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Islamic Crowdfunding For SMEs
Islamic Crowdfunding For SMEs
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 sector especially in the
emerging economies. This problem has resulted in large corporates getting larger
while SMEs face rising failure rates. The growth of most SMEs is also restricted
by the inability to employ skilled labour and harness new technologies.
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
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 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. 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.