What, in the name of Allah, is it all about ?

Islamic finance comprises of financial practices that are permissible under Sharia law. What Sharia law permits though, is not as easily defined. According to an article in the London Review of Books, "the real influence of sharia lies in the way this material is constantly read and recast by modern Islamic scholars, reinventing old traditions or asserting new ones". 

In recent years, Islamic finance, that previously only existed within the realm of high finance, has been brought to the micro level. Islamic finance and microfinance, it has been claimed, go hand-in-hand, because of the common tenets they share as unconventional solutions to financial needs that promote mutual responsibility and entrepreneurship. The popularity of microfinance in Muslim countries like Bangladesh is considered to be another encouraging sign that a merging of the two could substantially increase access to financial services. Infact, the Islamic Development Bank has identified microfinance as a key issue to be addressed by the Islamic finance industry for its growth. Although it currently caters to just a tiny fraction of the millions of poor Muslims around the world, some of the questions that the concept and implementation of Islamic microfinance raise are monumental.

To begin with, a question that remains largely unanswered : What is the actual demand for Islamic microfinance ? That 72 % percent of people living in Muslim countries do not have access to financial services does not necessarily indicate demand for these services. Neither does the fact that a lot of poor Muslims express an interest to switch to Sharia compliant products or cite religious reasons for not accessing the financial services available to them. A CGAP study found that 49% of the population in rural Java in Indonesia consider interest rate entirely prohibited and prefer to work with Sharia-compliant products. At the same time, even as one of the few countries where Islamic microfinance is concentrated in, only 2 % of microfinance clients in Indonesia are served by Islamic microfinance. If surveys measuring demand are really only measuring the need to demonstrate religiosity, then low demand may be one reason for the limited supply of Islamic microfinance available.

Or it may be that the costs are too high. Can Islamic microfinance achieve sustainability ? Islamic microfinance is associated with high transaction costs and operational risks in an interest-free environment. Unless there is a way to cut these costs, attracting investors and achieving profitability will prove to be difficult. 

That said, Sharia finance is more than just the prohibition of interest rates. Sharia law prohibits the violation of riba and gharar.To put it briefly, this is ensured by the following four principles : risk sharing, materiality (a  transaction must be directly or indirectly linked to a real economic transaction ), no contractual exploitation, and no financing of sinful activities. These principles can be abided by in a number of different ways, however, not all are applicable in the context of microcredit. This raises another question : Do permissible contracts allow for the diversification and customization of products ? 

Of the few products that are currently offered, murabaha is amongst the most popular. In this contract, a client asks for a commodity that the financier procures and resells to the client with a markup. The markup differs from an interest rate in that it is a fixed one time charge. The financier owns the product and bears the risk until the loan is repaid.The conditions that govern such a contract try to ensure that the loan is being used to procure productive assets by minimizing fraud from false record keeping. It has been shown that typical microfinance clients use a part of their loan for consumption needs. Since this is not possible using an Islamic microfinance product, does murabaha, by eliminating the 'misuse' of loans, provide for a more effective form of micro-lending ? 

Among others, one factor that determines effectiveness is the cultural perception of credit. One of the five pillars of Islam is zakah, the obligatory practice of spending 2.5 % of one's wealth for the benefit of the poor, in order to ease economic hardship and eliminate inequality. In fact charitable practices play a major role in Islamic society, and charitable institutions ( awqaaf / waqf ) may be delivering both Islamic microfinance services and other charitable services side by side . This causes microfinance to be also viewed as a charity. Then, to what extent will a charitable approach to microfinance, as against that of a business, be a hindrance to growth of the sector ? 

Eventually it comes down to evaluating how Islamic microfinance fares against regular microfinance. The differences in the products offered is especially pertinent. Are interest-free Sharia compliant products more client friendly or is interest merely redressed as adminstrative or service fees ? Where Islamic microfinance products seem similar to conventional products offered, Islamic microfinance may not succeed in reaching out to the unbanked that desire products that incorporate their religious principles.