Risk Management in
Islamic Financial Instruments
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2.7 ISLAMIC MICROFINANCE RISK
Lastly, it is important to discuss the risks involved with Islamic microfinance. It may seem
counterintuitive, but there have been several important risks identified as being present
within the scope of Islamic microfinance. Islamic finance’s conventional counterpart,
conventional microfinance, which grew out of pioneering MFI institutions like the Grameen
Bank in Bangladesh, is still developing, though it is considered one of Islamic banking’s rapidly
developing subsectors. With goals of poverty alleviation and other core Islamic banking
concepts, microfinance seems, at least on the surface, to capture the beauty and essence of
Islamic finance. Microfinance institutions in the conventional market provide entrepreneurial
entities and individuals with capital critical to their ventures, something traditional banking
institutions (due to insufficient profitability projections and the reticence of banks to lend to
the poor) under pursue. If such persons get access to capital, it is often at the hands of vulture
lenders (who charge incredibly high interest rates with less than favorable lending terms).
While one would think many, if not all, Islamic banks would have arms that provide micro
financing that is not the case.
In some ways, the credit risks that one may find in conventional and Islamic non-microfinance
lending are alleviated to some degree by the group-based consciousness and team linkages
created by a repayment environment that is conducive to effective repayment (given the fact
that if the lending group is unable to pay back the loan monies, then they will not be given
loans in the future), so that the group will not be disallowed from receiving more loans.
However, that said, Ahmed, Ashraf, and Hassan (2002) state there are risks in providing credit
to poor in developing countries, namely the fact that there is no evidence to suggest that
providing poor people with credit will facilitate successful entrepreneurial projects (Hassan
and Ashraf, 2013). As for conventional MFIs, Rahman (1999) cites asymmetric information
issues and underlying moral hazard concerns, that is, that loan capital may eventually end up
in the hands of male family members to be used for purposes other than those intended.
Additionally, Bennett (1998) reports that high operating and administrative costs can range up
to 400 percent per dollar lent, making economic consume enduring and unpredictable (Hassan
and Ashraf, 2013). Liquidity pressures, too, are of concern to MFIs, due to the fact that, in
general, MFI loans are short-term, which is also a cause for higher interest rates (Hassan and
Ashraf, 2013). Besides the fact that charging fixed, even lower rates of interest to the poor may
seem logical, in practice, it is not so simple, as many projects do not offer rates of return that
are profitable enough such that the entrepreneurs can repay the principal plus interest, let one
make any surplus after covering their debt service (Hassan and Ashraf, 2013).
Comparison of Islamic and non-Islamic NGOs (Hassan and Alamgir, 2002)
Islamic NGOs are late in coming to the field of rural development in general and
microcredit/micro-investment in particular. On the other hand several hundred secular NGOs
have been implementing microcredit programs since 1980s. Discussions with leaders of
Islamic NGOs reveal that they were late to appreciate the roles of NGOs and in fact had hostile
opinions about activities of secular NGOs. Gradually some of them appreciated that credit
programs can be implemented by blending Islamic principles of investment and mechanism
of mobilizing the poor, that is, the management practice of implementing microcredit