How SMEs Can Leverage Islamic Banking And Finance Products For Sustainable Growth

Mohammed Nasir Ibrahim Esq.

Small and medium enterprises (SMEs) play a big role in the Nigerian economy as well as in economies around the globe. The number of people gainfully employed by SMEs is more than those employed by large companies. Thus, SMEs are important for economic and social reasons, given the sector’s role in employment and in its contribution to the GDP of world economies.

Over 40 million SMEs exist in Nigeria, employing over 80 percent of the country’s population and contributing about 50 percent of the country’s GDP[i]. Most economies, particularly those of developing countries like Nigeria, march on the shoulders of small and medium-sized businesses. This is because SMEs are largely characterized by dynamism, innovations, efficiency, and their small size which allows for a faster decision-making process[ii].

However, a major blight in the development of this sector, especially in Nigeria is the lack of finance and products which can spur the expected growth. This is an issue that has been at the front burner and has been restated severally by the government, industry leaders and other stakeholders.

Most SMEs have challenges accessing the required finances to improve and grow their businesses; Finances that can improve their services and productivity whilst ensuring their consistent growth. SMEs tend to shy away from accessing finance from conventional institutions due to; inadequate or unavailable collateral facilities, high interest rates which becomes a burden on the SME and forces it to default in repayment.

Moreso, conventional financial institutions are reluctant to give unsecured loans however high the interest rate may be. And because of this reality, it has been stated that between 55% and 68% of SMEs in developing countries are either financially underserved or not served at all[iii]. And these high numbers translate into significant lost opportunities to develop viable businesses. Even in the G20 countries, it is estimated that SMEs face a financing gap of $1.3 trillion[iv].

Many countries around the world have embraced Islamic financing options to tackle their economic and infrastructural needs. Which has drawn acclaim to these Islamic products as been ethical and built on practices which prohibits interest, pre-determined interest or excess compensation without consideration[v].

The existence of Islamic finance has become an imperative in many jurisdictions of the world and it is expected to continue to spread. Nigeria is home to the largest population of Muslims in sub-Saharan Africa. It accounts for over 80 million Muslims. In recent times, Nigeria is opening itself to Islamic financing with hope of establishing a hub for non-interest banking[vi]. A situation that can be leveraged by SMEs to access finance, ensure financial inclusion and sustainable growth.

Nature of Islamic Finance

Islamic finance, despite its name, is not a religious product. It is however a series of financial products aimed to meet the requirements of a specific group of people averse to conventional finance which includes elements of interest and risk that are prohibited under Shari’ah law. The products under Islamic finance are usually to allow ethical business people to invest savings and raise finance in a way which does not compromise their religious and ethical beliefs.

A major characteristic of Islamic financing is that it is an asset-backed financing. Unlike the conventional concept of financing where banks and financial institutions deal in money. As Islam does not recognize money as a subject-matter of trade[vii]. In Islam, money has no intrinsic utility; it is only a medium of exchange. Therefore, money cannot in and of itself be a medium for profit making. Profit is generated when something having intrinsic utility is sold for money or when different currencies are exchanged, one of another.

Key features of Islamic Finance Products include:

1. The money advanced by the financier is be backed by an asset;
2. Money advanced by the financier can only be used for ethical products. i.e., such monies cannot be used by a gambling company to expand its operations; a pornography company to acquire new assets, e.t.c
3. The selling price of an assets remains fixed and does not increase with the passage of time as obtainable under the conventional banking system of interest.

Some Islamic Finance Products

1. Murabaha: This applies only to commodity purchase. Instead of taking out an interest loan to buy something, the customer asks the financial institution to purchase an item and sell to him or her at a higher price on instalment. The bank’s profit is determined beforehand and the selling price cannot be increased once the contract is signed. SMEs can easily use this product to purchase machineries, facilities e.t.c. for their production
2. Ijara: This is like a typical lease contract. Here, instead of issuing a loan for a customer to buy a product like car, the bank buys the product and then leases it to the customer. The customer then acquires the item at the end of the lease contract.
3. Mudarabah: This is an investment in which the bank provides 100% of the capital intended for the creation of a business. The bank owns the commercial entity and the customer provides management and labor. They then share the profits according to a pre-established ratio that is usually close to 50/50. However, if the business fails, the bank bears all the financial losses unless it is proven that it was the customer’s fault.
4. Musharakah: This is an investment involving two or more parties in which each party brings in capital and management skills in exchange for a proportional share of the profits.

These instruments aren’t exhaustive, but serve as the basic building blocks for developing a wide array of complex financial instruments. This thus makes suggests that there is great potential for financial innovation and expansion in Islamic financial markets.

Why SMEs Should Leverage Islamic Finance Products

In a business world marked by economic uncertainties and rising costs of operations, SMEs must seek for and adopt innovative means and methods to secure the sustainability of their businesses and tap into the huge stream of funds available and ripe for investments.

Although conventional financial institutions have many products that can be and are being used by these businesses, there exists so much fear and disinclination amongst business owners from using these products because of the level of uncertainty and volatility of the market. More so, business owners who for religious or ethical reasons cannot access and exploit the conventional products, can access the alternative provided by the Shariah finance model which has proved to be stable, ethical, resilient, dependable and fit for both long- and short-term investments.

The Islamic participatory schemes, such as mudarabah and musharakah, integrate assets of lender and borrowers; therefore, they allow Islamic banks to invest on a longer-term basis to projects with higher risk-return profiles and, thus, to support economic growth.

Islamic finance helps promote the financial sector development and broadens the scope of financial inclusion.  By expanding the range and reach of financial products, Islamic finance could help improve financial access and foster the inclusion of those deprived of financial services.

In many countries, Islamic banking assets have been growing faster than conventional banking assets. This is attributable to Islamic finance’s underpinning principles of promoting participation, equity, property rights and ethics which are all universal values. And these are values that are germane to the growth and development of any business whether small or medium.

[i] Toyin A., Deepening access to capital for Nigerian MSMEs during a pandemic https://www.brookings.edu/blog/africa-in-focus/2021/03/08/deepening-access-to-capital-for-nigerian-msmes-during-a-pandemic/

[ii] ibid

[iii]Bertrand B., How Islamic finance can grow SMEs; https://www.weforum.org/agenda/2015/11/how-islamic-finance-can-grow-smes/

[iv] Ibid.

[v] Oladeinde O., What Islamic finance products can do to Nigeria’s capital

market, infrastructural growth; https://www.pwc.com/ng/en/assets/pdf/islamic-finance.pdf

[vi] Felix C.O., Islamic Finance in Nigeria; https://www.mondaq.com/nigeria/islamic-finance/757434/islamic-finance-in-nigeria

[vii] Saray C., Characteristics of Islamic Finance; https://saraycon.com/characteristics-of-islamic-finance/