v2 29.12.2021 Topic 9 Risk Mitigation Techniques in IMF.pdf

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1. TOPIC 9.
RISK MITIGATION TECHNIQUES IN
ISLAMIC MICROFINANCE
Prof Dr Salina Kassim
IIUM Institute of Islamic Banking and Finance
International Islamic University Malaysia
29
th
December 2021
IBF 7612 Issues in Islamic Financial Inclusion

2. RISK MITIGATION IN IMF
The poor being denied access to finance because they are considered as
highly risky due to (i) absence of collateral, and (ii) steady income.
How to mitigate default risks in Islamic microfinance?
•Not charging high interest premium to compensate for high risk?
•In the absence of physical collateral as security?

3. Clients
Joint liability and
peer pressure,
social collateral,
religious collateral,
capacity building,
financial literacy
MFIs
Product features &
Product criteria
Sustainable
Islamic MF
Model
Environment
Technology,
Collaboration with
FIs, Good
governance

4. 1. GROUP LENDING, JOINT -
LIABILITY & PEER PRESSURE
Borrowers typically being assigned into groups of 4-8
members in a group; members act as collateral and support
system for each other
•The group is held liable and would be penalized for any
failure of repayment of any member -inculcate
discipline among borrowers
•Enforcement is heightened through peer pressure
among members of the group, shifting the burden of
default and disciplinary duty from MFI to the clients
instead
•Shift in responsibility creates proper incentives for the
group to screen and monitor each other as well as
through use of social connections and individuals’ local
information

5. 2. SOCIAL
COLLATERAL
➢Pool of resources attached within a person’s social
network -a richer or larger pool commensurate a higher
social return.
➢Each group member pledged their social capital
embedded in their ties with other borrowers.
➢Borrowers are said to have provided MFIs with social
collateral by being jointly liable for group loans’
repayments
•Members obtain soft information from their social
networks to assess (screening) among peers as guarantors
for each other’s loans
•As a monitoring mechanism amid no established database.
Borrowers use this information to monitor one another;
internal (among members) and external (within
community) social ties connected borrowers both to non-
borrowers from their community to constitute social
collateral
–Ensuring loans are used for pre-agreed income generating activities; not
repayment of other loans
–Members vouched for each other if there are external influence –avoid
multiple borrowings

6. 2. SOCIAL
COLLATERAL:
EXAMPLE
AIM: example of adoption of social capital as a risk
mitigation technique
➢Clear product characteristics: no collateral, no
guarantor and no legal action
➢Group are empowered to select own members:
Formation of groups by potential members (5
members in a group, same gender with no blood
ties, equal socio-economic status, create right peer
pressure and peer support) –verifications?
➢Weekly meeting:
➢for payments and various activities to maintain bonding
among members; potlucks, religious talks, motivational
talks
➢to provide updates on any issues arise among group
members: egfamily death, new birth, visitations, progress
of business, etc
➢required to maintain minimum 70% attendance, or else
not eligible for future loans

7. 5. CREDIT-
PLUS
APPROACH:
EXAMPLE
•In AIM, various non-financial services are
also provided such as financial education,
business skills training services and social
services.
•Prospective borrowers are required to take
part in a training program for a week prior
to joining AIM –purpose: to gain
understanding on the procedures and rules
relating to financing and repayment.
•Through entrepreneurship training,
entrepreneurial and management abilities
are developed among borrowers ensuring
efficient use of credit they received.
•Development training is a fundamental element in AIM as it goes
hand in hand with access to credit, including basic entrepreneurial
and technical skills training, business development training
•Human capital development programs like
leadership and motivational programs.
•Religious talks highlighting work ethics, debt
repayment and responsibility (amanah)
towards each other

9. 3.
RELIGIOUS/
SPIRITUAL
COLLATERAL
•Incorporate noble religious values to
ensure re-payment
Values
•Conduct transactions at holy places to
imbue/build in elements of amanah/
responsibility/accountability
Conduct
•Ensure greatest presence of local
community
•These holy places provide a platform
for accountability, community
engagement and a sense of benevolence
amongst people.
Community involvement

10. 3. RELIGIOUS/
SPIRITUAL
COLLATERAL:
EXAMPLE
Best example -AKHUWWAT
•Established since 2001. Offices are set up
in MOSQUES -community centers that
gather greatest possible number of the
local community
•All transactions are executed at local
mosque; loans are processed, disbursed
and collected
–Create sense of accountability, community engagement and an
benevolence
–Responsible for the honourand dignity of family
–Clear responsibility to repay debt in Islam: cores values
promulgated by the religious belief
–It also helps reduce organizational costs and creates a sense
of transparency
Now the largest IMF in the world: 7,045
Volunteers; 90,073 donors; 2,923,959
Beneficiaries

11. 4. SMALL AND FREQUENT
REPAYMENTS METHOD
•Having to pay a large lump sum amount –
burdensome to low income
•Payments normally be collected on weekly
basis during the weekly meeting
•Thus, attendance to the weekly meeting is
made compulsory to all
•Use of e-payment could facilitate the process
–but, with issues
Extending small
amount of
loans and
ensure frequent
repayments to
ensure
discipline

12. 5. CREDIT-PLUS
APPROACH
Integration of non-financial services along with
provision of microcredit –ensure repayment and
as a strategy for financial sustainability
Not provided by banks –too costly -involve
field workers
Such services can be classified into 2:
•Business/technical development: comprises of namely financial
literacy guidance, marketing services as well as generic
trainings like business planning, vocational skills and
management training
•Social/capacity development: include motivations, healthcare
and family education

13. 10.
PROGRESSIVE
LOANS
•Eligibility for subsequent loans is fully dependent
on financial/behavioral track record
•Borrowers can apply for bigger loan amount if good
track record is maintained
•Also depend on good behaviour:
•attendance to weekly meeting
•recommendation from peers/group members
•For example, AIM:
•Loans are to be repaid on a weekly basis
•Once fully paid, bigger loans are being offered -this
process goes on as the need arises.
•The first loan normally starts from RM500 up to a
maximum of RM4,000 for successive loans. Successful
borrowers could apply for a much bigger loans of
RM5,000 or more
•There are various types of loans: total maximum
exposure RM30,000

16. 6. MICRO
SAVINGS
•Savings can be implemented as a substitute for
collateral. Two types:
•Forced savings: MFIs would only provide credit with the condition of savings
offered as a package.
•Voluntary savings: allow MFIs to fulfill the demand of low income clients by
providing them with deposit-taking facility satisfying their propensity to save.
•Economies of scope for MFIS –diversified
products-savings & lending
•Also member savings as source of financing for
members
•Eg: AIM -sets a precondition in receiving credit is saving to instill the habit of saving
among its clients in the form of compulsory savings and weekly personal savings.
Amount accumulated only to be withdrawn if exit of program
•SHG: Ample saving as a requirement to borrow
•Help to support financial sustainability of MFI –
Case of BRI

17. 7. MICRO
TAKAFUL
•Definition: financial product/service that the
poor are willing and able to pay for so that they
are able to manage their risks better
•Another financial product
•MFIs benefit from economies of scope
•Contribute to improved financial inclusion
•Help to avoid use of business capital for other
uses
•Considered as more urgent by borrowers
•emergency purpose –death, hospitalization, marriage, etc
•Get coverage for otherwise expensive costs of
health coverage
•Help to support financial sustainability of MFI

18. 8A.
SCREENING
AND
MONITORING
•Process intend to verify proposers’
eligibility in meeting up the minimum
requirements of legal capacity before
obtaining financing.
•Contracting parties must be of age of majority, in full possession of
good mental faculties and financially solvent.
•Examples
•BMT: screening process is conducted through administrative selection,
interview, and feasibility study which include visitation to check the
business condition
•AIM: screening and monitoring are being done by group members.
Group members are responsible for repayment of each members

19. 8B.
SCREENING
AND
MONITORING
•Conceptually, in a strictly
regulated mode of mudharabah
financing:
•capital providers have the right to choose the best
business partners
•Specific criteria such as based on their personality
traits, administrative and entrepreneurial skills,
business feasibility
•The presence of collateral –not necessarily physical
collateral
•The practices of mudharabahand musharakahduring
the time of the Prophet is backed by spiritual
collateral
→Risk of non-repayment
of debt is greatly reduced

20. 9. PHYSICAL
COLLATERAL
REQUIREMENT
•Several IMFIs require physical collateral
•For example, BMT:
•Collateral required depending on financing schemes.
•Murabahah-based financing and rahn-based product. Eg, BMT Kubeoffers
gold pawning (rahn-based) product that requires its predominant Bugis
clients -whose adornment of gold jewelry is considered a cultural practice-
to pawn the jewelry as collateral in exchange of financing.
•Clients hailing from Sulawesi Selatan in possession of collateral need to
prove they are capable of paying 50% of nominal financing amount
•In Malaysia, ar-rahnubased IMF is expanding
very rapidly
•Suits the peculiarities of women micro-enterpreneurs
•Shariah issues
•In IMFIs, ijarah-based microfinance require the
proof of purchase of machines/fixed assets
•Still there are moral hazard
•How to handle this?

21. 11.
COLLABORATION
WITH FINANCIAL
INSTITUTIONS
•SHGs: Most dominant form of microfinance in India. Wide array
of financial and nonfinancial associations, however in India it
refers specifically to a group of 10–20 poor women who come
from relatively similar socioeconomic background and from the
same locality.
•Substantial growth: there are about 2.23 million SHGs were
reaching out to approximately 33 million members. India has 50
million households are living in impoverishment with very
restricted financial inclusion
•The self-help promotion institutions (SHPIs)
•facilitate SHGs with training, monitoring, support services and at times
provide them with initial capital injection too.
•SHGs to build up their own financial stability by saving and lending out their
members’ own resources.
•Most of the SHPIs are set up through the funding they received from
commercial banks of which are almost all government-owned. Most of
Indian SHGs eventually get loans from commercial banks.
•Bank Linkage Program -a bank lends directly to a group after
they are convinced of the group’s operations, maturity, and
capacity to absorb credit. Then, SHGs would lend out to their
members

22. 9. COLLABORATION
WITH FINANCIAL
INSTITUTIONS
BASED ON SELF -
HELP GROUP

23. 12. CREATION
OF FINANCIAL
SUSTAINABLE
GROUP BASED
ON FINCA
MODEL
•Creating financially-sustainable groups
•Small community groups are trained by FINCA in a 22-
module program with the target of establishing Community
Credit of Enterprise (CCE) that enables the members to
generate capital in setting up their own business models by
way of shares purchase.
•A supporting agency i.e. the local headquarters of
FINCA or its affiliate:
•Sets up individual village banks comprised of thirty to sixty
members which are mostly women
•It loans out money to the individual members of the village
bank
•At the initial stage of their establishment, the supporting
agency oversees the managerial aspects of the village banks
including the organization of a management committee
election, staff training as well as the establishment of a set
of conducts to govern the bank

24. 13. TAILOR-
MADE
PRODUCTS
•Products must be diversified according to payment
capacity of clients
•For starters
•For experienced members
•For seasonal business –Eid
•For different sector –agriculture vs trading
•For IMF, there is a very limited outreach on profit-
and-loss (P&L) products such as musharakaand
mudaraba, despite being the most encouraged types
of contracts by shariah scholars because they best
reflect the genuine Islamic principles
•costly operating expenses in providing them discourage
MFIs from offering them
•Innovations prompted by Al Baraka Bank in Nigeria and
WasilFoundation in Pakistan in using Musharakahand Salam
contracts to diversify their shariah compliant portfolio, thus
reaching out to more clients.

25. AIM
FINANCING
SCHEMES
Financing Scheme Limit
(RM)
Payment Period
i-Mesra
tofinanceeconomicprojectthatisbelieved
willprovidegoodreturnforSahabat
1000-2000
3000-10,000
max
12-50weeks
12-100weeks
i-Srikandi
Operatebaseonfasttrackconcept.Offer
financingtothosewithpotentialviableand
successfulproject
12,000-20,000
max
12-150weeks
i-Wibawa
OfferedtoSahabatwhoistakingfinancing
underi-Mesraandi-Srikanditoprovide
additionalcapital.
5000max 12-25weeksor
Monthlypaymentfor6
monthsorFullsettlement
inshot
i-Sejahtera
Housingormultipurposefinancing
1000-2000
3000-10,000
max
12-50weeks
12-100weeks
i-Bestari
Providefinancingforeducationalpurpose
1000-2000
3000-5000
max
12-50weeks
12-100weeks
i-Penyayang
Financinggiventosahabatwhofailtomake
repaymentofloanduetofailureinbusiness,
healthproblemandnaturaldisaster.
1000-2000
3000-5000
max
12-50weeks
12-100weeks
i-Emas
Financingschemefor75yearsandabove.
2000max 12-50weeks

26. 14.
TECHNOLOGY
ADOPTION
•MFIs to adopt technology to improve efficiency of
operations
•Eg: AIM uses e-payment system:
•Easy tracking of loan payment –building track records for
future commitment.
•Avoid loss/theft faced by field workers
•Communication channel of development/policies
•Build up national database, several benefits for
nationwide branches monitoring.
•Enable performance measurement system for incentive
payments –annual bonus,
•Recognition and information dissemation
•Division of over-populated branch
•Avoid clients moral hazard
•Successful experience of Kenya: various innovative
financial products through M-pesa; MFI through
blockchain and smart-contracts

27. 15. ENSURE
GOOD
GOVERNANCE
•Clear governance structure to ensure clear
responsibility and accountability
•AIM: funds come from Government grant; need to report
to the funder
•MFIs in Bangladesh -regulated by the central bank of
Bangladesh and microcredit regulatory authority (MRA).
•Upheld transparency and information disclosure.
•Eg: Annual reports/statement of accounts in the internet –
Akhuwwat
•Bangladesh: Annual Report of the Microfinance Industry
•Auditing –external and internal
•Need of performance measurement system

28. ORGANIZATIONAL CHART OF
AIM
Board of Trustee
Member
Managing Director
Audit Unit
Financial and Loan
Department
Audit Unit
Regional Operation
Administration
Department
Human Resources
Managerial Unit
Investment
Committee
Managerial
Committee
Audit Committee
Shariah Panel

29. Source Type Amount (RM Million)
Federalgovernment Interest-freeloan 300(USD78.9)
Federal government Grant 18.2 (USD4.9)
Ministry of Rural DevelopmentGrant 12.8 (USD3.4)
Ministry of Agriculture
-LembagaKemajuanIkan
Malaysia (LKIM)
Interest-free loan 4.0(USD1.05)
Financial Institutions Soft loan 28.05 (USD7.4)
Federaland state governmentsGrant to cover
operational costs
30.0(USD7.9)
SOURCES OF FUNDS AND
OPERATIONAL COSTS