Abstract

Islamic financial services have the eradication of interest and fair economic distribution of wealth as their main goals. Underinvested sectors such as MMEs are too often seen as areas with little economic or business potential. The Islamic services paradigm views such sectors as ideal opportunities for investments to fulfill the goals of development and profitability. This paper analyses the supply of finance to MMEs in a stage-wise manner. It deals with the range of services that are currently required by the MME sector and studies methods of making them available. After analysing the challenges faced by the MME sector due to non-availability of Islamic services, this paper lists the challenges facing the supply of Islamic services to MMEs and then proposes a framework to deal with those problems.

Introductory overview

The MME sector is heavily dependent on the informal sector for supply of finance. Informal credit markets restrict their lending to the larger and less risky clients, effectively excluding small enterprises from the market.

The formal sector though cognizant of the dearth of service providers in this circuit is blind to the low profit markets. In cases where the formal sector does have operations at the micro and medium enterprise level, it imposes collateral requirements that are inappropriate for a healthy development of the MME industry. After the recognition of the MME sector as one of the main drivers of the economy, there is a marked commitment by the banking industry to MME finance. Inspite of that, MMEs find financing a problem, for a variety of reasons. In developing countries, the problems are mainly due to the low quality of business plans. Add to it the priority list of the banking sector with its emphasis on short term finance instruments and its tendency to direct funds to later stage MMEs to mitigate risk.

It is thus the financially sophisticated who benefit and build, while a new entrepreneur corresponding to higher risk translates into higher interest rates. This situation is disturbingly capitalist, but in line with the maxim of 'maximum returns'; The maxim which is apathetic to value judgments. This scenario also leaves a strong stigma of failure on those who would like to try again.

Islamic services can exploit the economies of MMEs. The 'Maximum returns' paradigm  would be to accomplish humanitarian and development objectives that are profitably sustainable and result in fair spreading of economic growth. Profit sharing is bound to raise levels of entrepreneurial motivation, thus promoting it.

Supply Constraints

An examination of the hurdles involved in MME financing will give us insight into the supply constraints facing Islamic services. The way to a framework therefore would be to list those problems and study means of overcoming them. The challenges we need to overcome can be divided into three separate groupings.

1.    Higher costs

1.

–       Experts in the field of MME finance are both rare and costly

–       With no existing structure for MME finance, there is a need to build a new one

–       Maintaining MME operations: loan application processing, drawing up contracts and arranging required finance

2.    High Risks

–       Low collateral

–       Low quality of management

–       Low productivity of labor

–       Low entrepreneurial quality : lack of developed and detailed ideas about planned ventures

3.    Low Profitability

–       Low Returns

–       Uncertain cash flows

Supply Framework

Faced with these constraints, Islamic services are best served by a framework which deals with MME finance with a stage specific approach. A stage-wise analysis reveals that there is a marked difference in the nature of services required at startup and growth stages. Keeping in mind the twin goals of development and profit, this approach can help MMEs with the right priorities at the seed and startup stage while it can focus on profit intensive methods in the growth stage.

Channels of Supply

Thus, a dichotomy in approach is suggested. While Islamic Services to Seed and Startup stage will be social banking initiatives with an eye for development as much as for profit while Islamic Services for growth stage will be more profit intensive.

Seed and Startup stage

Seed and Startup needs to be addressed since capital does not achieve function if there is an improper resource allocation. The various channels that can be applied to enhance the service so as to improve on performance include multipartner delivery channels that diagnose problem areas and systematically solve them through their strategic alliances. The key concern is to undertake initiatives that tackle the problems of high cost and high risk.

The channels discussed are:

–       Local networks

–       Provision of Equity

–       Multi-partner delivery

–       Relationship banking

Local networks:

The inability to finance projects locally is one of the greatest single barriers to financing of infrastructure in developing countries. As a pre-requisite to studying and implementing local projects, Islamic services need to commit resources to analyse factors of production in each local environment. This coupled with specific information on the financial culture of the region will enhance the possibility of designing suitable finance instruments for the specific audience, thus leading to sustainable solutions. Additionally, Islamic services need to diversify resources over areas of local growth to enhance access by making it relevant to more number of people.

Provision of Equity:

The hallmark for any startup stage commitment should be equity. Equity encourages risk sharing through partnerships. Additionally a mechanical linkage of the bank to its projects will help create a long-term commitment. Long term commitments are important at seed and startup as traditional methods of conducting work and administration render substantial investments in a 'suspended' state and such partnerships alone can pave way for a development in this regard. Hence the bank's commitment to the developmental activity of the project involved is foremost in this regard. The actual provision can be affected either by the service provider or in partnership with equity investors.

Multi partner delivery:

As MMEs are relatively more disadvantaged in obtaining advisory support and other business services required to ensure their survival, Islamic services can expand their operations to include those by a multi-partner delivery.  Islamic Services can partner with Angels and NGOs and coordinate efforts for MMEs to benefit from voluntary management initiatives. Specialists are a key requirement that need to be addressed in MME support services. Technical Expertise at startup is critical as allocation levels at startup determine future direction of the company. Committing capital resources to machinery and training personnel may prove to be very costly to modify at a later stage. Hence the emphasis is on prioritizing investments with an eye for technical specifications.

Alliances with input suppliers, insurance companies and product processing industries will make the working of the MME smooth and free from major uncertainties. Islamic services can make strategic alliances with equity investors, leasing companies and debt monitoring firms to lend diversity and outsourcing to their finance products. The multipartner delivery scheme shows flexibility to support various types of instruments varying from equity to quasi-equity to venture capital and loans and guarantees hence emphasizing sustainability through the use of adequate instruments.

An important feature of the multipartner scheme is also to design and develop training plans to build sustainability in the management practices to develop personnel for later stages when the MME shifts from the narrow circle of suppliers and clients to more complex deals. The multipartner scheme is directed at optimization in each aspect of MME financial support, thus providing an important tool in overcoming the risk factor which discourages many financial institutions from startup stage investments.

Strategic partnerships may thus prove beneficial in overcoming the 'high costs' problem by using the limited amount of expertise in a networked manner. Such resource sharing through partnerships make it possible to compare practice and encourage a cumulative improvement in performance.

Relationship banking:

Future businesses will involve alliances, reliability, coordination and ability to listen to entrepreneurs and catering to them. In the MME sector, no predefined process can be created and replicated as specific demands vary.  Thus relationships assume a significant role. More importantly, it is an effective tool for deals with micro scale traders and entrepreneurs, as it provides a remarkable alternative to collateral by making explicit borrower specific data to the bank. With relationship banking, Islamic services can shift their focus from collateral to project viability. Key information regarding entrepreneur competence, skill, ideas of work help create a truer perspective and insights into his team provide an opportunity to see into the probable working of the planned project and hence have access to sensitive information that may help them improve the quality.

Relationship banking models have shown that the concept by itself is self-sustaining, without even policy support, such is the power of entrepreneurial relations.

Growth stage

Islamic support services need to improve on their start, and encourage the entrepreneur into the growth stage. Indeed the growth stage is a critical part of the MME life cycle as many MMEs fail in this stage. With the training and managerial experience imparted at startup, improvement in the quality of performance is expected. Growth stage investments should however be profit focused in order to generate adequate cash flows to reallocate the resources other financial services. Islamic services may seek to enhance access to these resources by making them conveniently available.

The channels discussed are:

–       Credit Information Systems

–       Trade associations

–       Sharia ratings

–       Leasing operators

–       MME networks

–       Partnerships

–

Credit Information Systems:

They can be used to rigorously analyze past and probable future with neutrality, serving to balance Relationship banking offset. Analysis typically involves financial standing and operational capability. The quest for a better ranking induces improvement in MMEs.

Trade associations:

They serve to spread information about contract breaching. This implies severe consequences which is often more than just losing the offended party. It thus increases willingness to accept contractual terms hence reducing risk.

Sharia ratings:

Islamic service providers can extract commitments from the customer to ensure all his subsequent dealings are based on Islamic principles, thus taking the concept of Islamic economics to the masses. A sharia-compliance rating body would serve to show how Islamically healthy each firm's practices are. It would be of immense value to possible finance deal partners.

Leasing agencies:

Growth stage investments may require a sizeable quantity of infrastructure goods, as it requires an up gradation of production process; they can be financed by leasing agencies. Leasing offers distinct advantages over credit, in that it eliminates the need for collateral and makes equipment immediately available for usage. Growth stage MMEs are expected to have a fair understanding of their system and its limitations and hence work with appropriate plans.

MME Networks:

Inter-firm linkages may help entrepreneurs to gain an understanding of other MME functioning. Such awareness and knowledge helps MMEs diversify, and use existing resource for profitable activity. Knowledge of innovative trends would serve to enhance resource usage, thus leading to additional revenue.

Partnership services:

Basic R&D support can be achieved by partnerships with academia for relevant research and university iprs. While Marketing and distribution companies can be held in a tie-up for professional advice. The bank's ability to operate in different countries could serve as a bridge for the growth stage MMEs to plan for export; the bank's overseas partnerships could help promote MMEs in newer areas.

 Conclusion

The framework described thus provides a comprehensive method for overcoming the challenges associated with the supply of Islamic services to MMEs through feasible channels. While the channels proposed at startup stage serve to tackle problems of high risk and low profitability, networking concepts provide for overcoming the challenges of information asymmetry and uncertainty in returns. Concepts in this framework also serve to enhance the relevance of Islamic services to a larger section of entrepreneurs.

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