Issues and Challenges in Financing the Poor:

Lessons Learned from Islamic Microfinance Institutions

Salina Kassim and Norizan Satar

IIUM Institute of Islamic Banking and Finance, International Islamic University Malaysia, Malaysia

Keywords: Microfinance, Sustainability, Baitul Maal Wa Tamwil (BMT), Amanah Ikhtiar Malaysia (AIM),

Islamic Finance.

Abstract: Despite the potentially important role of Islamic microfinance in making Islamic finance an inclusive

financial system, the industry is faced with a wide ranging of issues. By analysing the experiences of two

major Islamic microfinance institutions (IMFIs), namely Baitul Maal Wa Tamwil (BMT) in Indonesia and

Amanah Ikhtiar Malaysia (AIM) in Malaysia, this study aims to learn from their experiences of the issues

facing them in financing the poor. The study offers an area of novelty by undertaking a comparative

analysis between both institutions in efforts to understand the peculiarities facing each IMFI, unlike the

earlier studies which are commonly focusing on a specific IMFI. By employing a thorough review of the

available literature, the study finds that human resource and sustainability are the main issues facing both

IMFIs. While human resource is the most important factor ensuring success of the microfinance institutions,

structural issues such as reliance on subsidies could jeopardise their sustainability. Findings of this study

contribute towards providing important inputs for sustainability of the IMFIs as well as enriching the

literature in the area of Islamic microfinance institutions.

1 INTRODUCTION

Generally, microfinance aims at improving the

socio-economic condition of the poor through

various economic empowerment programs by

providing them access to finance at affordable costs.

While having a similar objective, Islamic

microfinance aims to fulfil the financial needs of the

poor and serves as a mean of poverty alleviation to

achieve equitable distribution of wealth and income

with full adherence to Islamic values. Islamic

microfinance has the potentials to play a crucial role

in making Islamic finance an inclusive financial

system by serving the financial needs of all

segments of the society, including the poor who are

commonly categorised as “unbankables”. In the

South-east Asian region, Islamic microfinance has

grown rapidly particularly in Indonesia and

Malaysia, where the Muslim-majority populations

have created a great demand for shari’ah-compliant

microfinance products specially catering for the

socio-cultural and religious peculiarities of the poor

in these countries. The Islamic microfinance

institutions (henceforth, IMFIs) continue to expand

their services to provide a variety of financial

services to the poor segment of the community,

particularly in the form of micro-financing, micro-

savings and micro-takaful. Efforts are continuously

taken to integrate the Islamic third sector, namely

zakat, waqf and sadaqah into the Islamic

microfinance to gradually mobilise the potential

fundings from the Islamic social finance.

The global movement of microfinance which

started in the 1980s have resulted in different

operating models in various parts of the world. In

Malaysia, Amanah Ikhtiar Malaysia (AIM) is the

largest microfinance institution established in 1987

is considered as one of the most successful IMFIs in

the world. AIM continues to receive accolades and

global recognitions such as the “Best Microfinance

Institution Award” from Global Islamic Finance

Awards for four consecutive years from 2013 to

2016. This institution has been mandated to alleviate

poverty and increase the household income under

the national development agenda, i.e., the Malaysian

Economic Transformation Plan.

Meanwhile in Indonesia, Baitul Maal Wa

Tamwil (BMT) is one of the successful IMFIs that

has grown significantly in numbers for the past

twenty years and improved the lives of thousands of

102

Kassim, S. and Satar, N.

Issues and Challenges in Financing the Poor: Lessons Learned from Islamic Microﬁnance Institutions.

DOI: 10.5220/0010115500002898

In Proceedings of the 7th ASEAN Universities International Conference on Islamic Finance (7th AICIF 2019) - Revival of Islamic Social Finance to Strengthen Economic Development Towards

a Global Industrial Revolution, pages 102-108

ISBN: 978-989-758-473-2

poor people in Indonesia. While being

heterogeneous in nature of operations with different

locality would have different determinants, the

success of BMT are dependent on determinants such

as capability of financial management,

characteristics of financing customers, capability of

risk management, familiarity among customers and

managerial team of BMT, adoption of information

technology (IT) and network (Hosen & Sa ’roni,

2012). Wulandari & Kassim (2016) stated that BMT

is able to maintain its sustainability through the fund

received from the social religious collection and

deposit from saving facilities offered by the

institutions. However, sometimes, BMT runs out of

their deposit fund due to financing. Hamzah et al.

(2013) found that internal factors such as lack of

capital and innovation in marketing banking

products, shortage of sources of funding, BMT

employees underperformance, facilities and

technologies that are not up to date affect

operational efficiency of BMTs. The external issues

are stiff competition among the BMTs, low level of

public trust towards BMT performance, lack of

networking and cooperation among other financial

institutions, lack of supervision and guidance from

government and Majlis Ulama Indonesia.

Asmy, Mohammed, & Abdullah (2016)

suggested that, to achieve sustainability which is

also an issue, cash waqaf system is an ideal option.

The cash from donor is channeled to cash waqaf

institution before being distributed to

microentrepreneurs involved in a musyarakah

mutanaqisah partnership. A slightly different model

of cash waqaf for BMT was suggested by Ascarya &

Sukmana (2017). They are suggesting that the cash

waqaf is managed by BMT so that BMT can also

generate income from it, and therefore can run more

socially beneficial programmes. The latter model is

better because it makes the microfinance institution

to be more independent and have more ownership

over their operations. Abdul Wahab et al. (2011)

mentioned in their article that fungibility issue,

number of employed members and number of

sources of income and household’s main economic

activities are associated with repayment problems in

the AIM. Being subsidized by the government, the

AIM offers limited microfinance products and has

standardized lending contracts compared to

Grameen Bank and Bank Perkreditan Rakyat

Indonesia (Mokhtar et al., 2012). More diversified

products enable customers to choose based on their

needs and extend the deliverability of the objectives

of the microfinance institutions.

Despite the various success stories, these

institutions face different internal and external issues

in their operations. While AIM is established as a

non-governmental organisation (NGO) receiving

grant from the government, BMT is established as a

cooperative and being more independent in terms of

sources of funds. Being a private trust body

mandated to reduce poverty, AIM has a clearer

governance structure and thus, has a more stable

source of funds compared to BMT. Consequently, a

number of BMTs have been shut-down due to

financial problems. However, if these two

microfinance institutions are scrutinised, there are

issues that are unique as well as common to both.

This study aims to compare the issues faced by AIM

and BMT and highlight how the issues can be

tackled by complementing the best practices of each

IMFI. In comparing the two IMFIs, extra emphasis

is given to aspects that could possibly jeopardize the

smooth running of the operations. The AIM and

BMT are chosen because these two institutions are

the leading example of the IMFIs in the world and

therefore, the issues that are faced are of important

interest to be shared with avid researchers in this

field so that, improvements in the future can be

materialized.

2 DISCUSSION

Issues and Challenges Facing the IMFI

Despite the various achievements of AIM and BMT

in empowering the poor, there are issues and

challenges that they are facing in providing financial

access to the poor. These issues and challenges can

be categorized into operational, product, and

governance aspects. Identification of these

challenges are important in efforts to institute

suitable measures and undertaken stratergies to

address the challenges for future development of the

IMFIs.

Human Capital Performance

A major issue facing the IMFIs is human capital

performance which comes in several dimensions.

First, there is a lack of motivations and

commitments by the IMFI staff in developing

Islamic microfinance products and services. Low

understanding in economic principles and Islamic

financial transactions aggravate the problem of lack

of capability of the human capital. In addition, there

are insufficient human resources with good

managerial skills to manage the performance of the

Issues and Challenges in Financing the Poor: Lessons Learned from Islamic Microﬁnance Institutions

103

institutions. Shari’ah compliance is a key feature of

doing business in Islamic microfinance but in

practice, many officers and employees of BMT have

low financial literacy. This situation is upsetting

because it will give impact on the perception of the

community towards the image of BMT. The

members of BMT are dependent on the institution to

educate and support them in understanding and

distinguishing between BMT and its conventional

counterpart. When these issues on human resources

are not addressed accordingly, there are public

perceptions that financial products and services

offered by BMT are similar with other conventional

financial institutions. In reality, most of the

administrators and management of BMT have no

background in finance and economics.

According to a research conducted by

Universitas Islam Indonesia, majority of the BMT

administrators are lacked of knowledge and

experience about managing Islamic finance

institution, thus in practice, the BMT often deviate

from the Islamic principles and are inefficient in

business management. In general, the BMT started

as a small business unit initiated by the public.

Having a limited business scope with limited human

resources capacity, human resource capability

management skill in BMT has difficulty to grow.

Due to budget constraint, human development

training cannot be undertaken resulting in poor

performance of human resources in BMT. This issue

causes many BMTs to suffer bankruptcy problem

because of operational failure (Nurasyiah et al.,

2016). For example, in the case of BMT in Pekan

Baru, the study supports that lack of quality human

resource and absence of specific regulations affected

its performance. The study also states most of the

employees in BMT do not have competency as

shari’ah practitioners and do not have the

understanding about the concept of business

(Hamzah et al., 2013).

Little or none has been written on AIM in terms

of human resource performance based on the review

carried out. This is a research gap that can be

focused by future researchers.

Cost of Fund and Perception of Interest

Cost of fund in BMT is higher than the cost of fund

in Islamic and conventional banks. This is because

BMT has to put in more effort to invite customers to

save and deposit their fund in BMT by giving higher

profit rate to depositor. At the same time, to offset

that cost, BMT transfers the cost to other products

which makes other products to cost more. This

situation influences perception of the people that

BMT is conducting financing scheme based on riba

although BMT claim that they operate their product

and service based on shari’ah principle (Kholis,

2012).

It is understood that the basic of Islamic finance

is the avoidance of riba. However, the perception of

Indonesian muslims on banking interest is still

divided even though Majlis Ulama Indonesia has

produced fatwa No. 1 in the year 2004 to forbid

interest rate. It is important to note that the

perception of Indonesian Muslims on interest is

classified into three groups: a) interest is riba, thus it

is haram, b) interest is halal as long as there is no

Islamic bank, and c) interest is halal. This position

restricts the opportunity of Islamic finance

institution to make ordinary Muslims as their target

market because of the different perception on

interest (Kholis, 2012).

In the case of AIM, there is zero cost of fund

because financing is offered based on qard.

However, a 10% service fee called ujrah is charged

to the members. Saad (2012) argued that this rate is

unusually high due to the unique operation of AIM

and suggested it to be waived or kept to minimum to

honour the spirit of qard hassan and offered to the

hard-core poor only. Offering loan in the form of

qard by charging service fee resembles conventional

loan to the eye of the public. Therefore, AIM as an

IMFI should consider introducing Islamic

microfinance products based on equity-based

financing such as mudharabah and musharakah to

the poor customers. By introducing Islamic

microfinance products, AIM will not only become

credit provider but more importantly, a business

partner to its clients to foster their businesses and

provide guidance to the clients to elevate themselves

from the chains of poverty.

Legal or Structural Problem and Standardization

on Establishment and Operations

To date, there is no specific act and regulation on

BMT in Indonesia. The existence of BMT in

Indonesia is based on Act of Cooperation and

Ministerial Decree about KJKS (Koperasi Jasa

Keuangan Syariah /Cooperation for Shari’ah

Finance Services). This means that BMT is still

governed by the conventional system. The Act of

Cooperation only regulates cooperation in

conventional structure. In Indonesia, Islamic banks

are regulated by a specific act (Act. No. 21 Year

2008). There is no formal standardized regulation

for BMT. This problem affects the stability of BMT

presence because it gives opportunity for many

“blind passengers” to manipulate the noble aims of

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

104

BMT for their own interest such as accumulating

wealth, getting higher benefit and misusing

depositor fund for their own business. The conduct

of the business of BMT become unethical and

opposite to shari’ah and practical principle. Since

there is no act and regulation or standardization for

BMT’s establishment and operation, fraud cases

cannot be taken into court of law and punished. The

consequence of their activity is that the reputation of

BMT in the society is damaged and compromised

(Kholis, 2012).

There is also lack of legal support from

government to BMT. Some of the issues are BMT

in Indonesia is not governed by legal provisions and

there is no suitable supervision system and guidance

system. This legal support issues become important

considering the fact that BMT is the organization

that administers and manages society’s funds. Banks

have deposit insurance agencies in the event of

liquidation but BMT does not have this kind of

support. The absence of a clear legal framework may

also lead to the inaccessibility of deposit insurance

agency. Thus, public savings collected by BMT is

not properly protected (Rusydiana & Devi, 2013a).

AIM, on the other hand, is a private trust body

that was established on 17 September 1987 and has

been registered under Trust Act 1952 amendment

1981 (Act 258). The establishment of AIM is a

continuance effort of “Ikhtiar Project” which was a

research project leaded by Professor David S.

Gibbons and Professor Sukor Kassim (AIM, 2017).

As a registered private trust body, AIM is being

governed by Lembaga Amanah Ikhtiar Malaysia

mainly by the Board of trustee in which the

membership consists of economy planning unit and

implementation coordinator unit from Prime

Minister department, Ministry of Finance Malaysia,

Ministry of Rural and Regional Development, state

representative and some other members that were

appointed on individual capacity (Cyber, 2017).

The member of the Board of Trustee has the

responsibility to ensure the administration,

operation, distribution of fund and the

implementation of project initiated for sahabat of

AIM conducted with due diligence without any

misappropriation (AIM, 2017). The operation of

AIM is based on the mandate given by the

government. In 2013, this institution was entrusted

with RM300 million to benefit over 500,000

borrowers by 2015 (Isfire, 2014).

Standardization of Shari’ah Supervisory Board

On the topic of the shari’ah compliance monitoring,

Dewan Shari’ah Nasional Majlis Ulama Indonesia

(DSN MUI) has appointed Shari’ah Supervisory

Board (SSB) in each Islamic Financial Institutions

(IFIs) representing DSN MUI to supervise and

ensure that the IFIs operate according to Islamic

principles. However, the presence of SSB in every

IFIs does not make people feel reassured because

people still see the gap between theory and practice.

BMT carried out standardization on three major

aspects which are the standard operating procedures,

human resources and financial statements. The role

of shari’ah SSB is still is optimal. Even though SSB

is an independent institution whose main function is

to supervise compliance of shari’ah in the

operations, IFIs need to be aware when they

overlook compliance on Islamic principles

themselves to avoid the risk of reputational damage.

Research on BMT Yogyakarta found that BMT in

general has implemented internal control, but there

are still weaknesses in the authorization procedures.

From 19 samples, only 11 BMT has SSB

(Mediawati & Agustami, 2016).

AIM has its own Shari’ah Advisory Board (Panel

Penasihat Syari’ah) that carry out standardized

supervision. This ensures homogeneity across the

products and services offered. No sources are found

to criticize or claim the functions of the advisory

board of AIM so far.

High Operating Cost and Reliance of Subsidy

The Islamic microfinance providers face the issue of

high operating costs in order to maintain financial

sustainability. BMT relies on subsidy since the cost

of financing incurred is the same regardless of the

size of the loans provided to the poor. Besides, high

margin reflects the problems of high transaction cost

in loan processing. In addition, the issue of high cost

will reduce financial inclusion. BMT, on average,

distributes around US$80-US$400 in loan which is

considered small. The administration cost that must

be covered by BMT is around 50 percent from the

nominal funding. This effectively means that, if

there is no support in terms of subsidy for BMT,

they must charge high margin to borrowers.

Therefore, the subsidy role is very important for

BMT to ensure its sustainability.

Subsidy has a direct influence on microfinance.

Subsidized lending will have a positive impact on

reducing financing rate or margin especially in

BMT. Many BMTs search for private donors

because the administration is easier than public

subsidies. The problem that occurs in BMTs is that

many BMTs can only sustain in the first two years

without subsidy. After that, many of them collapse.

External subsidy is crucial especially for the small-

Issues and Challenges in Financing the Poor: Lessons Learned from Islamic Microﬁnance Institutions

105

sized BMTs. Maintaining BMT performance by

maintaining subsidy stability is a challenge for

BMT. The government, national private companies

and international donors have to keep providing

subsidized financing sources for the poor using

BMT and the importance of subsidy is

unquestionable in (Kassim & Wulandari, 2015).

Customers prefers Islamic bank financing because of

the steadier and more stable flow of fund compared

to BMT. Increasing asset and drastic liability

mismatch lead liquidity risk and the less resilient

BMT is proned to external shocks (Ascarya &

Sukmana, 2017).

Delegated with the task of alleviating poverty in

Malaysia, AIM receives strong financial and non-

financial support from the Malaysian government

and its agencies, which is critical to its

sustainability. Financial support comes in the form

of interest-free government financing, grants and

soft loans through allocations made under various

Malaysia Plans. Similar to conventional

microfinance institutions, AIM unavoidably

experience high transaction costs due to asymmetric

information problems. These costs relate to

monitoring and searching costs and the cost of

administration, which are all directly associated with

the information problems in the rural financial

markets. Small loans are expensive because of high

overhead costs, which usually have a large fixed cost

attached. AIM must find a mechanism to reduce

transaction costs as added costs are often passed

onto clients.

AIM still depends heavily on the support from

the government and related agencies for funding.

The operational cost of AIM is relatively high and

salaries and administrative cost from the major

proportion of operation cost, nevertheless creating

only a small portion of assets. By means of a fixed

administrative charge of 10%, it does not cover its

operating costs and could not be sustainable and

self-dependent. AIM should look again on their

fundamental principles because of the loss of

direction in focusing on the not so poor or non-poor

and giving larger loans and better-off borrowers.

Therefore, there is no incentive from such

institutions to offer any other microfinance products

apart from microcredit loans to finance their

operation. This theory also occurred in BMT which

many of them searching for private donor because

the administration is easier than public subsidies as

mentioned earlier (Abdul Rahman & Dean, 2013). If

costs are not covered, the capital will be depleted

and continued access to financial services will be

difficult. Therefore, AIM should seek financial

funding from variety sources other than government

to maintain their sustainability in the long-term.

Repayment Problem among Members

Geographical distance is important because it will

lead to Islamic microfinance efficiency. The higher

distance will cause more credit rationing problem.

One of the features for the people at the bottom of

the economic pyramid is that, they live in the remote

areas which are far away from financial institutions

including BMT. People who live near to BMTs have

lower incidence of credit rationing. One of the

difficulties facing the poor borrowers in accessing

credit is the distance between the people and the

BMTs. In practice, BMTs need to include the

distance between the BMTs and the borrower to help

in deciding whether they should get financing or not.

This is because short distance will make the

monitoring process easier and the application would

have a greater chance of being approved. The

distance of a borrower’s house from BMT is also a

determinant of credit rationing. Financial services

nearness is described as poor people who live nearer

to microfinance institutions and can be contacted.

People who live closer to BMT will have easier

access to financing since it will reduce the cost of

monitoring because it does not require BMT staff to

take public transportation that would acquire a cost.

A greater risk will be faced by BMT if they give

funding to far away borrowers (Wulandari &

Kassim, 2016).

Furthermore, the long travel time from home to

BMT cause customers to get less access to

information and updates. It also makes the frequency

of customers’ meetings with BMT employees

getting smaller so the chances of bad repayment rate

increase and smaller participation of the customer of

BMT to borrowing. For example, in BMT Khairu

Ummah located on Jalan Raya Leuwiliang,

Leuwiliang, Kabupaten Bogor, as well as two

branches of BMT Khairu Ummah located in the

Cigudeg and Puraseda Village, Leuwiliang have a

bad repayment rate and one of the reason are the

customers’ home are far away from the BMT agency

(Effendi & Utami, 2016).

AIM members also have repayment issues, but

the cause of the issue is different and related to

client selection procedure of AIM that starts with

measuring potential clients’ average monthly

household income. Households with average

monthly household income below the Poverty Line

Income (PLI) has been calculated by the Malaysian

government since the year 1976. It was estimated

based on the necessity of food and other basic needs

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

106

and would be considered as absolute poor, while

households with average monthly household income

below half of the PLI would be categorized as

hardcore poor. Therefore, households whose average

monthly household income falls below the PLI,

including both poor and hardcore poor households,

are considered to be eligible to obtain microcredit

from AIM.

Microcredit services offered by AIM are not free

from repayment problem. Based on the survey in

Kelantan, Terengganu and Kedah, more than 50% of

the total respondents reported that they used credit in

non-income generating activities, which increases

the chance of encountering repayment problem.

Repayment problems can lead clients to leave the

program or become inactive borrowers. When

hardcore poor households’ income streams are

interrupted, which is commonly the case, the clients

may have to sell their fixed assets to repay the loan.

AIM therefore has to consider a flexible loan policy

to allow poor and hardcore poor households to

reorganize the loan when clients encounter any

financial crisis. AIM should also focus on

appropriate training and development programs in

order to enable the hardcore poor households’ to use

credit in income generating activities, grasp

employment generating opportunities as well as find

and invest in new income generating activities,

which eventually reduce their repayment problem

(Abdul Wahab et al., 2011).

Lack of Business Knowledge and Technical Skills

BMT is faced with the lack of entrepreneurial

development in the community (Rusydiana & Devi,

2013b). When potential members do not have the

skill to run a business, upward social mobility

cannot be achieved in the event of the members fail.

The lack of exposure and education also contribute

to the non-delivery of the financing granted with the

intention to assist the poor to increase their income.

PBMT Institute is one initiative to provide training

program related to managerial aspect of BMT in

order to produce competent and high-quality staff

and deal with human resources problem. However,

not many BMTs are interested to send their staff for

the programme since it requires some payment of

fee (PBMT, 2015).

In the Malaysian environment, entrepreneurship

culture is not well-blend amongst the Malays and

Bumiputera as compared to the Chinese. For

Chinese, most of their businesses succeed and they

transfer down their skills through generations.

Hence, knowledge in business management and

related technical skills have to be given to all

microfinance borrowers, when majority of them are

Malays and Bumiputera. In recent development,

AIM provides business and financial management

course to their borrowers. However, according to the

borrowers, only selected borrowers will be chosen to

attend the course. AIM also does not have a

standardized module of training specially to handle

different level of borrowers. For example, the level

of understanding financial and business management

topics may vary from each borrower. Moreover, the

trainer or the speaker also needs to make simpler for

the information and knowledge given because the

audiences lack education.

Based on the research, many AIM borrowers

lack knowledge on how to manage their business

income. Most of them do not know how to separate

their business income, between their business and

personal consumption. Many borrowers allocate a

large portion of their income for personal

consumption and only a least amount for their

businesses. Many use their businesses to financially

support their daily living expenses and make little

effort to expand their businesses. This is one of

many reasons, why some of their businesses

unsuccessful even after continuous microcredit

loans. The major constraints for the poor have

always been the dependence on a single economic

activity and the lack of skills to vary their sources of

income to supplement their daily living (Mason,

Wan Azmi, & Madden, 2015). The success of

microfinance depends largely on the skills and

understanding of the people managing the

microfinance programme given the unbankable

nature of microfinance clients themselves, namely

low literacy level, having little knowledge about

business, and having no physical assets.

3 CONCLUSION

Despite the various success stories of AIM and

BMT, both IMFIs have their own shortfalls. They

have almost similar categories of issues, being

formed having objective of poverty alleviation, most

issues stem from criteria of the members as well as

the staff of the institutions. Members with no

background in business and IMF staff with no

shari’ah training and exposure are among the most

serious potential factors for failure. Therefore,

human capital, from the members and the IMFs,

play pivotal role in ensuring the success of the social

financing.

Another glaring issue is the reliance on subsidies

of AIM and dependency on donors by BMT.

Issues and Challenges in Financing the Poor: Lessons Learned from Islamic Microﬁnance Institutions

107

Inevitably, the nature of profit maximization is not

the modus operandi, hence, these IMFs need to find

other source of funding such as SRI sukuk that has

been gaining ground over the recent years. This can

be further looked into in future research.

AIM is blessed with the support from the

government, while the BMT lacks this legal support.

Some amendment to the laws pertaining IMFs would

accommodate their growth. Shari’ah issue is not

seen as a stumbling block for the operations of AIM

but for BMT, it is more serious. The role of shari’ah

supervisory board is still minimal and the mixed

perception of the Indonesian public on riba puts

restriction for BMT to widen its market.

In summary, internal issues can be managed by

the IMFs and government but external issues that

concerns the mindset of the members need

intervention from more parties. BMTs issues are

more complex to be solved because of the non-

standardization elements in the operations as

compared to AIM. A special task force looking into

each and every BMT for improvement is ideal but

difficult.

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