Suhal Kusairi Nur Azura Sanusi School of Social and Economic Development

1. Capital Requirement and Financing Provision Regulation inIslamic Microfinance Institutions (IMFIs): Single and Double Mandate (s) Suhal Kusairi Nur Azura Sanusi School of Social and Economic Development Universiti Malaysia Terengganu suhal@umt.edu.my

2. Introduction Microfinance institutions have a very important role in providing financing for microenterprises. Have a major problem since they usually fail to get financing from standard financial institutions such as commercial banks. This type of business cannot meet the requirements needed by the commercial bank, such as collateral, proper documentation, and financial statements. MFIs also have an important role in reducing the poverty rate by helping low-income households increase their capacity and synchronize cash flow. Microfinance institutions are complements of government programs, for instance by providing subsidies, free assistance, or funds.

3. Empirical evidence using world data from 2005-2010 shows that microfinance institutions grew to comprise about 35% of the total establishments in the world. The number of active borrowers increased about 108%. Academic studies have found that microfinance institutions have an important role in equitability of income distribution, either through financing microenterprise or low income households (Ahmed, 2002) and (Churcil & Coster, 2001). Gallardo (2001) and Hoxhaj (2010) supported previous studies in finding that among microfinance institutions focused on financing, total assets, lending and the number of microfinance institutions always experienced a significant increase. Several studies have shown that a major problem is the position of microfinance institutions, since the service users do not have supporting financial data or collateral, and they are startup businesses.

4. In addition, the asset structure of microfinance institutions is weak, since it is normally very dependent on the government budget, financial institution and internal or external donors. Microfinance institutions are in a poor position in regards to raising funds from the third party. If problems cannot be solved, it is expected that microfinance industries will not achieve stability and sustainability. Unfortunately, the legal and regulatory infrastructures for both activities are weak, and the regulatory process is too simple, with a possibility of overlap between departments within a country. In any case, the development of microfinance institutions is very important for the industry, since it can increase people's capacity, reduce poverty, and develop new entrepreneurial businesses by a selection process and fair competition.

5. The efficiency of the industry is a golden goal which is desired by all parties involved. The development of regulations and laws will ensure that microfinance institution operations and activities are succeeding and can be controlled to ensure the interest of all parties. Unfortunately, the rapid development of Islamic microfinance institutions has not been supported by proper regulations and supervisions in all activities and operations. This is very important in order that Islamic microfinance institutions be efficient and effective.

6. Objective of study Objective of this paper is to explore the existing rules and regulation for microfinance institutions and how to better supervise them. This study will analyse the specific regulations and laws in financing provision and asset requirement, as well as the best practices on how to conduct supervision. These two issues are very important, since these factors will ensure the return and cost operational status of microfinance institutions and risk management. In addition, the stakeholder interest of both sides will be protected; the investor or depositor and the creditor or partner will be shielded from excessive risk.

7. Structure and Behavior of Islamic Microfinance Industry Five types of microfinance institutions:- Commercial Banks: - Provide microcredit as an integral part of the services provided to customers A microfinance unit is a substitute and it needs to meet the needs of regulators. Part of the credit must be extended to microenterprise industries. Non-banking institutions. A cooperative:- An economic institution formed by members of groups that have a specific purpose, whether in production, marketing, or finance. Non Government Organizations:- An organization established by a group of citizens with a specific objective; normally they are involved in social issues. Government Agencies Is established by the government to help government programs.

8. Each Islamic microfinance institution has a different focus on activities. Some focus heavily on financing/lending activity, some are balanced, but few are heavy on fund raising alone. Ilanto (2006) stated that microfinance activities are divided into two activities; collection of deposits and lending. Collection of deposits and lending can be divided into regulated and non-regulated microfinance. In addition, the central bank or microfinance development institution itself is the regulatory agency for microfinance activity. Table 1 shows the features of microfinance institutions in selected Asian countries.

9. Table 1: MFIs Structure in Asian Countries Source: Modified from Regulatory Architecture for Microfinance in Asia.

10. Regulatory and Supervisory Framework in Financial System The financial system consists of three components:- Financial institutions:- Act as financial intermediaries for fund surplus and deficit sectors. There are various financial institutions: commercial banks, insurance companies, mutual funds, finance companies, and deposit and savings companies. The types of institutions can be separated into two: banking and non-bank institutions. Financial market:- Can be divided into the money and capital market. Financial assets:- Is a product that is traded in the financial market. It shows the claim to real assets of the issuer.

11. The existences of strong, competent and effective regulatory and supervisory frameworks are a priority for each financial system of a country and the responsibility of the central bank. A central bank is responsible for the financial system’s stability, a reliable payment system, and high confidence of savers and investors. Currently, principle based regulations frameworks get a lot of attention in development, as they maintain prudential regulation in the financial system. Under this framework, principle based regulation and bank regulation have progressively shifted to the development of a high level of principle based standards and contain more details of bank regulation expectations related to the soundness of banks and businesses.

12. Regulation and Supervisory Framework in Islamic Microfinance Institutions Islamic microfinance institutions comprise a new industry that is growing very quickly. IMFIs give a high expectation of economic development and reducing the poverty rate. This is in line with the two main roles of Islamic microfinance institutions, to provide financing services to microenterprise and to help low-income households synchronize their cash flow. La Porta, et al. (1998) found that the legal and regulatory framework will greatly determine the performance of the industry. The majority of researchers favor activity regulation, as opposed to institutional regulation. They argued that regulation based on institution is very difficult since there is a lot of variability in the types of institutions and characteristics of IMFIs. It is more reasonable and simpler to regulate based on the activity of IMFIs than to regulate institutionally.

13. Most academics suggest that microfinance should follow the standard banking industry model in terms of prudential regulation and hierarchy regulation internationally, regionally, and nationally. However, Macchiavello, et al. (2011) did not agree with these conclusions since most microfinance activities are not related to the international environment in terms of financing assets or resources. The major activities of Islamic microfinance institutions include collecting funds from internal and external depositors or investors. It is very important to financial institutions that their assets are derived from external parties through deposits or financial investment instruments. In the Islamic finance industry, financial instruments can be created through Sadaqah, Waqf, Wadiah, Mudharabah, or Musharakah contracts. Another microfinance institution activity is financing, which is the main activity with the possibility of hampering management priorities.

14. Most microfinance institutions are the kind of government agencies, NGOs, and cooperatives who remain silent for implementing programs for social reasons, such as to help low-income households or to help increase the capacity and outreach of microenterprise. In addition, many creditors and partners of Islamic microfinance institutions have poor documentation, financial positions, and collateral. The diversity of the types of microfinance institutions causes difficulty in forming regulations and supervisory frameworks on what they should do or be prohibited from doing in their activities. The possibility of microfinance institutions becoming involved in a new transmission of monetary policy is very important in the future, given the enormous opportunities in microenterprise financing as their average market share is up to 30-40 percent of the country's financial assets and the majority of the population is involved in microenterprise financing.

15. Proposed Asset Requirement and Financing Provision Regulation in IMFIs The characteristics of microfinance institutions are very specific. Differ from standard commercial banks in terms of asset quality. Normally, the asset portfolio of a microfinance institution consists of microcredit, micro investments, and fixed assets. Microcredit portfolios frequently show lower delinquency than normal commercial bank portfolios (CGAP, 1996). However, MFIs normally have higher volatility due to the type of client and the characteristic of the business, especially if management becomes frustrated from a consistent focus on repayment performance. IMFIs have similarities in terms of asset quality with conventional institutions, but they have special characteristics and philosophies in terms of their basic ideas and behaviors (Shariah compliant).

16. Minimum asset requirements and capital adequacy ratio of IMFIs are factors that can be considered when looking at the current and future expectations that IMFIs become more independent financial intermediaries in terms of the collection and usage of funds. There is a strong argument for allowing IMFIs to use more aggressive strategies as the bank's equity business. This is due to the huge demand that is unmet by existing IMFIs. Since most IMFIs are not a complete financial intermediary, they have financial costs high enough to be exposed to bankruptcy more rapidly than normal commercial banks. In consideration, IMFIs should be charged a CAR (capital adequacy ratio) higher than the existing BIS (Bank International Settlement), which is at 8%.

17. Table 2: Simulation of Financing Portfolio Provision The standard rate of financing provision can be proposed into the measurement and weighted based on certain portfolio policies that are reviewed periodically. The general financing provision is recommended to be higher than for normal financial institutions, at about 2.5 percent Table 2 shows a simulation of the financing portfolio provision, the weighted for sale and lease contract, fee based contract, and the profit loss sharing contract.

18. For simplicity’s sake, IMFI activities are divided into single mandate, which focuses on financing activities only, and double mandate, which focuses on both financing and collecting of deposits from public. Table 3 shows that single mandate IMFIs are required to fulfill the minimum capital, financing and liquidity provision regulations. Double mandate IMFIs are required to fulfill the minimum capital, capital adequacy ratio, financing, and liquidity provisions. Table 3: Application of Prudential Regulation in IMFIs

19. Llanto (2006) noted that different regulatory frameworks will have varying impacts on MFIs and depositors. For microfinance regulation to be considered effective, it must show several characteristics, according to Vogel (2000). Therefore, the argument is that strong existing regulation should be based on the activities of microfinance institutions. Supervisory framework should be appropriate and in accordance with current requirements of the risk based supervisory framework. Figure 1 shows a risk based supervisory framework, starting with identifying the significant activities of financial institutions: lending and investment, and deposit and investment collection.

21. Conclusion The efficiency of the industry is a golden goal which is desired by all parties involved. Industry and the microfinance market describe the distribution of economic resources; industry utilized it in a more transparent, efficient, and equitable manner. The development of regulations and supervisions will ensure that microfinance operations and activities are succeeding and can be controlled to ensure the interest of all parties. The characteristics of microfinance institutions are very specific. Normally, the asset portfolio of a microfinance institution consists of microcredit, micro investments, and current and fixed assets. However, MFIs normally have higher volatility due to the type of client and the characteristic of the business, especially if management becomes frustrated from a consistent focus on repayment performance.

22. There is a strong argument for allowing IMFIs to use more aggressive strategies as the bank's equity business. As previously mentioned, risk factors should be considered in determining the assets. In consideration, IMFIs should be charged a CAR (capital adequacy ratio) higher than the existing BIS (Bank International Settlement), which is at 8 percent. The consequences of IMFI features are that IMFIs should monitor, analyse, and measure their financing portfolios on a regular basis. Financing portfolio can be categorized as standard, sub-standard, doubtful, and loss for every type of contract. In accordance with the characteristics of IMFIs exposed to higher risk. The financing provision is recommended to be higher than for normal financial institutions, at about 2.5 percent.

23. -THANK YOU-