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Islamic loans and SMEs - a plea for a new paradigm

19.11.2012Abdel Maoula Chaar

Small and medium-sized enterprises (SMEs) represent an established socio-economic development factor. In spite of this very central function of theirs, these companies face major difficulties when looking for means to fund their business[1]. This paradox can be partially linked to a communication problem between banks and SMEs: the former using more than often criteria and business models that do not correspond to the world of the latter, and SMEs owner-managers not understanding the banks' requirements. But is it really a paradox? As a matter of fact, a bank's primary purpose is to make sure its placements will receive the maximum return under risk conditions it thinks acceptable. For these financial institutions, SMEs represent a risky and complicated business with a deferred profitability. Their hesitation to lend them money is therefore logical and so are the drastic credit conditions they impose upon them when they accept to do business with them. As a consequence, SMEs are very often squeezed by these requirements and they are caught in a vicious circle where their revenues only suffice to pay back the loans at the expense of business development itself.

Some people consider islamic loans as the ideal solution to solve this problem. Interest (Riba) is banned and use of floating rate instruments with profit sharing (Moudaraba) or loss and benefits sharing (Mousharaka) seems to indicate that islamic banks have tamed the concept of financial risk. For small and medium-sized businesses, this alternative loan option has a very positive effect: they see the financial institutions sharing their risk and they only have to pay back their debt in relation to the success of their operations. However, in reality, islamic banks make increasingly and widely use of fixed interest rates instruments (Mourabaha, Ijara, Salam, Istisna’) whose margins are calculated on the basis of the prevailing inter-bank rates on their market, and on the client's risk profile; an approach at the end of the road fairly similar to the one used by conventional banks.

This contradiction originates in the idea according to which islamic finance would be an instrument to enable muslims to access nowadays financial services whilst respecting their religion's prescriptions. It would then be some kind of an exception to contemporary finance offering specific rules (no Riba, no Gharar, etc.) but in fact with shared purposes. This approach explains why so many islamic banks try, more or less successfully, to imitate conventional bank operations whilst respecting the Charia spirit.

The blatant defect in this view on islamic finance is that it hinders the development of its full potential. And indeed, as conventional finance looks for maximised returns for the operators from an individual point of view, the (theoritical) purpose of islamic banking is to optimise the return on the operations they get involved in, for the benefit of all parties. This approach, relying on the Charia's basics, relies on the regency principle (Istikhlaf), and on a philosophy fostering the participation of all to the development of the environment they belong to (I3mar al Ard). Considering this twist in the thinking, one could imagine a different islamic banking system; financing institutions could assess their performance on their "economic footprint" rather than on their direct financial performance. In this framework, financing SMEs would gain a completely different meaning. Instead of maximising the profits on loans under optimum risk conditions, their purpose would be to obtain a satisfactory return whilst taking part in operations contributing to the socio-economic development of their markets.

Dr. Abdel-Maoula Chaar is a Professor and Research Consultant at the Ecole Supérieure des Affaires. He is in charge of Research and Development and leads the development of the Islamic financial programs and activities of the school, Dr. Chaar teaches Master level courses on Islamic Finance. He is an editor and qualified trainer of the international Islamic Financial Qualification (IFQ). He has written a number of articles and participated in numerous books on Islamic Financial management issues.
Abdel-Maoula Chaar holds a PhD in Business Administration from the French university Paris-Est. He is specialized in Strategic Management. His PhD thesis looks at the influence of the Shari’a mindset on the formation of Islamic banks strategies as well as its impact on the institutionalization of the Islamic financial field. Dr. Chaar holds a Master’s degree in Research in Strategic Management from the same university and a Master’s degree in Marketing and Communication from ESCP Europe and ESA.


[1] For example, banks in the MENA region only grant them 8% of their loans (Rocha, R.; Farazi, S.; Khouri, R. et D. Pearce (2010). The status of bank lending to SMEs in the Middle-East and North Africa region : The result of a joint survey of the Union of Arab Bank and the World Bank, The World Bank – The Union of Arab Bank).  

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