Microfinance and Islamic Banking

Topics: Islamic banking, Microfinance, Muhammad Yunus Pages: 26 (7288 words) Published: April 11, 2013
Microfinance and Islamic Banking

Submitted to:
Dr. Mohammed Nurual Islam
Department of Business Administration
International Islamic University Chittagong
Dhaka Campus

Submitted by:
Rabiul Hossain
ID: B092070
Batch no: FIN-5

Date of Submission: 22/02/2013

1. Introduction:

Micro financing is not a new concept. Small microcredit operations have existed since the mid 1700s. Although most modern microfinance institutions operate in developing countries, the rate of payment default for loans is surprisingly low - more than 90% of loans are repaid.

Like conventional banking operations, microfinance institutions must charge their lenders interests on loans. While these interest rates are generally lower than those offered by normal banks, some opponents of this concept condemn microfinance operations for making profits off of the poor.

The World Bank estimates that there are more than 500 million people who have directly or indirectly benefited from microfinance-related operations.

2. Definition of Microfinance:

A type of banking service that is provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. Ultimately, the goal of microfinance is to give low income people an opportunity to become self-sufficient by providing a means of saving money, borrowing money and insurance.

Microfinance, according to Otero (1999, p.8) is “the provision of financial services to low income poor and very poor self-employed people”. These financial services according to Ledger wood (1999) generally include savings and credit but can also include other financial services such as insurance and payment services.

3. History of Microfinance:
Microfinance is not a completely new concept of finance and its roots can be found in medieval Europe, especially Ireland and Germany, instead of Bangladesh where the famous founding father of Grameen Bank, Professor Muhammad Yunus, with its own lending policy started its operations in the 1970s and who is nowadays a synonym for microfinance. In Europe in the 15th century, the Catholic Church founded so called pawn shops in order to protect people from shady loan sharks and moneylenders who gave out loans at usurious interest rates. These pawn shops later spread throughout the continent (Helms, 2006, 2). As further described by Seibel: “informal finance and self-help have been at the origin of microfinance in Europe” (Seibel, 2005, 3). More formal credit and savings institutions for poor people were already established in Ireland by the Irish Loan fund system as early as 1720, using peer monitoring to enforce the repayment in weekly installments of initially interest free loans from donated resources (Seibel, 2003, 2).

Robinson states that the 1980s represented a turning point in the history of microfinance in that MFIs such as Grameen Bank and BRI 2 began to show that they could provide small loans and savings services profitably on a large scale. They received no continuing subsidies, were commercially funded and fully sustainable, and could attain wide outreach to clients (Robinson, 2001). It was also at this time that the term “microcredit” came to prominence in development (MIX3, 2005). The difference between microcredit and the subsidized rural credit programmers of the 1950s and 1960s was that microcredit insisted on repayment, on charging interest rates that covered the cost of credit delivery and by focusing on clients who were dependent on the informal sector for credit (ibid.). It was now clear for the first time that microcredit could provide large-scale outreach profitably.

The importance of microfinance in the field of development was reinforced with the launch of the Microcredit Summit in...
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