Are you sure want to logout?

Islamic crowdfunding as a solution for SMEs

Thursday, June 16, 2016



The spirit of entrepreneurship has always been a part of Islam. Nine out of ten companions of Prophet Muhammad (pbuh) who were guaranteed heaven were businessmen. 

Today, entrepreneurs continue to be a driving force of the economy. The lack of financial support for small and medium enterprises (SMEs), however, threatens the growth of entrepreneurial spirit. We believe Islamic Crowdfunding offers a solution to this problem. Its ability to reach the wider community, regardless of geography, is a key enabler to rally support and mobilize wealth that could fuel social and economic development. In essence, Islamic crowdfunding realizes divine principles which are supportive of community participation in developing businesses. 
 

SMEs – A Neglected Sector 

Despite their importance and impact to the economy, support to SMEs have been lacking, especially on the financing side. In Southeast Asia SMEs, on average, account for about 90% of total businesses and generate close to 70% of employment. Yet, less than 20% of SMEs in the region have access to bank loans as a means of financing. Strict banking regulations imposed after the global financial crisis in 2008 have made banks and most financial institutions increasingly risk-averse. Hence there is a preference for banks to fund large corporates rather than SMEs. Additionally, minimal government schemes are in place to help the SME sector especially in emerging economies. This problem has resulted in large corporates getting larger while SMEs face high failure rates. 
 

Islamic Finance Has Forgotten The Small Players 

The current use of Islamic Finance has mainly benefited large corporates, while Islamic-based investments (outside of bank deposits) are mainly limited to high net worth individuals. Despite the Shariah focus on community support and involvement, the sector's contribution to SMEs and social projects is minimal.

Around 80% of Islamic financial assets comprise bank lending. Islamic banks also face the increasingly stricter regulations that their conventional peers face. The focus on reducing risk means that lending to SMEs, which do not have fixed collateral and long operating history, is not a priority.

Sukuk is the second largest Islamic financial assets making up around 15% of total industry assets. Similarly, it is the large corporates, which tend to benefit from issuances of these instruments. There is little, if any, trickle down impact to SMEs. Conversely, as the large corporates grow bigger they tend to crowd-out smaller businesses. 
 

Islamic Crowdfunding As A Solution For SMEs 

Combining Islamic Finance with crowdfunding has the potential to address financing issues faced by SMEs. Crowdfunding allows for a collective cooperation amongst individuals to pool resources for a cause, project or business they believe in. Its pro-community principle can be applied into supporting those in need of investments in real economic activities; in other words, the SMEs. Moreover, Islamic Finance emphasises on equitable distribution of wealth. 

This is evident in the maqasid al sharia (objectives of Islamic Law) wherein resources from the surplus sectors should be transferred to the deficit sectors for wealth to be smoothly circulated and human welfare realised. Crowdfunding similarly embodies this objective - unlocking investments from the community to the businesses needing financing the most. Integrating both concepts can support overall community growth through increased entrepreneurial activities, while reducing inequality. 
 

Not Limited To Muslims 

Islamic crowdfunding is an ethical form of financing and is not limited to Muslims only. It focuses on values and ethics – such as community development, honesty, and justice – which are universally accepted. As an example, an enterprise looking to fund activities that contribute to environmental pollution would not appeal to the public, more so to an Islamic crowdfunding platform. This resonates well with other investment screens such as Environmental, Sustainable and Governance (ESG) and socially responsible investing (SRI). The positive difference is that Islamic finance adds another filter based on Islamic Law, which Muslims believe is imposed to protect mankind. The filter prohibits the use of interest and excessive risk taking or uncertainty, among other things. 
 

Challenges Ahead…

Surely, there are challenges which could stifle the success of Islamic Crowdfunding. First, the lack of knowledge on how Islamic Finance and crowdfunding works. The use of Islamic finance structures are new to most people, especially as the use of conventional financing (interest-based) has become the norm in most communities. While Islamic Finance structures such as Murabaha (cost plus profit margin) and Mudharabah (profit sharing) are relatively straightforward, when it comes to finance and investment most people are apprehensive in trying something new. Furthermore, crowdfunding is a relatively new concept in developing markets, where SME financing is largely required. Thus, significant effort in educating the public about Islamic Finance and crowdfunding is required. 

The other big challenge is regulation. In the Islamic Financing side, compliance is required to ensure that the financing meets all the requirements under the Islamic Law. Getting a third-party compliance is costly. However, this can be avoided by working closely with knowledgeable institutions such as universities or other Muslim scholar associations.

On the crowdfunding side, there remains a lack of regulation in Asia. While most governments provide some space for crowdfunding platforms to operate, as long as existing laws are not breached, the absent of regulatory clarity creates some uncertainty and concerns by the public on the legality of the investment platform. It also makes it harder for crowdfunding operators to openly market its services and educate the public. 
 

...But Opportunities Abound 

These challenges are temporary and will help to boost Islamic crowdfunding when overcome. The growth prospect for Islamic crowdfunding is huge considering the relatively small market and massive demand for SME financing. We estimate total Islamic crowdfunding of USD30mn in 2015 versus the total crowdfunding market of SGD34bn.

One factor which may also boost the growth of the sector is the increased introduction of Islamic finance structures to meet the specific needs of SMEs and to limit the risks to investors. Most crowdfunding platforms currently use Murabaha (cost plus profit margin) and Mudharabah (profit sharing) contracts. Other structures which may be considered includes Salam (forward financing transaction), Ijara (leasing), and Diminishing Musharaka (diminishing equity partnership).

Kapital Boost as one of the pioneer in Islamic Crowdfunding and a key founding member of the Islamic Fintech Alliance (islamicfintechalliance.com), is excited of the sector's growth potential. However, what really drives us is the ability to bring together small businesses with small investors to support community growth and ethical investing. 

Categories:

You have not verified your account. To do so, please click the link on the Account Activation email (it might be in your Spam folder) that was sent to you shortly after you created an account with us.
If you'd like us to re-send the Account Activation email, please fill in your email address below and click submit
Membership Registration

OR

The Username you've chosen is taken.
Please use another one.

You already have an account in Kapital Boost.
Please click the button below to retrieve your password.



Thank you for registering!
A verification email has been sent to . Please follow the instructions in the email to verify your account. Remember to check the spam folder in case you don't see the email in your inbox.