The Ladder

A Blog from New America's Asset Building Program

Sharia-Compliant Microfinance: an Opportunity to Reach More Financially Excluded

Published:  July 13, 2010

Adek Berry/AFP/Getty Images

As the microfinance market develops, so does the diversity and range of products and practices. I’ve been struck by one intriguing trend: the rapid expansion of Sharia-compliant banking (aka Islamic banking), particularly in non-Islamic markets. For instance, despite its relatively small Muslim population (around 16%), Ghana Islamic Microfinance is now offering Sharia-compliant financial products, especially microfinance, aimed at the BOP market.

In fact, while it has been most popular among the traditional banks and clients in the wealthier areas of the Middle East and Malaysia, Islamic banking is expanding to new markets and consumers. In hopes of reaching millions of financially excluded people in Africa, the Middle East, and South Asia, Citibank is challenging microfinance institutions in the Muslim world to offer Sharia-compliant loans and services by offering capital and consulting advice.
 
The basic tenets of Sharia-compliant banking are found in the Islamic belief that risk of profit and loss should be shared by both the lender and consumer and that investments shouldn’t be made in businesses that violate Islamic beliefs. These traditions are taken from the Quran, as well as the Sunnah, a collection of sayings and lessons from the prophet Muhammad.  Because lenders do not charge traditional interest on a loan’s principal, it tends to be a more ethical transaction. Instead of charging interest, lenders use several different mechanisms to ensure modest profit and to cover overhead, often becoming partners in entrepreneurial projects. While lending methods and traditions vary across regions, the socially responsible nature of the transactions remains the same.  
 
Although the growth and envisioned potential of this banking model is piquing the interest of a variety of financial institutions, Sharia-compliant practices will likely meet obstacles in some non-Islamic markets. Will the essence of these practices endure if the profit-seeking institutions offering them are not properly regulated to adhere to them? With all the chatter over interest rate issues and ethical lending practices among MFIs I wonder if Sharia-compliant banking will soon face similar pressures. It looks for now, at least, that the movement is sustainable and will continue to grow. Whether for religious or financial reasons, if micro finance can harness some of the growth potential of Islamic banking, the MFI market will develop more fully and poor consumers will have the potential to benefit.

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