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Why Can't the IsMF Model be Digitalised?

In a progressive and socially responsible world, embracing technology is crucial for effectively delivering financial products and services to underserved sections of society, particularly in developing and underdeveloped regions. Digital financial inclusion stands as an imperative measure undertaken by governments to foster national survival and growth, subsequently encouraging financial institutions to commit to the initiative as well. Mr. Jim Yong Kim, President of the World Bank Group in 2014, extensively elaborated on the transformative role and benefits of digitally delivered financial services in eradicating global poverty in the long run. This is owed to their inherent accessibility, utilisation of biometric authentication tools, facilitation of seamless two-way government payments, and their overall unbiased nature. Although digital finance and its associated services significantly contribute to societal upliftment, they are still in nascent stages of adoption, undergoing continuous innovation and development. However, despite the migration of financial services such as P2P lending, banking, microcredit, insurance, exchanges, etc. onto digital platforms, several existing models within the financial industry, designed to serve the underprivileged population, have yet to undergo digitalisation. The Islamic Microfinance (IsMF) model is one prominent illustration.

Concept of Islamic Finance & IsMF Model

Islamic Microfinance (IsMF), also known as Interest-free Microfinance or Sharia-complaint Microfinance, is a branch of Islamic finance that has sparked widespread debate regarding its efficacy and viability. Brought upon by Islamic financing principles, its interest-free model aims to foster financial inclusion, spur entrepreneurial development, and promote balanced economic growth across Muslim and Non-Muslim communities. Financial activities governed by Shariah (Islamic Law), including banking, lending, borrowing, and investing, adhere to two fundamental principles derived from the teachings of the Quran: profit and loss sharing, and the prohibition of riba (interest). Considering its interest-free mechanism, Islamic banks and financial institutions typically earn a profit through equity participation in debtors’ business ventures and activities. Ultimately, this culminates in one of two types of partnership contract: Mudaraba (A contract wherein one party provides capital and another expertise, sharing only profits based on a predetermined ratio) and or Musharaka (A contract establishing a joint venture with equal contributions of capital and expertise, and profit and loss sharing) .  Upon maturity, lenders exit their equity holdings through an Initial Public Offering (IPO), Buyback or simply withdraw their ownership stake. Additionally, Islamic finance prohibits usury, speculation or maisir (gambling), which is fairly contradicting to its risk averse financing principles displayed by the IsMF model.

Originally emerging among Muslim businessmen in the Middle East during the Medieval Era, Islamic finance experienced a resurgence in the early 1960s, gaining significant traction among major banking institutions worldwide. This cultural, social, and ethical form of financing and investing, formed on the foundation of strong community trust and interdependence, spawned the establishment of numerous national interest-free institutions in countries such as Sudan, Iran, Bangladesh, and Pakistan, as well as various independent financial bodies globally.  

The Islamic Microfinance (IsMF) model, a subset of Islamic finance, aims to provide interest-free credit facilities to Micro, Small, and Medium Enterprises (MSMEs) and individuals who do not qualify for or cannot afford traditional microfinance due to poverty. Typically structured as Non-Profit Organisations (NPOs), cooperatives, community-based organisations, or social enterprises primarily funded by government subsidies and community contributions, IsMFs prioritise financial inclusion and social impact rather than profit maximisation. While they may generate some revenue through fees and donations, their primary objective is to stimulate entrepreneurial activities and uplift the underprivileged from poverty through accessible and affordable microcredit facilities. To enhance affordability, IsMFs generally refrain from claiming majority stakes in the borrower’s businesses or requiring rahn (collateral). Furthermore, they engage in legally binding contractual agreements with their clients, partners, and stakeholders, operating under the regulatory framework of institutions such as the RBI.  

A prominent institution exemplifying IsMF principles is the Grameen Bank, which is a microfinance specialised community development bank founded by 2006 Nobel Peace Prize recipient Prof. Muhammad Yunus in 1983. Originating in Bangladesh, the bank emerged from a research project aimed at eradicating poverty and stimulating businesses through micro-lending and banking services for rural populations residing in Bangladeshi villages. According to Muhammad Yunus, the bank symbolises “the creativity of human beings”, emphasising the role of entrepreneurial activity in poverty alleviation. As observed, the banks success heavily depends on the principles of social psychology, economics, community support and government backing in its operations. Witnessing a surge of popularity between 2003 and 2007, the Grameen Bank expanded globally in developed and developing countries, lending over $7.6 billion by the end of 2008 to the poor, including several women borrowers.

In India, numerous IsMF institutions operate based on the profit-sharing mechanism of Islamic finance, primarily structured as co-operative credit societies like Bait-un-Nasr Urban Co-operative Credit Society, Al-Khair Co-operative Credit Society and Sanghamam Multistate Co-operative Credit Society.


A Digitalised IsMF Model: Study of Akhuwat Islamic Microfinance (AIM) Program 


In discussing digitalised IsMF institutions, it is crucial to consider one of the world’s largest interest-free microfinance programs, Akhuwat Islamic Microfinance (AIM). Launched in 2001 by Dr. Muhammad Amjad Saqib of the Akhuwat Foundation, the AIM program is a cornerstone of their efforts. The Akhuwat Foundation is an NPO founded in Pakistan, which has significantly impacted the underprivileged community through its AIM Program, education programs, clothes bank, Khawajasira Support Program, housing projects and health clinics. Dedicated to creating a poverty-free society, as of 2022, Akhuwat had disbursed over 5.4 million interest free loans worth PKR 180 billion ($650 million) to 3 million Pakistani families, with a national impact factor of 22.3%. Based in Lahore, Pakistan, Akhuwat has a network of 750 branches across the country alone, providing a wide range of tailored interest-free microfinance products, such as family enterprise loans, agriculture loans, liberation loans, housing loans, education loans, health loans, marriage loans and emergency loans. Loan durations vary from 1 to 36 months based on the type and only requires principal repayment in easy instalments, with 0% interest and an optional 1% towards its mutual contribution fund.

Arabic word ‘Akhuwat’ means Mawakhat (brotherhood), which reflects its reliance on the strength and trust of the Muslim community in Pakistan, emphasizing the organisation's primary funding from society and government donations and subsidies. An article by Vatican News described the organisation as being “a concrete example of human fraternity, by seeking to promote compassion, solidarity and equality through microfinance”. Due to the integrity of the community, the loan repayment rate is at an astonishing 99% despite being sanctioned to low-income individuals, who are misconceived to have an unreliable attitude. Currently, Akhuwat has expanded its physical presence to several countries, including the UK, Canada, Sweden, the USA, Nigeria, Uganda, and Afghanistan.

Despite the success of Akhuwat’s Islamic Microfinance program (AIM), its digital platform currently serves primarily as an informational resource about its loan services and their respective procedures. Unlike other traditional microfinance institutions offering and granting micro-credit on their online platforms, Akhuwat merely provides information detailing these microfinance services, which must be accessed through its physical branches only. Even though these branches are highly accessible to rural societies throughout Pakistan, they have limited physical presence in other countries. An evident recommendation would be to transform the entire loan application as well as the sanctioning process online through Akhuwat’s website, to effectively realise their objective of eradicating poverty at a global scale. Nevertheless, it could be contended that the effectiveness of delivering online IsMF facilities is compromised by factors such as limited internet access, a lack of digital literacy, and low technological proficiency among impoverished communities.

An alternative perspective to consider is that the adoption of technology in any organisation benefits both its customers and management. Management gains from expansion, quick and convenient data collection, data-driven decision making, internal controls, development of Management Information Systems (MIS), increased oversight and cost savings from closure of redundant branches. Customers benefit from typical digital delivery advantages like accessibility, convenience, ease, availability, and enhanced customer experience. However, digital implementation would expose the organisation to common digital threats, like authenticity of applicants and safety of customer data.

Further research suggests that digitalising the process may potentially disrupt the Muslim fraternity and community balance, which the IsMF model builds on. The model is viewed by the Muslim community as social financing grounded in brotherhood and community building. However, the adoption of digital delivery could compromise this objective due its remoteness and lack of physical presence. Since the model relies on the sincerity and trust of the community, digitalisation may result in higher exposure to default risk, which questions its viability in the long run.

One noteworthy aspect of Islamic Microfinance programs like AIM is their adherence to cultural norms and practices. For instance, AIM disburses loans to borrowers in mosques, which are often frequented by Muslim men. This practice reflects the cultural context in which the program operates, where mosques serve as central community hubs. However, it's important to recognize that this approach may inadvertently exclude certain segments of the population, such as individuals who do not frequent mosques. Considering this, extending Islamic Microfinance models’ beneficial and socially progressive principles via digital platforms globally, may not be well-received in religiously sensitive and secularist countries such as Russia, Israel, India, etc.  

An often-overlooked aspect about most IsMF institutions is that it disperses cash-based loans because it typically caters to rural populations with limited access to banking and digital payment platforms. In this aspect, Akhuwat deliberately includes the Mosque as a venue for cash-dispersion, which strengthens the community as a whole and facilitates access and transparency. Akhuwat is commended on intelligently utilising the aspects of religious integrity and honesty in its lending procedure. Religiously, Mosques would engrave a deeper meaning within Muslim borrowers to strive and employ the funds in productive activity with prompt repayment of principal and any profit instalments. Evidently, this ideology and manner of thought would not be possible through digital delivery. Additionally, if digital delivery were to be employed, cash-based loans would be potentially replaced by bank transactions. Banking, specifically digital banking, implements superior governance, efficient transfers, cost savings, government oversight and audit, however as per a recent World Bank report, nearly 1.7 billion people are unbanked, which includes a great many individuals battling poverty. It can be argued that digital lending would promote adoption of banking among rural society in the long run and as a result would increase the impact factor globally. Furthermore, many IsMF institutions around the world are structured distinctly, which could have tax and regulatory implications if they make a surplus through their activities. Hence, IsMF institutions rely on cash-based loans to avoid any complications.

Furthermore, research indicates that small scale IsMF institutions would struggle to financially sustain digitalisation without societal contribution and government support. Constrained by its not-for-profit outlook, IsMF models do not emphasise on profit generation, however, it would be useful to view profits as an indicator of successful repayment and instalment rates. Moreover, the downside potential suggests that the credit may not efficiently contribute to the objective of social upliftment, consequently impeding the flow of funds.  Utilising a ‘pricing strategy’ such as a model that determines the profit-sharing ratio or ownership stake in the borrower’s business based on the risk and maturity of the loan, would be useful. Especially for small scale IsMF institutions, it would lead to lower bad debts and would fulfil the social mission.

Overall, the Interest-free Microfinance is an impactful and socially innovative concept, implemented in many countries across the world. To eradicate poverty globally, it is an imperative measure inculcating societal commitment and progressive consciousness throughout the world. It improves wealth distribution and could boost economic growth. However, if viable, digital transformation and expansion of IsMF models around the world must be undertaken mindfully, respectfully, and inclusively.


By Pia Kothari 








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