Sharia Finance: Ultra-Micro Financing Solution Under 9 Per Cent
Recent presidential instructions to reduce the pricing of ultra-micro financing to below 9 per cent have sparked lively discussion across sectors. Some view the challenge as formidable, given the high cost-to-serve and risk premia for the ultra-micro segment. However, we should regard this mandate not merely as a mathematical target but as a golden opportunity to shift the paradigm from financial inclusion to economic inclusion.
Sharia-compliant finance has natural foundations to meet this challenge. Sharia financial institutions function as active hubs for developing business in the real economy. By employing contracts such as Murabahah, Salam, Musharakah, and integrating Islamic social funds (zakat, infaq, sadaqah, and wakaf - ZISWAF), a single-digit below-9 per cent pricing target is not only possible but highly logical.
Strategy 1: Efficiency through Bulk Purchasing. High pricing of microfinance is often caused by small customers buying production inputs (fertilisers, seeds, tools) at retail prices. In Islamic finance, through the Murabahah contract (sale), the financial institution does not provide cash. The institution can execute bulk purchases directly from producers or distributors.
Simulations by the Islamic Development Bank (IsDB) show that with this negotiating power, sharia financial institutions can secure discounts of 20% to 40% off market prices. If an institution obtains a 30% discount and then applies a profit margin (markup) to the customer, the real cost borne by the customer will be lower than borrowing money at a low interest rate while buying goods at high retail prices.
Strategy 2: Salam to Break the Chain of Middlemen. A major problem for ultra-micro is being trapped by middlemen who lend capital on terms that require buying harvest results at very low prices. The Salam contract (advance payment) is a sharia-compliant solution that is very pro-farmer. A financial institution provides 100% working capital upfront to farmers for planting needs. The farmers repay it with the harvest at the agreed time.
In this model, the sharia financial institution acts as a market linker. The institution guarantees the purchase of farmers’ harvest at a fair price, then sells it back to large buyers (off-takers) or to national food reserves at a premium price. The profits of the sharia financial institution come from the price difference, not from burdening farmers with interest on capital.
The Farmers to Market (F2M) model in Sudan has demonstrated this approach’s success by involving tens of thousands of small farmers whose incomes rose significantly after breaking the exploitative distribution chain.