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Islamic Financing for SMEs Presented By: M.Shoaib Malick Unit Head-SME-Meezan Bank Limited.

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Presentation on theme: "Islamic Financing for SMEs Presented By: M.Shoaib Malick Unit Head-SME-Meezan Bank Limited."— Presentation transcript:

1 Islamic Financing for SMEs Presented By: M.Shoaib Malick Unit Head-SME-Meezan Bank Limited

2 Islamic Financing for SMEs  Introduction to Islamic Banking  Significance of SME Sector  Difference Between Islamic Banking & Conventional Bank  How IB, can address business needs (100%)  Comparison of Islamic Mode of Finance and Conventional  Islamic Modes of Financing Short Term Modes of Islamic Financing Short Term Modes of Islamic Financing Long Term Modes of Islamic Financing Long Term Modes of Islamic Financing Trade Finance Facilities in Islamic Banking Trade Finance Facilities in Islamic Banking  Challenges in SME Financing  Conclusion

3 Significance of SME Sector 1Total Population182Mn100% 2Financially Included18.2Mn10% 3Financially Excluded163.8Mn90% 4Financially Excluded-Major SectorSME 590% of all private enterprisesSME 6SMEs access to finance from banking sector: Pakistan India Bangladesh 04% 33% 32% 7SME lending of total credit06% 8Surveyed Facts Hard to borrow from banks Not even have a bank account 51% 31%

4 Contribution of SME Sector to Economy

5 Current Status of SME Financing:  SME financing witnessed continues decline by banks/DFIs since  Due to consistent decline in this sector, share of SMEs also reduced from 16% to 6% in overall advances of banks in last 4-5 years. Reasons for downfall:  Adverse economic conditions.  Law and order situation.  Shortage & rising costs of electricity and other utilities.

6 Reasons for downfall:  Growing NPLs.  Natural catastrophes also hamper this sector badly in consecutive years of 2010 & 2011 and created wipeout situation for small sized units.  Banks also took a risk-averse posture from this sector, due to deteriorating business conditions for SMEs.

7 5 Years trend of SMEs

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9 9.4%16.1%22.1%28.9%32.4%38.9%

10 SME Financing For Working Capital  Key portion of financing is used for working capital in SMEs, which constitutes 76% of total SME lending.  However other is followed by Trade Financing & Long term/Fixed Investment.

11 SMEs provide a significant portion of jobs world wide SME contribution to formal country employment Median values Source. Ayyagari, Beck and Demigirguc/kunt. 2003

12 GDP Contribution of the SME sector increases, and informality decreases with income

13 Definition of Riba Any increase over and above the price, without due consideration is Riba

14 We find the differences are on three levels: 1. Conceptual & Socio-religious level - not money lenders - cannot deal with interest & non permissible industries 2. Business model & Governing framework - IB actively participates in trade and production process - Governing framework in terms of Shariah Advisor &/or SSB Distinguishing Features

15 15 3. Product Level Implementation - usually asset backed & involve trading/renting of asset & participation on profit & loss basis - Implementation is not just a mere change of paper work and terms but it involves - having the right intention, - the correct sequence of steps and timing of execution Distinguishing Features

16 Parties:Bank & Client Limit :Rs Mn Rate:K+2 Tenor :1 year Purpose :To buy Cotton Parties:Bank & Client Limit:Rs Mn Rate:K+2 Tenor:1 year Purpose :To buy Cotton Islamic BankingConventional Banking PERCEPTION OF ISLAMIC BANKING

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18 Parties:Bank & Client Limit :Rs Mn Rate:K+2 Tenor :1 year Purpose :To buy Cotton Parties:Bank & Client Limit:Rs Mn Rate:K+2 Tenor:1 year Purpose :To buy Cotton Islamic BankingConventional Banking PERCEPTION OF ISLAMIC BANKING = OWNERSHIP Goods Services

19 Islamic Banking Basic Difference between Islamic and Conventional Modes of Finance Conventional Client Money money + money (interest) Bank

20 Islamic Banking Basic Difference between Islamic and Conventional Modes of Finance Islamic Islamic Bank Client Goods & Services money

21 Salesxxx Cost of Goods Sold Raw Materialxxx Direct Laborxxx Over Headxxx Gross Profitxxx Operating Expenses Admin. & Gen. Expxxx Salariesxxx Utilitiesxxx Otherxxx Net Profitxxx Income Statement Liability/Deposit Products Istisna/Tijarah Murahaba Istisna/Tijarah Deposit Products

22 Current Assets: Stocksxxx Receivablexxx Cash in handxxx Advances & Depositxxx Fixed Assets: Plant & Machineryxxx Land & Buildingxxx Total Assetsxxx Owner’s Equity: Capitalxxx Liabilities: Creditorsxxx Financial Liabilitiesxxx Total Liabilities & Equity Balance Sheet Murahaba/Import Murahaba/FIM/LC Deposit Products Istisna/Tijarah/Bai-Salam/Usance-Murahaba Musharka Murahaba/LGs/Ijarah/Tijarah Murahaba/Istisna/Tijarah/LG DM/Ijarah/Murahaba

23 Conventional BanksIslamic Banks 1. The functions and operating modes of conventional banks are based on fully manmade principles. 1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. 2. The investor is assured of a predetermined rate of interest.2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). 3. It aims at maximizing profit without any restriction.3. It also aims at maximizing profit but subject to Shariah restrictions. 4. It does not deal with Zakat. 4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat. 5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks. 5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well. 6. It can charge additional money (penalty and compounded interest) in case of defaulters. 6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are give for early settlement at the Bank's discretion. Difference Between Islamic Banking & Conventional Bank

24 Conventional BanksIslamic Banks 7. Very often it results in the bank's own interest becoming prominent. It makes no effort to ensure growth with equity. 7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity. 8. For interest-based commercial banks, borrowing from the money market is relatively easier. 8. For the Islamic banks, it must be based on a Shariah approved underlying transaction. 9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations. 9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations. 10. The conventional banks give greater emphasis on credit- worthiness of the clients. 10. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects. 11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors. 11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller. 12. A conventional bank has to guarantee all its deposits.12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al- wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position..

25 Meezan Bank Limited Financing Product Comparison Islamic Vs. Conventional Bank S.# Islamic ProductConventional Products Working Capital Finance 1 a) Murabaha b) Murabaha - Spot c) Istisna - Export & Local d) Meezan Tijarah - Export & Local e) Murabaha FE-25 Export & Import Current Finance / Running Finance 2Murabaha - PledgeCash Finance 3 a) Ijarah - Plant & Machinery b) Ijarah - Sale & Lease Back for Plant & Machinery c) Diminishing Musharika - Plant & Machinery d) Diminishing Musharika - Premises / Land for Commercial use e) Diminishing Musharika - Sale & Lease Back (Plant & Machinery; Premises Land & Building) f) Musharaka Demand Finance / Term Finance

26 Financing Product Comparison Islamic Vs. Conventional Bank S.#Islamic ProductConventional Products Export Related Facilities: 1 a) Bai Salam against Discrepant Export Sight Bills b) Bai Salam against Export sight contract c) Murabaha against Accepted export Usance Bill (Bank Risk Line) d) Murabaha against Un-accepted export Clean Usance LC e) Murabaha against un-Accepted export Discrepant Bills under Usance LC f) Murabaha against export Usance Contract Finance Against Foreign Bills 2 a) Murabaha against Un-accepted Local Usance LC b) Murabaha against Accepted Local Usance LC (Bank Risk Line) Local Bill Purchases 3 a) Istisna – Export b) Islamic Export Refinance Facility (IERF) Part I & II - under Murabaha c) Islamic Export Refinance Facility (IERF) - under Istisna (Local and Export) and Tijara (Local and Export) Finance Against Packing Credit Part - I & II

27 Meezan Bank Limited S.#Islamic ProductConventional Products Import Related Facilities: 1 a) Sight LC under MMFA b) Sight LC under Master Agency Agreement (For Ijarah & Diminishing Musharaka) c) Sight LC wihthout MMFA (Exceptional Cases) d) Usance LC without MMFA f) Usance LC under MMFA (Exceptional cases) g) Usance LC under Master Agency Agreement (for Ijarah and Diminishing Musharaka) Import Letter of Credit 2 a) Local LC(Sight) without MMFA b) Local LC (Sight) under MMFA (Exceptional cases) c) Local Usance LC wihtout MMFA d) Local Usance LC under MMFA (Exceptional cases) Inland Letter of Credit 3 a) Murabaha - Financing of Imported Merchandise (FIM) Pledge b) Murabaha - Financing of Imported Merchandise (FIM) Spot Finance Against Imported Merchandise - FIM 4 Finance Against Trust Receipt Letter of Guarantee 1 Letter of Guarantee / Shipping Guarantee/Standby Letter of Credit Letter of Guarantee / Shipping Guarantee Financing Product Comparison Islamic Vs. Conventional Bank

28 Short Term Financing Needs Raw Material Raw Material Overheads / Utilities Overheads / Utilities Finished Goods Finished Goods Trade receivable financing Trade receivable financing Rental financing Rental financing Long Term Financing Needs Acquisition/replacement/ expansion of fixed assets, plant & machinery Acquisition/replacement/ expansion of fixed assets, plant & machinery

29 Issues & Challenges of SMEs DemandSupply Lack of Collaterals to Meet Bank’s Requirements Shortage of Marketing Skills-(Bank Side) Informal Organizational Structures Informal Accounts & Management System Lack of Credit & Collateral History Low Level of Financial Literacy Reluctance on part of SMEs External Shocks SMEs perceived as high risk borrowers Corporate Finance Mindset Lack of Infrastructure for SME Business High Lending Costs Absence of SME R&D Centers in Banks

30 Plain Murabaha Advance Payment Murabaha Suppliers Credit Murabaha SLC under MMFA Tijarah Istisna Diminishing Musharaka Ijarah Bai Salam

31 Plain Murabaha Plain Murabaha Murabaha Agreement Agency AgreementOrder Form Purchase of Goods by Agent Payment of Purchase Price* Intimation of possession of goods by the agent (Declaration) Offer & Acceptance (Murabaha Contract) Payment of Murabaha Price *Payment of purchase price is either direct payment to supplier or through customer account For Detail

32 Advance Payment Murabaha Advance Payment Murabaha Murabaha Agreement Agency Agreement Order Form Payment of Purchase Price* Purchase of Goods by Agent Intimation of possession of goods by the agent (Declaration) Offer & Acceptance (Murabaha Contract) Payment of Murabaha Price *Payment of purchase price is either direct payment to supplier or through customer account

33 Credit Murabaha Credit Murabaha Murabaha Agreement Agency AgreementOrder Form Purchase of Goods by Agent Intimation of possession of goods by the agent (Declaration) Offer & Acceptance (Murabaha Contract) Payment of Purchase Price* Payment of Murabaha Price *Payment of purchase price is either direct payment to supplier or through customer account

34 SLC under MMFA SLC under MMFA Murabaha Agreement Agency Agreement Order Form & LC Application Establishment of LC Receipt of Import Documents Intimation of possession of goods by the agent (Declaration) Offer & Acceptance (Murabaha Contract) Retirement of LC Through Murabaha Payment of Murabaha Price

35 Tijarah Tijarah Master Tijarah Agreement Agency AgreementWritten Offer Payment of Tijarah Price upon Acceptance Delivery of Goods & Acceptance of Delivery by bank Intimation of possession of goods by the agent (Declaration) Offer & Acceptance (Murabaha Contract) Retirement of LC Through Murabaha Payment of Murabaha Price For Detail

36 Thank You


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