Experiences in Regulating and Supervising Muhammad Zubair Mughal Chief Executive Officer Alhuda centre of Islamic banking and economics www.alhudacibe.com Experiences in Regulating and Supervising Islamic Microfinance Institutions - Pakistan as Case Study At Regulatory and Supervisory Framework in Islamic Microfinance 18th – 19th March, 14 - Khartoum – Sudan

Contents Basic Principles of Shariah Based Microfinance. Source and Mechanism of Islamic MF Products Type of Islamic Microfinance Institutions in Pakistan Legal and Regulatory Structure of Islamic MFIs State Bank of Pakistan Guidelines for Islamic Microfinance. Shariah Compliance for Islamic Microfinance Licensing , Reporting and Operating Criteria. My presentation will cover following Area’s

Basic Principle of Shariah Based Microfinance Prohibition of Interest Care for the poor is a religious obligation in Islam Asset Based Financing Risk Sharing Sanctity of contracts Financing in Halal/Shariah Compliant Activities. Micro Takaful ( Islamic Micro Insurance) Beneficial for both Muslim and non-Muslim This is an important principle of Islamic Microfinance, Actually, interest is forbidden in all the divine religion but Islam have strict verdict on it. Therefore Muslim hesitant to unutilized Conventional financial system and remains exclude from financial access. It is Necessary that all contracts should be free from Gharar. Infact, poverty alleviation is the religious obligation in Islam.e.g. Zakhat, Sadqa ( Donation ) , Tabbrumm, Fitrana , Ushre etc, which are dedicated for financial well being of Poor peoples. Islam always encourages Asset based Financing, we have seen the recent international financial crises, and learned a lesson that financing without the backing of assets is always risky. Risk Sharing is one of the fundamental principle of Islamic Microfinance. Islamic Microfinance Emphasizes the Sanctity of Contracts. Micro Takaful is a Shariah Compliant System of Risk Mitigation. “Assisting the poor is a pillar of Islam”

Source of Islamic Microfinance Overview of Islamic Microfinance Mechanism Source of Islamic Microfinance Islamic finance is the outcome of religion in banking Islamic Microfinance Products Mechanism Sources of Islamic Microfinance Quran Sunnah Ijma’a (jurist consensus) Ijtihad & Qiyas (analogy) Lets examine how Islamic Microfinance Products originated, Basically there are Four Main sources of Islamic Microfinance product, 1) Quran-e- Pak, the holy book of Muslims, we have derived many Islamic Microfinance product from Quran-e-Pak e.g Ijarah, Bai etc, the Second source of Islamic Microfinance is Sunnah, its mean the sayings & Practiced by the Holy Prophet Hazrat Muhammad Salalah wa all he walis, Many Islamic Microfinance Product have been derived from Sunnah such as Mudarabah, Wakala, Intisna etc , Ijma’a , the consensus among Jurists, some Microfinance Product derived from Ijma’a Like Late payments charity mechanism which is being utilized in Islamic Microfinance Sector, and the last source is Ijtihad & Qiyas ( Analogy ) , Takaful or Micro Takaful is example of Ijtihad. As per concern about Islamic Microfinance Product, I have segregated them into 4 categories for broader understanding about their mechanism. In partnership Mode, MFI’s & their clients enter into Partnership agreement for a business venture on profit and Lose sharing Mechanism. we have two Product in Partnership based mode, Musharakah & Mudarabah. In Trade based Mode, MFI’s & their Clients enter into trading agreements, the products of Trade based Modes are Murabahah, Musawamah, Salam and Instisna. There are two products in Rental based mechanism, Ijarah is Shariah Compliant mode of leasing and Diminishing Musharakah. There are some other Modes in Islamic Microfinance available, like, Qard-e-Hasan, Waqf & Zakhat, Islamic Cooperatives etc. We will discuss about these products latter on

Factors to be considered while doing IMF Poverty Alleviation Element and more…. Moral Ethical Social Trainings & Quality HR Shariah Compliant Funds Free from Gharar Micro Takaful Free from Interest Financing Shariah Vetted Products Shariah Compliant Investments A Misconception removed Islamic Microfinance is a system not the Religion, it can be utilized & operated by both Muslims and Non-Muslim Communities for Poverty Alleviation, Social & Economic Development. Islamic Micro Finance Ensure Shariah Compliance There are certain factors to be considered while doing Islamic Microfinance……………. But at this stage, I would like to rectify one misconception that islamic Microfinance is for Muslims, Basically …….. So Islamic Microfinance is not only Muslim worlds but also for whole world. Shariah Complaints funds: it is necessary for Islamic Microfinance Institution to have shariah complaint fund in Asset side & liability side. Shariah vetted products according to AAOIFI guidelines. Trainings & Quality HR: This is very important element for Islamic Microfinance Institutions. Ensure Shariah Audit: There should be qualified Shariah Advisor, Shariah Review etc. All the Financing should be free of interest. Micro Takaful: which is the mechanism of of Shariah compliant insurance.

Islamic Microfinance Institution Worldwide

Global - Islamic Microfinance Industry 300+ Islamic Microfinance Institutions operating in 32 Countries USD 1 billion Market Size. Indonesia, Bangladesh, Pakistan and Afghanistan have 80% share of Global Islamic Microfinance industry (CGAP) 2 Million Active financing Clients. Murabahah & Qarz-e-Hasan are the Major Products. Share of Islamic Microfinance in Islamic Finance industry & Microfinance Industry is less than 1%

Compatibility IMF Products with MF Models Grameen Model: Amna Iftikhar – Malaysia, Islami Bank Bangladesh Limited etc. Village Bank Model: Sanadiq program -Jabal al-Hoss, Syria, FINCA - Afghanistan etc. Credit Union Model: Muslim Credit Union (Tobago), The Amwal Credit Union etc. Cooperative Model: AlBaraka MPCS – Mauritius, Al- Khair Coop. – India, Muslim Community Coop.– Australia, Karakorum Cooperative Bank – Pakistan. Self-Help Group: Aameen Society – India For Profit Banks/MFIs : Ghana Islamic Microfinance Banks – Ghana, HSBC Amanah – U.K, Bank Islami - Pakistan `

IMF’s Product for all Level of Poverty and more…. Salam, Istisna and other products Non-Poor Transitory Non-Poor Qarz-e-Hasan, Murabahah, Ijarah, Mudarabah Transitory Vulnerable Transitory Poor There are certain factors to be considered while doing Islamic Microfinance……………. But at this stage, I would like to rectify one misconception that islamic Microfinance is for Muslims, Basically …….. So Islamic Microfinance is not only Muslim worlds but also for whole world. Shariah Complaints funds: it is necessary for Islamic Microfinance Institution to have shariah complaint fund in Asset side & liability side. Shariah vetted products according to AAOIFI guidelines. Trainings & Quality HR: This is very important element for Islamic Microfinance Institutions. Ensure Shariah Audit: There should be qualified Shariah Advisor, Shariah Review etc. All the Financing should be free of interest. Micro Takaful: which is the mechanism of of Shariah compliant insurance. Chronic Poor Zakat, Sadqa, Ushar Extremely Poor

Legal & Regulatory Framework The legal and regulatory framework of Islamic micro-finance Pakistan as Case Study

Pakistan Population - 180 million Muslim population - 97% GDP – USD 225.1 billion Per Capita Income – USD 1260 Category – Lower Middle Income Poverty Rate – 22.3% (less than USD 1.25/ per day) Microfinance Industry – Developing Lack of Funding (Least interest of Donors) in Islamic microfinance while demand of Islamic Microfinance is rising Source: World Bank (website)

Pakistan - Islamic Microfinance Industry 14+ Islamic Microfinance Institutions operating in Pakistan 350 + Branches of IMFI’s 500,000+ Active financing Clients. Murabahah & Qarz-e-Hasan are the Major Products. Micro Takaful, Micro Saving, Branchless Banking etc.

Pakistan - Islamic Microfinance Industry Institution Islamic Microfinance Products Akhuwat Qaraz-e-Hasna, MicroTakaful, Grants Ihsaas Trust Murabaha, Musharakah, Salam Asasah Mudaraba, Musharaka Muslim AID Murabaha Islamic Relief Murabaha and Qarz-e-Hassan Wasil Foundation Murabaha, Ijarah, Salam & Istisna MicroTakaful HHRD Murabaha, Mudarabah NRDP Qard-e-Hasana, Murabaha NRSP Murabaha - Mudarabah with BOK for funding Source Naymet Bank Islami, Farz Foundation. BOK, etc. Qard-e-Hasana, Murabaha, Salam

Pakistan & Islamic Microfinance Industry Innovation: Micro Takaful IT Integration (Mobile Banking) in Islamic Microfinance Livestock Product with Islamic Microfinance operation Micro energy & Micro Saving products Challenges: Unavailability of Shariah Compliant fund Reluctance of Donor Agencies for Islamic Microfinance Accounting & I.T systems., Rating Agencies. Law and order in Northern part of Pakistan Future Prospects: Rapid growth of IMFIs with high acceptability from the Muslim community. Govt. Interest and IDB Support AlHuda Centre of Excellence in Islamic Microfinance

Type of Islamic Microfinance Institutions in Pakistan MFIs, IMFIs, NGO’s, Rural Support Program: Registered and Supervised by SECP under Companies’ Ordinance 1984 (Section 42) Trust, Foundations, Waqf, Cooperatives etc: under joint companies ordinance 1861 Microfinance Bank: Regulated by State Bank of Pakistan Islamic Banks/Banks with having IMF operation: Regulated by SBP According to legal and regulatory aspects, we can categories Pakistan’s Islamic Microfinance Industry into 4 categories.

State Bank of Pakistan Guidelines for Islamic Microfinance Business by Financial Institutions Option 1 Establishment of Full-fledged Islamic Microfinance Bank (IMFBs) Option 2 Islamic Microfinance services by Full fledged Islamic banks Option 3 Islamic Microfinance services by conventional banks Option 4 Islamic Microfinance services by conventional microfinance banks (MFBs)

Establishment of Full-fledged Islamic Microfinance Bank (IMFBs) Option 1 Establishment of Full-fledged Islamic Microfinance Bank (IMFBs) Licensing Nation wide Microfinance Banks; Province wide Microfinance Banks; Region wise Microfinance Banks; District wide Microfinance Bank Application Compliance with Legal framework and Prudential regulations Bank draft of PKR 500,000 by applicant Appointment of Shariah Advisor by applicant according to fit and proper criteria of SBP. Shariah vetted Products along with product structure and its beneficial use. Ensure the Expertise, Shariah Compliance Mechanism, Quality HR, Policies, Manual, Procedure etc.

Islamic Microfinance services by full-fledged Islamic Banks Option 2 Islamic Microfinance services by full-fledged Islamic Banks Mode 1 - Islamic Microfinance counters at existing branches Mode 2 - Stand alone Islamic Microfinance branches and mobile banking Mode 3 - Independent IMFBs as subsidiary of MFBs Mode 4 - Developing linkages with IMFBs and IMFIs

Islamic Microfinance services by Conventional Banks Option 3 Islamic Microfinance services by Conventional Banks Mode 1 - Microfinance counters at existing branches Mode 2 - Stand alone Islamic Microfinance branches and mobile banking Mode 3 - Establishing Independent Islamic MFBs as Subsidiaries of conventional Banks Mode 4 - Developing linkages with IMFBs and IMFIs

Islamic Microfinance services by Conventional Microfinance Banks Option 4 Islamic Microfinance services by Conventional Microfinance Banks Eligibility Criteria: Shariah Advisors Particulars (SAP) according to the fit and proper criteria of SBP Shariah Compliant Deposit and Financing Products. Infrastructure and Logistic requirements Required changes in Memorandum and Articles of Association allowing the acceptance of deposits on PLS basis Segregation of Funds (Islamic and conventional) Set up Separate Islamic Microfinance division (IMD)

Establishment of Islamic Microfinance Division (IMFD) Policies Procedures/ Practices Shariah Compliance Capital Adequacy Cash Reserves and Statutory Liquidity Requirement (SLR) Financing need, source and utilization Products mechanism SOPs/ Manuals Risk management Compliance with SBP directives, Role and responsibilities Human Resource Training periodically

Compliance to be ensured by IMFI in: System and Control Internal Audit Accounting Records Utilization of Conventional Branch Network

Shariah Compliance Shariah Supervisory Board at Central Bank /SECP Internal Shariah Advisor Shariah Audit/Shariah Review Shariah supervision of Islamic Microfinance Network

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