Ricardo E. Torres | Microfinance Best Practices Forum Almont | Butuan City June 25-26, 2015
This conversation paper is focused on development financing. Tahe primary audience are interested investors in Islamic financing. The data is limited on the issue of scale or scalability in financing. The fact is that, based on worldwide growth trend, Islamic based financing is a good financial product.
A financing product must be scalable. Scale leads to a business viability and creates impact. Scalability is always a big challenge especially if the investment is for ARMM where 49% of the 4.1 million population are poor and 9 out of every 10 are in need of shariah compliant financing.
In the last 5 years, there has been much interest or movement on the subject of Shariah Compliant or Islamic financing in the Philippines. In the first 6 months of 2015 alone, there were at least 3 fora and conferences among civil society organizations, excluding this one that talked about Islamic financing.
One major movement started in 2008. In 2008-2009, the Development Bank of the Philippines (DBP) took full control, infused equity and approved a rehabilitation plan of the only Islamic Bank in the country, the Al Amanah Islamic Investment Bank. The resources of the Al Amanah Bank who was deep debt in 2008 jumped from 83M in 2007 to more than 1Billion by 2013. Also, in November 2013, the Asian Development Bank trained its sight on Islamic financing and conducted its “1st Conference on Islamic Finance” in Manila Philippines.
ADB President Mr. Nakao said Islamic financing was relevant since about 80% of the world’s Muslim live in the member countries of ADB. Also, Islamic finance increases financial inclusion and stability. ADB noted that Islamic financing may learn from the growth of microfinance.
The Peace and Equity Foundation studied the Islamic finance market in 2012. We partnered with the Al Qalam Institute at the Ateneo de Davao University. Surveys and consultations revealed that while there were development focused Muslim organizations engaged in peace advocacy and livelihood programs only the AIIB and one MF organization were mentioned as investors in Islamic financing.
PEF’s decision to invest in Islamic Financing or Shariah compliant financing was motivated first by the Foundation’s desire to be an impact investor in social enterprise solutions, especially in agri-industries. The mission is help households acquire assets and communities to create wealth and be disaster resilient.
Secondly, PEF seeks to be a thought leader in development finance. In the deliberation about Islamic finance, a PEF board member with years of experience in investment banking said: PEF knows little about the Islamic market; we do not understand the tools and there are no local models to start with. If we invest in Islamic financing, we are brave and crazy. But learning is essential. Invest!” A culturally compliant business model is needed in Muslim Mindanao: thus the Shariah or Islamic financing program was established.
PEF entered into a mudarabah contract with 2 organizations. The equity is less than 2M pesos. By end of 2014, the investment grew 8 folds. And from 2016-2020, the investment is planned to double in terms in number of partners and amount.
Also in 2014, the Foundation, unknowingly, held shares in least 20 of the 66 Shariah compliant securities that are listed in the Philippine Stock exchange. But even with a growing portfolio, PEF is far far away from scale. There is still much too much to learn.
In the meetings on Islamic Finance, (SLIDE 6) the topics often revolved around the concept of riba, gharar, and maysir. As more conferences are held, arabic words like musharaka, mudaraba, ijara, waqf became easier to pronounce and memorize. But the logic on the use of these tools is like a FB relationship: it’s complicated, especially from the point of conventional finance. Often you will hear, ah “pareho lang pala sa microfinance, may interest din, binago lang pangalan.” Or compared to microfinance, what is the return on equity? If Islamic Financing does not add interest, how is profit made, sustained and scaled up?
The experience of formal banking or the AIIB and the microfinance industry may offer insights on the issue of scalability. Both these institutions started their growth between the periods of 1974-2000 and peaked around 2005.
First, the Al Amanah Bank. After 20 years of operation, the AIIB was as an indebted bank by 2008. From a purely financing angle, the poor performance may have not been caused by the lacked funds or tools in Islamic investments. In the same period, countries like Malaysia and Indonesia have been testing and refining instruments in Islamic financing. In 1991, the Accounting and Auditing Organization for Islamic Financing Institutions was established. The organization helped to set standards and train people. By 2006, the Sharia based finance world is growing at a compounded average rate of 20%. Today, there at least 600 Islamic financing institutions in 75 countries that provides a diversity of financial models. The AIIB was established at a period when there were industry drivers for growth both locally and internationally. What did AIIB missed to do? Or over-did?
Some said that the creation of Al Amanah Bank was politically motivated and largely government led; thus, was not destined for sustained growth. Still others said that the lack of clear regulatory framework caused the stagnant growth of AIIB. But, according to experts, Malaysia’s Shariah economy and finance investments was also government driven. And Indonesia had its first Islamic Bank in 1992 and slowly evolved its regulatory framework and Islamic financing tools from 2000-2010. The reasons behind the slow and negative growth of formal Islamic financing investments in the Philippines when other countries were growing is another interesting subject.
The experience of microfinance Institutions, the darling of development finance is more encouraging. A 2015 Philippine market data showed that there at least 4.6M microfinance borrowers with a combined portfolio of 1.3B US$. In terms of borrowers 47% of these borrowers are clients of 2 MF institutions that built their portfolio following and innovating on the business model in Bangladesh. In Bangladesh, there are 5 times more MF borrowers. Records from CGAP however point out that only a little over 100,000 households are actual Shariah compliant borrowers in Bangladesh. PEF has reached barely 1,000.
Scalability is a key challenge for conventional microfinance because of the prohibition on interest. Experts agree that absence of a regulatory framework had positive effects on the scale that the microfinance industry has attained. In fact, it was only in late 2000 that BSP recognized MF as formal financial institutions. It took the formal banking industry at least 15 years to follow the financial model of early groups like CARD and ASA.
These two experiences, from AIIB and MF organizations offer some insights on the scalability of Islamic Finance.
The DBP and AIIB remain as the largest depository of conversation pieces in Islamic financing. AIIB has articulated the issues why Islamic financing is not yet in a position to scale up: 1) lack of clear legal and regulatory framework, 2) scarcity of experts at the industry and community level and 3) unfamiliarity of investors and borrowers on Islamic finance.
PEF confirms that many Muslims households and organizations are also not familiar about the ways and means of Islamic Financing. PEF, in partnership with Cordaid of Netherlands and Al Qalam Institute is organizing evidenced based conversations and learning events on Islamic financing for local leaders, board and staff of Muslim organizations. More than 20 people have been exposed to industry scholars and practitioners in Indonesia. The formation of local and even a national Shariah Council and support structures like pool of Islamic accountants are key steps being done. The program is on its 3rd year.
The experts from the Universitas Islam Indonesia said that Islamic financing in their experience has or is still undergoing three phases : 7 years of understanding, 7 years of testing and another 7 years of purification of tools to create a truly shariah compliant product. Give or take 21 years!