Contemporary Islamic Finance: Innovations, Applications and Best Practices

CHAPTER 23

Islamic Microfinance

BLAKE GOUD

Principal, Sharing Risk, and Correspondent for the Americas, The Islamic Globe

With the growth in Islamic finance as well as microfinance, it is perhaps surprising that the Islamic microfinance industry has been very slow to develop. Microfinance is a concept, pioneered in Bangladesh by the Grameen Bank, in Bolivia by BancoSol, and in Indonesia by Bank Rakyat, where poor borrowers who are overlooked by the formal banking system receive small loans from microfinance institutions (MFIs) tostartmicrobusinesses.¹ Inmost cases, the MFI makes loans to groups of people (in many cases, focused on women).

The reason the MFI focuses on groups of borrowers, rather than lending to one at a time independently of the group, is that the typical clients of MFIs are excluded from normal banking because they have no assets to post as collateral against the loan they are receiving and are therefore seen as poor lending risks by the banks. In a group lending system, each borrower in the group is responsible for the other members' loans. If one borrower defaults on her loan, the other group members will not usually be required to repay the defaulted loan. Instead, if one of the group members defaults on her loan, the other group members will lose further access to credit. This provides an incentive for group members to monitor the other members and generates social pressure on other members, making them more likely to repay. This social pressure, referred ...