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How Islamic Financial Institutions can support SMEs and Entrepreneurship

Professor Emilio Escartin
By Professor Emilio Escartin
4 years ago
As a rule of thumb, small enterprises have up to 50 employees, medium-sized enterprises up to 250 employees, while micro enterprises are defined as having up to 10 employees. SMEs are the lifeblood and backbone in emerging markets, keeping local economies humming. Looking at the Islamic community (where you can easily find SMEs in those emerging markets) around the world, PROF EMILIO ESCARTIN says that SMEs (and micro enterprises) are the single type of business you can find as the engine of the economy in such markets.Islamic banking, Murabahah, Shariah


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  1. SPECIAL REPORT How Islamic ϐinancial institutions can support SMEs and entrepreneurship As a rule of thumb, small enterprises have up to 50 employees, medium-sized enterprises up to 250 employees, while microenterprises are defined as having up to 10 employees. SMEs are the lifeblood and backbone in emerging markets, keeping local economies humming. Looking at the Islamic community (where you can easily find SMES in those emerging markets) around the world, PROF EMILIO ESCARTIN says that SMEs (and microenterprises) are the single type of business you can find as the engine of the economy in such markets. Prof Emilio Escartin is a professor of Islamic finance at the IE Business School in Spain. He can be contacted at eescartin@faculty.ie.edu. It is estimated that there are more than US$500 million-worth of SMEs around the world, of which over US$300 million are in emerging markets and roughly a third of those in Muslim countries. This makes a clear case for Islamic financial institutions and jurisdictions to support SMEs, especially as SMEs keep struggling to gain reliable access to capital, with an estimated 68% of SMEs in developing countries being financially underserved or not served at all, according to the World Bank. The World Bank further estimates that SMEs and microenterprises across the Middle East and North Africa region alone are in need of up to US$13.2 billion in Islamic financing. In a World Bank report, it was noted that SMEs in emerging markets account for more than 58% of employment and 47% of the GDP. The gross of the labor force (employment) is generated by SMEs. I have worked closely with SMEs during my last 23 years and in particular during my last five years in the Middle East, when I was serving for Bahrain Development Bank where our markets were SMEs and microenterprises. Our banking activity was mainly Shariah compliant (Islamic finance). We have a customer base of over 5,000 SMEs and since the bank’s inception in the mid-90s, we have generated over 4,000 jobs (sustainable jobs) as an example of the role a financial institution (also development institution) plays in a Muslim country, with special focus in an emerging market like Bahrain. About 90% of Bahrain businesses are SMEs (41% are unbanked) and account for about 75% of private sector employment. © In many Muslimmajority countries, Islamic banking assets are growing faster than conventional banking assets But even though SMEs play such an important role in the global economy, they have historically struggled to gain reliable access to capital. The World Bank says that between 60% and 70% of SMEs in developing countries (emerging markets) are either financially underserved or not served at all. These high numbers translate into significant lost opportunities to develop viable businesses. For instance, in the African continent (Muslim-majority countries), SMEs face a financing gap of over 24 US$136 billion annually. On top of that, in the G20 countries, this gap is over US$1.3 trillion. The Islamic banking system is defined as a banking system whose principles underlying its operations and activities are founded on Islamic or Shariah rules. Since its first establishment in the 1960s, Islamic banking has shown remarkable development considering the system is relatively new compared to the conventional banking system first established over 400 years ago. A unique feature of Islamic banks is its profit and loss scheme which is usually conducted through the principle of Mudarabah (profit-sharing) and Musharakah (joint venture). As the assets and liabilities of lenders and borrowers are integrated in this scheme, this unique feature, in theory, allows Islamic banks to lend on a longer-term basis to projects with higher risk-return profiles and, thus, to promote economic growth. However, though experts in Islamic economics and finance generally recommend a profit/ loss-sharing scheme over other trading modes, Murabahah has been extensively used by Islamic institutions as its permissibility is beyond doubt. 20th March 2019
  2. SPECIAL REPORT Continued Murabahah can be defined as a ‘costplus sale’, in which parties bargain on the profit margin over the known price. Because of its debt-like nature, Murabahah is mostly used as an alternative to the conventional modes of credit. The Islamic finance industry has expanded rapidly during the last decade, with annual growth rates of over 15%. Today, Islamic financial assets are estimated at near US$3 trillion. By 2025, it is estimated to reach US$8 trillion. It’s also good to mention that in many Muslim-majority countries, Islamic banking assets are growing faster than conventional banking assets. Islamic finance institutions are helping and supporting SMEs through the mobilization of financing from nonbanking channels, such as venture capital, private equity, crowdfunding and capital markets, offering innovative asset-based and equity-based financial products that overcome the shortcomings of banks’ SME financing. I believe it is a must for policymakers (in Muslim and non-Muslim countries, the UK for instance) and development practitioners to unlock the potential of Islamic finance. Although key standardsetting bodies such as the IFSB and AAOIFI have made substantial progress, the regulatory framework, supervisory processes and standards for the industry have yet to be fully formed and implemented. Addressing these challenges effectively will put Islamic financial institutions in a position to design and offer financial products that are relevant to SMEs, while reducing transaction costs and adequately securing their exposures. Entrepreneurship is a broad word that is used to describe the activity of one or more individuals to come up with an idea and implement it to benefit the community to subsequently increase the growth and success of the individual or group. It is considered to be the main aspect of economic growth and the tool for further development, and it provides a highly productive environment. Entrepreneurs can have a major impact on a growing economy through such results as reducing unemployment © and increasing levels of creativity, productivity and development of the economy. The growth of an economy is strongly related to the level of performance of entrepreneurship in that economy. It is essential to realize the significance of economic growth and to assess growth levels. Generating income can occur through either employee salaries or entrepreneurship. The level of employment is considered to be a part of economic growth whereby entrepreneurs create more jobs and lower the unemployment rate in an economy. The success of entrepreneurs is beneϔicial to the economy as a whole: it creates more jobs, generates additional income and adds the value of new products or services to the market Entrepreneurs will always seek the best opportunity for financing, therefore, the concept of crowdfunding is popular among entrepreneurs. Crowdfunding is an online funding method that is controlled by individuals and can be a source of financing for entrepreneurs instead of referring to financial institutions. Islamic banks can be a source of financing for entrepreneurship, whereby entrepreneurs can obtain their capital from Islamic banks. significant impact on the achievement of this vision. About 85% of its GDP is non-oil as of 2018 with a special bias on SMEs, start-ups and encouraging the entrepreneurial ecosystem. The expansion of existing and new startups in the economy will achieve the job creation objective, which will lead to more investments in the business market and more opportunities that will help in the success of entrepreneurs in Bahrain. Bahrain is the leading center of the world banking sector, specifically in Islamic finance. The role of Islamic banks in Bahrain’s economy can lead to an increase in investments, productivity and liquidity, which are all indications of economic growth. The existence of Islamic banks in particular can create significant liquidity for entrepreneurship worldwide. The aim of all entrepreneurs is to succeed in their work at minimal cost. Therefore, entrepreneurs will always look for the most suitable and low-cost banking services that will meet their needs to achieve their objectives. Moreover, Islamic banking follows the profit/loss-sharing method in financing, and financing entrepreneurs involves a certain level of risk. To avoid exposure to risk, Islamic banks ensure that entrepreneurs have all of the support that is needed to become successful. This type of collaboration between Islamic banks and entrepreneurs leads to economy growth because Islamic banks and entrepreneurs generate profits from such activities. The success of entrepreneurs is beneficial to the economy as a whole: it creates more jobs, generates additional income and adds the value of new products or services to the market. Receive all the latest news via the No.1 Islamic finance based feed In the case of the Kingdom of Bahrain for instance, its economy has been highly dependent on oil revenue; however, the recent diversification of the Kingdom’s economy has resulted in an increase in its GDP and a strong enterprise culture. As the 2030 vision of Bahrain encourages job creation, entrepreneurs will have a 25 20th March 2019