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SME financing by Islamic banks

Published Nov 21, 2016 06:59am

A GROWING bias for Shariah-compliant borrowing among small and medium enterprises is helping Islamic banks and Islamic banking windows of conventional banks in targeting them.

But corporate and consumer financing still dominate their credit portfolios too heavily and SME loans remain only a small fraction of their portfolio-mix.

“Owners and managers of a large number of SMEs have a deeper craving for Shariah-compliant financial services than large businesses and companies,” says the Shariah advisor of a local Islamic bank. “But IBIs have only lately started capitalising on this. The more they go for SME financing, the more they’ll realise this segment has a real big potential,” he predicts.


“Owners and managers of a large number of SMEs have a deeper craving for Shariah-compliant financial services than large businesses and companies…But IBIs have only lately started capitalising on this”


The conventional banking system has done little to satisfy the borrowing needs of SMEs, thereby making way for Islamic banks to fill the gap.

Islamic banking institutions (IBIs) are also being driven towards funding SMEs by other factors:

“First of all, we’re being pushed towards SMEs and agricultural financing by the central bank,” says the head of an Islamic bank. “Secondly, we’ve also learnt, after over a decade’s experience, that leaving these two segments under-served is unwise as both have a great growth potential.”

Currently the share of corporate and consumer financing in IBIs credit portfolio-mix is at 78.1pc and 10.9pc respectively, as of June 2016. Against this, the entire banking industry’s corporate and consumer financing is 67.1pc and 6.4pc of their total credit.

Despite some progress made by IBIs, SME financing has a nominal 2.8pc share in their financing portfolio whereas their share in the overall banking industry’s lending is just double—5.6pc.

“These numbers reveal a key reason why Islamic banks have started focusing more on SMEs and why they must keep this focus intact,” says a senior central banker.

But despite product development and volumetric increase in lending by some individual banks, the SMEs share in IBIs’ overall financing has declined from 4pc in FY12 to 2.8pc in FY16. The stock of IBIs lending to SMEs has, however, increased from Rs11bn in FY12 to Rs19.5bn in FY16 as, well-capitalised IBIs have boosted their overall financing during these four years.

“The share of SMEs in the overall mix of IBI financing will not rise very fast for some years, even if we continue to lend more to them, simply because lending to the corporate and consumer sectors remains so huge,” says the head of Islamic banking of one of the top five commercial banks. Some Islamic banks like Meezan Bank and Dubai Islamic Bank (Pakistan) up-scaled their lending to SMEs, industry sources say.

For boosting SME financing, Meezan Bank has partnered with Karandaz, a private company established by UK’s DFID and the Bill and Melinda Gates Foundation to promote access to finance for small businesses. This arrangement, along with a large network of branches, has helped the bank reach out to SMEs in semi-urban and rural areas.

Dubai Islamic Bank is taking advantage of its expertise in product development and has been making efficient use of Murabaha, Wakala and Istithmar, etc, to meet working capital requirements. For the financing of SMEs’ long-term fixed capital needs, a different range of products with innovative versions of Musharaka and Ijarah are being offered.

According to an IFC study, the potential financing needs of un-served and under-served SMEs in Pakistan is $3.8bn or close to Rs400bn. The Islamic banking industry currently accounts for 11.4pc lending of the entire banking industry. So IBIs can absorb about Rs45bn of the SMEs potential in the present context.

But whereas fast expanding branch networks of IBIs and growing use of mobile and internet banking, make it easier for them to boost their lending to SMEs, or to other segments of borrowers for that matter, a couple of issues remain in place. Islamic banks have not been able to bring their cost of SME credit at par with that of conventional banks, industry sources say.

Besides, “multi-step documentation to conform to the Shariah aspect of their financial products makes borrowing very complicated, which is easier to handle by the corporate sector, but most SMEs cannot afford it,” says a former central banker well-versed with the issues of Islamic banking.

Despite the bias for Shariah-compliant borrowing, SMEs are not aware of Islamic banking products, which is also a key impediment to growth in Islamic financing of SMEs.

Islamic banks, and Islamic banking windows of conventional banks, do have product information available in Urdu, but the problem is that product details are replete with Shariah related jargon and owners and managers of SMEs don’t understand them, mid-tier officials of Islamic banks admit.

The best way to promote Islamic financing of SMEs is to train branch level bank staff in communicating the specifics of a financial product in simple language with potential borrowers.

Published in Dawn, Business & Finance weekly, November 21st, 2016