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Islamic microfinance; Importance and prospects

Muhammed Palath Introduction Access for financial institutions is considering as an important method for economic development. Development economists find that financial exclusion is the major reason for poverty not only in India but everywhere in the world. The importance of an inclusive financial system is widely recognized in the policy circle in recent years and financial inclusion is seen as a policy priority in many countries. An all inclusive financial system enhances efficiency and welfare by providing avenues for secure and safe saving practices and by facilitating a whole range of efficient financial services. Though the formal financial institutions are beyond their reach poor people depends of financial arrangements on indigenous sector as a way to meet their financial needs. Microfinance institutions are systematic arrangements for fulfilling financial needs of the local people. What is Microfinance? The term microfinance refers to "the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low income households and, their micro enterprises." It has no concrete model for microfinance. Any institution or group which is providing financial service specified above directly or through groups with a purpose of improving living condition of people are considered as microfinance. The idea of providing credit to the poor as a tool for increasing their income and thereby reducing poverty is not new. What are new in microfinance are the innovative methods of providing credit to the poor. That is, the usage of social collateral such as group guarantee instead of physical collateral, progressive lending approach, peer pressure and peer monitoring etc. Mobilization of savings from the poor, linking credit provision to savings, social mobilization process that involves awareness building and formation of self-help groups and provision of other services such as insurance to cover risks and distresses faced by the poor also new to financial sector. The relevance of microfinance Financial inclusion is considered as a shortest way for poverty alleviation and economic development. Financial inclusion is defined as the access, availability and usage of the formal financial system by all members of the economy. These include not only banking products but also other financial services such as insurance and equity products. It has generally been observed that the poor people dont have access to bank loans. Private money lenders charge very high interest rates. This makes it difficult for poor people to access funds for starting small income generation activities or for meeting urgent consumption needs. Micro Credit caters the need of people for small loans. Micro finance includes support services along with the loan component. Raghuram Rajan (2008)1 observes Indias poor, many of who work as agricultural and unskilled/semi-skilled wage laborers, micro-entrepreneurs and low-salaried worker, are largely excluded from the formal financial system. Over 40 per cent of Indias working population earn

but have no savings. Even accounting for those with financial savings, too large a proportion of the poor lie outside the formal banking system. For example, only 34.3 per cent of the lowest income quartile has savings, and only 17.7 per cent have a bank account. By contrast, in the highest income quartile, 92.4 percent have savings and 86.0 per cent have bank accounts. Similarly, 29.8 per cent of the lowest income quartile had taken a loan in the last two years, but only 2.9 per cent had loans from banks (about one tenth of all loans), while 16.3 per cent of the highest income quartile had loans and 7.5 per cent had loans from banks (about half of all loans). Banks have not been provided financial services to clients with little or no cash income. In addition, most poor people have few assets or no assets that can be secured by a bank as collateral. In the absence of formal financial institutions the poor people regularly depends on local moneylenders, relatives or friends for their credit needs. Raghuram Rajan in his report quotes a data from Indian Institute of Social Science (IISS). The data points out that in the 25% of lowest income population (they are extremely poor) 39.8% of credit needs are fulfilled by moneylenders and 39.8% by relatives and friends. Their only 9.6% of credit needs are met by banks 5% by co op societies. In the next 25% of population (relatively poor) only 20.7% of credit needs are fulfilled by banks. Majority of their credit needs are also fulfilled by moneylenders and relatives/friends, 32.2 and 34.3 respectively. The high dependence on informal sources in turn implies that bulk of the borrowing by the very poor is at very high interest rates. Almost half the loans taken by the lowest income quartile carry annual interest rates above 48.4 per cent. The loans taken by second lowest income quartile carry 39.7%.as interest. Non accessibility of formal financial institutions is the reason behind the high interest rate payment of the poor. (Raghuram Rajan 2008)2 Implementation of microfinance is a powerful tool for financial inclusion and poverty alleviation. Raghuram Rajan continues Microfinance is the fastest growing non institutional channel for financial inclusion in India. A key factor that influenced the success of microfinance was its ability to fill the void left by mainstream banks that found the poor largely uncredit worthy, and were unable (or unwilling) to design products that could meet the needs of this segment in a commercially viable manner. Using group-based lending and local employees, microfinance provides financial services (largely credit) using processes that work, and in close proximity to the client. These qualities facilitated the proliferation of microfinance from a virtually non-existent activity in 1990 to a small, but increasingly important, source of finance for Indias poor. (Raghuram Rajan 2008)3. In order to address the issues of financial inclusion, the Government of India constituted a Committee on Financial Inclusion under the Chairmanship of C. Rangarajan. The Committee submitted its final report to Hon'ble Union Finance Minister on 04 January 2008. This report also suggests opening specialized microfinance branches / cells. (Rangarajan 2008)4 Positives of microfinance In short microfinance is a better and efficient method for financial inclusion, social and economic upliftment, economic empowerment and through it poverty eradication. Problems with interest based microfinance But now Micro Finance institutions introduced for filling the gap created by banks becomes most exploitative institutions. In rural areas many MFIs were charging high interest rates. Y. S. Rajasekhara Reddy, (2008)5 former chief minister of the Andhra Pradesh, once complained that some MFIs were "worse than moneylenders" because they charged interest rates

over 30 percent. The poor people normally pay interest to money lenders as bank is beyond their reach. In the case of MFIs or SHGs also people pay interest. According to India's National Crime Records Bureau, more than 87,000 farmers committed suicide between 2002 and 2006 because of failing harvests and huge debts. A 2004 article in The Lancet, a renowned British medical journal, found that young women in South India had the highest suicide rate in the world. Sudhirendar Sharma, a former World Bank analyst and now director of the Delhi-based Ecological Foundation, thinks that microfinance is part of the problem. The rural suicides, he wrote, "cast a dark shadow on the fledging microfinance sector." (Thilo Kunzemann 2008)6 Sharma complains that usurious interest rates of up to 40 percent and forced loan recovery practices were intimidating the poor. The World Development Report (2000-06) acknowledges that the reach of micro finance has been limited to moderately poor sections rather than the poorest and recommends greater flexibility in loan size and repayment schedules to reach poorer sections in any region. The interest rates on loans charged by traditional NGOs including Grameen Bank are high by any standard (20-35%), and reports of poor borrowers having to dispose of whatever assets they have to pay the usurious interest are not uncommon (Rahman, 1999)7. For the last one year microfinance is a hot discussion for the medias especially in Andhra Pradesh, there state govt. recently introduced a separate regulation for microfinance institutions. The media and various official agencies find that more than 50 persons were committed suicide within one year because of the harassment of microfinance officials. After that state government implemented a microfinance law which cannot limit the rate of interest charged by MFIs. Reserve Bank of India appointed a committee to study about the issue or microfinance in the country under the chairmanship of Shri Y.H Malegam. The committee submitted its report last January recommends for separate regulatory structure for microfinance NBFCs and also suggested to fix the maximum interest rate of 24% from clients. The supporters of microfinance as a poverty alleviation measure arguing that it make available micro loans to the poor. But actually the rates of interest charged by these microfinance institutions are very high up to 60 percent. Different Medias are reported on the occasion of increasing farmer suicides in Andhra Pradesh and other states that private microfinance institutions are charging the interest rate up to 80%. We add the recent farmer suicides in the Wayanad and Palakkad districts of the state of Kerala. When different commissions are collected the true reasons for suicides it is find that all farmers have huge debts in microfinance institutions including Kudumbasree, which is the government sponsored poverty eradication mission in Kerala. News papers are reported that all this SHGs are charging higher interest rate up to 60 percent and will increase the exploitation. Empowerments of poor people are not possible through this model and the result is increasing poverty in the country. Relevance of Islamic microfinance As a way of escape from the above issues of traditional (interest based) MFIs, a handful of Interest-free MFIs have come forward very recently to provide interest free financial services. Many of the countries of the world studied the evils of interest and introduced interest

free banks and microfinance institutions. Asian Development Bank in its 2006 report points out that the special characteristics of interest free finance can provide alternative means to reach undeserved groups in small rural areas and agriculture producers. In India main factor which inhibits these institutions to enter in to real banking business is the prohibition from the RBI. Even then non banking financial companies and interest free micro credit institutions are doing interest free banking activities so as to benefit thousands of people of the country. Guiding principle of the said microfinance institution is to become sustainable, side by side with promoting entrepreneurship amongst financially disadvantaged segment of the population with the sole objective of creating enabling environments for them to fully participate in the economic process and build up assets of their own. Many studies in different parts of the world especially in Bangladesh shows that in a short span of time, interest free MFIs have been performing better than the tradition MFIs in the field of resource mobilization and poverty alleviation (Chowdhury, 2007)8. Raghuram Rajan (2008)9 suggests starting interest free financial institutions in India as a remedy of financial exclusion; which is the main reason for extreme poverty in the country. In his words Another area that falls broadly in the ambit of financial infrastructure for inclusion is the provision of interest-free banking. Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products (where the return to the investor is tied to the bearing of risk, in accordance with the principles of that faith) results in some Indians, including those in the economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith. This non availability also denies India access to substantial sources of savings from other countries in the region. As a mother country for microfinance initiatives many Bangladesh based studies are available about the effect of it on poverty alleviation. Mohammed Obaidullah (2008)10 compiled 17 studies about effect of microfinance on poverty alleviation. Most of the studies find that the positive effects of functioning of microfinance on poverty. But in his book he make a comparative study about the interest based institutions and interest free institutions, both are prominent in Bangladesh. He also makes case studies from Indonesia and Turkey, two secular countries and does a comparison with those countries. After a deep analysis he concludes that interest free micro credit is more productive and so effective for poverty alleviation. For that he studies about Rural Development Scheme of Bangladesh Islamic Bank, Credit guarantee scheme of Turky and micro finance sheme of Bank Rakyath Indonesia. It also suggests concentrating finance to livelihood-growth enterprises on interest free basis is more helpful to reduce poverty because it is more productive. Islamic microfinance in India and its scope Though there is no permission to start interest free banks hundreds of interest free micro credit institutions are working in the country. These institutions are financing micro level and not charging interest. These institutions are known as muslim funds or bilasudi funds in north india and interest free nidhis or societies in Kerala. These are providing loans from Rs 500 to Rs 25000 to needy persons. This institutions help to reduce debt burden and debt trap of poor people. So it is a way to reduce poverty. No detailed data are available about the functions, and performance of such institutions as it is not subjected for a detailed analysis. Rahmathulla (1999)11 conducted a study about interest free institutions in India. It shows that the highest

number of such institutions is in Kerala, followed by Uttar pradesh, Andra Pradesh, Maharastra and Karnataka. Mohammed Rafeeq (2005)12 gives a detailed picture about evolution of interest free financial institutions in India. In his study he classifies IFIs in India in to financial association of persons, co operative credit societies, and Islamic financial investment companies. Financial association of persons does not belong to the organized sector of Islamic finance in India. These are the effort of private efforts of ordinary Muslims living or working together in market, Madrasas, colleges, mosques and Anjumans. They are generally organized small funds by subscribing weekly or monthly basis and utilizing it to finance a member by taking lot or using any other method. More than hundred these institutions are identified by the author which financing up to one lakh with a capital of up to 100 lakhs. Another model is Muslim fund which was originated during the Indian independence movement due to financial problems of that period. According to him the first muslim fund is started in 1941 at Tada Bavli in Up. The co operative credit societies was also started in the same period, the Patni co operative credit society is considered first interest free co operative society which was started in 1938 and registered in 1942 at Surat. Among the whole models Islamic investment and financial companies are generally the only profit earning IFI s in India which is functioning on profit and loss sharing basis. Arshad ajmal (2010)13 explores the cooperative model for interest free microfinance in India. The author presents that interest free microfinance as an endeavor (envisaged by its proponents) part of an alternative of present economy after criticizing the present microfinance institutions. It compiles especially the situation of Muslims in India and suggests that for making better economic position of Muslims demand to concentrate on Muslim dominated districts as prime target. But once these districts selected, the Interest Free Microfinance unit should address the all deprived communities. It also tries to evaluate whether the economy of unorganized sector is in itself can be a viable proposition in terms of efficiency and acceptability. This evaluation is not based on class consciousness but encompassing the all who believe in justice and equity in economy. But the main thrust should be on Muslims, Dalits (Schedule Castes) and Adivasis (Schedule tribe). It finally deals in detail about the philosophy of Cooperative, cooperative principles, available legal framework in India and suggests an architecture plan of Interest Free Microfinance in India through civil society The former prime minister of India Indira Gandhis slogan, garibi hatao (eliminate poverty) is as poignant and relevant today as it was in the early 70s. Its popularity serves as evidence of the belief among all Indians that those born into lower stations in life, through no fault of their own, deserve a chance to better their own condition and that it is the responsibility of the government to help them have that chance. Yet even today, horrible disparities exist between different segments of Indian society. Income, unemployment and literacy vary significantly by caste, linguistic identity and religious identity. We should do all that we can to provide disadvantaged Minorities with the tools they need to improve their condition. The Indian banking sector has been opened considerably in the past decade or so and openness to interestfree banks is a reasonable next step. Islamic banking and microfinance is one way to better provide the disadvantaged Muslim minority (among others) with the tools it needs to improve its situation. The potential benefits of allowing this include decreased economic disparity between the Muslim minority and the rest of the nation, better integration of that Muslim minority, and

increased national economic growth. By creatively accommodating the ideological differences of its Muslim minority, and keeping an open mind about interest-free finance, the India can position itself to reap these potential benefits. The government of India can grow one step closer to actualizing the spirit of garibi hatao by reforming its banking sector and allowing the establishment of interest free financial institutions. And the community leaders should try to implement microfinance institutions on local level as a way to escape from the exploitation of interest and to avail other financial services. References: 1,2,3,) Raghuram Rajan ( 2008) report Chapter 3 Broadening access to finance 4) Rangarajan C (2008). Committee on Financial Inclusion e submitted its final report on 08 January 5) Rajasekhara Reddy Y S, (2008) former chief minister of Andhra Pradesh a speech Copied from Thilo Kunzemanns Is Microcredit a Debt Trap? January 16, 6) Thilo Kunzemann, Can microcredits fight poverty or are they a debt trap for the poor? publishing date: January 16, 2008 Allianz knowledge partner site 7) Rahman, S.M. (2008), Impact of Rural Development Scheme (RDS) of IBBL on The Rural Poors Livelihood in Bangladesh, Unpublished Research Report, Islami Bank Training and Research Academy (IBTRA), Bangladesh. 8) Chowdhury, A. M. R., and Bhuiya, A. (2004), The Wider Impacts of BRAC Poverty Alleviation Programme in Bangladesh, Journal of International Development16(3), 369-386.68 9) Raghuram Rajan ( 2008) report Chapter 3 Broadening access to finance 10) Role of Micro finance in poverty alleviation Obaidullah Mohammed (2008), IRTI Jeddah. 11) Rahmathullah (1999), Problems of interest free banking in India, in the Muslim & Arab Perspectives international Islamic magazine, Vol 4 issues 7-12,New Delhi: The institute of Islamic & Arab studies 12) Rafeeq Mohammed B a study of the evolution of the interest free financial institutuions in India PhD thesis submitted at PG department of economics Jamal Mohammed College Tiruchirappalli TN) 13 Arshad Ajmal (2010) Interest Free Microfinance in India: Exploring the Cooperative Model Option, International Seminar on Islamic Finance in India: Products, Institutions and Regulations October 4-6, 2010, Kochi, Kerala, India