Aligning Islamic finance with SME, Micro financing and Sustainable Development Goals (SDG)

islamic finance
Muhammad Arif
Muhammad Arif (Chairman CAIF)

The worth of worldwide Islamic financial assets leapt from half a million dollars in the 1970s to over one trillion USD by 2009. With an annual growth rate of around 14 per cent, assets have doubled over the past five years, and now exceed two trillion USD.1 Ernst & Young estimates that global Islamic assets will top 3.4 trillion USD by 2018.

While Islamic banking and finance has long been dominated by the liquidity-rich, advanced economies in the Persian Gulf, the fastest growing markets are now more evenly spread across the world. Qatar, Indonesia, Malaysia, Saudi Arabia, Turkey and the United Arab Emirates are estimated to currently hold 80% of IBF assets, with a five-year compound annual growth rate (CAGR) of 18% from 2009 to 2013, and an expected CAGR of 19% from 2014 to 2019.

Within this field, the slow-but-steady growth of Islamic microfinance has recently become more dynamic, fuelled by increased attention from governments, central banks, donors, and commercial Islamic banking and finance institutions (IBFIs), with some estimates projecting a global Islamic microfinance five-year CAGR of 19.7% from 2013 to 2018.

This report explores how the promise of Islamic microfinance lies in its unique benefits in terms of user experiences, poverty alleviation-related outcomes and product innovation, and access to poor clients who need liquidity but may be reluctant to engage with non-Islamic finance.

Islamic microfinance is poised to increase the overall market share of Islamic banking and finance by folding untapped populations into formal financial activity. As IBFIs in established economies push up against the borders of Sharia (Islamic law) compliance in the race to establish viable sukuk (bonds), takaful (insurance), and a Sharia compliant stock exchange, expanding the reach and profile of Islamic microfinance through partnerships and funding strategies can help meet the liquidity and market access needs of the poor-and help the global IBF industry better embody motivations for Islamic economic activity in the Qur’an and Sunnah (the practices, teachings, and path of the Prophet Mohammed (PBU)).

Islamic microfinance holds, for example, tremendous potential to tap into and productively channel scattered Islamic donor streams (namely zakat, sadaqat, and waqf) toward strategic, impact-oriented goals.

Several recent reports focus on the unique considerations of development and the global Muslim population. According to these reports, the inherent social justice potential of Islam is a rich and underutilized resource for poverty alleviation.

While this is not untrue, Islamic microfinance-like all methods promoting financial inclusion-is no silver bullet. This report fills a gap in existing reviews and quantitative research on Islamic microfinance that focus on indicators and metrics without examining the place of cultural contextualization.

An anthropological fieldwork enables complexity and nuance in institutional practice and user experience to arise through a methodology of “participant-observation,” repeat minimally structured interviews, and relationship-building. This addresses methodological challenges in microfinance research: banks, acting as gatekeepers, can (un)intentionally circumscribe access for researchers. The need for the poor to ensure continued access to banks affects their responses to market research and customer surveys. Male field researchers may face difficulty in eliciting information about intimate familial or financial challenges from female microfinance clientele.

This report also offers historical and theological contextualization for present-day debates and developments, overviews of commonly used Islamic (micro) finance products and descriptions of key countries and institutions in the global Islamic (micro) finance industries. Examinations of the Islamic (micro) finance landscapes in Bangladesh, Indonesia, and Pakistan along with case studies of Islamic microfinance programs in Bangladesh and Pakistan illustrate the variation in relevant legal, political, economic, and geographic considerations. Ethnographic attention is given to the unique challenges faced by female clients and female-headed households, implications of client relationships with IMFI field officers, and the absence of tools for clients to address personal accounting and calculation challenges.

Finally, there is a lack of relationships between Islamic microfinance and digital tools that could easily promote product and platform innovation and aid service provision. The report offers starting points for digital interventions to meet the needs of the poor while addressing longstanding cost and value chain inefficiencies in Islamic (micro) finance.

The Islamic Development Bank is arguably the best-positioned institution to currently act as a research and development hub for Islamic microfinance, shaping and testing new products and services, optimal legal environments, and basic computing requirements. The scope for the collaboration is high and the capacity for innovation in this still-nascent industry, where supply has not met demand, should encourage impatient optimism of industry observers, providers, and clients alike.

With the global commitment to the SDGs i.e. No Poverty, Zero Hunger, Good Health, Well-Being for people, Quality Education, Gender Equality, Clean Water and Sanitation., Affordable and Clean Energy. Decent Work and Economic Growth, we have set the course of all our development efforts towards promoting prosperity, preserving and protecting our planet and improving the livelihoods of all people.

At the same time, we acknowledge that the implementation of this ambitious agenda requires significantly more financial resources. The gap in financing for SDGs is currently estimated at US$ 2.5 trillion every year and we know that Official Development Assistance (ODA) alone is not an adequate source of financing. ODA flows from the member countries of the OECD Development Assistance Committee (DAC) was US$146.6 billion in 2017.

Hence, to help countries deliver the SDGs, we need new approaches and innovative partnerships, involving both stakeholders and sources of capital, including the private sector, faith-based and social giving, which is why this discussion today is so important.

One vital area where innovative partnerships could better respond to the financing needs of SDGs is Islamic finance, which is one of the fastest growing financial industries. Global assets in Islamic finance have grown from about US$200 billion in 2003 to US$ 1.7 trillion in 2015; and are expected to reach US$3.5 trillion in 2021. Considering the scale, strengthening our collective ability to better leverage Islamic finance will be crucial to offer governments a strong, non-traditional source of financing to advance their local SDG implementation and leave no one behind.

The core principles of Islamic finance – channelling funding to the real economy, avoiding excessive speculations, and limiting debt to the value of assets – and Islamic social finance tools -Zakat, Sadakah, Waqf – are highly aligned with the spirit of the SDGs. The Islamic Development Bank found Islamic Finance to be especially relevant in addressing ten of the 17 SDGs, including goals pertaining to poverty alleviation, infrastructure development, financial stability, and beyond.

UNDP and other parts of the UN have already begun to scale up our efforts to engage member countries on Islamic finance in innovative ways. In Indonesia, for example, UNDP is partnering with BAZNAS – the national Zakat collection body – to apply Zakat funds, for the first time ever, towards local SDG plans, beginning with renewable energy projects in underserved communities. UNDP Indonesia is also working with Badan Wakaf Indonesia, their national waqf board, to collaborate on SDGs and develop a digital platform for waqf contributions. UNDP is also working with the Indonesian Ministry of Finance to support the issuance of their first $1.25 billion sovereign green sukuk. This sukuk, which is oversubscribed, shows that the SDGs are a huge investment opportunity, with vital potential to leverage Islamic Finance partnerships for green investments.

In Palestine, UNDP is facilitating the mobilization of funds for SMEs through Islamic microfinance, and in Turkey, we are exploring new ways to blend Islamic finance with crowd funding through Block chain technology. These types of projects could be replicated from the Philippines to Pakistan, from Sudan to Suriname.

Impact investment is another new form of financing, growing rapidly and estimated to be worth $1 trillion by 2020. It has much in common with Islamic Finance, being value-based with a moral purpose to do good, intending to generate a measurable, beneficial social or environmental impact alongside financial return and seeking to build inclusive financial systems, valuing financial stability and shared prosperity. UNDP has been actively engaged in fostering impact investment – both conventional and Islamic – in service of the SDGs.

In 2017, UNDP and the Islamic Development Bank (IDB) launched a joint report titled I for Impact: Blending Islamic Finance and Impact Investing for the Global Goals. The report was a key step forward in conceptualizing Islamic finance-based impact investing, and building an ecosystem in support of this idea, with strategies and approaches to leverage Islamic financial instruments, like sukuk and micro-takaful, for development financing.

To help bolster this potential, UNDP and the Islamic Development Bank also launched the Global Islamic Finance and Impact Investing Platform, which promotes market-based solutions to sustainable development challenges, with the aim of positioning Islamic finance and impact investing as leading enablers of global SDG implementation through private sector engagement. The platform is a knowledge hub for peer learning, a forum for policy dialogue and a market place for deal sourcing and match making. By bringing together different actors in the Islamic finance and impact-investing arena, it aims to create a collaborative working space among stakeholders, and nurture a business ecosystem for Islamic finance and impact investing.

And this is just the beginning. UNDP is present across 170 countries, with expertise ranging from economic empowerment, governance and sustainable development to resilience and conflict prevention. We have a proven track record of developing and managing a large portfolio of development projects, and can support Islamic Finance organisations to align with the SDGs, monitor, report and communicate development impact, as we are already doing in Indonesia and other countries. We look forward to your ideas today to guide our future engagement, and help governments to leverage the new sources of financing needed to significantly advance their progress towards sustainable development