Opportunities in Islamic Financing for SMEs

Ariful Islam Chief Operating Officer & Executive Director Meezan Bank Limited Pakistan January 24, 2012
1

Economic Overview of SME Sector

Pakistan
No. of SMEs

3.21
Million
Access to Finance

Wholesale/ Retail Trade/ Hotels

53%

Community/ Social Services

Manufacturing Others
Key Messages

22% 20% 5%

8.6%

SME sector is the major growing force behind the fastest growing economy. Access to finance is limited Low financial inclusion SMEs are strong linkages with corporates; these links are crucial for making a systemic productive capability.

Source: The Economic Census of Pakistan 2005/State Bank of Pakistan Development Finance Review March 2011

Islamic Banking
Industry Snapshot Pakistan

Deposits
USD Million

2
(CAGR)

Net Advances & Investments

USD Million

74%
3
Islamic Branches
Share in Banking Industry Deposits

65%
(CAGR)

2003 0.40%

2010 7.2% 6.20% 8.12%

72%
(CAGR)

Net Advances & Investments 0.50% Islamic Branches 0.25%

Key Messages Islamic banking sector is growing enormously since inception Meezan Bank is the first and largest Islamic bank in Pakistan
Source: State Bank of Pakistan

Meezan Bank Limited

Differentiating Factors

Size Brand Credibility Product Range Dedicated RMs

Large branch network of 275 branches in 80+ cities

High powered Shariah Board Largest product range of all Islamic Banks The key is to understand the business cycle of the customer Independent Service Quality team reporting directly to COO

Service Quality

Meezan Bank Limited

Background and necessary details
Background
A publicly limited company.

Shareholders and Shariah Board

Main Shareholders are Noor Financial

Investment Incorporated in January 1997 and started bank. operations an investment

Company,

Pak-Kuwait

Investment Company and the Islamic Development Bank of Jeddah.

In January 2002, Meezan Bank was granted the countrys full fledged

Internationally renowned Shariah Supervisory

Board chaired by Justice (Retd.) Maulana

Muhamad Taqi Usmani.

commercial banking license as a

dedicated Islamic bank, by the State Bank of Pakistan.

Meezan Bank Limited

Key Performance Indicators

Assets
USD Million

2
(CAGR)

Deposits
USD Million

47%

50%
(CAGR)

Income
USD Million

4
(CAGR)

Profit after Tax

USD Million

48%

28%
(CAGR)

Meezan Bank Limited

Key Performance Indicators

No. of Staff

Branches

51%
(CAGR)
Key Messages Meezan Bank is committed to providing Shariah compliant financial solutions

57%
(CAGR)

Meezan Bank is rated A-1+ (Short term) and AA- (Long term) by JCR-VIS Credit Rating Co. Ltd Robust Product Development and Shariah Compliance framework in place Strong focus on staff Learning and Development

Meezan Bank Limited

Challenges in offering Shariah Products

Documentation

Being small SMEs are often averse to documentation

Awareness

Lack of awareness posses to be a challenge

Organisation

Unprofessional attitude of staff

Disclosure

Reluctant to disclose financials due to tax reasons

Non-compliance

Do not follow Process Flows

Heading towards the right path . . .

Conventional Banking vs Islamic Banking
Financial Needs of SMEs
1 Short Term Finance 2 Long Term Finance

Trade Finance

Fund Management

Financial Models

Conventional Banking
Money
Money + Money (Interest)

Islamic Banking
Goods & Services
Money

Heading towards the right path . . .

What are some significant/interesting results

Key Messages

Although SMEs are currently a very small % of our portfolio the represent a very large population of customers that bank with Meezan and use branch banking servicesMeezan has 1259 SME relationships compared to 292 Corporate accounts SMEs are more faith driven than larger corporations and access to Islamic finance is increasing the Financial Inclusion of this sector - Islamic banking brings SMEs into financial system who do not wish to enter into it due to interest based financing

More SMEs can now grow due to access to finance Financial Access -Islamic banking brings out SMEs from informal financial system and helps them contribute to economy. Islamic banking offers need based financial solutions npl is lower

Heading towards the right path . . .

Conventional Banking vs Islamic Banking
1
Short Term Finance Possible Islamic Banking Solutions Murabaha

Working Capital

Overheads / Utilities
Finished Goods Rental financing

Salam / Istisna
Tijarah Lease / Sub lease

Long Term Finance

Possible Islamic Banking Solutions Diminishing Mushakarah (Shirkat-ul-Milk)

Asset acquisition & Business Expansion such as SME Auto (Buses, Coaches, Trolleys or Oil Tankers, Fleet Car Finance) Plant & Machinery

Ijarah

Heading towards the right path . . .

Conventional Banking vs Islamic Banking
3
Trade Finance Possible Islamic Banking Solutions

Sight LC
Usuance LC Forward Cover Shipping Guarantee Export Credit Financing

Murabaha / Ijarah
Musawamah Waad Kafalah Murabaha / Istisna

Fund Management

Possible Islamic Banking Solutions Qard Mudarabah

Checking accounts
Cash Management Remittance

Islamic Mode of Financing

Brief Introduction
1 Murabaha
Underlying Principle Tenure Pricing Pre-payment discount Application Cost plus profit Short term Fixed Not allowed Purchase of raw material

1. Payment of Cost

3. Payment of Murabaha Price

Supplier
2. Delivery of goods

Customer

Islamic Mode of Financing

Brief Introduction
2 Salam
Underlying Principle Tenure Pricing Application Advance payment purchase Short term Fixed Purchase of agricultural / homogenous commodities

1. Payment of Price

3. Delivery of goods

Customer

2. Delivery of goods

3. Payment of Price

Market

Islamic Mode of Financing

Brief Introduction
3 Istisna
Underlying Principle Tenure Pricing Application Made to order Short term Fixed Financing cost of production

1.Istisna agreement & payment

3. Sale of goods

Customer

2. Delivery of goods as per schedule

4. Sale proceeds

Buyer

Islamic Mode of Financing

Brief Introduction
4 Tijarah
Underlying Principle Tenure Pricing Application Finished goods purchase Short term Fixed Receivable financing

1.Sale agreement & payment

3. Sale of goods

Customer

2. Immediate Delivery of goods

4. Sale proceeds

Buyer

Islamic Mode of Financing

Brief Introduction
5 Ijarah
Underlying Principle Tenure Pricing Early Termination Application Rent on usufruct of asset Long term Fixed / Variable Allowed Fixed asset financing

1. Payment of purchase price

3. Usufruct of asset

Vendor

2. Transfer of title

4. Payment of rentals

Customer

Islamic Mode of Financing

Brief Introduction
6 Diminishing Musharakah
Underlying Principle Tenure Pricing Early Termination Application Joint ownership Long term Fixed / Variable Allowed Fixed asset financing

1. Rent

Customer

2. Gradual transfer of ownership

Islamic Mode of Financing

Brief Introduction
7 Mudarabah
Underlying Principle Tenure Pricing Early Termination Investment into Islamic assets Short term / Long term Variable based on weightages Allowed Checking accounts / Cash Management solutions

Application

1. Depositing funds

2. Investing into Islamic Assets

Car Finance Import/ Export

Investors

4. ROI based on weightages

(net of management fee)

3. Investment Returns

House Finance

In case of Mudarabah Assets incur a loss, distribution will be based on prorata basis

Risk Management Framework

Islamic Banking offers need based financial solutions
Customer approaches Islamic Bank for financing After making a credit decision as per banks policy

Islamic bank offers need based mode of financing

Key Messages Islamic banking offers process driven financial solutions based on SMEs need Islamic banking facilities banks in understanding SMEs businesses to offer need based financial solutions Islamic banking inherently provides risk management framework to financial institutions Islamic banking minimizes chances of mis-utilization of funds

Transactions are backed by underlying asset; and involve trading / renting of asset and participation on profit and loss basis
Islamic banking offers Shariah compliant process flow for need based financial solution