1. Background 1.1 Finance for Economic Growth 1.2 Unjust Credit Disbursement 1.3 Micro Finance in India 1.4 Financial Exclusion of Poor 1.5 Need of Financial Inclusion
1.1 Finance for Economic Growth No individual, community or economy can attain desired economic growth if not allowed to access affordable source of finance. Compared to the corporate sector, the farmers and micro enterprises in the unorganized sector have no source of equity funds to share the associated financial risks in their economic activities; rather burdened through higher interest rates on debts. India needs to develop sources of micro equity funds to allow the farmers, household workers, and micro enterprises compete with others active players in this globalized monopolistic market.
1.2 Unjust Credit Disbursement - I
1.2 Unjust Credit Disbursement - II
1.3 Micro Finance in India After observing the success of Micro Finance in Bangladesh, the Indian Government introduced Micro Finance system in India In India Micro Finance has been framed as a tool to attain financial inclusion. Initially Micro Finance Institutions (MFIs) in India emerged with Government support; later on it grew through interest based lending from Banks. After 2010 when banks stopped lending to MFIs, few players are looking for alternative source of funding to attain sustainable growth. Indian MFIs have yet to develop micro equity funds to promote livelihood activities.
1.4 Financial Exclusion of poor NSSO data reveals that 51.4 per cent farmer households (45.9 millions out of 89.3 millions) in India do not access credit, either from institutional or non-institutional sources. Indian Council for Research on International Economic Relations suggests that only 12 per cent of unorganized retailers have access to institutional credit; and 37 per cent felt the need for better access to commercial bank credit. Sachar Committee Report reveals that only 10% Muslims access formal banking services and they get just 4.7 percent credits extended by banks against 7.4 percent share in individual deposits.
1.5 Need of financial inclusion To improve financial inclusion, the demand side efforts including improving human and physical resource endowments, enhancing productivity, mitigating risk and strengthening market linkages been undertaken; but so far financial inclusion of Indias second largest community (whose religious ethos conflicts to that of interest based banking system in India) been ignored. The High Level Committee for financial Sector Reforms constituted by the Planning Commission of India has duly recommended that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. This is in consonance with the objectives of inclusion and growth through innovation.
2. Introduction 2.1 Definition of Participatory Micro Finance 2.2 Fundamentals of Participatory Micro Finance 2.3 Practical Applicability of PMF 2.4 How different from Conventional Micro Finances? 2.5 Advantages of PMF over Conventional Micro Finance
2.1 Definition of Participatory Micro Finance (PMF) Participatory Micro Finance (PMF) is a process wherein the financier instead of lending small amount on interest to someone; actually involves in customers business through trade practices; or by sharing associated business risks or by leasing out high value assets to the customers. Unlike interest based lending return on investment is not fixed; but depends on profit in the business. Since Participatory Micro Finance adheres to the principles of Islam, it may be used as alternative to Islamic Micro finance in countries like India, Turkey, Japan, Nepal and China etc.
2.2 Fundamentals of Participatory Micro Finance Participatory Micro Finance is based on teachings of the Holy Quran, the books of Hadiths and Islamic Jurisprudence etc. Riba (Interest) of any kind is strictly prohibited. Financing upon business activities which may harm the human and financial resources of any economy (like alcohol, pork, gambling, porn, non tangible assets, interest rate SWAP etc.) are not allowed. It promotes sharing of business risks instead of shifting the associated business risks upon others. It prohibits participation in business with uncertain risks or trading based upon pure speculations. It disallows signing conditional business contacts.
2.3 Practical Applicability of PMF Applicability of Participatory Micro Finance are tested and recognized as ultra modern financial products for Micro and Small Enterprises (MSEs). Musharaka and Mudaraba may help MSEs to get micro equity funds compared to higher cost debts. Istisna and Ijara may serve MSEs get material and Assets needed for processing / manufacturing. Bai Salam may help farmers get required funds to sow crops as fair prices for harvest. Murabaha allows small retail get business stocks. Micro Housing Finance and Asset finance can be provided through Diminishing Musharaka.
2.4 How different from Conventional Micro Finances? Business Parameters Participatory Micro Finance Conventional Micro Finance Money as Capital ResourceDeclinedAccepted Money as tradable AssetDeclinedAccepted Equity FinancingPromotedRestricted Lending money on InterestRestrictedPromoted Conditional Business ContractsNot allowedAllowed Forward SaleAllowedDisallowed Partnership with customerAllowedNot Allowed Leasing of Tangible AssetsEncouragedDiscouraged Fixed Return on investmentNot allowedAssured Purchase and Sell of GoodsAllowedDiscouraged
2.5 Advantages of PMF over Conventional Micro Finance PMF helps achieving financial inclusion of specific customers seeking finance without interest. PMF directly accelerates livelihood activities. One Murabaha assures at least 2 value additions. PMF helps farmers avail interest free funds with assured fair prices for their harvest / produces. PMF helps micro and small enterprises get equities to share business risks instead of debt burdens. PMF helps counter economic problems like inflation, fiscal deficit and recession etc. PMF can help banks and financial institutions from financial crisis like sub prime mortgage crisis.
3.1 Musharaka (Equity Finance) Equity Finance (Musharaka) is a mechanism wherein group of persons pull their resource and convert them into equities for running any business to shares the profit and loss (if any) at mutually consented ratios among the subscribers. Musharaka is used to raise equities for venture capitals, facilitating cooperatives, farmer producer companies, processing industry and exports etc. Musharaka facilitates Micro and Small Enterprises by allowing them to share business risks among equity holders who may in return own the enterprises and get profit in return of bearing risks.
Structure of Equity Finance Investor A Investor B Investor C Joint Venture Enterprise Pull required resources and convert them into equities (shares) of any joint venture enterprise to collectively own the shares; and accordingly bear the associated business risks. Share subscribers of Joint Venture Enterprise mutually distribute earned profit / loss (if any) on pre agreed ratios as reward for sharing associated business risks.
3.2 Mudarabah (Trust Finance) Trust Finance is a mode of finance wherein the Financier having faiths on any person / party extends funds allowing the party to manage that fund for execution of any business activity with a condition that all financial risks shall be borne by the financier; but profit shall be shared among both the parties on mutually agreed ratios. Mudaraba promotes business relationship among skilled but poor entrepreneurs and such capital owners who are unable to manage the business. This may be used to promote micro and small enterprises through partnership.
Structure of Trust Finance Entrepreneur / Fund Manager Financier / Capital Provider The Financier keeping faith upon the Entrepreneur (Fund Manager), provides capital, shares associated business risks and allows the entrepreneur to use the capital for managing the enterprise. Business Enterprise Administer the funds to control the Enterprise Receives profit in return of managerial efforts Provides capital on faith for any business Receives profit in return of sharing business risks
3.3 Murabaha (Cost – Plus Finance) Cost Plus Finance (Murabaha) is a mechanism where the financier instead of lending money to the needy, converts him into a customer; buys required goods for him; adds a mark up profit over the actual costs (in consent with the buyer) and sells to the client with deferring the receipt of payments for a specific period of time. Since under Murabaha, one financial transaction needs at least two real time sales transactions, it allows the economy register more value additions in trade activities compared to registered growth in the financial sector, thus uplift economic growth.
Supplier / Vendor instantly collects full Payment against supply of goods / assets on demand from banks / MFIs Suppliers / Vendors Purchase goods / assets from Vendors / Suppliers Adds Mark up Profits over purchased goods / assets Sell goods / assets to the client / customer on credit terms Banks / MFIs Receives goods / assets from Banks / MFIs on credit terms Makes payment for goods / assets in set installments Client / Customer Structure of Cost – Plus Finance
3.4 Ijara (Lease Finance) Lease Finance (Ijara) is a mechanism where the financier buys any tangible asset or equipment and leases out that to any customer (on rental basis) for a specific period of time (with provision to own that after paying the title / ownership fees at the end). Ijara allows the poor enterprises to acquire and use high value assets like premises, vehicles, tools and machineries etc. without high capital expenditure to purchase the required asset at once through interest bearing loans; rather manages it by paying regular monthly rents in installments for using the assets. It also safeguards the financiers with value of tangible assets against high valued financial risks.
Receives full payment for tangible asset from the bank / financier against order. Delivers the tangible asset along with the title to the financier / bank against payment. Manufacturer Purchases the asset from the manufacturer Leases out the asset to the customer. Receives total lease amount in installments. May transfers the title of the asset after completion of lease agreement if sought by the customer. Financier / Bank Receives the asset from the bank on terms of lease agreement. Uses the asset and pays rent to the financier as par lease agreement. After successful completion of lease agreement may get the title of the asset by paying the title fees to the financier. Customer / Ultimate User Structure of Lease Finance
3.5 Istisna (Manufacturing Finance) Istisna (Manufacturing Finance) is a process where payments are made in stages to facilitate step wise progress in the Manufacturing / processing / construction works. Istisna enables any construction company get finance to construct slaps / sections of a building by availing finances in installments for each slap. Istisna also helps manufacturers to avail finance for manufacturing / processing cost for any large order for goods supposed to supply in stages. Istisna helps use of limited funds to develop higher value goods/assets in different stages / contracts.
Structure of Progressive Finance Builder / Manufacturer / Processing Units Builder / Manufacturer / Processing Units Finance company / Bank Make payment to the Builder / Manufacture in advance for development / process any item with specified terms Receives manufactured goods / developed units / assets from the manufacturer or builder against payment. Delivers specified units after manufacturing / developing as per specification to the bank / finance company. Receives payments in advance from the banks or finance company to manufacture / develop specified unit / s on specific terms.
3.6 Bai Salam (Forward Sale) Under Forward Sale (Bai Salam) after negotiating price of a commodity the buyer makes the payment in advance for set quality and quantity to be delivered by the supplier on any future date. With known purchase cost in advance through Bai Salam the traders plans their future business flows. Advance sale helps the farmers to get interest free funds for meeting financial need at one hand and mitigating the risk of uncertain harvest prices. The Government may help farmers by paying them in advance for purchases of their harvests; keep those commodities in cold storages / godowns; to regulate supply and prices of essential commodities.
Makes full payment in advance for purchase of specified quality and quantity of commodity on specified price for supply on future set date. Receives specified quality and quantity of commodity on specified date from the farmer / supplier. Financier / Buyer Negotiates price of specified commodity with the financier / buyers and duly Signs an agreement before receiving full payment in advance; and is bound to deliver the commodity (with specified quality and quantity) on set future date. On specified date (as per forward sale agreement with the buyer / financier) makes the delivery of the specified quality and quantity of commodity to the buyer / financier. Farmer / Supplier Structure of Forward Sale
3.7 Qard E Hasna (Benevolent Loan) Qard E Hasna (Benevolent Loan) is the scheme under which the customer can get credit in cash to meet activity based household financial needs like educational, medical or marital etc. Under Qard E Hasna, the financer lends money to the borrower without interest. Under Qard E Hasna only actual cost of operation along with principal amount is allowed to recover from the beneficiary. Qard E Hasan cannot be linked up with profitability of the borrowers livelihood. Borrower can make pre payment and can also delay the payment if genuinely need more time.
Extends finance without motive to earn profit / reward in this life, but to have reward in the life hereafter. Receives exactly the same amount financed to the customer Bank / Lender Seek interest free finance from the bank or lender to meet out personal non commercial (Household) needs Returns back the same amount without any interest or penalty to the bank or lender by paying in installments on specified period of time. Customer / Beneficiary Structure of Benevolent Loan May also collect receivable service charges from the beneficiaries to run the institution without profit. May pay set service charges to enable the financial institution meet its actual operational expenses.
3.8 Diminishing Musharaka (Diminishing Partnership) Diminishing Musharaka is a Participatory Business which starts with collective investment on any asset / project by two or more parties; but ends with complete conversion of ownership for one party who purchases the shares of other/s in that particular asset / project during a time frame. Whole process needs three different set of contracts defining – Collective Investment in any asset or project between two or more parties Terms of Diminishing Participation among partners Contracts defining terms of Lease or selling of the undivided share of one or more partners in the asset / project to the other partner.
The bank / financier and the customer enters into joint ownership agreement before buying any asset in partnership. Bank / Financier Customer Bank / Financier lease out his share in the asset to other partner on rent against use of his share in the asset. Bank / Financier Customer The customer buys remaining shares of the bank / financier to completely own the asset and to diminish banks / financier share in the asset. Bank / Financier Customer Structure of Diminishing Partnership Stage 1Stage 2Stage 3
3.9 Takaful (Islamic Insurance) Takaful is a Shariah compliant insurance system where members of any group duly come together to share associated business risks of group members by subscribing Takaful fund. Group members duly subscribe premiums of Takaful Funds to compensate the losses, if incur in business of any members of that group. The members agree to invest the Takaful fund with condition to share the profit / loss realized through investing the funds in legal and ethical businesses. Insurance company manages the funds and assures insurance subscribers to compensate business losses if any.
Creates Takaful Funds with own initiatives and seed capital. Invites the Takaful Subscribers Administer the Takaful Funds Entitled to invest the Takaful fund into ethically permissible trade / industry. Insures the subscribers against any loss / damages. Insurance Company Created by Insurance Company Used to protect the subscribers May be invested into ethically permissible businesses Small Takaful fund may further be insured through larger Takaful Funds. Takaful Fund Subscribes premium of the Takaful funds Receives compensation in case of losses from Takaful funds Receives profit from Insurance company in case of profit earned after investing Takaful funds into profitable businesses. Takaful Subscribers Structure of Islamic Insurance
4. Market Conditions 4.1 Demand forces yet to envisage 4.2 Regulatory hurdles for PMF 4.3 Infrastructural deficit for PMF 4.4 Taxation Problems for PMF 4.5 Shortage of Equity Funds 4.6 Accounting and IT software 4.7 Education & Training of staff
4.1 Demand forces yet to envisage Participatory Micro Finance is new concept for Indian market and is yet not be recognized by all. Since Participatory Micro Finance is not offered by any big bank / financial institution in India; and people are mostly unaware about it, we have yet to envisage demand forces for PMF. Under constraint regulatory conditions few small financial institutions with limited resources offer PMF at local levels, which are not known to all people, so real demand forces are yet to envisage. No genuine envision for Participatory Micro Finance demand forces is done by any reputed financial institution / research institute.
4.2 Regulatory hurdles for PMF The Reserve Bank of India (RBI) as regulator for Banks and NBFCs in India has yet not considered provisioning grounds for Participatory Finance. Banks and NBFCs registered as MFI with RBI are not allowed to raise equity / funds with provision to invest in business on risk sharing basis. RBI not allows banks / MFIs to participate in trade of commodities and tangible assets. Takaful is not recognized as Insurance Product by Insurance Regulatory and Development Authority (IRDA) in India. Double stamp duty on Ijara transactions adds cost of assets thus hurdles Ijara growth.
4.3 Infrastructural deficit for PMF Since demand forces for PMF is not envisaged so far, there is no significant effort to create required infrastructure for Participatory Micro Finance. No source for equity funds is available to meet requirement of MFIs to promote PMF in India. No institutional network to promote cooperation and coordination among financial institutions dealing with Participatory Micro Finance products in India. There is no institutional effort to develop required market linkages to promote Participatory Micro Finance businesses in India. Limited infrastructure facilities in rural areas hurdles experimenting PMF in potential rural areas in India.
4.4 Taxation Problems for PMF Unless PMF is considered as a viable business the issue of taxation will hurdle experimental efforts. Like Ijara, there is also taxation problems for other PRTF products like Murabaha, Bai Salam and Istisna etc. where bank or MFI need to buy and sell commodities. The taxes imposed on commodities bought by Bank or MFI for sale through Murabaha, Ijara or Bai Salam increases the net cost of commodities, thus make it challenging to compete with other sellers in the open market because majority of sellers in the unorganized market avoids collecting and paying taxes on their sale.
4.5 Shortage of Equity Funds No Bank or MFI in India are allowed to raise equity funds which is basic source for PMF, so banks and MFIs find it difficult to start PMF. In absence of Equity Funds, banks / MFIs cannot afford to finance businesses on principles of Participatory Finance. There is no provision to create mutual funds by Banks / MFIs for their specific needs. There is no regulator to raise funds for Takaful (Islamic Finance) which may have otherwise boosted Participatory Micro Finance in India. The provision to pay stamp duty and registration fees for mutual funds also hurdles equity for PMF.
4.6 Accounting and IT software There is no ready to use accounting package for Participatory Micro Finance which hurdles even the experiment of PMF products. There is no ready to use IT software suitably meeting the requirements of PMF business. Without Accounting and IT software banks / MFIs hesitate to experiment PMF business on pilot basis. There is also no institution to lead development of required Accounting software and information technology required for PMF. Besides Accounting and IT software, PMF business need database of Business directory to develop required backward and forward market linkages.
4.7 Education & Training of staff So far in India major to educate pupils in Islamic Banking and Finance, few institutions have initiated new courses as part of financial management. So far the courses on Islamic banking and Finance has not touched the Micro Finance Sector. The concept of Participatory Micro Finance and its scope in Indian unorganized sector is yet to realize by the academicians and industry players. There is no stuff of Qualified and expert teacher and trainers in Indian market to provide education and training on PMF. No textbook on Participatory Micro Finance is available in India for reference by industry players.
5. Road Ahead 5.1 Create Public Awareness 5.2 Establish Business Models 5.3 Create Funds for PMF 5.4 Forward Linkage of Takaful Fund 5.5 Develop Financial Infrastructure 5.6 Road Ahead 5.7 Thank You
5.1 Create Public Awareness Public awareness on Participatory Finance through – 1.Setting up practical business models 2.Benefitting the target customers 3.Publishing Articles and Blogs 4.Publishing Analytical Reports 5.Public addresses in mosques 6.Addressing the Panchayat Meetings 7.Interaction with Social Workers & NGOs 8.Distribution of Handbills and Pamphlets 9.Arrangement of Seminars and workshops 10.Holding Interactive discussion sessions 11.Telecasting Live TV shows 12.Educational and training Sessions
5.2 Establish Business Models Most important means to promote Participatory Micro Finance in India could be establishment of working Business models in potential markets. BASIX India group has already done pilot at Parbhani district of Maharshtra and is now aiming to scale up that pilot project in Mewat District of Haryana. Businessmen, farmers and artisans seeking Participatory Finance should be grouped at local levels according to nature of business relation among themselves. Different small size companies may be established with object to serve the target client with economies of scale in local region and develop market linkages at larger scale. Success of Working Business models in different sectors would self prove its worth and inspire others. Farmers Producers Company may be handy working model.
5.3 Create Funds for PMF Since there is no existing source of Participatory Finance, members associated with business groups established to promote Participatory Finance need to create pool of equity funds and risk mitigating Takaful funds. For any society registered under Multi State Cooperative Societies Act. 2002, it is possible to develop series of liability side products depending on nature and objective of deploying the deposit and funds. Such deposits and funds could be used to promote participatory finance among the members of business group by mode of Musharaka, Mudaraba, Murabaha, Ijara, istisna, Bai Salam and Takaful etc. to allow mutual help the members. Hopefully success of pilot project led by BASIX India Group may draw attention of potential investors towards PMF.
5.4 Forward Linkage of Takaful Fund On pilot basis members of any cooperative dealing in Milk production or poultry etc. may be motivated to form a group for pooling out Takaful Fund to subscribe associated business risk of members of particular business group. The Premium of Takaful Fund may be lesser compared to other insurance products if no interest / bonus is planned. So, it would not be very difficult to mobilize group members. Takaful funds would work as hedge to protect the members of the group by compensating the business losses if occurred for any member. Small Takaful funds at local levels should further be linked to large scale Takaful funds at regional, national and international levels to ensure reinsurance of the Takaful Funds and provide economies of scale for Takaful Funds.
5.5 Develop Financial Infrastructure We have to develop following financial infrastructure for promotion and development of Participatory Finance in India Text books and reference materials for study Education and training system for new comers Accounting Software Mechanism to provide safety nets to investors Online interactive database for business enterprises Required logistics and warehousing Relevant processing units Last end market linkages for each business module. Delivery channels Communication and interaction platforms System of accountability towards share holders Media to project expected rate of returns on new coming project to attract fresh and potential investors
5.6 Road Ahead Successful implementation of BASIXs pilot project on Participatory Micro Finance at Parbhani has encouraged us to scale it up in Mewat. Again the successful execution of PMF at Mewat will bring considerable changes in – Livelihood of farmers benefitted through PMF Milk producers accompanied under PMF projects. Micro Entrepreneurs benefitted through equity finance Members of Consumer Cooperative Societies Members subscribing Takaful Funds Entrepreneurs dealing business linkages through PMF Owners and Managers of Cold Storages Business Groups established under PMF Workers engaged into activities run under PMF. Owners and Managers of processing units set under PMF Promoters and Investors of PMF in India