ISLAMIC MICROFINANCE AS A POVERTY ALLEVIATION TOOL ...

PPCSS INTERNATIONAL JOURNAL SERIES Vol. 2 Number 1 October, 2015 185

ISLAMIC MICROFINANCE AS A POVERTY ALLEVIATION TOOL:

EXPECTATIONS FROM OGUN, NIGERIAN

SUB - NATIONAL STATE

ONAKOYA,* Adegbemi Babatunde

&

ONAKOYA, Adefisayo Olasunkanmi

ABSTRACT

This study attempts to understand how Islamic microfinance as a financial inclusion

strategy can be applied in alleviating poverty and maintain sustainable development

in Nigeria. It analyses the convergence of microfinance and Islamic finance in

providing financial access to the poor in compliance with the Islamic social principle

and tenets. This research employs the use of survey questionnaires and semi

structured interviews. A descriptive analysis of data obtained from selected urban

and rural areas was conducted using the deductive approach. The survey conducted

in Ogun State, a sub national government of Nigeria reveal that notwithstanding the

current upsurge in religious tension in Nigeria, religion is not a hindering factor to

the implementation of Islamic microfinance. The religious affiliation is not

considered critical to accessing microfinance products and services. The study

recommends that microfinance of the Islamic genre , should together with other

monetary and fiscal policies, will engender financial inclusiveness and be a veritable

alternative of providing further inclusive financial access to the Muslims, the poor

and other ethically minded investors in Nigeria. In order to achieve sustainable

poverty alleviation, the ‘Tabarru’ principle which, focusses on helping the small-

scale entrepreneurs and

ONAKOYA,* Adegbemi Babatunde, Department of Economics, Tai Solarin University of Education,

Ijagun, Ijebu Ode, Nigeria. [email protected]

ONAKOYA, Adefisayo Olasunkanmi, London School of Business and Finance, University of Wales, U.K.

[email protected]

mailto:[email protected]


the poor vulnerables, meet their financial requirements, should be considered for

adoption.

Key words: Financial Inclusion, Islamic banking, Microfinance, Islamic Microfinance,

Poverty alleviation, Nigeria

1. INTRODUCTION

The stability of the financial environment plays an important role in the economic development of

a country. Through its many agency and general utility functions conventional finance has over

the years, recorded tremendous successes in the United Kingdom. Conventional banking practice

is, predicated upon the intermediation model. The banks and other financial institutions earn

generate profits from the intermediation spread between earned demand deposits and savings

deposits (Ryu, Piao, & Nami, 2012). The development of a healthy national financial system is

seen as a channel for the broader goal of national economic development. However, the coverage

of financial services for most people are of limited success in developing countries (Adams

Douglas, Graham & Von Pischke, 1984).

However, a section of the society have, been excluded from the financial system, with

consequential, implication for sustainable development. Therefore, the provision of access to the

formal financial system and services such as savings, payments, transfers, credit and insurance

becomes critical in order to obviate the deleterious impact of development disparities. The

financial inclusion framework which consists of the demand-side (consumers) and supply-side

(financial sector providers) sides aims at ensuring that users and financial service providers are

included in the formal sector and have incentives to actively do so. In this respect, and for

inclusiveness, microfinance, which is a subdivision of the financial sector focused on fighting

poverty, provides a medium for filling the credit gap created by the conventional banks. The

advocacy for the emergence of an alternative form of finance based on the need to, effectively

address the financial needs of the neglected low-income earners and poor begun to gain traction.

Khan (2008) explains that microfinance refers to providing loans and other credit facilities to the

poor with a focus on those not served by traditional institutions through programs designed

specifically to meet their needs and circumstance.

Dahiru and Zubair (2008) considers financial exclusion as the major challenge confronting

the microfinance scheme in Nigeria. This is corroborated by Aliyu and Zubair (2008) who contend


that the majority of the population of Nigeria live below the poverty line, despite various

conventional microfinance institutions. Such programmes have largely failed to meet the goals of

providing access to more poverty-stricken people. The federal government of Nigeria has also

grasped the importance of microfinance as a vital medium to increase access to the formal financial

system. The apex bank in Nigeria states that out of about 40 million people living in abject poverty,

the current microfinance institutions has covered less than one (Central Bank of Nigeria - CBN,

2011).

The results obtained from several microfinance studies in Nigeria results have shown a

positive influence on poverty (Irobi, 2008; Wright, 2000; McCulloch & Baulch, 2000). The

microfinance in Nigeria is however faced with daunting challenges. These include: high repayment

default rate inadequate awareness, communication gaps and insufficient support from government.

In addition, they suffer from inadequate equity capital and lack of standardized reporting in

addition to performance monitoring for the system (Irobi, 2008). Frasca (2008), given the reported

constraints of the conventional microfinance, advocates for Islamic microfinance as a veritable

alternative to conventional microfinance. Sanusi (2013) also advocate for the strategic introduction

of Islamic and other Sharia compliant finances which he considered key in bringing in large part

of population into an organized financial sector.

Islamic finance as defined by Jobst (2007) is a financial relationship involving

entrepreneurial investment that, is subject to moral prohibitions. The principles Islamic finance

forbid interest earning, risk taking, gambling, sinful activities, money lending to customers and

speculative trade. It is predicated on real goods and services trading based and contract-sharing

reward. It is about ethical dealings with wealth redistribution objective and reduction of poverty

(Hayat, 2009).

Although Islamic microfinance is yet to be implemented in Nigeria, this study is set out to

examine its possible impact on poverty alleviation in the country using Ogun State, one of the 36

sub-national governments as a case study. The research investigates the Islamic concept of

microfinance as a financial inclusion strategy in alleviating poverty. The scope of the sample is

purposively based on carefully selected key stakeholders comprising of regulatory body, financial

institutions and general public.

The rest of the paper is organized as follows: the conceptual review that covers the concept

of financial inclusion, Islamic finance, conventional and Islamic microfinance, comparison of both


financial systems, and poverty and poverty alleviation in Nigeria; the methodology of study;

findings and analysis; conclusions and recommendations based on the findings of this study.

2. CONCEPTUAL AND LITERATURE REVIEW

2.1. Poverty

The World Bank (2004) defines poverty as a condition where the basic human needs such

as healthcare, education, food, water, shelter are not available. It further states in its 2002

publication that a person is deemed poor if his/her consumption level is less than US$1 per day.

Dogarawa (2007) reports that Nigeria is, rated among the world’s top 20 poorest nations. with high

level of poverty, despite the amount of crude oil, natural gas and other natural resources the nation

produces. As the decades have gone by, the number of people living in poverty continues to

increase. However, the rate of poverty in Nigeria has dropped from 35.2% of population in

2010/2011 to 33.1% in 2012/2013, according to the World Bank country manager at the Nigeria

Economic Report (2014).

The causes of poverty have been ascribed to several factors. For Nnadi (2008), it is the

impact of globalization on the Nigerian economy through a foreign direct investment decline and

unemployment. Unfortunately, sumarising the Development Indicators report of the World Bank

for Africa, Teshome (2008) surmised that the hitherto veritable gateway to employment

(education) is no longer certain. Corruption, defined by Transparency International as the abuse of

power entrusted officially for private benefit has been fingered as yet another culprit (Ozoh, 2012).

The lack of diversification of the economy resulting on over dependence on Oil, the lack of capital

and the labour resources under-utilization of during the farming season are others (Igbuzor, 2004),.

The combination of these various complex poverty contributing factors also include negative and

/ or low economic growth, deffective macroeconomic policies, lacuna in the labour market

resulting in limited job growth, low productivity and low wages in the informal sector, and a lag

in human resource development (Olowa, 2012).

2.2 Financial Inclusion

Financial inclusion also known as inclusive financing is the provision of financial services


at costs which are affordable to disadvantaged and low income segments of society. The main aim

is the alleviation of poverty. It is envisioned that the economic empowerment of the poor will be

made easier by easing access to financial capital, hitherto unavailable to this class of people.

Microfinance involves the provisioning and making possible financial services hitherto

inaccessible to the low income segment of society. Globally, the institution of microfinance is

recognized as a veritable instrument for promoting financial inclusiveness and consequently,

reduction of poverty.

The estimate of global working-age adults with no access to any type of formal financial

services to be about 2.5 billion. In addition, only 24% of adults in Sub-Saharan Africa have a bank

accounts (Muzigiti & Schmidt, 2013). The figures for Nigeria as of 2010 are no less favourable:

About 79 percent of the population do not have access to formal financial services, The women

folks and the rural population constitute about 85% and 86%of the unbanked population

respectively. Illiteracy is another factor which forces them to deal with cash. Research shows that

55% and 19% use bank for savings purposes, and prevent theft respectively. In all, only 3% use

Microfinance banks (Credit Awareness, 2010). The task of admitting these 'exiles orphans' into

the formal financial family is an arduous one. One of the veritable avenue for achieving this is

through microfinance.

2.3 Conventional Microfinance

Microfinance, a way of providing access to financial services for small and micro

businesses, hitherto difficult because of qualifying parameters high transaction costs. The

cooperative societies were known by different names in Nigeria: Esusu in the Southwest, Adashi

in the North and Etodo in the Eastern part of Nigeria. The country has about 870 conventional

microfinance banks licensed by the Central Bank of Nigeria (CBN, 2013).

Several microfinance researches in Nigeria have results showing a positive influence on

beneficiaries (Irobi, 2008; Wright, 2000; McCulloch & Baulch, 2000). All the authors consider

microfinance as a powerful and effective and poverty alleviation contrivance. The microfinance in

Nigeria is however faced with daunting challenges. These include: inadequate awareness, high

repayment default rate, insufficient support from government and communication gaps. In

addition, they suffer from inadequate equity capital and lack of standardized reporting in addition

to performance monitoring for the system (Irobi, 2008).


All the various governments in Nigeria have at one time or the other recognised the

debilitating impact of poverty on the citizenry and the economy. These programmes are directed

towards the poor especially amongst rural dwellers and women. Some of the finance based anti-

poverty programmes put in place by the government of Nigeria in the past were the Peoples Bank,

which sought to provide loans to prospective entrepreneurs on soft terms and without stringent

requirements of collaterals. The Peoples Bank were to serve as sources of cheap funds for

communities. Others efforts include the Community Banks and rural banking regulations of the

CBN which forced banks to open branches in the rural area hitherto considered unprofitable. The

essence of these inclusive financing programmes which have recorded varying levels of success is

poverty alleviation.

The next discussion will be on the Islamic microfinance which provides another vista of

opportunity for financial inclusiveness to millions of Muslims and other ethically minded investors

who currently rebuff microfinance products that do not comply with Islamic law (Haram) and

other morals.

2.4 Islamic Microfinance (IsMFI)

The distinguishing features of key Shari'a principles from the conventional genre has

necessitated the emergence and development of a separate finance industry. Specifically, Islam

prohibits speculative investments (Mayseer), interest (Riba), usury, and Gharar which is

commercial uncertainty. In addition, all activity must be for permitted purposes (Halal), (Figure.

1).


Figure1: Key Principles of Islamic Finance

Source: Adapted from Abdullah and Chee (2010)

Islamic microfinance represents the convergence of two sectors: microfinance and Islamic

finance. It has addresses unmet demands in microcredit facilities in addition to meeting the key

Islamic injunctions of providing support to for the less fortunate (Karim, Tarazi & Reille, 2008).

The objective is to enhance the living standard of the poor because it discourages exploitation and

social injustice. The philosophical basis of the Islamic financial system according to Dogarawa

(2008) is in the Adl (social justice) and Ishan (benevolence). In view of these principles the positive

influence of Islamic microfinance, on reduction in the level of poverty is manifested in the

inclusion of those that have hitherto been excluded from financial services. The Islamic

microfinance is more inclusive than the conventional one in addressing poverty alleviation. It

blends the creation of wealth with understanding for the poor. The transparency in accounting

and the meticulous documentation in the Islamic framework, is a central requirement of financial

transactions.

Financial Inclusion


A composite model of Islamic microfinance which combines the profit with the not-for-

profit modes of Islamic microfinance has been provided by Obaidullah (2008). The model starts

when a Zakah Fund is established with contribution from donors and /or by an Islamic

Microfinance Institution (IsMFI) or programme. This fund is applied in acquiring monetary and

physical assets. The physical assets are used to expedite skills and training education while in the

view of (Hassan, 2010), the monetary assets is kept in the form of a cash Waqf, or Sadaqat. The

IsMFI identifies the needy and economically inactive destitute persons to whom part of Zakah

funds is given towards meeting their basic necessities in terms of grants and safety net expense. In

addition, the IsMFI arranges for skills training to these economically inactive persons.

The beneficiaries are constituted into groups when graduate with requisite skills. These

teams mutually guarantee the provided facilities (Kafala) with combination of for-profit debt-

based modes (Ijara, Salam, Bai-muajjal, Isijrar or Istisna) and / or equity-based modes

(Musharaka or Mudaraba). The group members are provided with higher levels of financing when

they pay back their current debt. In case of actual defaults, the liabilities accounts are paid off from

the Zakah funds. In order to ensure the sustainability of the programme, the team members are to

form a micro-insurance (Takaful) fund from their savings. This composite model of Islamic

microfinance is represented in Figure 2.

Figure 2: Composite Model of Islamic Microfinance

Source: Adapted from Obaidullah (2008).

Donor /

Waqf

Zakah

Fund

Micro Savings

Self Help

Group of

Economically

Active

Beneficiaries

For-Profit

Microfinance

Micro

Takaful

Cash /

Waqf

&

Physical

Assets

Skills Training

Safety Net

Guarantees

Economically

Inactive

Vulnerable Poor

2

4

1

3

5

6

7

8

9

10


Awojobi and Bein (2011) attest to the efficacy of the micro finance schemes in all n the

Middle East nations. The schemes has successfully enhanced employment opportunities, improved

social and economic condition of the target, and raised real wages. This findings is also supported

by Siddiqi (2002) who reports the comparative advantage of Islamic finance over the conventional

alternative.

Islamic financial products and services are available to all regardless of religious belief.

Islamic microfinance products include Salam for financing agriculture and Bay al-Muajjal-

Murabahah of providing working capital (Hassan, Kayed, & Oseni, 2013). There are many models

in operation. Dhumale and Sapcanin (1999) identified three main instruments Islamic Micro

Finance (IMF) models. In the profit and loss model (Mudaraba), entrepreneur manages the project

using the funds provided by the financial institution who bears the possible loss. In the Musharka

model, a joint venture arrangement exists wherein both the entrepreneur and financial institution

contribute to the capital and sharing of any profit or loss. In the Murabaha scheme, the bank

procures the products and sells them to micro entrepreneur and with a markup.

The model propounded by Hassan and Ashraf (2010) provide for the creation of a Zakah

fund (one of the Islamic five pillars) is designed to address the poorest of the poor with which to

cover the losses arising from the default by very small microenterprises. The fund also covers part

of the project evaluation costs of the commercial banks. Qardhasan loans are also provided for

funding micro insurance to reduce vulnerability of the non-poor from becoming poor due to

external shocks. This is in addition to the creation of mutual guarantee funds to pay for accidents,

losses of property. In addition, loans are also provided to build the productive capacity of the

households as part of inclusive growth programmes.

Dasuki (2006) recommends the group-based lending scheme and Ibn Khaldun’s concept

of Asabiyah which as a unifying force is analogous to the modern concept of social capital. In the

Qardhasan savings/lending model, the loan depositor receives saving points instead of interest for

the size and duration of the funds provided. After achieving a sufficient number of those points,

the group member should be eligible for taking out a loan himself. The model which is a form of

cooperative finance practice has been professionally applied by non-Muslim banks JAK Medlem,

Nordspar (Sweden and Denmark) and by Strohalm Foundation (The Netherlands).

The Islamic microfinance banks needs to institute measures that guarantee loan repayment.

In the event of default by a group member, De Aghion and Morduch (2005) recommend that in


line with the practice of the Grameen bank, such defaulter and the other group members will have

to quit their membership of the bank. The other group members are likely to repay the loan on

behalf of the defaulter since they would want to retain their beneficial membership of the bank. In

effect, they are would, in the face of possible collateral liability be careful in admitting a group

member. This is useful to micro-lenders in overcoming “adverse selection” problem.

If the Islamic microfinance banks considers the business project too risky despite the

various risk mitigation techniques available, Wilson (2007) recommends that it should adopt or

adapt the Wakalah model which is acting only as an agent for the disbursement of funds provided

from Zakat fund or Non-Governmental Organisation (NGO) and other donor agency. This may

become necessary since Islamic microfinance institutions do not intend to go into bankruptcy

occasioned by massive repayment defaults. Islamic finance by nature which is asset-backed

provides opportunity for more realistic funding of production and real investment activities. This

in the opinion of Umar (2014), facilitates the development of critical infrastructure which should

contribute positively to the development of the real sector of the economy. The next area will

discuss the methods and approaches through which facts will be gathered in this study.

3. RESEARCH METHODOLOGY

In this study, as advocated by Saunders, Lewis, and Thornhill, (2009), triangulation which, within

one study deploys more than one data collection method to achieve a more accurate research has

been used. In order to vitiate the impact of perception bias, the use survey questionnaires have

been coupled with semi structured interviews. The choice of multiple methods as advocated in

business and management research by Saunders et al. (2009) has been adopted.

The descriptive analysis including ratio analysis and percentage analysis were used to

describe the socio-economic and demographic characteristics of respondents in the study area.

Specifically, the size and composition, the sex and educational attainment of the respondents were

analysed in the study. The use survey questionnaires and semi structured interviews was employed.

The structure of the questionnaires provides for both open and close-ended questions. The

respondents are to pick their choice in the structured questionnaire section. Steps have been taken

to eliminate as much as possible bias and ambiguity. The respondents were also given the

opportunity to freely comment on the ability of the Islam in providing entrée avenues for the

“unbanked” into the formal financial system.


Four hundred copies of the questionnaire were administered in ten clusters towns drawn

purposively and divided equally between rural and urban areas spread throughout the State. These

are Abeokuta, Ijebu-Ode, Sagamu, Ota, Ilaro, Ago-Iwoye, Ijebu Ife, Kobape, Imeko and Imo Lisa.

The target respondents include agriculture, retail marketing, civil service commission,

beneficiaries of OSAMCA loans and general public which consist of civil servants bankers and all

other occupations. A stratified random sampling technique has been adopted for this research to

reflect the population size of each town. Next, we present the data analysis and interpretation of

results.

4. FINDINGS, DATA ANALYSIS AND DISCUSSIONS

The number of responses received was 344 (86%) The response rate is considered adequate

for drawing empirical inferences. Ten semi structured interview sessions were held with

enlightened professionals in sociology, banking and finance management on the subject matter.

The result of the findings show that all the people in and above the age bracket of 18 and 60 years

will benefit from Islamic microfinance which coincides with the constructive and productive work

force.

From the above analysis, a good majority of Christian respondents (68%) agrees to patronize

Islamic products when provided which attest to the fact that religion is not a constraining factor to

access Islamic microfinance. This is not surprising in view of the fact that religious this society do

not really discriminate along religious lines. Different religious persuasions can be found within

even nuclear families.

The research has revealed that about 38% of the respondents have been refused loan

requests in the past due to inadequate funds which corroborates


the fact that existing micro finance institutions are not capable of meeting the demand of the

potential market. Indeed, CBN, (2005) states that existing micro finance in Nigeria serves less than

one million out of the potential 40 million people living in abject poverty.

From the findings, 68% of the sample population are interested in sharing their business with an

Islamic micro finance bank (Table 1).

Table 1: Readiness of Respondents to Share Profit with Islamic Microfinance

Response Number of Respondents % Distribution

Yes 234 16

No 110 84

Total 344 100

Source: Field Survey 2014

This indicates the perception of respondent with respect to the significance of the Islamic genre of

finance to the expansion of their business operations due to the principle of profit and loss sharing

Of the respondent, 84% objected to punishment for loan default which has been a major

challenge for Islamic finance. However, Eighty nine percent (89%) of respondents wholly support

the notion that Islamic microfinance can alleviate poverty, which supports the findings of majority

of the literature. On the questions designed to find out what the respondents feel about the impact

of Islamic microfinance on the real sector of the Nigerian economy and if a positive sustainable

development is attainable. Seventy Eight percent (78%) of respondents are positively in line with

the position of Siddiqi (2002) that Islamic finance creates better value for financial activities

through to the close link between real economic activities and Islamic finance.

The summary of the findings of semi structured interview the open-ended questions are

that the conventional poverty alleviation schemes in the past years have not been successful in the

last two decades. Their comments included ‘poor’, ‘it has not worked’, ‘they have not performed’, ‘poor

outlay,’ ‘it has failed’, ‘no improvement’, ‘those schemes more often suffer implementation problems’, and

‘they are inefficient’. They also agree that Islamic microfinance in concert with the right fiscal and

monetary policies framework, will contribute positively to poverty alleviation in Nigeria.


All the respondents to this question are not aware of any structure put in place to promote

Islamic microfinance. The respondents also freely comment on the ability of the Islam in providing

entrée avenues for the “unbanked” into the formal financial system. Majority (91%) believe in the

ability of Islamic microfinance to generate financial inclusiveness through the provision of Halal

(Shariah sanctioned) products including Mudaraba (profit and loss sharing by borrower/manager

and the financier), Musharka (Joint venture wherein both the bank and entrepreneur participate in

capital and share profit and loss) and the Murabaha (cost plus markup sale). Finally, majority of

the respondents responded in positive light toward the introduction of Islamic microfinance in to

the country.

The findings of this study are consistent with the theoretical underpinning of Islamic

finance which is the sharing of profit and loss (PLS). To some extent, economic principles and

analyses are based on the Qur’an and the Sunnah which are the sayings and doings of prophet

Muhammad (SWT). As reported by Chapra (2008), it is the collective obligation (Fard Kifayah)

of a Muslim society to take care of the basic needs of the poor. This is considered as the raison

d’etre of society itself. In addressing poverty alleviation in an Islamic society, charity (the broad

term being Sadaqat) takes a central position. Indeed, when compulsorily mandated on an eligible

Muslim, Sadaqat is called Zakah which is the third among five pillars of Islam. Beyond these

personal efforts at reducing poverty, institutional arrangements are also in place.

The operational scope of Islamic microfinance (IsMFI) is wider than its conventional

counterpart. The intendment of microfinance is meant to get the poor out of poverty. However, the

poorest population are still left out by conventional MFIs (Choudhary, 2002). The IsMFI is

required to cater to this category by integrating the poverty eradication programmes, including

Zakat, Qard-Alhasan and other voluntary charities (Sadaqatt) into their mandate.

5. CONCLUSION

The various financial inclusion strategies and programmes have met with varying degrees

of success. The ideology of an Islamic microfinance institution appears to be potentially of a

comparative advantage because Muslims want to carry out economic activities according to their

religious injunctions. A population of about 80 million Nigerians Muslims constituting about half

of its total population (Pew Research Centre, 2009) creates a potential market for this financial

services genre. Coupled with about 70% of Nigerians living below poverty, the Islamic


microfinance can be a veritable alternative of providing further inclusive financial access to the

Muslims.

The findings of this study are that religious affiliation is not a critical hindrance to access

Islamic microfinance products and services. With the perception that the existing conventional

microfinance institutions do not cater enough for those who really needs their services, Islamic

microfinance when established promises to widen the breath of provision of financial services to

the poor, other ethically minded investors and indeed many other Nigerians of all faiths.

Furthermore, it was noted in this study, that the adoption Islamic microfinance as a

financial inclusion strategy for poverty alleviation needs to be accompanied with other enabling

fiscal and monetary policies for it to be effective. Islamic microfinance concepts should be adopted

by the government in concert with the structural transformation of the economy in order to achieve

a sustainable, balanced and broad-based economic growth and development which will be

inclusive of the poor and the disadvantaged.

In conclusion, as recommended by (Wilson 2007), sustainable poverty alleviation can only

be achieved by teaching poor how to fish. For this objective to be achieved, the ‘Tabarru’ principle

which focusses on helping the microentrepreneurs and the vulnerables poor meet their financial

requirements should be considered for adoption.


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