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As traditional financing gives large corporations an advantage, Islamic crowdfunding may be the best option for SMEs to raise fresh capital
The spirit of entrepreneurship has always been a part of Islam. Nine out of the ten companions of Prophet Muhammad guaranteed heaven were businessmen.
Today, entrepreneurs continue to be a driving force of the economy within the muslim community. However, as with any small and medium enterprise (SME), the lack of financial support threatens the growth of the entrepreneurial spirit.
Islamic Crowdfunding offers a solution to this problem.
The strategy has a unique ability to reach the wider community, regardless of geography, and enables support and wealth mobilisation that fuels social and economic development.
In essence, Islamic crowdfunding realises divine principles which are supportive of community participation in developing businesses.
SMEs – A Neglected Sector
Despite their importance and impact to the economy, support for SMEs is generally lacking — especially when it comes to financing.
Let’s take Southeast Asia’s largest economy, the majority-Muslim country of Indonesia, as an example. According to a February 2015 report from the Asia Development Bank, 97.2 per cent of the country’s employment comes from SMEs. It generates 57.8 per cent of GDP in. Yet, in a study of 5,900 firms across Southeast Asia, 38.6 per cent cited access to finance as their biggest hurdle.
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 sector, especially in the emerging economies. This problem has resulted in large corporates growing in size while SMEs face rising failure rates.
Also Read: Malaysia, IDB to join forces to found the world’s first Islamic Venture Capital
The growth of most SMEs is also restricted by the inability to employ skilled labour and harness new technologies.
Traditional Islamic finance has forgotten the small players
The current use of Islamic financing has mainly benefited large corporates, while Islamic-based investments (outside of bank deposits) are 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 per cent of Islamic financial assets comprise bank lending but Islamic banks face regulations that are more strict than their conventional peers face.
The focus on reducing risk means lending to SMEs, which may not have fixed collateral and long operating history, is not a priority.
Sukuk are Islamic Bonds and are the second largest Islamic financial asset — making up around 15 per cent of total industry worth. 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.
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 in which they believe. 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.
Also Read: Islamic crowdfunding site EthisCrowd gets US$362K seed round to support affordable homes projects
Crowdfunding similarly embodies this objective — to unlock investments from the community and stream it down to businesses most in need of financing. 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 not limited to Muslims.
The strategy focuses on values and ethics such as community development, honesty, and justice — universally accepted morals in most religions.
As an example, an enterprise trying to fund activities that contribute to environmental pollution would not appeal to the general public any more so than it would 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 that may 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 interest-based financing 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 many 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.
For conventional Islamic financing, compliance is required to ensure the financing meets all the requirements under Islamic Law. This is a hurdle because getting third-party compliance is expensive. However, these costs can be avoided by working closely with knowledgeable institutions such as universities or other Muslim scholar associations.
For crowdfunding, there is a lack of regulation in Asian countries. While most governments provide some space for crowdfunding platforms to operate, as long as existing laws are not breached, the lack of regulation creates uncertainty and concerns by the public on the legality of the investment platform.
This makes it difficult for crowdfunding operators to openly market their 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.
Also Read: Muslim fashion e-commerce startup HijUp raises capital
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 and Mudharabah contracts. Other structures which may be considered includes Salam (forward financing transaction), Ijara (leasing), and Diminishing Musharaka (diminishing equity partnership).
However, what really drives us is the ability to bring together small businesses with small investors to support community growth and ethical investing.
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Erly Witoyo is passionate about crowdfunding, Islamic/ethical finance, and tech. Together with my partners, we combine the the three to create an Ethical Finance Ecosystem in Asia.
A partner and co-founder of:
1. KapitalBoost – a crowdfunding platform helping small businesses raise funds for asset purchase.
2. Ethiscrowd – a crowdfunding platform for property investments and development in Indonesia.
3. gostartem – a tech-focused crowdfunding platform
We’re interested in collaboration/partnerships that make sense. Also interested in networking and exchanging views/ideas. Please feel free to contact me by email and let’s grab coffee.
The post Why Islamic crowdfunding can clear Asia’s SME financing hurdle appeared first on e27.
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