Introduction:

Microfinance refers to making small loans available to poor people (especially those traditionally excluded from financial services) through programs designed specifically to meet their particular needs and circumstances. Over the last few years micro-finance has been increasingly recognized as an important component in poverty alleviation strategies. Poor households face difficulty in generating regular and substantial income to save for future and are extremely vulnerable to economic, political, and physical downturns. A little drop in income or increase in expense can have a disastrous effect on their already low standard of living. They have limited access to health care facilities; have low literacy rate and poor living conditions. Death, sickness, or accident may force them to dispose their property or some of the productive assets, which in turn further decreases future income and current livelihood. The frequency of losses is also greater for the poor; many are regularly exposed to natural disasters like flood, fire, and theft with limited means of recovery. The World Bank estimates that there are over 7000 microfinance institutions, serving some 16 million poor people in developing countries. The total cash turnover of MFIs world-wide is estimated US$ 2.5 billion and the potential for the new growth is outstanding. The Microcredit Summit estimates that US$21.6 billion is needed to provide microfinance to 100 million of the world's poorest families. Other estimates tell us that worldwide, there are 13 million microcredit borrowers, with USD 7 billion in outstanding loans, and generating repayment rates of 97 percent; growing at a rate of 30 percent annual growth. Despite all this less than 18% of the worlds poorest households have access to financial services. Microfinance initiative is widely acclaimed as a new approach to alleviate Poverty, to bring about economic development and to improve the living conditions of the poor. The Islamic world is enormous with over 1.2 billion people. Poverty rate is quite high in all Muslim countries, more than 40% of the poorest people on earth live in Muslim countries, except a few countries in Southeast Asia and the Middle East. Poverty levels have also been associated with high inequality alongside low productivity. Half of the Indonesia population (about 129 million) is living below the poverty line of US$2 a day. While in South Asia two largest Muslim states - Bangladesh and Pakistan alone account for 122 million living below the poverty line where as 100 million Muslims of India are also living below the poverty line (IRTI, 2007, p.18). Conventional micro financial services facilities do not meet the needs of majority of Muslim population in developing countries like Pakistan, Bangladesh, Indonesia as well as in developed countries like UK, USA and Australia. The reason is that conventional micro financial institutions charge interest on their loans provided to small and medium enterprises as well as women entrepreneurs. A vast majority of Muslim population refrains from availing conventional micro financial services due to the element of interest that is considered repugnant to Shariah. Over 470 millions Muslim population is living below poverty line (less than $2 per day) in four largely populated Muslim countries: Pakistan, Bangladesh, Indonesia and India. In this scenario, Islamic micro finance has tremendous potential in these countries and could be used as a powerful weapon to fight against poverty. It can develop a valuable human capital base by satisfying the financial needs of Muslim community and positively contribute towards the economic growth in those countries. Despite a real appeal in Muslim countries, Islamic microfinance represents less than 1% of global microfinance. Islamic banking, with its emphasis on risk sharing and, for certain products and collateral-free loans, is compatible with the needs of some micro-entrepreneurs. Viable projects that are rejected by conventional lending institutions because of insufficient collateral might prove to be acceptable to Islamic banks on a profit-sharing basis However, they concluded that from a microfinance standpoint the mudaraba model (profit-sharing) has more drawbacks than the murabaha model (cost plus markup). The murabaha model is overall more cost effective, has a lower margin of error, and provides immediate collateral for a MFI because the MFI owns the goods until the last installment is paid. MFI has to create various reserves to cover various risks arising due to the nature of its assets and liabilities. To protect from withdrawal risks, the MFI can use takaful and profit-equalization reserves to give depositors competitive returns.

Islamic Financing Instruments:

In addition to Al-Qard Al-Hassan (the benevolent loan), the loan with zero return, the literature separates the other Islamic financing instruments into two main categories: 1) Debt like financing (non profit and lost sharing) such as: Murabaha (cost plus mark up), Ijara waqtina (leasing), bai salam (forward contracts) and bai muajjal (spot sale), etc. 2) Investment Financing (profit and lost sharing) such as: Mudaraba (Trustee Financing), Musharaka (Equity Participation), Muzarah (Share of Harvest) and Direct Investment. So far, the focus for Islamic microfinance practitioners has been on debt financing instruments that closely resemble conventional microfinance. The most widely offered Sharia-compliant contract is Murabaha (cost plus markup sale contract), an asset-based sale transaction used to finance goods needed as working capital. Typically, the client requests a specific commodity for purchase, which the financier procures directly from the market and subsequently resells to the client, after adding a fixed mark-up for the service provided.

Islamic microfinance in Pakistan:

Pakistan and Bangladesh account for an estimated 122 million Muslims living in poverty, or about 10 per cent. of the world's Muslim population. Pakistan is among the few countries in the world which has a separate legal and regulatory framework for microfinance banks. The framework allows microfinance and commercial banks to extend a range of microfinance services to poor and low income people through various arrangements. Consequently, the State Bank of Pakistan has formulated guidelines for provision of Islamic microfinance produces and services. These guidelines are intended to increase the scope of microfinance services and products consistent with Shari'a principles, and specify the four types of institutional arrangements eligible in offering Islamic microfinance. Apart from the banks, the other notable Islamic microfinance institutions (IMFIs) in Pakistan are Akhuwat and Islamic Relief. Pakistan has developed a unique mosque-centered structure. In the case of Akhuwat, Islamic microfinance is dispensed by small interest-free charitable loans (qard al-hasan) with an administration fee of 5 per cent. in a spirit of Islamic brotherhood. There is no funding from international donors or financial institutions. All activities revolve around the mosques and involve close interaction with the community. There are no independent officers and loans are disbursed and recovered in the mosque. It uses collateral-free group and individual financing based on mutual guarantees. Anecdotal evidence suggests that the fact that loans are disbursed in a mosque, also attaches a religious sanctity to the oath of returning it on time. Islamic Relief disburses murabaha-based financings to individuals based on a combination of personal guarantors, group savings accounts, co-signers and community recommendations to ensure repayment. These guarantee mechanisms are highly efficient and repayment levels are in the range of 95-99 per cent. Murabaha financings are typically delivered to borrowers' business premises. Islamic Relief is continually working in partnership to establish new lending programmes based on Islamic models of microfinance and expand existing programmes in the wider community.

Obstacles in Islamic micro financing:

If there are so many poor Muslims in the world, and if the overwhelming majority of those Muslims do not have access to financial services, and if two thirds of these either insist or prefer having financial products that comply with Sharia, and if there are MFIs that are providing Islamic microfinance services, then why hasnt Islamic microfinance succeeded in reaching as many clients as conventional microfinance?

According to the 2008 CGAP focus note on Islamic Microfinance: Although there is ample evidence of demand for Islamic microfinance products, this demand can only be met if low-income clients are convinced that the products offered are authentically Islamic. Critics of Islamic finance products suggest that the pricing of some products offered as Sharia-compliant too closely parallels (or even exceeds) the pricing of conventional products. For example, some institutions offering Murabaha, seem to disguise interest as a cost markup or administration fee.
The cost of Murabaha involves more than simply giving the money to a borrower so he/she can go and buy the items needed for their enterprise. Costs are elevated by the additional staffing costs incurred when staff members accompany clients to buy the goods/materials/equipment covered by the loan on top of all of the transactions completed in conventional lending. To minimize this cost, in most cases, MFIs try to minimize the number of loans by giving larger loans to a smaller number of borrowers. As a result, they either serve less impoverished clients, clients who were not impoverished, or they serve a poor client with a loan larger than his/her capacity to pay. In addition, in most cases, Murabaha does not allow a late payment fee, and MFIs seems to take that into consideration when they price their product. Murabaha also tends to be less flexible, and does not allow borrowers to get cash they need to pay other expenses, such as utilities. Those MFIs that focused on Al Qard Hassan products with no fees or a small fee were unable to cover operational costs and remained dependent on subsidies which prevented a wide outreach. The other MFIs used Murabaha which is the closest to the conventional microcredit and raised suspicions about their compliance with Sharia law. To be sustainable, MFIs charged rates and fees that were equal or higher than the rates of conventional loans making clients wary because of the high cost of services. Another main reasons for the low growth of Islamic microfinance lies in the lack of willingness on the part of the large Islamic banks. The Islamic finance industry has often shown little interest for microfinance and the fight against poverty. Other barriers include regulation, which is rarely favorable, lack of public awareness, due to the western economy, the low level of academic research, and the lack of innovation:

Solutions to obstacles:
It seems that what was done so far is copying and pasting from conventional microfinance. Many practitioners simply added another product instead of devising a new business model. When the conventional microcredit/microfinance movement began in the late 70s, the pioneers at that time thought outside the box of the conventional banking and its business models and came up with new models which proved over the years that the poor are credit worthy and can take loans and pay them back without the need for the collaterals conventional banks ask for and can pay high enough interest rate to cover the cost of the operations and to allow the MFI/bank to make some profit. Islamic Banks need to think outside the box of conventional microfinance and its business models and come up with new models that comply with the Sharia on the one hand, and that can reach millions of poor Muslims with financial services on a sustainable basis. low-income populations, who often rely on local religious leaders to address religious issues, These leaders seem to perceive the Murabaha as if it is simply a rebranding of conventional finance and not truly reflective of Islamic principles. More efforts should be invested in convincing those local leaders and the poor clients, with the authenticity of the Islamic financial products if Islamic microfinance is to reach its full potential. The absence of institutional credit guarantee is an important factor that demotivates the commercial banks and IFIs to be involved in micro-credit activities for low income groups of society as well as small and medium enterprises. It is essential to establish linkages among various institutions at micro, meso as well as at macro level for the growth of Islamic MF industry. if various organizations including Govt. agencies, Central Bank, Commercial and Islamic Banks, Takaful and Cooperative Companies as well as NGOs and NPOs could be interlinked, they can reach at the poorest of the poor of a society and significantly contribute towards the development of micro-enterprises, enhancing the financial inclusion and alleviating the poverty from the gross-root levels of a society.

An example of Innovative way of Islamic micro Financing.

Islamic Microfinance Challenge: Profiling Tanzania Eco-Volunteerisms Honey Project by Mohamed Yasin : Monday, April 11, 2011 Every week the blog will feature a different finalist of the Islamic Microfinance Challenge and share the projects ideas and innovation.

Tanzania eco-Volunteerisms (TeV) honey project is a community development program providing rural poor communities of Tanzania with an innovative microfinance model that is in complete compliance with Islamic guidelines for business and finance. TeVs microfinance activities are sustainable, scalable, and market-driven and include interest-free loans (qard hasan), savings (wadiah), and insurance (takaful). TeVs mission is to invest in communities by introducing sustainable beekeeping. The investment of beehives benefits a large number of poor at the grassroots level who are involved in apiculture. TeV empowers communities by offering each family two Langstroth Hives (beehives) on an agro-based, qard hasan loan. Each loan is interest or riba-free and does not require any form of physical collateral or al-rahn. Each family will harvest honey and will benefit from a revenue stream based on fair-market-value sales to TeV. TeV will then export the raw honey to wholesalers at a profit, capitalizing on market opportunities. Each family will have two years to pay back the qard hasan to TeV. The revenue stream that each family will produce from selling their harvested honey will be partitioned into three segments: 25% will translate into loan repayments to TeV, 25% will contribute to the cooperative farming savings fund (wadiah) called Asali Saccos, and 50% will be new cash at the disposal of the participant families. Earnings per family will further increase if they decide to invest their savings into more Langstroth Hives to produce more honey. Furthermore, TeV will insure

(micro-takaful) families hives to mitigate potential financial harm impacting the participants. The cost of insurance is included in the cost of the initial purchase. TeV focuses on capacity building of farmer communities in addition to offering products. The principles of self-help and the trust within the communities are key to economic and socio-cultural freedom for Tanzanias millions of poor Muslims. TeV intends to have the following impact through this program: Reduce poverty income from honey sales enables families to reduce poverty through access to more spending on education and health services. Empower women interest-free loans will be distributed to the matriarchs of participant families. TeV will empower women by enhancing their contribution to household income and assets, encouraging independent control over decisions that affect their lives. Conserve the environment revenue from the Langstroth Hives reduces the dependency on natural resources like cutting trees to sell as fire wood and charcoal. Empower communities- each community is given considerable independence for managing its own operational apiaries, such that each one remains decentralized as encouraged in Islamic teachings Inculcate a culture of savings one quarter of the revenue stream earned from the sale of their honey to TeV will be allotted to a savings account called Asali Saccos, a cooperative farming program that encourages a culture of savings amongst beekeeper families. Each year participants will be able to invest their savings to purchase more Langstroth Hives.

Innovation TeVs approach to poverty alleviation is more inclusive than the conventional one, as it provides poor, rural Tanzanians with a medium of revenue through the implementation of an innovative, niche business model that does not emulate the traditional micro-finance concept. By enabling communities to participate and own new technology in beekeeping enhances financial, social, and environmental sustainability. TeV provides fair-market-value prices to their micro-suppliers of honey. The use of the Langstroth Hive in Tanzania is also an innovation. Although these hives were invented over 150 years ago, many Tanzanian beekeepers are unfamiliar with its technology. Too many local beekeepers rely on inefficient bark beehives which yield lower amounts of honey in comparison. Moreover, the quality of honey produced from the uneconomical bark method is inferior to the quality of honey produced by Langstroth Hives. This is because that method allows wood shavings to enter the harvested honey. TeVs Langstroth Hives will represent a technical shift in industry operations. Sustainability TeVs interest-free loans to its participants are cyclic in nature; they are disbursed to participants, returned to TeV, and disbursed again. TeVs advocacy of financial inclusion and entrepreneurship is coated by the principle of risksharing through its partnership with Tanzanias rural poor communities. In order to reduce repayment vulnerability families are grouped in clusters of 10 owning 20 beehives to enable repayment through peer participation. Furthermore, TeV further reduces the likelihood of default by only demanding repayment when revenue from harvested honey is constant and by spreading repayment over two years. In order to reach clients, TeV has devised a masjid-wide approach; depending on each communitys Imam to guarantee a potential participants honesty and integrity. Imams form the core group in the social collateral model .