat Foundation case studies Case 1: Rehana Ahmed Case Rehana and her two kids lived with her mother and an unemployed background brother. They could barely feed themselves twice a day and remained constantly worrying over fixing the next meal. She was not even able to buy milk for her kids. Luckily she found a sewing job in her neighborhood, but didn’t own a sewing machine. She requested her employers to buy her one. That is when they told Rehana about Akhuwat Foundation Qarz-e-Hassana scheme. Business Stitching type Business Rural Sindh location (continued)

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Table 11.4 (continued) Loaned amount Economic welfare

Rs 5000, then Rs 8000 with 0% markup as a Qarz-e-Hassana

Business type

Cycle manufacturing factory

She managed to export her fancy bridal stitched dresses to England (positive impact on poverty reduction) Finance education of her brother and kids (positive impact on literacy figure) Finance lung operation of her younger child (positive impact on self-sufficiency) Case 2: Shafiq-ur-Rehman Case As a disabled person, Shafiq had faced harshness of life more than a normal background person. The only way he made his meager living some four years ago was to vend mobile phone accessories in a nearby market on his tri-wheel motorcycle. He found it hard to make both ends meet on daily basis. One day someone told him about Akhuwat and its operations. He had deep urge to go to Akhuwat for loan but was shy for being turned down due to his disability and extremely lower social status. One brave day, he went to Akhuwat and met Dr. Amjad Saqib (Akhuwat’s founder). He was surprisingly polite to him and he got a loan allocation within 15 days. Business Shop of mobile accessories and toys type Business Punjab location Loaned First Rs 5000, then Rs 8000, and finally Rs 45,000 with 0% markup as a amount Qarz-e-Hassana Economic Increase in income made him able to continuously repay loan (approval of welfare his future loan applications to expand his business) Owned his own shop (positive impact on poverty reduction) He is able to get more loan to extend his business to a small shop (his dream) Case 3: Khurshid Kamal Case Some seven years ago, Khurshid had to separate from his extended family. background All he has was Rs 10,000 and a roof of only one lowly maintained room. With a wife and four little children, making an honest living seemed impossible to him. He needed only a few thousand rupees to set up his own shop of cycle repairing to stand on his feet, but none of the relatives or friends lent him. One day, a neighbor advised him to go to Akhuwat for loan. He says he was reluctant as he always avoided sweet-coated interest-­ based loans because it results in complete social and economic chaos for anyone taking such a loan. On assurance that Akhuwat is a completely interest-free microfinance organization, he rushed to it for loan and got it.

(continued)

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Table 11.4 (continued) Business location Loaned amount Economic welfare

Punjab Rs 10,000 and later 30,000 with 0% markup as Qarz-e-Hassana Business flourished in no time (positive impact on financial condition) Possession of a seven lac plot (positive impact on asset possession) All his children are studying in English-medium schools (positive impact on literacy figure)

Source: http://www.akhuwat.org.pk/

Table 11.5  Center for Entrepreneurial Development (CED) case studies Case 1: Sam’s Cake Factory by Sumaira Waseem Case Sumaira after marriage moved to Saudi Arabia with her husband. With a background master’s in political science degree in hand and absolutely nothing to do in a foreign land, Sumaira planned to start an online cake business after an unhappy experience of ordering a fondant cake online for her daughter’s birthday. The experience compelled her to wonder whether she could start her own business. She signed up for cake baking and decoration classes in one of the finest institutes (CED) and completed all the advanced levels. She has started her fondant cake business. Sumaira’s cakes were exceptionally good in design and taste. She laid the ground for her business by selling her pastries to people in her close community, and gradually, the word spread around. She launched a Facebook page by the name of Sam’s Cake Factory where she would post pictures of her masterpiece cake designs. She gained popularity not only in Saudi Arabia but also in Pakistan and was catering 40–50 orders per day. In 2011, Sumaira decided to move to Pakistan and dedicate their complete efforts into building Sam’s Cake Factory. Hence, her husband left his job and formed a partnership with Sumaira to take their business to a full-fledged corporate level. No sooner did they announce the opening of Sam’s Cake Factory in Karachi. With the passage of time, the need to organize their business into a professional setup was realized. As kitchen was growing smaller for her large orders, Sam first requested her neighborhood bakery owner to allow them to use their kitchen after closing time which was graciously granted. Shortly after, they bought a van and hired a driver to facilitate on-time deliveries to customers in a cost-efficient manner. Sumaira decided to use her father’s vacant apartment as her workshop. She renovated the apartment and hired a team of ladies from the neighborhood and trained them to become professional cake designers. She and her husband, now free from operational tasks, took the liberty to tour various workshops and exhibitions around the world to keep abreast of the latest technologies and trends in the cake industry. She made sure to sustain an edge over her competitors by investing into latest technologies and equipment such as 3D edible printer. Sam’s Cake Bakery is at the moment a renowned name among the middle and upper-middle class in Karachi. (continued)

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Table 11.5 (continued) Business type Business location Loaned amount Economic welfare

Cake bakery Karachi

Nothing except nominal payment of CED training center for getting training Huge amount of profit obtained in very short time span (huge positive impact on profit earnings in a short time span) Big change in standard of living (huge positive impact on wealth creation) Conversion from paid employment to self-employment with faster expansion of business and hiring of a lot of new baking staff and trained them (big positive impact on poverty reduction figures) Case 2: Wondermilk by Sarah Jahangir Case Sarah Jahangir had never imagined one day she would start camel milk background business. But she always had an entrepreneurial mind. However, it was not until her mother’s diabetic incident that manifested the inception of Wondermilk. After witnessing an astounding improvement in her mother’s condition with the use of camel milk, an idea came in Sarah’s mind: why not promote camel milk brand in Pakistan as a healthy substitute to cow milk? Sarah was determined to sketch the right marketing and promotion strategies that could create a new market for camel milk. With the help of her family, she was able to trace some herders outside of Karachi. She succeeded in earning their trust and developing a relationship based on partnership. She came up with the name Wondermilk to signify its health benefits. Starting a new business on its own, with almost zero users and no awareness, was a difficult task, but getting training from CED, Sarah searched for cost-effective means to streamline her production process. She went for second-hand bottles from the local bottle street and purchased cost-effective equipment like chillers and sterilizers from her initial capital. She spent time training the herdsmen on the issues of hygiene while milking the camels. Their business model was simple: orders were taken online and customers were responsible for collecting their orders. Alternatively, home delivery was made for a marginal fee using a local delivery service, also a start-up in Karachi. As her customer base began to increase, Sarah decided to instigate her business to the next level. She introduced line extension such as five different flavors like chocolate and cold coffee and category extension into a range of desserts like rice pudding, promoted by Wondermilk website. Business Camel milk selling type Business Karachi location Loaned Used own savings of PKR 55,000 amount (continued)

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Table 11.5 (continued) Economic welfare

Availability of cow’s milk substitute (positive impact on availability of substitutes for good health) Fast expansion of business (huge amount of money created) Large number of people hired (positive impact on poverty reduction) Case 3: Kanwal Ful Makeup by Kanwal Khalid Case From a salon review website, Kanwal’s entrepreneurial skills formed to background perfection by the time she set up her own makeup training studio. After dropping out of one of the most prestigious institutes in Karachi, Kanwal moved to Bahrain immediately after her marriage in 2011. While her stay in Bahrain, a mega sale on a perfume store marked the beginning of her steps into the world of entrepreneurship. Realizing a potential gap in the market for items unavailable in Pakistan, she started a Facebook page “Personally Yours” whereby orders were placed online and delivered via courier or in person during Kanwal’s monthly visits to Pakistan. Kanwal struck upon another opportunity at the real-estate business when her landlord asked her husband to find potential tenants for three apartments. Posting online ads on various Facebook pages, she succeeded in earning a hefty commission from the landlord. Her move to Riyadh in 2012, with a conversation with a friend in Riyadh about lack of regulatory body over salons and spas ignited an idea to create her own Facebook group that would serve as a platform for individuals to share their experiences and give their reviews about local salons. The page attracted not only customers but also advertisers from whom Kanwal started charging a nominal fee for every ad posted, yet another way to make money. The group gave Kanwal an insight into starting her own professional makeup classes. She planned to get entrepreneurship training from CED. Also, she registered into a professional course conducted by a makeup artist and placed an advert to teach basic makeup and styling techniques on her Facebook group only after a few classes. Kanwal found her skills improving with every class. The turning point in her business cropped up when she was tapped to do makeup and styling for a fashion shoot in Pakistan. She returned to Karachi to complete her business degree and made several engagements during her stay: giving makeup classes to eager students and booking further classes. She also set up her makeup studio in her own house. Presently, she hosts online makeup tutorials, attends talk shows on various channels and manages a team of two who work in her makeup studio. Business Makeup training studio type Business Karachi location Loaned Nothing amount Economic Fast business expansion (big positive impact on wealth creation) welfare Her Facebook page turned out to be a magnet for customers and competitors (positive impact on profit margin) Source: http://ced.iba.edu.pk/

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11.7   Conclusion While comparing Models A, B and C, we have concluded that the main objective of microfinance loans for entrepreneurship is to pull out people out of poverty. However, interest-based microfinance do not fulfill this objective due to lower acceptability of such loans in Muslim countries like Pakistan. Therefore, both Models B and C are preferred over Model A in Pakistan (subjective wellbeing of individuals increased in Models B and C due to interest-free element of loans and so they feel more satisfied and felt barkat in their business). Now if we compare Models B and C, then both are interest-free entrepreneurship loans and are playing a vital role in reducing poverty figures of Pakistan. However, we have argued that Model C is better than Model B, because it is more innovative and sustainable in terms of poverty reduction. Innovative in a sense that before entering in to the world of entrepreneurship individuals got skills (via training from training centers) to run their business in more innovative and effective way. Training made individuals so effective in running their business that in most of the cases they felt no need for interest-free seed money from training centers (as we have shown in above case studies) and their businesses flourish to a massive level in no time. Therefore, it is recommended that Models B and C should be replaced with Model A in order to get sustainable fastest solution of poverty reduction.

Notes 1. These five principles are bird in hand, experimentation, affordable loss, lemon for lemonade and pilot in the plane. 2. Microfinance businesses of Akuwat Foundation include dressmaking, industrial electrician, artificial Insemination, plumbing, food cooking and kitchen management, motorcycle mechanic, beautician, embroidery, welding, computer hardware, computer software and auto mechanic. 3. Sarasvathy’s theory of Effectuation (2001) describes an approach to making decisions and performing actions in entrepreneurship processes, where you identify the next, best step by assessing the resources available in order to achieve your goals, while continuously balancing these goals with your resources. 4. Al-Quran, Sura Al-Baqara, 2:275. 5. Al-Quran, Sura Al-Baqara, 2:278–279. 6. Results based on multidimensional poverty statistics. Multidimensional poverty report (2016).

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F. MAHMOOD AND A. ISHAQ

7. Pakistan Microfinance Network. 8. MicroWATCH, Issue 32, Qtr 2, 2014, PMN. 9. MicroWATCH, Issue 32, Qtr 2, 2014, PMN. 10. Microfinance growth strategy 2020 prepared by Pakistan Microfinance Network. 11. Convention loan means loans with interest payment, while Islamic loan means loans without interest payments.

References Ahmad, H. (2007). Waqf-based Microfinance: Realizing the Social Role of Islamic Finance. Paper Written for the International Seminar on “Integrating Awqaf in the Islamic Financial Sector” Singapore, March 6–7. Ahmed, F., Siwar, C., Idris, N.  A. H., & Begum, R.  A. (2011). Impact of Microcredit on Poverty Alleviation Among Rural Women: A Case Study of Panchagarh District in Bangladesh. African Journal of Business Management, 5(16), 7111–7119. Akhter, D. W., Akhter, D. N., & Jaffri, S. K. A. (2009). Islamic Micro-Finance and Poverty Alleviation: A Case of Pakistan. In Proceedings 2nd CBRC, Lahore, Pakistan. Aslam, M.  N. (2014). Role of Islamic Microfinance in Poverty Alleviation in Pakistan: An Empirical Approach. International Journal of Academic Research in Accounting, Finance and Management Sciences, 4(4), 143–152. Attanasio, O., Augsburg, B., Haas, R. D., Fitzsimons, E., & Harmgart, H. (2015). The Impacts of Microfinance: Evidence from Joint-Liability Lending in Mongolia. American Economic Journal: Applied Economics, 7(1), 90–122. Brau, J. C., & Woller, G. M. (2004). Microfinance Institutions: A Comprehensive Review of the Existing Literature and an Outline for Future Financial Research. Journal of Entrepreneurial Finance and Business Ventures, 9(1), 1–26. Dunford, C. (2006). Building Better Lives Sustainable Integration of Microfinance and Education in Child Survival, Reproductive Health, and HIV/AIDS Prevention for the Poorest Entrepreneurs. Journal of Microfinance, 3(2), 1–25. Frasca, A. (2008). A Further Niche Market: Islamic Microfinance in the Middle East and North Africa. Austin: Center for Middle Eastern Studies & McCombs School of Business University of Texas. Goud, B. (2007). Islamic Microfinance. Institute of Halal Investing. Grameen Foundation. (2007). USA. Retrieved from http://www.grameenfoundation.org/ IDLO. (2009). Islamic Microfinance Report. International Development Law Organisation, Allen & Overy LLP. IRTI and World Bank Launch Global Report. (2016). Islamic Finance 2016— Islamic Finance: A Catalyst for Shared Prosperity?

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Index1

A Access, 3–7, 10, 11, 13–15, 17–19, 22, 29, 31, 32, 34, 35, 52, 55, 82, 84, 86, 88, 115, 130, 137–155, 159, 160, 162, 163, 166, 170, 173, 174, 176–179, 181, 182, 185, 194, 195, 205, 206, 210, 211, 213, 217, 228, 233 ANP-BOCR, 208 B Behavioral biases, 176 C Causes, 6, 7, 9, 39–50, 83, 84, 96, 111, 112, 114, 116, 121, 125–127, 138, 151, 157n14, 201, 221, 228

Conventional, 7–9, 14, 16, 23, 29, 32, 33, 39–50, 87, 103, 109, 111–114, 116–119, 121–129, 131, 134n7, 153, 154, 172, 183, 185, 196, 206, 207, 227–231 D Development, 4, 5, 7–10, 14–17, 20–22, 33, 35, 52–55, 58, 61, 81, 83, 91–104, 110–112, 117, 128, 130, 131, 137–145, 151, 153, 154, 162, 166, 168–170, 180, 181, 183, 185, 193, 194, 217, 222, 226, 228–230, 233 Digital finance, 10, 160, 178, 185

 Note: Page numbers followed by ‘n’ refer to notes.

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© The Author(s) 2020 A. Elzahi Saaid Ali et al. (eds.), Enhancing Financial Inclusion through Islamic Finance, Volume I, Palgrave Studies in Islamic Banking, Finance, and Economics, https://doi.org/10.1007/978-3-030-39935-1

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INDEX

E Enforcement mechanism, 29 Entrepreneurs, 10, 11, 20, 21, 24, 47, 83, 137, 153, 154, 222, 224, 226, 227, 229, 233

Islamic finance, 4, 7–9, 40, 58, 60, 61, 81–89, 92, 98, 103, 109–133, 161, 178, 185, 198, 228 Islamic microfinance, 7, 8, 51–78, 88, 96, 228–232

F Financial inclusion, 3–11, 13–35, 51, 55, 81–89, 110, 112, 137, 138, 141–154, 159–186, 193–217, 230 Financial inclusion for farmers IFIs/ BMT, 11, 195–197, 201, 203, 206, 209, 210, 212–215 Financial services, 4–7, 10, 13–15, 18–19, 22, 32, 55, 82–84, 88, 96, 97, 112, 137–155, 160–162, 174–177, 181–183, 185, 224, 226–229 Fintech, 4, 10, 11, 133, 159–186 Food security, 6, 194, 195, 206, 211, 212, 216, 217

L Liquidity management (LM), 9, 109–133

I Impact, 8, 9, 20, 23–27, 31, 52–54, 78, 81–89, 92, 97–99, 101, 103, 104, 112, 116, 126, 130, 146–147, 151, 168, 175, 177, 180, 183, 184, 222, 226, 227, 230, 233–238 Income and wealth inequalities, 6, 7, 39–50 Inequality, 4, 7, 14, 15, 39–49, 55, 58, 77, 110, 138, 160, 184, 228 Islamic banks, 9, 54, 109–133, 181, 183, 194, 197, 199, 215 Islamic economics, 7, 9, 17, 39–50, 95, 110, 112, 114, 132

M Mapping, 8, 10, 58–69, 138–144, 154 Maqasid al-Sharı̄ʿah, 4, 8, 9, 91–104 Maslaha, 9, 97 Millennium Development Goals (MDGs), 5, 8, 53–55, 58–69, 98 P Pakistan, 10, 11, 47, 48, 52, 117, 118, 120, 122, 133, 146, 153, 159–186, 221–226, 228–231, 236–239, 240n10 Performance metrics, 7, 14, 31–32 Perspectives, 4–11, 13–35, 39–50, 92, 97, 160, 168, 229 R Research, 4, 8, 11, 27, 31, 40, 41, 48, 50, 52–56, 58, 60, 61, 69, 77, 92, 163, 174, 175, 177, 178, 195, 198–204, 216, 222, 227, 230 S Shariah, 9, 10, 78, 83, 86, 88, 89, 110, 112, 114, 118–127, 129, 131, 132, 135n7, 142, 161, 180, 185

 INDEX 

Skill-based, 11, 221–239 Social and economic justice, 89 Social inclusion, 9, 35, 109–133 Sustainable Development Goals (SDGs), 4–8, 10, 53–55, 58–61, 69–78, 110, 132 Sustainable growth, 10, 104, 112 Sustainable model, 11, 221–239

T Takāful, 4, 8, 84, 85, 91–104, 129, 173 Tax, 9, 17, 22, 24, 42, 44, 83, 98, 178, 179, 223 Z Zakah, 9, 97

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