Financial Instruments for The Poor

1.0 Introduction
This report is prepared as a requirement of the course Financial Institutes & Markets. It starts with a discussion on the origin of the report (1.1), objective of the study (1.2) and methodology of the study (1.3). Then relevance and background of the research (1.4) are discussed to provide a clear understanding about the research. After the background an elaboration is given on the problem definition, the aim and the added value of the research (1.5).

1.1 Origin of the Report

The report originated from the requirement to do for 4th semester of the Department of Finance & Banking, Jahangirnagar University has assigned the researcher to conduct a report, which would be followed by a formalities, rules and regulations of formal report preparation. The researcher has chosen the topic of Financial Instruments for the Poor and he had approved the proposal and gave the researcher useful direction to prepare the Report.

1.2 Objective of the Study

The main objective of the report is to discuss any kind of method or item that increases the financial asset of an entity and at the same time financial liability of another entity.

1.3 Methodology of the Study

Sources of Data: In preparing our report we have gathered information from both primary and secondary resources. The whole information has been gathered from the Internet, different books, magazines, newspapers and class lecture sheet. We have also visited many places and done field work to collect data for the research. Data is analyzed from different perspective of views. These analyzed data will be disseminated with the relevant parties.

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1.4 Background and relevance of the research: The Context

Bangladesh is a small country with a very low per capita income. Here people still struggle for the basic needs fulfillment. When still lots of people struggle to have a minimum shelter, little amount of food to live; they need to develop their financial condition. Therefore, as they need to be financially improved, some financial instrument can specifically improve them. Government is trying to build a proper framework for the improvement of the poor people. The background of this research is those factors which lead the development of the financial condition of the poor along with an analysis of some financial instruments.

1.5 Problem definition, aim, and the added value of the research
This research is basically a descriptive one with some characteristics of normative research focusing on Financial Instruments for The Poor. Here it tries to define how different processes can reduce the poverty efficiently which we define as financial instruments. Focusing on these financial instruments we basically try to work to find a solution of a serious problem perhaps the main problem that

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Financial Instruments for The Poor

2.0. Economy of Bangladesh

Bangladesh is a small country with quite a small and poor economy. Since its independence the country has been administered by lots of undisciplined administrations that could not ensure the maximum utilization of the available resources let alone finding the new sources of resources. As a result the country is still a developing country. Bangladesh is basically an agrarian country. Majority of the population is involved with agriculture either directly or indirectly. But the contribution of agriculture in total GDP has been decreasing in the last few years and currently service is the dominating sector in the Bangladesh economy.

Figure-2.1: Sector Wise Contributions to GDP (Source: BBS, 2006) But from the labor involvement perspective still agriculture sector has the dominance in the economy. This sector has the highest level of direct labor involvement and one of the major findings is that though the contribution of agriculture in GDP is decreasing, labor involvement is not decreasing. Rather more and more labor force is being involved in the agriculture sector. It might happen due to the high level of unemployment in the country. Service sector involves the second highest amount of labors. The labor involvement in construction sector is increasing year to year. It well explains that the sector is a growing sector.

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Financial Instruments for The Poor

Table-2.1: Sector wise employment (in million)

3.0 Financial Liberalization and Reforms in Bangladesh

There is no denying the fact that the financial system plays a significant role in the economic development of a country. The importance of an efficient financial sector lies in the fact that, it ensures domestic resources mobilization, generation of savings, and investments in productive sectors. In fact, it is the system by which a countrys most profitable and efficient projects are systematically and continuously directed to the most productive sources of future growth. The financial system not only transfers funds from savers to investors: it must be able to select projects which will yield the highest returns, accumulate sufficient quantities of capital to fund the range of investment projects across economic activities, account for price risks across assets, monitor performance, and enforce contracts. According to the McKinnon- Shaw hypothesis (1973), the conventional wisdom is that flexibility and efficiency of the financial system are crucial to the growth and development of a market economy. A comprehensive study by King and Levine (1993) from across 119 developed and developing countries over the 1960-1989 period provides compelling evidence that economic growth is dramatically dependent on the size of financial sector, credit to private sector and enterprises and interest rates. The larger the financial sector in the context of the overall economy, the greater the share of lending by depository rather than central banks, and the greater the share of credit to private sector rather than public sector, the greater is the rate of economic growth. Financial sector in Bangladesh, like most in developing countries, is dominated by banking institutions. With recent gains in financial fronts Bangladesh's financial sector is 4|Page

Financial Instruments for The Poor

now comparable with most of the countries in South and East Asia in terms of financial deepening (measured by broad money to GDP ratio). This was 80 percent in India (2008) followed by 50 percent in Bangladesh (2008) and Pakistan (2007) and 35 percent in Sri Lanka. Bangladesh, like other developing countries, still has an underdeveloped financial system and is facing serious problems with the operation of its financial system and poor financial intermediation presents significant disincentives to foster economic growth. Given the very low levels of both domestic and national savings, and together with population growth, Bangladesh needs more resources for investment. Thus, financial development is a prerequisite for economic growth. There is broad agreement that the establishment of a competitive efficient and transparent financial system will result in higher economic growth and create employment opportunities. Therefore, evolution of a sound and well-integrated financial system through appropriate policy stances in the monetary and banking arena is essential to facilitate the economic development of any country.

4.0 Financial Instruments

Actually by financial instrument we want to mean any kind of method or item that increases the financial asset of an entity and at the same time financial liability of another entity. But here we will not working with all the financial instruments rather emphasizing on those which help to reduce the poverty.

4.1 Financial Instruments to Reduce Poverty

We want to show what kind of financial instruments can be used for poverty reduction. Because we have a strange thinking when we talk or think about poverty as most of us assume that by very nature of not having the money the poor cannot manage themselves properly and cannot get themselves free from the curse of poverty. But through in our report we want to show you that empirical facts do not support this. Besides money we have couple of ways which are known as financial instruments, can be used for poverty reduction. In recent days poverty alleviation has become a buzzword in our country. And thats why different types of financial instruments are used. Those are micro credit, Zakat, Wakf, sukuk etc.

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4.1.1 Microcredit

Microfinance and the impact it produces, go beyond just business loans. The poor use financial services not only for business investment in their micro-enterprises but also to invest in health and education, to manage household emergencies, and to meet wide variety of other cash that they encounter. The ranges of services include loans, savings facilities, insurance, transfer payments and even micro-pensions. Evidence from the millions of micro-finance clients around the world demonstrate the access to financial services enables poor people to increase their household incomes, build assets and reduce their vulnerability to the crisis that are so much a part of their daily lives.

4.1.1.1 Achievement of micro finance: Social aspects:

Microfinance and the impact it produces, go beyond just business loans. The poor use financial services not only for business investment in their micro-enterprises but also to invest in health and education, to manage household emergencies, and to meet wide variety of other cash that they encounter. The ranges of services include loans, savings facilities, insurance, transfer payments and even micro-pensions. Evidence from the millions of micro-finance clients around the world demonstrate the access to financial services enables poor people to increase their household incomes, build assets and reduce their vulnerability to the crisis that are so much a part of their daily lives. Access to financial services also translates into better nutrition and improved health outcomes, such as higher immunization rates . It allows poor people to plan for their future and send more of their children to school for longer. It has made women clients more confident and assertive and thus better able to confront gender inequities. Microfinance clients manage their cash flows and apply them to whatever household priority they judge most important for their own welfare. Thus micro finance is an especially participator and non-paternalistic development input. Access to flexible, convenient and affordable financial services empowers and equips the poor to make their own choices and build their way out of poverty in a sustained and self-determined way. 6|Page

Financial Instruments for The Poor

Specifically it assesses impact in the areas of eradicating poverty, promoting childrens education, improving health outcomes for women for women and children and empowering women. A short description of specific areas is given below: Eradication poverty Promoting childrens education Improving health outcomes for women and children Empowering women Participation in social activities Reduction of unemployment rate Beggar can turn to business Information technology for the poor

4.1.1.2 Microcredits impact

For many women, helping establish and operate their Village Banking group is their first experience in self-governance and democracy; serving as a Village Bank officer is their first leadership opportunity. Womens status within the home increases as their self-confidence and economic self-sufficiency grow. They demonstrate significantly greater empowerment as measured by physical mobility, ownership and control of productive assets such as land, involvement in family decision-making, and legal and political awareness and participation. And their empowerment increases the longer they stay with their microfinance programs compelling evidence of a causal link. Microcredit lending is based on a culture of accountability and ownership where women have a setting to realize their potential with total dignity. Since this is their money, their responsibility, their skills and their businesses, they take total ownership After a year or more, many Village Bankers make significant improvements to their businesses, their homes, and their lives. Because neighbors support each other while growing their businesses, Village Banking helps invigorate entire communities.

By having access to credit and by building collateral through participation in these programs, borrowers can eventually graduate into a more formal system that will provide them with loans for education, health, housing, and emergency family funds.

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Microcredit grows self-esteem for borrowers because it provides options and opportunities to become independent economically. Microcredit institutions combine microfinance, new technologies, and innovation to empower the worlds poorest people to escape poverty. From simple small loans, the worlds poorest families can then create their own jobs, raise household incomes, and improve their standard of living.

4.1.1.3 Micro-insurance:
Providing the poor with insurance against risks of any kind is the mission of microinsurance. A small and repetitive payment covers - in a pool of people - the probability of a negative event deeply effecting one of them. By sharing the risk, the price can be kept low and the disruption to the partners of the affected person can be avoided. For instance, the death of a micro-credit borrower, potentially leading to a negative legacy to the already badly hit family, can be insured so that the debt is eliminated (and the family even given the money for the funeral) while the MFI recovers the money from the insurer. By pooling all the MFI clients, the payment required for covering this risk can be kept quite low. Micro-insurance is getting into new areas such as health risks, property damages in productive assets, weather-indexed crop insurance for farmers, storm housing damage, etc. These extensions rely on the observation that poverty can easily be the result of negative events, that the poor are the most hit by many widespread risks and that their precautionary savings are freezing badly needed resources. At the same time, the huge number of poor and their wide geographical distribution is an attractive feature for the insurer, since the larger the pool, and the less correlated the events, the lower the payment necessary to cover the negative occurrence, thus its affordability for the poor themselves. These opportunities are at odds with traditional insurance institutions, those are usually excluding the poor from coverage.

4.1.1.4 Micro-franchising for innovative and clean goods

A recent development in microfinance is to identify a technological innovation that, embodied in a new durable good or equipment, could improve the life of the poor directly or by the revenues achieved through the commercial sales of the services it provides. For instance, mobile phones have been purchased by poor women in Bangladesh (using a micro-loan) and the services of phone calls sold to the entire village, boosting not only the woman revenues (and her capability of paying back the loan) but also her 8|Page

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social centrality ("Before nobody invited me to marriage ceremonies, now I am the first to know and be invited, because they use the phone to invite all the others", as Muhammad Yunus quoted at the Asian-Pacific Microcredit Summit 2008). The key partner is the producer of the innovation or the global service provider (e.g. the mobile phone producer or the phone company) that is crucially interested in selling in rural areas and to the poor. By signing and implementing franchising partnerships with economic giants or new entrants, MFIs become the vehicle of modernization of the areas where they operate, empower the technological level of their clients, and diversify their products. In other cases, the microfinance institution could be selling durable goods directly, operating a commercial margin to contribute to fixed costs.

4.1.2 Islamic Economic System

Islam is a comprehensive religion. Islamic economic discussion is as old as Islam itself that is an integral part of Islamic teaching. Basic principles of this economic system are al-Quran and al-Sunnah. Its revelation took place gradually. It is based on situation

4.1.2.1 Basic Characteristics of Islamic Economics

1. Islamic Economics is developed based on several philosophical foundations derived from the Quran and the Sunnah: tawheed, justice, freedom, amanah (trust) and responsibility, al-taawwun wa altakaful (cooperation spirit). 2. Islamic economics is based on real sector productivity. Monetary sectors performance will be determined by the real sectors performance. It is because all economic transactions and instruments in Islamic perspective are based on the real sector. eg. Musharakah and Mudarabah. 3. the existence of principle of halal and haram {halal: permissible; haram: not permissible (in terms of the thing itself and in terms of process, such as prohibition of maysir, and gharar)} Instruments for Poverty Reduction according to Islamic Economies Zakat and Infak Wakaf Sukuk 9|Page

Financial Instruments for The Poor

4.1.2.2 Zakat
Zakat is a financial instrument that is obligatory for those whom are eligible to be muzakki (zakat payer). It is distributed to 8 groups called mustahik (zakat recipients), with priority given to the poor and the needy.

4.1.2.2.1 Objectives of Zakat

Increases welfare level of zakat recipients Increases productivity Promotes business ethic works as potential funding source for development Increases the wealth and asset in productive ways Encourages people to perform their worship in the best way. Reflects the spirit of sharing-based economy

4.1.2.2.2 Impact of Zakat to reduce poverty

Proper utilization of Zakat could effectively alleviate poverty from the society. only micro credit alone could not remove poverty from the society. Proper utilization of Zakat could play an effective role in this connection. The fund of Zakat should be utilized in a planned manner to eradicate poverty, economic development and for improved living of the neglected section of the society. Zakat should be incorporated in development strategies of the government. Islam always encourages the rich to be kind, helpful and champion of human dignity. Zakat is a unique instrument for poverty alleviation as wealth is transferred from rich people to poor people. This will improve the living condition of the poor people of the society and make them self- sustained. Zakat is a financial tool that can ease the burden on the state budget and meet the needs of the poor. It is not only a type of charity, but a duty imposed on rich Muslims by our Islamic Sharia, too.

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4.1.3 Waqf

Waqf means denoting a building or plot of land or even cash for Muslim religious or charitable purposes. The donated assets are held by a charitable trust. In this concept, Mutavalli (Cash-Waqf Fund manager) collects the fund from Waqif and invest the money in the real sector (mainly Small & Medium-sized Ventures) and in any Shariah based investment opportunities. Mutavalli will then allocate all profits and returns gained from the investment to any poverty alleviation program to enhance the quality of poor peoples life, such as free education and health services, cheap basic food, etc.

4.1.3.1 Cash Waqf

Cash waqf is one of the alternative solutions amid the inability of government in providing prosperity for Indonesian society. On the other side, the system of cash waqf return allocation need to be rejuvenated in a professional way. Waqf or Islamic endowment is a well-known topic in the area of Islamic economics, Islamic finance and Islamic jurisprudence. In general, waqf could be categorized into several categories from three different aspects i.e. timing of waqf, purpose of waqf (the beneficiaries) and the waqf object.

Waqf

Timings

Purpose

Object

Permanent

Temporar y

Family

Charity

Moveable

Immovable

General

Specific

Figure 4.1: Categories of Waqf in Islamic Jurisprudence 11 | P a g e

Financial Instruments for The Poor

4.1.3.1.1 Cash Waqf collection and allocation

Cash Waqf collection is basically made for 2 purposes. i)Distribution for social sector ii)Distribution for productive sector

Cash Waqf collection

Distribution for social sector

Distribution for productive sector

Allocation

Rehabilitation of Poor family

Education & Culture

Victims of natural disaster

Facility & Social Services

Health & Cleanliness

Figure 4.2: Cash Waqf collection and allocation

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4.1.4 Sukuk
Sukuk is an innovative Islamic financial product. Islamic bond operated based on Islamic transactions which are real-sector based. It can be used in mobilizing huge fund available in financial market. It is invested in real sector projects that can be used in poverty eradication project. eg. Ijarah sukuk for the purchase of ships given for the poor fishermen.

4.1.5 The Rationale for Financial Sector Reforms

Financial sector reform means two distinct but complementary types of changes that are to establish a modern financial system capable of acting as the wheel of the economy and allocating the economys savings in the most productive way among different potential investments. First, liberalization of the sector: putting the private sector rather than the government in charge of determining who gets credit and at what price. Second, establishing a system of prudential supervision designed to restrain the private actors so that it can be reasonably sure that their decisions will also be broadly in the general social interest. The use of endowment and Zakat funds - properly linked to State general plans - can supplement resources for the state budget deficit. It is an economic vision applied successfully in some countries such as Malaysia. There are many powerful economic studies about it. It is also a fundamental part or our faith; rooted in the teachings of our religion which helps us fight, even eradicate poverty.

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5.0 Conclusion
Poverty is the main obstacle in the way of development of a country. Not only for a specific country but also for the whole world It is perhaps the basic problem. In the countries of the third world and the developing countries are mainly affected with this problem. By making poor countries poorer this problem actually makes discrimination between the countries of the world. As the third world and developing countries can not solve the poverty problem rather they are facing more poverty problems, as a result there creates difference among the countries. As a developing country, this problem is more acute. So if we want to see our country as a developed country we have to find the solution of poverty first. Thats why through this report it is shown different types of poverty reduction processes which we define as financial instruments can be used to reduce the poverty gradually from the country. The main instrument can be the microcredit which is a process of issuing loan to marginal people just to make them financially stable. It can be main weapon for us to fight with the poverty. Here it also shows other various instruments like Jakat, Waqf, Sukuk etc. But the main purpose of these instruments is the poverty reduction and proper allocation of resources among the people above all among the countries of the world. so its the time the govt of the countries should come forward and take necessary steps to get free from the curse of the poverty by trying to use these financial instruments efficiently and effectively.

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Reference

Bangladesh Bureau Of Statistics(BBS) www.financialdiaries.com www.financialexpresss.com http://nextbillion.net/interview-with-brigit-helms-ceo-of-unitus www.microfinacegateway.com

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