New Delhi: Microfinance institutions (MFIs) have turned the business of lending tiny amounts to the unbanked poor—from vegetable vendors and tailors in the cities to fishermen and farmers in the villages—into a thriving industry with assets estimated at almost Rs 12,000 crore in fiscal 2009.
But MFIs have been targeted by critics for alleged profiteering at the expense of the poor by charging interest rates as high as 24-36%.
K.A. Siddique Hassan believes he has an alternative method that will keep vulnerable borrowers out of the debt trap—of lending at no interest at all.
Ray of hope: Alemmunisa (foreground) is one of the women entrepreneurs who launched a vegetable business with help from Jan Sewa. Abhijit Bhatlekar / Mint
From the campus of the Jamaat-e-Islami Hind, an organization that promotes Islamic teachings in south Delhi and where he is vice-president, Hassan has been striving to craft a new form of microfinance inspired by teachings of the Quran.
Pinning its model on the tenets of the Shariah, or Islamic law, the organization started a not-for-profit organization called Sahulat Microfinance Society earlier this year, with the express purpose of discouraging riba (Arabic for “interest”) in financial dealings. Income is in the form of profit-sharing.
To provide professional inputs, Hassan has enlisted a dozen experts, including Hyderabad-based microfinance institution Basix Group and a former World Bank official. The plan is to set up at least 500 new microfinance societies under the Sahulat (Urdu for convenience) umbrella in 10 years.
Hassan is not the only one to have had the idea. In Mumbai, the All India Council of Muslim Economic Upliftment (AICMEU), which supports community development programmes, wants to open microlending centres across India, strictly enforcing the Islamic prohibition on charging interest.
In March, AICMEU’s Jan Sewa Cooperative Credit Society obtained approval to offer business credit to women in 12 states, including Maharashtra, Karnataka and West Bengal. Al-Khair Cooperative Credit Society, which works in Bihar, plans to expand into Delhi, Jharkhand and Uttar Pradesh.
Islamic lending, which began in Egypt, has already found resonance in many parts of the world where Muslims form a majority of the population.
In India, where Muslims account for 13.4% of the population, the situation is different. Islamic banks, which have ridden the petro-dollar to grow to $950 billion (Rs 43.23 trillion) in global assets, aren’t allowed to function under the law, although a 2008 government committee headed by economist Raghuram Rajan favoured promoting interest-free financial instruments.
Islamic microfinance traces its rise to a friendlier cooperative law that gives legal sanctity to many Islamic financial products even as scepticism grows about the lending practices of MFIs.
An amendment to the 2002 Multi-State Cooperative Societies Act allows groups of individuals to participate in both raising deposits and sharing surplus income, which is integral to doing business according to the faith.
Unlike modern banking, which has an interest-led obligation, Islamic finance is mostly about sharing both rewards and losses under a pre-arranged contract.
Under Shariah, banks get involved in the selling and buying of goods. That is incompatible with Indian banking law, and some experts say interest-free banking is not feasible as banks have to pay interest on savings and buy government bonds at fixed interest rates.
Hassan says most Islamic products are safe because the lenders themselves are often involved in equity participation, reducing the chance of crises such as the sub-prime shock in the US that felled many institutions and led up to the global financial crisis.
“Our intention,” he says, “is to open these concepts as a tool of empowerment to all without discrimination.”
There are, of course, profits to be made by banking for the poor as MFIs have demonstrated. But a recent Economic & Political Weekly article by Tara S. Nair, associate professor at the Gujarat Institute of Development Research, pointed to disturbing trends in the microlending industry, including abnormal profits and companies doubling income through cross-holding of shares.
The microfinance debate
The debate rose in pitch as SKS Microfinance Ltd raised $358 million in an initial public offering last month that was subscribed 13.6 times.
“Most of the profit-seeking activity has been extended to the other end of the logical extreme,” Nair said in a phone interview. “While there is an urgent need to expand financial services, one doubts whether it’s addressing their (the poor’s) needs.”
Criticism of microlending practices and the high interest rates they charge on loans to the poor has been accompanied by calls for stricter regulation of MFIs. There have been concerns that MFIs could find themselves laden with defaults because of the risk that multiple institutions may have lent to the same borrowers.
Helping hand: K.A. Siddique Hassan of the Jamaat-e-Islami Hind plans to take interest-free banking to the poor under Sahulat Microfinance Society. Ankit Agrawal / Mint
“We are trying to correct ourselves,” says Anoop Kaul, head of financial inclusion at Basix and a member of Sahulat.
Some in the industry will now share data on credit histories to check that customers do not borrow from multiple sources, which reduces their ability to repay.
But Nair says many things are still taken for “granted by the industry”. The norms of profit-sharing and shareholding structure, for instance, are never mentioned in their reports. “You cannot forget about the little guy, and only think about investments, profits and top line,” she says.
Islamic cooperatives offering microfinance won’t be in that situation. Jan Sewa, promoted by AICMEU, strives for a return of 4-6%. Its subsidy-linked model will train women in entrepreneurship with government bank-linked assistance, while loans will be made through charity donations and zakat, the mandatory 2.5% contribution of annualized income prescribed by Islam.
But are these “service fees” interest rates by another name?
“Generally the math works (in) such (a way) that all charges paid almost equal interest rates. However, the structure is Islamic-compliant as a (service) charge,” says Abizer Diwanji, head of financial services at audit and consulting firm KPMG.
Rahmatullah Abdul Ahad, managing trustee of AICMEU, says: “In modern banking, interest is the price of money, including profit, while in the Islamic system, it’s the cost of money in mobilizing and lending.” Sometimes simple credit—not working capital—is enough to start a small business, Ahad adds.
While it is still early days, people are already benefiting from Jan Sewa.
Last month, Alemmunisa, a 40-year-old mother of three, joined two friends and started selling vegetables on the sidewalk of Kanjur Marg in Mumbai. Jan Sewa had put them in touch with a Pune wholesaler.
At the end of the first fortnight, they earned Rs 2,500, after paying Rs 10,000 to the supplier. “We are happy to get the benefits,” she says, “and we want to sell more vegetables.”
A lack of financial literacy and half-hearted government policy are among the biggest hurdles for financial inclusion in India, according to Diwanji. “By promoting Islamic banking, the government can extract capital and bring people into the banking network,” he says.
Many of the new entrants into Islamic microfinance think they will fill this gap, and they would be happy to repeat the success of Al-Khair, which has operated around Patna since 2002. Collecting deposits of less than Rs 200 a day, Al-Khair today has 7,000-odd customers and a deposit balance of Rs 4.1 crore.
While it charges a service fee of 3.5% for regular loans, Al-Khair also offers short-term business loans, with a built-in profit-share clause, as one of its many products; it charges even lower fees on this product.
“It’s all about truthful relations, because you can’t always demand balance sheets from someone who takes a small amount,” says Arshad Ajmal, Al-Khair’s founder.
Al-Khair, a non-profit society, spends 30% of its earnings in social enterprise schemes; its main source of profit is selling merchandise products, such as fans, emergency lights and scooters, under a murabaha, or “cost-plus-finance” scheme.
This allows Al-Khair to buy goods from wholesalers, then sell them with an added financing charge of 8-15%. This still works out cheaper than retail prices.
Shiv Kumar Singh, who runs a clothing store in Patna’s Gardanibagh area, has borrowed from Al-Khair 14 times in the last four years. He also represents one of the invisible people that India’s formal banking network bypasses every day.
When Singh, 35, went to the local Canara Bank office for a loan, officials made him open an account. A year later, they informed him that his request couldn’t be processed because he lives in a rented accommodation without any permanent address.
Singh says he’s constantly in need of funds to expand his shop. So he asked his wife Sushma to open an SKS Microfinance account last year while he repaid his loan to Al-Khair.
He says he pays Rs 250, or 2.5%, on the Rs 10,000 he borrowed, while his wife is required to pay Rs 4,000, or 20%, on the Rs 20,000 she borrowed, apart from the rs 80 paid as insurance every month.
The repayment schedule at Al-Khair is six months, while at SKS collection begins within a week, he says.
His expenses grow every day, Singh says. “We need money to buy goods, but (we’ve always found it) difficult to get,” he adds.