Microfinance involves extending small loans to individuals for buying tools which will help them in setting up small businesses requiring rudimentary skills, to earn their lively hood and repay loans. Examples could be extending a loan for purchase of a
sewing machine for tailoring, extending a loan to purchase tools to set up a two wheeler mechanic shop or extending a loan for purchase of livestock like cattle.
But very few may avail this kind of interest bearing credit facilities as interest or riba is prohibited as per Sharia. Another option is to look at extending microfinance the Sharia way. Sharia compliant financing concepts like Murabaha, Ijarah, Diminishing
Musharakaha etc. can be used to bring more people into the ambit of microfinance in accordance with Islamic principles.
How do microfinance institutions extend credit the Sharia way? One way is to extend finance based on cost plus concepts like Murabaha and Tawarruq. The tools like sewing machine or other small equipment required for setting up business can be treated as
an asset. The microfinance institution can first purchase the asset and then sell it to the individual to whom the credit is to be extended at a predefined profit. The selling price of the asset can be paid by the individual in deferred installments over a
period of time. Similarly in cases where the individual needs cash only, the concept of Tawarruq can be used where in the bank first sells the asset at cost plus profit and then buys back the asset. Here also the selling price is paid by the individual on
Second way is to use the rent based concept, Ijarah. Here the microfinance institution will first purchase the asset and then lease it to the individual. The cost of the asset and the profit are recovered in the form of rentals and the asset is transferred
to the individual by the end of agreed tenor.
In both the above approaches, the microfinance institution can look at procuring the assets in bulk and bargain on the cost, so that even the individuals to whom the assets are sold or leased can be benefited.
Another way is to use the concept of partnership, Diminishing Musharakaha. Where the amount involved is little large, the microfinance institution can look at entering into a partnership, contributing the major component. The profits out of the business
can be shared in the agreed ratio and the microfinance institution can sell it’s share to the other partner over a period of time finally exiting the partnership.
The microfinance institutions can also look at imparting some basic vocational skills to it’s members on need basis.