ISLAMIC MICROFINANCE TO MICRO ENTREPRENEURS

BY: SAEBANI HARDJONO

Candidate Doctor of Islamic Economics & Finance (IEF) TRISAKTI - Jakarta - Indonesia



Microfinance has become one of the most sustainable and effective tools in the fight against global poverty.
Islamic microfinance has the potential to not only respond to unmet demand but also to combine the Islamic
social principle of caring for the less fortunate with microfinances power to provide financial access to the
poor.
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Segala puji[2] bagi Allah, Tuhan semesta alam [3]
All the praises and thanks be to Allah, the Lord of the Alamin (mankind, jiin and all that exists).

[2] Alhamdu (segala puji). memuji orang adalah karena perbuatannya yang baik yang dikerjakannya dengan
kemauan sendiri. Maka memuji Allah berrati: menyanjung-Nya karena perbuatannya yang baik. lain halnya
dengan syukur yang berarti: mengakui keutamaan seseorang terhadap nikmat yang diberikannya. kita
menghadapkan segala puji bagi Allah ialah karena Allah sumber dari segala kebaikan yang patut dipuji.
[3] Rabb (tuhan) berarti: Tuhan yang ditaati yang Memiliki, mendidik dan Memelihara. Lafal Rabb tidak dapat
dipakai selain untuk Tuhan, kecuali kalau ada sambungannya, seperti rabbul bait (tuan rumah). 'Alamiin
(semesta alam): semua yang diciptakan Tuhan yang terdiri dari berbagai jenis dan macam, seperti: alam
manusia, alam hewan, alam tumbuh-tumbuhan, benda-benda mati dan sebagainya. Allah Pencipta semua alam-
alam itu.
There is no proper equivalent to Rabb in the English language. It means the One and the Only Lord for
all the universe. Its Creator, Owner, Organizer, Provider, Master, Planner, Sustainer, Cherisher, and
Giver of security.
Surat Al-Fatihah which is As-Sab Al-Mathani (i.e. the seven repeadtedly recited Verses) and the Grand
Quran which has been given to Rasulullah (Sahih Al-Bukhari, 6/4474). It gives of two kinds:
1. Guidance of Taufiq and it is totally from Allah, i.e. Allah opens ones heart to receive the truth
(from disbelief to Beleive in I slamic Monotheism).
2. Guidance of Irshad through preaching by Allahs Messengers and pious preachers who preach the
truth, i.e. I slamic Monotheism.
Cited by Saebani Hardjono - Source: DR. Muhammad Muhsin Khan and DR. Muhammad Taqi-ud-Din Al-
Hilali, (1996), The Noble Quran, Darussalam, Global Leader In Islamic Books.
ISLAMIC MICROFINANCE TO MICRO ENTREPRENEURS
(A STUDY BASED ON INSTITUTIONAL NETWORK APPROACH)
BY: SAEBANI HARDJONO
Candidate Doctor of Islamic Economics & Finance (IEF) TRISAKTI - Jakarta - Indonesia

Introduction
This presentation consists mainly with four different parts.
First, Islamic banking and the investment mode, and the Islamic bank practices in
Indonesia.
Second, microfinance and Islamic microfinance in general and an Indonesian context.
Third, the concept of Networks and the Financial & Societal Sector Institutions.
Forth, how Islamic microfinance develops and establishes different network
relationships,

The Aim and Objective
To study Islamic microfinance in relation to the micro entrepreneurs based on the institutional
networking, especially in the case of Indonesia.
To give a better understanding an important role of Islamic microfinance in the effort of
alleviating poverty through facilitates the poorest working with micro credit.
Method
In writing this paper author implements the method of literature study/review based on
available reference materials.









Part one: Islamic bank - A bank without interest
An Islamic bank may be defined as a financial intermediary:
The objectives, operations, principles and practices must conform to Islamic Law (Shariah);
All its operations and activities without interest (Alam, 2001).
The aim of Islamic economics [(Molla et.al. (1988)]: Is not only the elimination of interest-
based transactions but the owner of capital and the entrepreneurs: sharing the result.
It differs from an interest-based system in which the risk is mainly borne by the entrepreneur.
We can call Islamic banking as participatory banking.

Islamic banks as observed by International bodies
Prof. Wohlers-Schraf (1983), in his study entitled Arab and Islamic Bank conducted by
Development Centre, Organization of Economic Co-operation and Development (OECD), reported
that Islamic bank can play a vital role in economic growth and development.
He has mentioned that:
Islamic banking is trying to develop the relationship between finance on one hand and
industry and commerce on the other. This new relationship is the basis of the Islamic
economic system being set up.
Though Islamic principles have yet to be put to the test in the competitive of international
finance, the two systems are similar in that they both strive for closer ties between financial
intermediation and economic asset creation. Islamic banks could make a useful contribution
to economic growth and development particularly in a situation of recession, stagflation and
low-growth level because the core of their operation oriented towards productive
investment.
Islamic Banks Around The World
Nassief (1989), Ahsan (1989), and Kazarian (1991) observed:
More than 70 Islamic banks and Insurance houses are rendering interest-free services in Asia,
the Middle East, the Far East, Africa and Europe and North American countries.
The Islamic Society of North America Canada (ISNA, 2000), has initiated Islamic banking
activities and started lending interest-free funds to their customers especially for
housing and other projects.
Islamic Banks Around the-World
The Islamic Society of North America
Canada (ISNA, 2000), has initiated Islamic
banking activities in recent years and started
lending interest-free funds.
Western banks such as, the Kleinworte
Benson, Citibank and ANZ Grindlays also
started to adopt the pattern of Islamic
banking in cost-plus financing.

Islamic banks have emerge around the world: includes in North America Canada, Europe, Africa, and
Asia.
All countries a round the world, both in the North and in the South, need more venture capital. Loan
capital is available, particularly from industrialized countries but at high interest rates.
Islamic Bank in Indonesia
2001 - 2007: Islamic (sharia) banking in Indonesia was experiencing a high growth.
2008: The growth of Islamic banking is still able to enjoy high growth, given a climate
conducive in form of Indonesian macroeconomic conditions well enough, although not
free from negative influences of global econom ic recession.
2009 - the future: Growth and development of Islamic banking in Indonesia can not be
separated from macroeconomic conditions.
Indonesian macroeconomic conditions would surely affect on the banking industry in
general and for Islamic (sharia) banks as well.

Macroeconomic prospects of Indonesia
Growth and development Islamic banks, require a strong economic foundation--the
achievement of positive economic growth in the country. To keep the economic growth is
a prerequisite for the development of the banking sector, including Islamic banks.
Indonesia's economic growth in 2008, in a global recession, still recorded a positive
growth of 6.1% which is supported by the improvement in private investment, public
purchasing power which is still quite strong
Economic growth affects people's income and ability to make consumption and savings.
The capacity of banking to finance the real sector has been supported by public funds in
the form of savings.
The national economic growth has a positive impact on the growth of Islamic banking.
The decline in inflation pressures and the strengthening of the rupiah giving space for
Bank Indonesia to gradually lower the BI rate in order to encourage the real sector.
For the banking sector, it suggests positive prospects for stimulating the real sector, especially in
the microfinancing.
Indonesia Islamic Banking Prospects
Indonesian Islamic (sharia) banking industry in 2009 still to enjoy the high-growth, i.e.
in the range of 38% with the establishment of new Islamic banks--is higher compared to
banking growth in national.
The growth includes the growth of Third Parties Fund, the amount of financing, the
increasing number of customer accounts, and the amount of funded economy sectors.
Instead of macroeconomic conditions that are still conducive, micro factors in the
banking industry and Islamic finance also affect the acceleration of the development of
sharia banking industry, which includes:
o Planned opening of new Islamic banks
o Optimizing the business capacity of Islamic banks; and
o Support national Islamic financial environment, includes an Islamic
microfinancing.
Completion of Tax Law perfection (VAT) at the beginning of the year 2008 also be a
gateway for the entry of new investors into the sector of national Islamic banking
industry, thereby expanding the industrial capacity.
Coordinating Minister for economy committed to remove murabaha double tax also be
strong drivers of Islamic banking products marketing.

Besides the prospects are affected by macro economic as described above, Karnaen A.
Perwataatmadja, and Hendri Tanjung deliver prospects in terms of internal factors which are
strengths for the development of Islamic banks, as follows:
1. The support of Muslims who are the majority population.
2. The existence of Islamic banks in accordance with the needs and expectations of people,
with the advantages as follows:
a. Encourage togetherness between the parties by sharing the risk: losses and profits.
b. Murabaha financing and bai bithaman can be done without physical collateral .
c. Financing mudaraba will not burden customers with fixed costs that are
determined in advance. Customer obligation is to share the results reasonably in
conform with agreements and business development.
d. Customers get yield subject to their performance and development of the banks
that are transparent to the customer in mind.
e. Occurs balance between the funds channeled to assets to be foundation, because
each loan is based on a reality.
f. Provide free interest loans, called Qardul-hassan, which is distributed to the right
people, funds are collected from Zakat, Infak, and Alms, and cash waqaf.
g. No worry about the cost of money because the interest is not known.
h. Not charge interest, so more resistant to the negative influences of globalization
monetary turmoil.
i. Competition among Islamic banks do not eradicate each other since they work in
a partnerships network with the motto fastabiqul khoirot.

Challenges, in order to maintain such high growth is in more sustainable.
Five major challenges of sharia banking in addition to other challenges that also need to be dealt
wisely [(Agustianto, (2007)], as follow: human resources, financing problem, regulation aspect,
optimization of networking services, and product innovation.











Modes of Investment of Islamic Banks
Islamic banks use various modes of investment such as:
Mudaraba,
Musharaka,
Murabaha,
Bai-Muajjal,
Bai-Salam, and
Quard E-Hasan.
Mudaraba or (Capital Financing) is an Investment through self employed entrepreneur.
Musharaka or investment under partnership.
Murabaha is a cost plus sales on cash basis.
Bai-Muajjal is a cost plus sales under deferred payment.
Bai-Salam is an Advance Purchase or Hire-Purchase under Shirkatul Milk Ijara or leasing.
Quard-El-Hasan means an interest-free loan given to the needy people in a society.
In order to know Islamic banking procedures that all Islamic banks in many Muslim countries follow
to invest their funds under various modes of financing; a detailed description of each mode is given
below.
Modes of Investment of Islamic Bank
The modes or techniques of accepting deposits and lending funds to
customers differ from conventional banks.

Mudaraba or capital financing: Under the Mudaraba mode or the Capital Trust
Islamic banks supplies the entire capital of the business and the customer gives his time and
expertise: a relationship between the supplier of capital and the user of capital. The bank and
the customer work together and share profits and losses [( Khoja and Ghuddah (1997)]
In essence is based on the concurrence of those who have capital with those who expertise to
earning halal profit (lawful) which will be divided between them in ratios agreed upon.
The investor is known as Rab-Al-Mal meaning the owner of the property and the
entrepreneur is called Mudarab meaning the manager of capital.
When the venture ends, the entrepreneur returns the entire capital to the bank, along with an
agreed proportion of profit. If there is any loss, it is born by the bank.
The advantage with this partnership is that it combines the efforts of human beings and their
skills with the capital; which contribute the development of society and assists to solve
unemployment problems by utilizing manpower resources in a productive way.

Musharaka or partnership financing:
Musharaka means a profit sharing joint venture. The bank and the customer contribute
capital jointly.
They also contribute managerial expertise and other essential services at agreed proportions.
Profit or losses are shared according to the contract. agreed upon.
An individual partner does not become liable for the losses caused by others.
Due to this joint venture this technique is also known as Equity Participation investment.
Profit is distributed according to a predetermined ratio, and loss, if any is also shared
according to the capital ratio.
Both the bank and the customer take part in the management and control of the
entrepreneurial activities.

Murabaha (Mark-up or costs-plus-profit based financing)
Murabaha means a cost-plus profit based financing [( Khoja & Ghuddah (1997)].
Islamic banks which undertake the purchaser of commodities requested by the customer and
then resell them on Murabaha to whom promised to buy for its cost price plus a margin of
profit agreed upon previously by the two parties.
The bank agrees to purchase for a client who will then reimburse the bank in a stated time
period at an agreed upon profit margin. The mark-up price that the bank and the buyer agree
to is mainly based on the market price of the commodity.
The bank earns a profit without bearing any risk.




Quard E Hasan (interest-free loan)
Quard E Hasan means an interest-free loan given by the Islamic bank to the needy people.
The practice of dealing with this sort of investment differs from bank to bank.
Quard E Hasan is normally given to needy students, small producers, farmers, entrepreneurs
and economically weaker sections of the society, who are not in a position to obtain loan or
any financial assistance from any other institutional sources.
The main aim of this loan is to help needy people in a society in order to, make them self-
sufficient and to raise their income and standards of living.




















Part two: Microfinance - A Contextual Review
Microfinance is globally acknowledged as an effective instrument in alleviating poverty.

Microfinance refers to finance services such as credit, savings, insurance provided for low-
income people or widely called economically active poor.
Microfinance emerged in the 1970s as social innovators to offer financial services to the
working poor - who were considered "un-bankable" because of their lack of collateral.
These tiny loans are enough for hardworking micro-entrepreneurs to start or expand small
businesses such as weaving baskets, raising chickens, or buying wholesale products.
Income from these businesses provides better food, housing, health care and education for
entire families, and most important, additional income provides hope for a better future.

Lesson from Grameens Founder - Nobel Prize winner Mohammed Yunus.
Grameen Foundation:
States its goal that is simple to see poor people, especially the poorest and those living in
harder to reach areas, have access to microfinance and technology and as a result of access
to these services, move themselves out of poverty.
Envisions a world where the poor have broken the generational chain of poverty and lead
lives of respect, dignity and opportunity.
Collaborates with local organizations and allies around the globe to provide products and
services that allow them to:
1) reach deeper into poor communities with microfinance.
2) provide access to microfinance and technology services among the poor and poorest.
3) ensure they are moving out of poverty over time.
Their mission is to enable the poor, especially the poorest, to create a world without poverty.
In all its work, Grameen foundation embraces and draw inspiration from its core values are:
to empower the worlds poor, especially the poorest women;
accountable for transparency and measurable results, including social and financial
performance;
a difference in the lives of the poor;
partnerships with those who can advance the mission before acting alone;
respect, invest in and promote local social entrepreneurs and local ownership; and,honor the
voice, professionalism and integrity of all staffs and volunteers.
Microfinance in Indonesia
Indonesia is made up of more than 17,000 islands and is home to nearly 230 million people. Nearly
half the population lives under the $2.50/day poverty line.
The population are considered near-poor, living just above the poverty line.
The risk of a household falling below the poverty line is very high. Over 38 percent of poor
households in 2004 were not considered poor in 2003,
The countrys vulnerability to price shocks particularly increases in rice prices. Over 75 % of
the poor spend a quarter of their incomes on rice.
When rice prices increase, as they did in 2006, millions of people fall back into poverty.
Rural households account for about 57 percent of the countrys poor, and almost two-thirds of
poor households involved in agriculture, such as fishing and farming.
Urban poverty is on the rise and the conditions in urban areas are comparatively worse.
The islands of Java and Bali contain 59 percent of Indonesias population, and 57 percent of
its poornearly 140 million people.
Despite a continuous reduction in poverty rates over the last several decades, nearly half of
the population still lives below the $2.50/day poverty line.
The demand for microfinance services is immense. Despite the existence of over 50
thousands registered microfinance institutions, very few are targeting the poor and poorest.
More than 50 % of Indonesias entire opulation remains without access to formal financial
services.

Maping Microfinance in Indonesia

Microfinance is globally acknowledged as an effective instrument in alleviating poverty.
Microfinance refers to finance services such as credit, savings, insurance provided for low-income
people or widely called economically active poor. And as we know, year 2007 is becoming the
International Year of Microcredit (Microfinance) as what the United Nations has mentioned.
Indonesia micro finance institutions can be divided into two categories, i.e., bank and non-
bank sectors:
o BRI (Peoples Bank of Indonesia) and BPR (Rural Bank), mostly private, belong to
bank sector.
o While non-bank sector can be classified into two kinds: formal and non formal.
Formal category includes:
o cooperative,
o LDKP/Rural Credit Financing Institution ( Lembaga Dana dan Kredit Pedesaan ),
o pawnshop, and
o BKD/ rural credit association (Badan Kredit Desa ); is supervised by BRI on behalf
of BI (Central Bank of Indonesia). LDKP gets formal status as local governments
institution.
Non-formal micro finance institutions are carried out by NGOs and self-help groups.

The demand driven for micro finance development is so great:
98.5% business entity in Indonesia or 41.8 million of business units are in micro category,
Of which, less than 10 million of business units get finance services from formal market.
The rest (>30 million),are mostly trapped into informal market called money lenders.
The interest rates charged by money lenders are so high (ranging from 20%-50% per month).

The Indonesian government indeed does not stay doing nothing to face this situation. Government has
implemented projects and programs, most of them with micro finance component. These programs
have wide scale and great outreach to the people.
There are 70 projects of government institutions (supported donors, with budget almost US
$300 millions) which have a micro finance component.
Different from many other countries in which micro finance is developed by NGOs, in
Indonesia micro finance development role is hold by government.
Unfortunately, the main weakness of government project is that it is not sustainable.
Psychologically in encountering such a project, the people consider it as grant so that
sometimes it is not repaid.
Furthermore, the interest applied is subsidized which results in negative impact or distortion
on micro finance (commercialization) industry.

Further, based on lessons learned from the best practitioners over the world, it was agreed that in
developing micro finance require 4 important following points:
1. reaching the poorest
2. reaching and empowering women
3. building financially sustainable institution
4. measurable positive impact
In Indonesia, micro finance approaches can be categorized into 4 kinds:
Saving led microfinance
Credit led microfinance.
Micro banking.
Lingkage model


1. Saving led microfinance
Financial mobilization is based on capacity of the poor (saving). It is also membership based,
of which membership and participation are crucial aspects. Some forms of institutions within
the communities are: self-help groups (SHGs), Credit Union (CU), Koperasi Simpan
Pinjam/KSP (savings and credit cooperative), etc.
2. Credit led microfinance
The main source of finance is not from saving mobilization of the poor but from other source
intended for the poor (credit). Therefore, considerable amount of fund is needed for the poor
through credit service, such as Badan Kredit Desa/BKD (rural credit association), Lembaga
Dana Kredit Pedesaan/LDKP (rural credit financing institution), Grameen Bank model, ASA
model, dll.
3. Micro banking
It refers to banking sector designed to conduct micro finance services. It includes BRI
(Peoples Bank of Indonesia) and BPR (rural banks). Moreover, BRI is acknowledged as the
giant of microfinance institution (Bank) in the world.
4. Lingkage model (self-help group and bank)
It is on the basis of operating the existing institutions, both informal social organization that
is often called Kelompok Swadaya Masyarakat/KSM (self-help group) and formal finance
institutions (bank). The two different natures of institutions are organized and linked based on
mutual symbiosis and benefits. Bank will get greater number of clients (outreaching), while
the poor can get access to financial support. In Indonesia, it is widely recognized as Pola
Hubungan Bank dan Kelompok Swadaya Masyarakat/ PHBK (Bank-Self-Help Groups
Linkage) in 1988.
Indonesia, eventually is often called as micro finance laboratory in the world, considering the
availability of various kinds of micro finance in the country and great need of development.
Is required a forum to develop micro finance.
The objective of the forum is to build micro finance as industry to reach the poor widely.
The Indonesian Movement for Microfinance Development (Gema PKM ) as a forum
consisting of 7 stakeholders, i.e., government, finance institutions, NGOs, private sector,
academicians/researchers, mass organizations, and funding institutions.
Data Institutions and Statistic of Microfinance in Indonesia
No Institution Unit Creditor Credit Saver Saving
1 BPR 2,148 2,400,000 Rp9,431,000,000,000 5,610,000 Rp9,254,000,000,000
2 BRI Unit 3,916 3,100,000 Rp14,182,000,000,000 29,870,000 Rp27,429,000,000,000
3 Badan Kredit
Desa
5,345 400,000 Rp197,000,000 480,000 Rp380,000,000
4 KSP 1,097 665,000 Rp531,000,000,000 na Rp85,000,000,000
5 USP 35,218 na Rp3,629,000,000,000 na Rp1,157,000,000,000
6 LDKP 2,272 1,300,000 Rp358,000,000,000 na Rp334,000,000,000
7 Pegadaian 264 16,867 Rp157,697,252,000 No Savers No Savings
8 BMT 3,038 1,200,000 Rp157,000,000,000 na Rp209,000,000,000
9 Credit Union
& NGO
1,146 397,401 Rp505,729,317,823 293,648 Rp188,014,828,884
TOTAL 54,444 9,479,268 Rp28,951,623,569,823 36,253,648 Rp38,656,394,828,884
Data compiled by Gema PKM, October 2004
Only less than 25% of micro enterprises can be served through micro finance institutions. Actually,
there are some constraints to develop microfinance in Indonesia. The most problems, such as:
1. Legal and regulatory framework
2. Wholesaler of microfinance
Micro finance is becomes burning issue in Indonesia.
High-Level Policy Meeting on Micro finance and Rural Finance in Asia (26-28 Feb 2004 in
Yogyakarta) 13 central banks of Asian countries and related ministries from Afghanistan,
Bangladesh, Cambodia, India, Laos, Malaysia, Nepal, Pakistan, Philippine, Sri Lanka,
Thailand, Vietnam, and I ndonesia formulated strategies and policies to support micro
financing sector.
Micro finance is believed as effective and strategic instrument to alleviate poverty. Komunike
Yogyakarta 2004 statement that really promoted micro finance was declared.
Islamic Microfinance

Conventional microfinance products have been very successful in Muslim- majority
countries. One of the earliest microfinance programs originated in Bangladesh with the
experience of the Grameen Bank initiated by Nobel Prize winner Mohammed Yunus.
The Muslim- majority countries, such as Indonesia and Pakistan, have a vibrant microfinance
industry; approximately 44 % of conventional microfinance clients worldwide reside in
Muslim countries.
Yet, conventional microfinance products do not fulfill the needs of many Muslim clients. Just
as there are mainstream banking clients who demand Islamic financial products, there are also
many poor people who insist on these products.
Indeed, Sharia compliance in some societies may be less a religious principle than a cultural
one -- and even the less religiously observant may prefer Sharia compliant products.
Islamic finance has boomed in recent years; but what has hit the headlines is big money that is
moved around, following the principles of Islamic law.
Since the Grameen Bank in Bangladesh and its founder, Professor Muhammad Yunus, who
was awarded the Nobel Peace Prize in 2006, microcredit and microsavings have been widely
discussed as instruments of poverty alleviation and local development.
But Islamic microfinance has hardly been mentioned in this context, i.e., the collection of
small savings and the provision of small loans based on Shariah.
An estimated 72 percent of people living in Muslim-majority countries do not use formal
financial services (Honohon 2007).1 Even when financial services are available, some people
view conventional products as incompatible with the financial principles set forth in Islamic
law.
Some microfinance institutions (MFIs) have stepped in to service low-income Muslim clients
who demand products consistent with Islamic financial principlesleading to the emergence
of Islamic microfinance as a new market niche.
Islamic microfinance represents the confluence of two rapidly growing industries:
microfinance and Islamic finance. It combines the Islamic social principle of caring for the
less fortunate with microfinances power to provide financial access to the poor.
Unlocking this potential could be the key to providing financial access to millions of Muslim
poor who currently reject microfinance products that do not comply with Islamic law. Islamic
microfinance is still in its infancy, and business models are just emerging.

2007s global survey on Islamic microfinance, CGAP (Consultative Group To Assist the Poor)
collected information on over 125 institutions and contacted experts from 19 Muslim countries as
such:.
Estimated the global outreach of only 380,000 customers and accounts or 0.5% of total
microfinance outreach.
Islamic microfinance is very concentrated in a few countries, with the top three countries:
I ndonesia, Bangladesh, and Afghanistan, accounting for 80 percent of global outreach.

Total assets of Islamic financial products is estimated at US$500.5 billion (The Banker 2007) and the
Islamic finance industrys 100 largest banks have posted an annual asset growth rate of 26.7 %,
outpacing the 19.3 % growth rate of their conventional counterparts (Kapur 2008).
Discovering Islamic Microfinance
There are numerous small enterprises, some of remarkable ingenuity in solving their technical
problems in a difficult environment, but all facing one core problem: lack of access to credit.
The bank offered two main products.
o Mudarabah: the bank carefully selected highly profitable large enterprises, invested in
them and shared the profit, gaining in some cases up to 80 per cent.
o Murabahah: the bank bought e.g. machinery and sold it to its customers, to be repaid
in instalments with a fixed mark-up, not much different from conventional credit.
Any type of speculative lending would have been against Islamic law.
Then there was qard al-hasan: charitable microcredit without any profit-sharing or mark-up
and the only type of unsecured lending permitted under Shariah. This represented only an
insignificant proportion of the bank's portfolio and reached but a small number of clients.
Islamic Microfinance in Indonesia
Indonesia is probably the country with the greatest diversity of both conventional and Islamic
microfinance. The former evolved over a period of over one hundred years, preceded by a history of
informal finance of unknown depth, the latter, still on a modest scale, over a period of fifteen years.
Indonesia possesses one of the most differentiated microfinance infrastructures in the
developing world:
o Comprising some 6,000 formal and 48,000 semi-formal registered microfinance units
o Serving about 45 million depositors and 32 million borrowers; 800,000 channelling
groups; and Millions of informal financial institutions and self-help groups.
In contrast to many other countries, the large majority of microfinance institutions in
Indonesia are found in rural and peri-urban areas.
There is hardly an institutional type of microfinance that is not found in Indonesia. One of the
most successful microfinance models worldwide, the reformed Bank Rakyat Indonesia (BRI)
units, were designed by Harvard Institute for International Development (HIID), early 1980s.
Islamic finance in Indonesia, the largest Muslim country, has evolved since around 1990,
mainly in response to political demands from Muslim scholars and organizations.
The first Islamic cooperatives were established in 1990, followed by rural banks in 1991 and
the first Islamic commercial bank in 1992.
In 1998, Bank Indonesia gave official recognition, as part of a new banking act, to the
existence of a dual banking system, conventional and Islamic, or shariah-based.
This led to the establishment of a second Islamic Commercial Bank (ICB) and, until
December 2003, of eight Islamic Commercial Banking Units (ISBU) (out of a total of 138
commercial banks, comprising a total of 299 banking offices), with a continuing upward
trend, reaching 3 (ICBs) and 19 (ICBUs) in December 2005.
The growth pattern of Islamic rural banks has been quite different. After an initial period of
growth until 1996 when they reached a total of 71, their number almost stagnated during and
after the financial crisis, reaching 78 by 1998 and a mere 84 by 2003 (out of a total of 2,134
rural banks), and 92 by December 2005.
The first Islamic cooperative was established in 1990. Rapid expansion started after 1996, as
a result of promotion by Center for Micro Enterprise Incubation (PINBUK), a non-
government organization (NGO), and continued throughout the financial crisis, but stagnated
after 1999 at around 3,000 and then declined to less than 2,900 as of 2003 (out of a total of
some 40,000 microfinance cooperatives).

Highlights of the evolution of Islamic finance include (as of December 2003):
Origins of Islamic finance due to initiatives by Muslim scholars around 1990.
Islamic cooperatives: Start in 1990, rapid expansion after 1996, stagnation in 1999,
followed by decline; 2,900 Islamic microfinance cooperatives out of 40,000
Islamic microbanks (BPRS): Initial growth since 1991 until 1996 followed by stagnation; 84
out of a total of 2,134 rural banks.
Islamic commercial banks: continuing upward trend since 1992; 2 Islamic banks and 8
Islamic banking units out of 138 commercial banks.
Recognition of a dual, conventional and Islamic banking system, by Bank of Indonesia (BI)
in 1998.
Indonesia gives insight into the development of Islamic microfinance because of its dual
conventional/Islamic microbanking system, which includes both conventional rural banks (Bank
Perkreditan Rakyat or BPRs) and Sharia-compliant rural banks (Bank Perkreditan Rakyat Syariah or
BPRSs).
BPRSs are privately owned and are regulated and supervised by Bank Indonesia. They are
licensed to offer banking services (loans and savings facilities, but no payments services) in a
district area only. As of December 2006, there were 1,880 BPRs and 105 BPRSs.
BPRSs are more socially oriented than BPRs. Their mission statement calls for supporting the
community and, in particular, microentrepreneurs. They also have strong links with
Indonesian Muslim mass movements, such as Nahdlatul Ulama or Mohammedia.
Each BPRS has a Sharia board to monitor the conformity of products to Islamic principles.
However, board rulings are not consistent, and consequently, Islamic microfinance products
can vary widely depending on the specific BPRS.
BPRSs primarily offer murabaha products and savings services based on a revenue sharing
model. They have been quite successful at mobilizing savings for the community, and their
loan to-deposit ratio is over 110 percent.
BPRSs are meeting a growing demand for Sharia compliant microfinance products. Their rate
of growth has been impressive, from March to December 2007, these banks :
o Murabaha receivables increased by 26 %;
o Musharaka Financing increased by 27 %, and
o Mudaraba financing increased by almost 50 %
(Bank of Indonesia 2007).

BPRSs can be profitable but nevertheless, like many microfinance providers, they face several
challenges in reaching sustainable scale.
Islamic Commercial Banks
The market leaders in Islamic finance in Indonesia are the commercial banks. During the
reporting period, 1991-2003, they focused on medium- and large-scale finance.
We are now observing the beginnings of a slow expansion into microfinance.
Since BI gave official recognition in 1998 to a dual banking system, conventional and Islamic
banks, interest in Islamic microfinance that has spread among commercial banks, inspired by
religious concerns and fuelled by low rates of non-performing loans.
Islamic commercial banks, as of 2003, accounted for a mere 0.74 per cent of total assets of
the banking sector. However, during 2001-03 the share of Islamic commercial banks has
increased from 0.17 per cent to 0.74 per cent and stood at 2.19 per cent in December 2005.
Most remarkable is the difference in performance between conventional and Islamic commercial
banks in relative terms:
The Islamic banks lend more of the funds deposited, with a loan-to-deposit ratio
(LDR)/financing-to-deposit ratio (FDR) of 97 per cent compared to 54 per cent of the total
commercial banking sector;
Their gross non-performing loans ratio (NPLR) is persistently lower, and the improvement of
their performance is faster than that of conventional banks after the financial crisis.



















Part three: Institutions and its influence on Microfinance
DR Nurul Alam developed an analytical frame of references to study the lender-borrower
relationships between different financing organizations (FO) and rural-based small and cottage
industries (SCI) based on Business System institutional approach. [Whitleys (1992a)]
The different of small and cottage industries (SCI) as well as financing organizations (FO) of
similar nature are grouped and institutionalized into different SCI systems and Financing
Systems.
The theoretical model is also used to carry out a comparative study as to how financing
organizations under different financing system differ from each other while lending funds
towards SCI owners under different SCI systems.
Therte are four components of different SCI systems and financing systems. ( DR Nurul Alam).
These components are:
nature of organization,
market organization,
employment systems and
authority and control systems.

Accordingly to Whitley (1992b) a comparative analysis of the business system is the systematic
study of these configurations and as to how they become established in markets.
The Islamic financing system is seen as a financing business system of its own, with a foundation
based on religion, having its own rules governed by the Islamic laws. These rules differ from those of
other financial systems.
There are three different financial systems such as :
MBFS (Market Based Financing System), such as conventional banks,
CFS (Cooperative Financing System), and
TMLS (Traditional Money Lending System), viewed as particular arrangements of
hierarchy-market relations that become institutionalized and relatively successful in a
particular context.

A similar arrangement is also done to institutionalize different rural-based small and cottage
industries.
Different small and cottage industries (SCI) of similar nature are thus, grouped into three different
systems, such as:
Grass-root level (GL),
Season-based (SB) and
Semi-mechanized (SM) SCI systems.

Different financing organizations and small and cottage industries under different Financing Systems
and SCI Systems are regarded as economic actors acting within these organizational fields.
These four major componenets of financial institutions:
Islamic Financing System (IFS).
Cooperative Financing System (CFS).
Market Based Financing System (MBFS).
Traditional Money Lending System (TMLS).
can be seen in this following diagram.
Economic
Actors
IFS
CFS
TMLS
MBFS
Market Based
Financing Systems
Islamic Financing Systems
Traditional Money Lending System
Cooperative
Financing Systems
Major Financial Institutions

Concepts of Janssons (2000) network institutional model was also taken into consideration for
developing this theoretical frame of references.
Network institutional model [Jansson (2000)] highlights network relationships between the
multinational corporations (MNC) in India and major external parties in the product/services market
like:
customers,
intermediaries,
competitors and
suppliers.




There are so many factors in the society system influencing the lending and borrowing system.
This system consists of:
political,
legal,
government,
family clan,
religion, and
country culture

How the influence of each of those factors can be seen as the diagram below.
Economic
Actors
(FOs & SCIs)
Political
Systems
Legal
Systems
Govern-
ment
Family
Clan
Religion
Country
Culture
How each of those factors influence the lending & borrowing system
Society
















Microfinance Institutions (MFIs) in Indonesia

Peoples Credit Bank/Bank Perkreditan Rakyat (/BPR) is the generic name of a small-scale unit bank
- one type of microfinance institution in Indonesia. BI classifies it as a rural credit bank.

The Directorate of Economics and Monetary Statistics of Bank Indonesia divides the rural credit
banks into three sub-groups namely:
(1). BPR non-rural, i.e. new BPRs, petty traders / village banks, BKPD, and employee banks,
(2). BPR rural, i.e. village banks, paddy banks, and
(3). LDKP (village credit fund institution)..

Bigger sized Microfinance Institutions (MFIs) are urban based. Indonesian Peoples Bank/Bank
Rakyat Indonesia (BRI) state owned rural bank, is the market leaders.
BRI shifted its strategy to remedy the losses of their village units, which accounted for Rp.
76.6 billion, accumulated from 1970 to 1985 (15 years), by moving their offices from the
rice centers (rural or village area) to the business centers. [Martokoesoemo (2001:83)].
BPRs, which is originally as market bank; established before the banking deregulation
package on October 28th, 1988, remain situated as close as possible to markets (urban
business districts/areas) and are owned by both private or local/regional governments.
The newest BPRs; established after 1998, cluster in central business locations, both in the
regencies and urban districts that have better business prospect.
The outcome of the conversion, there was additional 1,350 new BPRs. This regulation led
to the growth of rural banks in urban areas as close as possible to the business centers.
The unbalanced distribution of MFIs on some islands in the country is rooted in them using
location as a key strategic factor for their future business success where Sumatra, Java, and
Bali are favorite places for MFIs, since they are considered to have business growth centers.
Java Island dominates Indonesia in terms of the number of MFIs, and particularly the BPR.
> 70% of total BPRs operate in Java. Out of the 2,228 BPRs, 71.7% are on Java and 28,3%
are on the other islands.
The distribution of 36,376 savings and lending cooperatives (koperasi simpan pinjam, KSP)
and savings and lending cooperative units (unit simpan pinjam koperas, USP) per December
2003 is 54% on Java Island.
In Central Java, there are 4,939 or 13.6% total KSP and USP. Central Java, which has an area
of 32,564 km2 or 1.7% of the area of Indonesia and a population of 32 million (5.1%), has
approximately 8 % of the total MFIs.
Meanwhile, the geographic distribution of two emerging microfinance institutions in
Indonesia: BMT and Swamitra, seem to follow the distribution of BPRs.
As of 2004, of about 42% (or 1.456 units) of BMT and 29%(or 160 units) of Swamitra
cooperatives operate in Java.
In Central Java, the Bukopin regional office in Semarang is in charge of 11 Swamitras and
Solos office handles 14 Swamitra units.
While BMTs account for 447 units approximately 13% of total BMTs in Indonesia. The
nature of BPRs locality can be traced from their ownerships, offices, and branch offices.
Local investors, private or local government, own most of the BPRs. The reason is simple; they know
more about their hometowns and their future prospects. The nature of BPRs locality is also
determined by rules and regulations.
Islamic Microbanks/Rural Banks (BPRS) in Indonesia
During the 15-year period 1989-2003, the total BPR sector had grown to 2,134, comprising 2,050
conventional BPR and 84 BPRS.
The development of Islamic micro bank has almost come to a standstill after a promising
start in the early 1990s.
BPRS grew at an overall average of 12 per year during the 6-year period, 1991-96, when
their number had reached 71. When the Asian financial crisis hit Indonesia, 1997 and 1998,
their growth slowed down to less than 4 per year.
During the following five years, 1999-2003, their net growth almost stagnated, averaging 1
per year: 7 were newly established, 2 were closed at the beginning of 2004. Their total
number was 84 in December 2003 (down to 82 in February 2004).
The average growth rate of the conventional BPR during the 15-year period was 137
institutions per year--compared to only 6.5 BPRS per annum during a 13-year period.
Conventional rural banks have thus grown more than 20 times faster than Islamic rural banks per year.
Moreover, average assets of BPRS amount to only 38 per cent of the assets of conventional BPR;
during 2001-2003, total assets of the BPRS grew (nominally) by 70 per cent, compared to a growth
rate of 173 per cent of the total BPR sector.






Part four: Concept of Network and the promotion of different networks
by Islamic Microfinance Proces

A common feature in the network approach is the focus on the system of enterprises instead of an
enterprise being an independent unit. Here, the enterprise is regarded as a node in a system of
commercial and relations, where production is regarded only as a part of the activities of the enterprise
[(cf. Rasmussen. 1988)].
Different Types of Network
Kanter [Rasmussen (1986)] has developed three typologies of network, namely: Instrumental
network, Personal network, and Symbolic network..
These typologies include:
Instrumental network: relations as e.g. in supply and sales contacts, PR relations etc.
Personal or (affective) network: where contacts between people are rooted in sympathy or mutual
support, exchange of information and as a mutual inspiration.
Symbolic or (moral) networks: are rooted in common attitudes towards a specific goal (political,
ethnic, religious, moral etc.).

Below we disply the diagram of the different types of networks.
Industrial
Network
Actors
Activity
Resources
Personal
Network
NETWORK
1 Instrumental Network
2 Personal or (affective) network
3 Symbolic or (moral) network
Instrumental network: e.g. in supply and sales contacts, PR relations
Personal (affective) network : rooted in sympathy or mutual support.
Symbolic (moral) network : a rooted in common attitude/goal (political,
ethnic, religious, moral)
Different Types of Networks


Network then can be viewed from various relations that are built among the various actors in society,
such as: transaction, communication, instrumental, sentiment, authority/power, kinship and
descent relation [Kuklinski & Knoke, (1988)].
Network consists of relations that act as a bridge between two sets of: persons, objects,
events, or nodes.
Network, as observed by Easton (1989) from the perspective of different theory-constitutive
metaphors, is defined as: relationships and positions, structures and processes.
Network can be divided into three different group such as formal, social, and business
networks [Johannisson et.al. (1912)].
In the modern business, inter-organizational relationships enable firms to meet the challenge
of modern business of simultaneously achieving economy in production (Hkansson, 1993).
Relationships furthermore provide firms with an identity, which sets the direction of future
development.
The improvement of industrial activities and the development of the same depend on good
network relations among interested groups within and outside the organization.
In industrial sectors technological development depend on technical exchange between different
actors; This exchange leads organizations to form of relations that stands as a base for a network.
Network may be classified into two groups;
external or interorganizational and
internal or intra-organizational networks.

Inter and intra- organizational Network
A well-established relation with source institutions outside the organization is essential in attaining a
higher level of performance in organizational activities. While a cohessive internal networks are
needed to strengthen the organization.



Interorganizational network emerges as the actor forms a relationship with the outside or external
source.
Thus an external network means relations of an organizational unit to other organizations.
Inter-organizational network consists of all organizations linked by a specified type of
relations and is constructed by finding the ties between all organizations in a population
[Aldrich (1979, p.281)].

Intraorganizational network is an internal networks or is a link or relation that builds among the
individual actors within the organization.
Personal Network
Personal network is a relation between persons that is based on both social and business activities.
"Personal Networks are constituted by relationships based on trust and thus established through an
elaborate learning process, encompassing both the joint history of the parties involved and their
assumed future(Johannisson & Gustafsson, 1984)."
The personal network of entrepreneurs and their small firms/ventures combine social and business
dimensions .
This network may be divided mainly, into two types, such as:
social network and
business network,
on which excessive research studies have been carried out [Johannisson (1990), Aldrich, (1976), Cook
& Emerson (1984), Anderson & Carlos (1976)],.

Industrial Networks

Industrial activities are mainly concerned with the production of goods and distribution of the same to
the end consumer in the society.
Industrial network is based on actors/entrepreneurs relationship in various processes from the stage
of:
production till the
distribution stage.

Industrial network is a relationship that takes place among all actors that are involved in making the
industrial functions efficient and effective.
A network is defined as a model or metaphor, which describes a number, usually a large number, of
entities, which are connected.
In the case of industrial as opposed to, say, the entities are actors involved in the economic processes
which convert resources to finished goods and services for consumption by end users (Axelsson and
Easton (1994).
In an industrial network, there are actors/entrepreneurs at several levels [Johansson & Hkansson
(1993, p.24, cf.) Axelsson & Easton (1994)].
There are five characteristics of actors/entrepreneurs:
(1). Perform and control activities,
(2). Develop relationship through exchange process,
(3). Activities on control over resources,
(4). Goal oriented (i.e. the general goal of actors is to increase their control over network), and
(5). Differential knowledge about activities, resources and other actors in the network.
Network Model
Different networks may have different aspects of linkage (Janssons, 1999), such as:
purpose,
types and
structure
Purpose of linkage may be either instrumental or social. Economic actors/entrepreneurs in a certain
environment establish relationships for instrumental reason or social reason.
Instrumentality is defined as purposive action, i.e. organizational units are assumed to make
conscious, intentional decisions to establish linkages for example exchange of products to
increase profit (Jansson, 1999, p.4).
Organizational units may also establish their relations for social reasons. Actors
/entrepreneurs between two organizations could share liking of each other or may belong to
similar group like similar types of job or social status. A linkage may also grow between
actors of different units due to same cultural group, for example, Muslim or Hindu culture.



Microfinance system and micro enterprise system i.e., are connected and promoted by networking,
among each others, through a group of micro entrepreneurs as i.e., may be established by a five
members each.
Each group then appoints their group leader who will then make a Team
Team of five leaders who then appoints Team leader
Team leader who will communicate to microfinance institution/Islamic bank, to get loan.

In the diagram below we will see how this networking flows.
PL
DF
FS HC
SM
MFS Institution MES
Intra
Organizational
NW
Economic Actors
Islamic
Bank
Economic Actors
Intra
Organizational
NW
TEAM
GROUP
MICRO ENTREPRENEURS
Micro Finance & Micro Enterprise Networking
Micro Finance System Micro Enterprise System
5 - 5


In the society, there is Social exchange which is related to three different social factors such as:
individual attributes,
social group and
cultural group.

Social exchange, in contrast to economic exchange, , as Jansson (1999, p. 4) argues, is signified by
unspecified obligation as it involves the principle that one person does another a favor, and while
there is a general expectation of some future return, its exact nature is not stipulated in advance.
Structural characteristics of linkages consists of degree of interdependency, commitment to exchange
partners, duration of relationships, i.e. long or short term relationships, scope of exchange relations,
the degree of stableness and scope.
Social Network and social exchange network
A social network consists of social tie or relations and characterized by social norms, based on
culture, family, relatives and friends and acquaintances (Anderson & Carlos (1976).
Social network can also be defined as a relationship that enables one to collect
information about the conduct and behavior of others in society.
Thus a social network bears a great importance in the pre-start up stages of an enterprise.

Business activities normally originate from the exchange of goods and services. Social exchange
theory is based on individuals or organizations, considered as unitary actors. The author (1987 p.
150) further reports,
It is the basic assumption in exchange network analysis that individual actors behavior reflects
the structure of network.
The Islamic banks in the microfinancing very much relly to the role of the social network, consists of
religious groups, social leaders, and local leaders, to get information, support and entrust before the
banks lend the loan to the borrowers. It is known as the Network Triangle, that can be framed up as
below.
Religious Group
Social Leaders
Local Leaders
Islamic
Financing
System (IFS)
GL System
SB System
SM System
The Network Triangle

As it can be seen, the Network Triangle connected the three very important elements in the
microfinance:
Islamic Financing System (IFS),
Religious Group, Social Leaders, Local Leaders, and
Financial Institutions such as Grass-root Level (GL) System, Season-Based (SB) System, and
Semi-Mechanised (SM) System.
The relation between Islamic banks and customers in the Islamic microfinance system is very close,
personal, and deep.
The banks supervisors using networking and personal approach to the religious group to tap any
necessity information of the customers: i.e., their habit and their dayly life activities.
To get the efficient and effective in collecting an information concerning the distribution of loan and
saving prospect, banks promote to the customer to make a group of five and appoints their own leader.
Every five of leaders then they have been asked to make a Team and appoints one of the memebers as
a Team leader. This system has been institutionalized among the customers which is lender and
borrower relation then established.
We can see here clearly that Islamic banks have initiated and promoted of networking in the
Islamic mirofinance to the entrepreneurs to built relation, intra or inter organizational.
The members become fammiliar each other and the role of religious group, social leaders, an
local leaders becomes emerge.
Trust, participation, and the religious value as the underlying back bone of the relation will
tightening this networking to achieve the goal for every member.
Islamic banks hold as a center role of networking, influencing, and promote a better
networking in the microfinancing and entrepreneurs activities.

Conclusion
Islamic banking in the microfinance system is holding a center role in developing the
relationship and networking between finance institutions and intrepreneurs.
Microfinance is globally acknowledged as an effective instrument in alleviating poverty
refers to finance services such as financing, savings, insurance provided for low-income
people or widely called economically active poor.
Indonesia microfinance development role is hold by government. Unfortunately, that it is not
sustainable. The people consider it as grant so that sometimes it is not repaid.
Microfinance system and micro enterprise system are connected and promoted by networking
among each others, through a group of micro entrepreneurs established by each member.
The Islamic banks in the microfinancing very much relly to the role of the social network,
consists of religious groups, social leaders, and local leaders, to get information, support and
entrust before the banks lend the loan to the borrowers. It is known as the Network Triangle.
.Jakarta, November 15th, 2010

SAEBANI HARDJONO
Candidate Doctor of Islamic Economics & Finance (IEF) TRISAKTI - Jakarta - Indonesia
REFFERENCE


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11. Haron, Sudin and Wan Nursofiza Wan Azmi, (2009), Islamic Finance and Banking System
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Saebani Hardjono
Candidate Doctor IEF TRISAKTI Jakarta Indonesia, 15th 2010