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An Alternative Approach to
Financing Micro, Small and Medium-Sized Enterprises:
Crowdinvesting with Profit-and-Loss Sharing Instruments
in the Middle East and North Africa,
with a Special Focus on the Arab Republic of Egypt
Atilla Yücel
A thesis submitted to the Finance Center Münster
in partial fulfillment of the requirements for the degree of
Master of Science in Business Administration – Finance and Accounting,
University of Münster.
October 29, 2013
II
Abstract
This paper investigates the use of Islamic profit-and-loss sharing instru-
ments and of cross-border crowdfunding for micro, small and medium-sized
enterprise finance in the Middle East and North Africa, focusing on Egypt to
include country-specific considerations. The equity-based financial instru-
ments, and crowdfunding as a funding channel, are assessed and a financing
scheme of profit-and-loss sharing crowdinvesting is developed, using the
results of a survey of experts and desk research. The proposed model aims
to foster smaller-scale enterprise finance based on a diminishing partnership
setting (musharakah mutanaqisah) by scaling down investments while using
the scope of partnering intermediaries, improving financial and investor in-
clusion. The remuneration scheme enables capacity building in enterprises,
thereby reducing risks. The technology on which this scheme rests can facil-
itate the transfer of information along with finance from domestic and for-
eign retail investors. Funding from institutional sources could further pro-
mote local investments. The model could advance finance for smaller-scale
firms where traditional financial intermediaries are reluctant or unable given
the limitations to resources and information. It seems viable with respect to
a set of criteria selected based on an analysis of the existing literature. Some
challenges remain, however, and further proof is required despite first evi-
dence confirming the validity of the basic features.
Keywords: crowdfunding, financial inclusion, financial sector develop-
ment, Islamic finance, microfinance, SME finance
III
Contents
List of abbreviations .................................................................................. VI
List of figures .............................................................................................. IX
List of tables ................................................................................................ XI
1 Introduction ........................................................................................... 1
2 Background and literature review ....................................................... 4
2.1 Micro, small and medium-sized enterprise finance .......................... 4
2.2 Islamic finance, Islamic microfinance and profit-and-loss
sharing instruments ........................................................................... 7
2.3 Crowdfunding ................................................................................. 11
3 Financial sectors and micro, small and medium-sized enterprise
finance in the Middle East and North Africa region ........................ 14
3.1 Micro, small and medium-sized enterprise sectors ........................ 14
3.2 Financial sector development ......................................................... 14
3.3 Legal and regulatory framework and financial infrastructure ........ 15
3.4 Financial institutions and other intermediaries ............................... 16
3.5 Financial access .............................................................................. 17
4 Criteria for a viable micro, small and medium-sized enterprise
financing scheme .................................................................................. 19
4.1 Income generation or enterprise development ................................ 19
4.2 Information asymmetry and risk mitigation ................................... 20
4.3 Cost efficiency and sustainability ................................................... 21
4.4 Legal and regulatory feasibility ...................................................... 22
5 Analysis of profit-and-loss sharing instruments and
crowdfunding for micro, small and medium-sized enterprise
finance with a focus on Egypt ............................................................. 23
5.1 Benefits of applying profit-and-loss sharing instruments ............... 23
5.2 Primary obstacles to applying profit-and-loss sharing instruments 25
5.2.1 Legal and regulatory framework ...................................... 25
5.2.2 Financial infrastructure .................................................... 26
5.2.3 Financial institutions ........................................................ 27
Contents IV
5.2.4 Financial access ................................................................ 28
5.3 Benefits of applying crowdfunding ................................................ 30
5.4 Primary obstacles to applying crowdfunding ................................. 33
5.4.1 Legal and regulatory framework ...................................... 33
5.4.2 Financial infrastructure .................................................... 35
5.4.3 Platform operators and financial institutions ................... 36
5.4.4 Financial access ................................................................ 37
6 Proposal of a financing scheme of profit-and-loss sharing
crowdinvesting in micro, small and medium-sized enterprises
in Egypt ................................................................................................. 39
6.1 Preliminary considerations ............................................................. 39
6.2 Target enterprises ........................................................................... 40
6.3 Financial instrument ....................................................................... 40
6.4 Crowdinvesting and financial intermediary and other partners ...... 41
6.5 Funding ........................................................................................... 41
6.5.1 Private placement and financial intermediation ............... 41
6.5.2 Distribution channels ....................................................... 42
6.5.3 Pre-selection, risk assessment and risk mitigation ........... 43
6.5.4 Information ....................................................................... 43
6.6 Crowdinvestors and other funding sources .................................... 44
6.7 Remuneration .................................................................................. 45
6.8 Final considerations and differentiation ......................................... 45
7 Final appraisal ..................................................................................... 46
8 Conclusion ............................................................................................ 47
Appendices
I Legal and regulatory frameworks for crowdinvesting .......................... 51
II Case of a crowdinvesting portal offering profit-and-loss sharing
instruments – Shekra in Egypt ............................................................... 53
III Migrant remittances and the Middle East and North Africa region ...... 58
IV Cases of down-scaling banks offering profit-and-loss sharing
instruments............................................................................................. 59
Contents V
V Additional considerations on the proposed financing scheme of
profit-and-loss sharing crowdinvesting in micro, small and
medium-sized enterprises in Egypt........................................................ 61
VI Tables..................................................................................................... 65
VII Figures ................................................................................................... 70
Directives, laws, regulations, and standards ............................................ 82
References ................................................................................................... 84
VI
List of abbreviations
ADIB Abu Dhabi Islamic Bank
AML Anti-Money Laundering
BGD Bangladesh
BHR Bahrain
BRN Brunei Darussalam
CBE Central Bank of Egypt
CF Crowdfunding
CFP Crowdfunding platform
CGAP Consultative Group to Assist the Poor
CI Crowdinvesting
CIP Crowdinvesting platform
CONSOB Commissione Nazionale per le Società e la Borsa
CTF Counter-Terrorism Financing
DFI Development finance institution
DJI Djibouti
DZA Algeria
EC European Commission
EFLRI Entrepreneurial Finance Lab Research Initiative
EFSA Egyptian Financial Supervisory Authority
EGP Egyptian pound
EGY Egypt
EU European Union
EUR Euro
FDI Foreign direct investment
FSD Financial sector development
G-20 Group of 20
GBR United Kingdom
GBR United Kingdom
GCC Gulf Cooperation Council
GDP Gross domestic product
List of abbreviations VII
GIZ Deutsche Gesellschaft für Internationale Zusammenarbeit
GmbH (German International Cooperation)
HIC High-income country
ICT Information and communication technology
IDN Indonesia
IF Islamic finance
IFC International Finance Corporation
IFSB Islamic Financial Services Board
IM Islamic microfinance
IMF International Monetary Fund
IMFI Islamic microfinance institution
IRN Iran
IRQ Iraq
JOR Jordan
KWT Kuwait
LBN Lebanon
LIC Low-income country
MAR Morocco
MENA Middle East and North Africa
MFC Microfinance service company
MFI Microfinance institution
MIC Middle-income country
MIV Microfinance investment vehicle
MIX Microfinance Information Exchange Market
MM Musharakah mutanaqisah
MSE Micro and small enterprise
MSME Micro, small and medium-sized enterprise
MYS Malaysia
NGC Non-GCC middle-income
NGO Non-governmental organization
NPV Net present value
OECD Organization for Economic Co-Operation and Development
List of abbreviations VIII
OHI OECD high-income
OMI Other middle-income
OMN Oman
PAK Pakistan
PE Private equity
PLS Profit-and-loss sharing
PSR Profit-sharing ratio
QAT Qatar
SAU Saudi Arabia
SDN Sudan
SEC Securities and Exchange Commission
SME Small and medium-sized enterprise
SSA Sub-Saharan Africa
SYR Syria
TUN Tunisia
TUR Turkey
UAE United Arab Emirates
USA United States of America
USD United States Dollar
VC Venture capital
YEM Yemen
IX
List of figures
Figure 1 – Conceptual overview of financing options for enterprises ...... 70
Figure 2 – Overview of financial access of micro, small and medium-
sized enterprises ...................................................................... 70
Figure 3 – Financial sector development in the Middle East and North
Africa in comparison to other regions ..................................... 71
Figure 4 – Financial sector development in countries of the Middle
East and North Africa .............................................................. 72
Figure 5 – Islamic finance landscape: global outreach and size of
leading markets ........................................................................ 73
Figure 6 – Islamic microfinance landscape: global outreach ................... 73
Figure 7 – Survey respondents agreeing/disagreeing with benefit of
applying profit-and-loss sharing instruments in micro, small
and medium-sized enterprise finance (n=38) .......................... 74
Figure 8 – Survey respondents choosing factor as most critical to
applying profit-and-loss sharing instruments in micro, small
and medium-sized enterprise finance (n=38) .......................... 75
Figure 9 – Survey respondents agreeing/disagreeing with benefit of
applying (cross-border) crowdfunding as a funding channel
in micro, small and medium-sized enterprise finance (n=38) . 76
Figure 10 – Survey respondents choosing factor as most critical to
applying (cross-border) crowdfunding as a funding channel
in micro, small and medium-sized enterprise finance (n=38) . 77
Figure 11 – Survey respondents agreeing/disagreeing with applicability
of crowdinvesting business model (n=38)............................... 78
Figure 12 – Survey respondents choosing option as most suitable for a
financing scheme of profit-and-loss sharing crowdinvesting
in micro, small and medium-sized enterprises (I) (n=38) ....... 79
Figure 13 – Survey respondents choosing option as most suitable for a
financing scheme of profit-and-loss sharing crowdinvesting
in micro, small and medium-sized enterprises (II) (n=38) ...... 80
List of figures X
Figure 14 – Survey respondents agreeing/disagreeing with supportive
measure (n=38) ........................................................................ 81
Figure 15 – International remittance inflows of countries of the Middle
East and North Africa .............................................................. 81
XI
List of tables
Table 1 – Stereotypical characteristics of micro, small and medium-
sized enterprises ...................................................................... 65
Table 2 – Indicators for assessing profit-and-loss sharing financial
instruments for micro, small and medium-sized enterprise
finance ..................................................................................... 66
Table 3 – Indicators for assessing crowdfunding as a funding channel
for micro, small and medium-sized enterprise finance ........... 67
Table 4 – Illustration of a (re)payment schedule in musharakah
mutanaqisah (diminishing partnership) ................................... 68
Table 5 – Illustration of a (re)payment schedule in musharakah
mutanaqisah (diminishing partnership) combined with
ijarah (leasing) ........................................................................ 69
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 1
1 Introduction
Micro, small and medium-sized enterprises (MSMEs) are main drivers in
job and wealth creation. In low and middle-income countries, they provide
around 45% of employment and a third of gross domestic product. Yet, they
severely lack access to capital: the funding gap is estimated at more than
USD 2 trillion.1 In the Middle East and North Africa (MENA), where youth
unemployment is the highest among developing countries,2 more than a
third of smaller-scale enterprises cites access to finance as a major con-
straint to growth, according to the World Bank Group's Enterprise Surveys.
The regional MSME funding gap is among the largest in relative terms.3
Notably, up to two thirds of individuals and entrepreneurs in the Muslim-
majority countries of the MENA region refrain from using conventional fi-
nancial services or prefer services that comply with their beliefs.4
This paper investigates Islamic profit-and-loss sharing (PLS) instruments
and cross-border crowdfunding (CF) as well as their complementary appli-
cation as an alternative approach to MSME finance in the MENA region.
Islamic finance adheres to principles that emphasize the financing of eco-
nomic activity while safeguarding social welfare. As outlined by the Con-
sultative Group to Assist the Poor, Islamic microfinance is seen as a key in
expanding financial access for millions of individuals and entrepreneurs.5
Still, the industry only has a small outreach, also due to its focus on instru-
ments that are inefficient or unprofitable, namely mark-up sale (Arabic:
murabaha) and benevolent loans (qard hassan). Further funding sources,
more efficient product delivery and convenient products are needed.6 Equi-
ty-based PLS instruments (e.g. musharakah) seem to offer a valid alterna-
1 IFC (2010a), pp. 6-13; Stein et al. (2010), p. 1; Ayyagari et al. (2007/2003). 2 IMF (2012), p. 51; Rocha et al. (2011), pp. 36/37. This paper uses the World Bank's
definition of the MENA; see footnote 59 on p. 14. 3 World Bank Group (2013); IFC (2012/2011a); Farazi et al. (2010); Stein et al. (2010). 4 According to IFC studies in Algeria, Jordan, Syria, Yemen etc. (Karim et al. 2008). 5 El-Zoghbi/Tarazi (2013); Khaled (2011); Karim et al. (2008). 6 El-Zoghbi/Tarazi (2013); Huda (2012); Sanabel (2012); Khaled (2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 2
tive and are favored by scholars as they stipulate the sharing of risks among
investors and investees. However, they are barely used by financial institu-
tions as issues of asymmetric information make them costly.
CF emerged in high-income countries in recent years as a means to fund
projects by collecting small contributions from a large group of investors
over the internet. Funding volumes resemble those of donations, (mi-
cro)loans, or private equity, and yet CF covers a funding gap that is not
served, or only barely, by traditional funding sources – especially for entre-
preneurs and firms that don't qualify for a bank credit because of insufficient
collateral or equity capital.7 Initial evidence suggests that CF is a potential
funding scheme for entrepreneurial finance across borders, including in low
and middle-income countries (LICs and MICs). However, cross-border CF
schemes are almost entirely donation- or debt-based, in which case interest
rates are still relatively high.
Could CF foster MSME finance by means of PLS where traditional interme-
diaries cannot? Based on the status of MSME finance in the MENA region,
and the challenges facing it, the aim of this paper is to assess PLS as well as
CF and to suggest a viable complementary financing scheme for MSMEs.
To date, there is almost no research on CF in MSME finance in developing
countries, let alone on crowdinvesting (CI) with PLS instruments. The ra-
tionale for this paper is that PLS instruments advocate entrepreneurship –
donations need to be targeted at the extremely poor. Equity capital allows
the sharing of risks in times of economic or financial distress and enables
the financing of enterprise growth, which can lead to employment genera-
tion, income, productivity and economic growth. CF unlocks direct access
to investors looking for semi-commercial or "impact-first"8 investments,
allows outsourcing tasks and diversifying the investor base to spread risks.
7 Belleflamme et al. (2013a/b); Lehner (2013); De Buysere et al. (2012); Giudici et al.
(2012); Hornuf/Klöhn (2012). 8 El-Zoghbi/Gonzalez (2013), p. 2.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 3
The author assumes that a diminishing partnership (musharakah
mutanaqisah) in particular is a suitable PLS instrument for a prospective
financing scheme. CF helps in screening projects while supporting entrepre-
neurs. A cross-border PLS CI scheme can be applied in collaboration with
financial intermediaries in order to expand financial access of MSMEs
while collecting funds from individual, public and private institutional in-
vestors, provided that legal, infrastructural and institutional hurdles and
those pertaining to the provision of financing to MSMEs can be overcome.
This paper assesses the application of PLS instruments and CF (as a funding
channel in the context of development finance) in MSME finance with a fo-
cus on Egypt using a set of indicators. These were compiled based on an
analysis of the existing literature. A PLS CI financing scheme for MSMEs is
developed for Egypt, considering country-specific conditions. The results of
a survey, that also tested the indicators, give direction to the analysis and the
development of the proposed model, both supplemented by desk research.
For the paper, the literature and data on the subject were reviewed, existing
CF schemes examined and relevant cases studied. A total of 38 scholars and
practitioners were surveyed about PLS, CF and PLS CI in MSMEs; target
respondents were 310 experts within the areas of financial or private sector
development and/or with a focus on MSME finance, Islamic finance, or CF.
The survey was laid out for MICs to reach a wider circle of experts. The
analysis focuses on Egypt, where the German International Cooperation is
implementing financial sector development measures and where political
unrest was limited prior to July 2013. However, scholarship-aided field re-
search had to be cancelled due to the deterioration of the political situation.
The paper starts with a literature review. This description and subsequent
examination of financial systems and MSME finance in the MENA lay the
groundwork for the rest of the paper. The paper continues by introducing the
criteria for a viable financing scheme, summarizing the indicators, before
moving on to the analysis. Then, a PLS CI scheme is proposed as part of the
local financial system. The paper ends with a final appraisal and conclusion.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 4
2 Background and literature review
2.1 Micro, small and medium-sized enterprise finance
MSME finance addresses a diverse segment of the private sector, constitut-
ed of firms in the lower and middle ranges in terms of size, and served by
different types of financial institutions. Despite their importance, these firms
severely lack finance in the majority countries.
MSMEs are a heterogeneous group. Definitions of firm size depend on
turnover, number of employees or lending volumes, but they vary across
countries and banks. For example, according to the definition used in Egypt,
micro enterprises have 1 to 5 employees, small enterprises have 6 to 10 em-
ployees, and medium-sized enterprises have 11 to 100 employees. The In-
ternational Finance Corporation (IFC) on the other hand defines MSMEs as
having 1 to 9, 10 to 49, and 50 to 250 employees, respectively.9 In terms of
lending volumes, by definition, micro enterprises are extended loans up to
USD 10,000, small enterprises up to USD 100,000 and medium-sized enter-
prises up to USD 1 million. MSMEs can further be divided into formal (reg-
istered) enterprises and informal and non-employer enterprises, a large and
hard to measure sub-group.10 In LICs and MICs worldwide, the number of
formal MSMEs is estimated at 80 to 100 million. Around 70% are micro
and 30% are small and medium-sized enterprises (SMEs). The total number
of formal and informal MSMEs is estimated at 365 to 445 million.11
Generally, financial services to MSMEs are provided by commercial banks,
microfinance institutions (MFIs), cooperative banks or credit unions, and
funds. Depending on the number of loans and the value of loan portfolios,
micro (and very small) enterprises are typically served by MFIs, while the
SME clientele is primarily targeted by banks.12 More specifically, in an at-
tempt to promote income growth, MFIs generally serve financially exclud-
9 Alternatively, micro enterprises (1 to 4) and very small enterprises (5 to 9 employees). 10 IFC (2011/2010); Farazi et al. (2010); Stein et al. (2010); Ayyagari et al. (2007/2003). 11 Based on IFC's definition. IFC (2010a); Kushnir et al. (2010); Stein et al. (2010). 12 Glisovic/Martinez (2012); IFC (2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 5
ed, low-income individuals as well as micro enterprises. Because micro and
small enterprises (MSEs) have many features in common that distinguish
them to medium-sized enterprises (see table 1), down-scaling banks, up-
scaling MFIs, and specialized institutions have started to reach out to the
MSE group as a whole.13 Finally, there is a growing trend of equity funds
(local, regional, funds of funds; funded by retail or public and private insti-
tutional investors such as development finance institutions; DFIs) and pri-
vate equity (PE) and venture capital (VC) firms investing in the MSME sec-
tor in emerging markets. Impact investment funds such as microfinance in-
vestment vehicles (MIVs) and SME funds aim to generate social and envi-
ronmental as well as financial returns. However, the sector lacks intermedi-
aries such as incubators promoting investment-ready firms to meet investors'
demand.14 Overall, an overview of financing options that are available to
MSMEs provides a first hint of the deficiencies in funding sources available
to firms at the lower size range (figure 1).
Financial sector development (FSD) and financial access of MSMEs are
critical for private sector development; they are crucial for investments, for
employment generation, for income and for economic growth.15 Yet, it is
estimated that 85% of all formal and informal MSMEs in developing coun-
tries suffer from financing constraints; two thirds are financially excluded.
The total credit gap for these enterprises is estimated at USD 2.1 to 2.5 tril-
lion (figure 2), around 14% of total gross domestic product (GDP) or one-
third of the volume in outstanding credit to MSMEs in these countries. The
13 Metzger (2013); Glisovic/Martinez (2012); BFC (2011); IFC (2011); Hashemi et al.
(2003). 14 El-Zoghbi/Gonzalez (2013); IFC (2010a); Stein et al. (2010). 15 Allen et al. (2012); Cull et al. (2012); Ardic et al. (2011); Beck et al. (2011a); Pearce
(2011). FSD plays a supportive role for economic growth: financial deepening helps in-dustries to fund investments and reduces financing constraints, especially of smaller firms (Beck et al. 2005; Rajan/Zingales 1998), positively affecting the economy (Demirgüç-Kunt et al. 2006). Expanding the financial access of enterprises is critical (Beck et al. 2009). Access to finance or financial inclusion, i.e. the provision of formal financial services to unserved/underserved households and firms, usually covers a range of financial services. This paper focuses on access to funds.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 6
funding gap results from the discrepancy between these firms' specific fi-
nancial needs and the supply of services by financial institutions.16
Financial exclusion is caused by many factors. The literature points to weak
creditor rights, collateral and insolvency regimes, credit reporting systems
and a lack of accounting and auditing practices – all factors that would re-
duce risks from information asymmetry – as the main obstacles in the envi-
ronment of entrepreneurial and corporate finance. Additionally, micro en-
terprises generally lack sufficient collateral or regular cash flows while
smaller firms tend to have a weak capital base. These deficiencies "make
expanding access to finance costly and risky"17 and require economically
sustainable ways to provide funding to both existing clients that are under-
served and to potential clients that are not served at all, the majority of
which are formal micro and informal enterprises.18
Overall, in order to improve MSME finance, public and private stakeholders
need to take actions at three levels: (i) the enabling environment, i.e. the le-
gal and regulatory framework (encourage bank entry, competition and lend-
ing as well as business registration) and the financial infrastructure (stipu-
late accounting and auditing standards, establish public credit registries and
private credit bureaus, and efficient payment systems); (ii) financial institu-
tions (optimize business models: funding, products, service delivery); (iii)
financial access (develop bank lending to SMEs and microfinance, support
down/up-scaling of institutions, implement public support schemes or risk
mitigation initiatives to foster lending and expand financial access).19
16 Based on IFC's MSME definition. SMEs account for more than 30% of the gap, for less
than 10% of all MSMEs. IFC (2010a); Stein et al. (2010); Beck/Demirgüç-Kunt (2006). 17 Pearce (2011), p. 4. 18 Allen et al. (2012); Demirgüç-Kunt/Klapper (2012); Glisovic/Martinez (2012); Iqbal et
al. (2011); Farazi et al. (2010); IFC (2010a); Stein et al. (2010). 19 Arvai et al. (2011); Pearce (2011); Rocha et al. (2011); IFC (2010a); Stein et al. (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 7
2.2 Islamic finance, Islamic microfinance and profit-and-loss shar-
ing instruments
The principles set forth in Islam led to the emergence of the interest-free and
risk-sharing instruments of Islamic finance (IF). Islamic microfinance (IM)
promotes financial access, but it has yet to achieve scale. The PLS instru-
ments hold promise for entrepreneurs, but they still face some challenges.
IF encompasses financial transactions that conform to Islamic law and juris-
prudence.20 The principles of IF are derived from these sources that promote
the financing of economic activity while safeguarding social justice and
welfare. Any contractual terms underlying financial relationships are basi-
cally permitted unless expressly prohibited.21 Prohibitions include (i) riba
(interest or usury; any unjustifiable excess, or any pre-specified yield guar-
anteed independent of the return of an investment); (ii) gharar (uncertainty
that can be prevented; speculative or ambiguous arrangements such as deri-
vate instruments); (iii) maysir (gambling; activities such as short-selling);
(iv) haram (forbidden activities; funding businesses that trade in impermis-
sible products such as alcohol or firearms).22
IF stipulates the earning of profits from transactions backed by tangible as-
sets and from investments in which risks (and returns) are shared between
lenders and borrowers or investors and investees.23 The requirement of in-
terest-free financing in spite of risky investments led to the emergence of
several instruments that adhere to the principles of IF while resembling con-
ventional instruments.24 These can be broadly categorized into asset-based
(e.g. leasing; ijarah), debt-based (primarily, mark-up sale or cost-plus sale
of an asset; murabaha), and equity-based (PLS) instruments, which will be
20 Islamic law (sharia or shari'ah) covers the holy book (qur'an) and the actions/sayings of
the prophet (sunnah/hadith). Islamic jurisprudence (fiqh) includes consensus among scholars/jurists (ijmah) and deduction from law/reference to former cases (qiyas).
21 Iqbal et al. (2011); Jobst (2007); Iqbal/Molyneux (2005); Lewis/Algaoud (2001). 22 Jobst (2007); Iqbal/Mirakhor (2006), Iqbal/Tsubota (2006), Iqbal/Llewellyn (2000) in
Jobst (2007), p. 4; El-Gamal (2006); Iqbal/Molyneux (2005); Lewis/Algaoud (2001). 23 Beck et al. (2011a), pp. 100/101; Karim et al. (2008); Jobst (2007). 24 Beck et al. (2010); Jobst (2007).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 8
presented in more detail below. Finally, the redistributive instruments of ob-
ligatory alms (zakat), benevolent loans (qard hassan), donations (sadaqah),
and trusts (waqf) aim to foster social justice.25
IM has received much attention from practitioners and academics. It repre-
sents the combination of microfinance and IF, both of which have similar
elements, particularly their focus on social welfare and their advocacy of
entrepreneurship. IM is recognized as being a key mechanism for expanding
financial access of millions of low-income individuals and entrepreneurs in
Muslim-majority countries who do not use conventional financial services
out of religious convictions, or who would prefer services that comply with
their beliefs – be they of a religious or a cultural nature.26
However, IM still has a limited outreach relative to conventional micro-
finance (around 1% in terms of clients), despite a rapid increase in the glob-
al number of providers and clients in recent years. The concentration on
murabaha financing and benevolent loans, a limited experience with PLS
and funding constraints of providers have hindered a wider outreach and
prevented the industry from reaching scale. More specifically, the depend-
ence on tangible assets in murabaha, which doesn't permit the disbursement
of cash, lead to relatively high transaction costs compared to conventional
microcredit, challenging the efficiency of IM institutions (IMFIs). There is a
growing consensus that further exploration of the actual demand for IF and
IM, of customer preferences in the light of product pricing, and of sustaina-
ble business models is required. Therefore, the German International Coop-
eration (GIZ) and the Consultative Group to Assist the Poor (CGAP) are
conducting a demand-side and a cost-efficiency study in the MENA region
at the time of writing. The industry itself on the other hand needs to find fur-
25 Iqbal et al. (2011); Ismail/Smolo (2011); Khaled (2011); Jobst (2007). 26 El-Zoghbi/Tarazi (2013); Khaled (2011); Karim et al. (2008); Dhumale/Sapcanin
(1999).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 9
ther (commercial) funding sources, experiment with more convenient prod-
ucts, also cash-based ones, and improve the efficiency of product delivery.27
Despite their limited use in banking and microfinance, PLS instruments are
considered as the most preferable IF modes by scholars as they best adhere
to the principles of IF.28 In PLS contracts, two or more parties basically
agree to share any profits (and losses) of a project based on a pre-specified,
mutually agreed profit sharing ratio (PSR). Investors must not be guaranteed
any payments from the venture.
More specifically, in a mudarabah scheme (similar to VC or trustee financ-
ing), one party (investor) provides all funding for a venture and obtains
ownership in equity. The other party (entrepreneur) manages the venture
with regard to pre-specified objectives and may use the funds on a restricted
(narrowly defined investment criteria) or unrestricted basis. Any losses are
borne solely by the lender unless they have occurred due to misconduct or
breach of the terms of reference by the borrower. In a musharakah contract
(similar to a joint venture), two or more parties agree to make capital (or in-
kind) contributions to a venture. Profits are shared in proportion to the share
in capital or another pre-specified PSR, i.e. the entrepreneur may receive an
additional share in profits for his management. Both ownership and losses
are shared on the basis of each party's financial contribution. In a
musharakah mutanaqisah setting (referred to as diminishing partnership;
MM), the entrepreneur gradually buys out the investor.29 Finally, PLS can
be used for depositor funds, with unrestricted as well as restricted or special
investment accounts (besides interest-free demand deposits).30
27 El-Zoghbi/Tarazi (2013); Sanabel (2012); Khaled (2011); Pearce (2011); Ahmed (2002). 28 El-Zoghbi/Tarazi (2013); Abou-Gabal et al. (2011); Shaikh (2011). 29 Hanif (2011); Ismail/Smolo (2011); Usmani (2010/1998); Sadique (2008); Ahmed
(2007), pp. 54-64; Jobst (2007); IFSB-2, title C.5, sec. 1, para. 168-170. 30 Unrestricted: funds are used for investment activities; available at any time; quasi-equity
in an economic sense. Restricted: funds are invested in pre-agreed projects/sectors until maturity; non-voting equity in an economic sense (Ali 2011, pp. 5-8/18 ff.).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 10
Proponents of PLS instruments emphasize their feature of sharing profits
and risks, in contrast to mandatory servicing of debt regardless of project
outcomes. It has been argued that unlevered firms, that use participatory
PLS financing modes, are more resilient to macroeconomic shocks than lev-
ered firms,31 and that PLS financing based on MM is profitable and superior
to debt from the standpoint of both investors and investees.32 On the other
hand, there is agreement that the limited use of PLS instruments is due to
the risks arising from asymmetric information. It has been suggested that the
IM industry has mostly relied on murabaha and qard hassan loans because
the use of PLS would be associated with higher operating costs due to in-
formation asymmetries, especially with respect to smaller-scale firms.33
Suggestions to address this issue are multifaceted: Some analyze the effects
of variations in the PSR on adverse selection and adjust the payoff structure
in PLS to curb moral hazard.34 Others argue that issues of information
asymmetry can be reduced by introducing capital contribution and loss-
sharing by the investee.35 In fact, musharakah includes both features. Re-
searchers at Harvard University developed a set of psychometric tests in or-
der to overcome the issues of asymmetric information in MSME finance at
"low transaction costs and with few information requirements".36 Some
scholars have suggested applying group lending (peer selection/monitoring)
to musharakah, thereby providing social collateral (joint guarantee) and re-
ducing operating expenses.37 Above all, in an experimental setting, it has
been found that PLS contracts perform better than interest-based contracts
in terms of truthful reporting and (re)payment discipline.38
31 Shaikh (2010a). Akacem/Gilliam (2002) argue that banking systems would be more
resilient to shocks. Wilson (1993) stresses the positive impact on the economy. 32 Saad/Razak (2011). However, they neglect risks arising from information asymmetry. 33 El-Zoghbi/Tarazi (2013); Abou-Gabal et al. (2011); Hanif/Iqbal (2010). 34 Jouaber/Mehri (2012/2011). 35 E.g. Shaikh (2011/2010b). 36 Abou-Gabal et al. (2011), p. 6. 37 Ahmed (2007), pp. 61/290 with reference to Abdalla (1999/1997) and Ibrahim (2004). 38 El-Komi/Croson (2012). They assume that borrowers feel more obliged to comply with
contractual terms in return for the perceived fairness, i.e. the risk-sharing feature.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 11
2.3 Crowdfunding
Having initially emerged in industrialized countries as an online, social form
of peer-to-peer funding via intermediary platforms, CF (or crowd-funding)
appears as a suitable funding scheme for MSMEs in emerging markets, too.
In recent years, CF has emerged as a means to fund projects by aggregating
small contributions made directly by a large group of individuals. Concep-
tually, combining the wisdom of the crowd (crowdsourcing)39 and finance, it
is “an open call, essentially through the Internet, for the provision of finan-
cial resources either in form of donation or in exchange for some form of
[monetary, material or social] reward and/or voting rights”40. CF thus repre-
sents an alternative scheme for the delivery of funds and allows start-ups
and firms "to raise capital from sources beyond conventional ones".41
Theoretically, CF avoids traditional financial intermediaries. In practice,
project initiators (entrepreneurs) and capital contributors (crowdfunders or
crowdinvestors; private donors, lenders, investors) are brought together on a
growing number of online CF platforms (CFPs) where communication be-
tween all parties takes place during and after the funding phase.42 A bank or
financial service provider facilitates escrow and payment services. Depend-
ing on the financing method and the rights of contributors, CFPs can be cat-
egorized as equity-based (CI or crowd-investing) and lending-based (both
yield financial returns), donation-based (mostly philanthropic), and reward-
based, i.e. based on non-monetary rewards or the pre-ordering of products.43
39 The "practice of insourcing contributions and skills in a distributed manner from indi-
viduals to develop products/services or solving (...) problems" (Giudici et al. 2012, pp. 2/3 with reference to Surowiecki 2004).
40 Belleflamme et al. (2013a, p. 8) and Larralde/Schwienbacher (2010, p. 4) based on Lambert/Schwienbacher (2010, p. 6) and Klemann et al. (2008, p. 6).
41 Giudici et al. (2012), p. 2. That is, family, friends, the state, MFIs, banks and angel/VC investors. Cf. Lehner (2013), De Buysere et al. (2012), Firth (2012), Hornuf/Klöhn (2012), pp. 237/255/256, Lambert/Schwienbacher (2010).
42 This paper uses crowdfunder/crowdinvestor instead of crowd-funder/crowd-investor. 43 Belleflamme et al. (2013a/b); De Buysere et al. (2012); Giudici et al. (2012); Ibra-
him/Verliyantina (2011); Larralde/Schwienbacher (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 12
CFPs work on an ex ante (projects start upon successful fundraising) or ex
post basis (funding completed projects).44 Usually, CFPs pre-select project
proposals; funds must be raised in a limited period and/or up to a specified
target. Contributions can be as small as USD 5. Depending on the lower and
upper limits, funding volumes can range from a few hundred dollars to USD
10 million: This resembles (micro)loans, angel investments, VC or PE, and
yet covers a funding gap, somewhere in the range of USD 10,000 to 2 mil-
lion, that is typically not, or only barely, served by traditional funding
sources.45 However, average volumes are below USD 10,000.46
Most CFPs operate in the United States (USA) and Europe and are reward
or donation-based. Around one million campaigns raised an estimated USD
1.5 billion in 2011. Donations dominate by number of projects. Average
funding volumes are larger in the equity and lending category.47 Depending
on the country-specific context, CI remains limited due to regulatory hurdles
or other legal complexities pertaining to (private) equity financing. This
raises the important – if not the most important – question of the degree to
which provisions that safeguard investor protection can be lowered for the
sake of expanding finance to smaller-scale firms (see Appendix I).48
CF emerged with the advancement of information and communication tech-
nology (ICT) in high-income countries (HICs). However, it "typically tar-
gets enterprises that usually fit the SME (...) and start-up archetypes, (...)
enterprises that have the greatest difficulty in accessing finance in develop-
44 Rubinton (2011); Kappel (2009). 45 Strongly depending on income levels, microloans cover amounts from a few hundreds
of dollars up to USD 30,000, angel investments range from USD 20,000 to 1 million, VC from USD 200,000 to 5 million, PE deals with even larger amounts. However, the availability of the latter three is relatively limited (Belleflamme et al. 2013b, p. 4 with reference to Linde/Prasad 2000; Dapp 2013; Lehner 2013; Ashta et al. 2012). Regarding CI, a comparison can be drawn to what Ashta et al. (2012, pp. 356/357) define as micro-investments of micro-angels: "as low as $10 per month pooled together to invest $1,000 after a few months" whereby "capital will be returned with (...) financial or social gain."
46 Belleflamme et al. (2013b); Dapp (2013); Eisfeld-Reschke/Wenzlaff (2011). 47 Crowdsourcing LLC (2012). 48 Lehner (2013); De Buysere et al. (2012); Hornuf/Klöhn (2012), pp. 252-260 and cf.
Bradford (2012a/b), pp. 115/116; Röthler/Wenzlaff (2011); Rubinton (2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 13
ing countries."49 To date, the combination of CF and micro or SME finance
in these countries, is basically represented by two models. In the first, a few
international, mostly ex post and donation or debt-based CFPs let individu-
als from HICs donate money or lend it on charitable terms, starting at USD
25, to partnering MFIs that, ex post, refund microloans to clients in LICs
and MICs.50 In the second model, CFPs operate in these countries and try to
attract individual local, regional or international capital contributors.51 There
are at least three active IF CFPs: one, Shekra, is an equity-based CI platform
(CIP) and presented in detail in Appendix II.52
Presumably, ex ante CF, and especially CI, seem promising in terms of in-
formation, control, risk sharing, and accessing new funding sources.53 De-
spite a debate about their use in promoting entrepreneurial finance, migrant
remittances could be channeled through CF to foster MSME finance in
MENA countries.54 Public support schemes or private guarantees could
stimulate CF by creating incentives for commercial financiers.55 In collabo-
ration with banks or MFIs, CF could be implemented as an integral funding
scheme.56 Still, the role of CF in financing growth of SMEs beyond start-
ups has to be examined.57 Legal or regulatory and infrastructural barriers
pose a challenge to the implementation of cross-border CF.58
49 Lemma (2013); cf. Persson (2012); cf. Everett (2010). 50 Betterplace.org, bluebees.fr, eureeca.com, kiva.org, microworld.org, to name a few. 51 Cumplo.cl, shekra.com, socialproject.ph, and zafen.org, to name a few. 52 Zoomaal.com (Lebanon), yomken.com (Egypt), and shekra.com (Egypt). 53 Lehner (2013); Everett (2010). 54 Metzger (2013). 55 Funding Circle (n.d.a) and Niesen et al. (2013), respectively. 56 Niesen et al. (2013). 57 Hynes (2009). 58 Lemma (2013).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 14
3 Financial sectors and micro, small and medium-sized
enterprise finance in the Middle East and North Afri-
ca region
3.1 Micro, small and medium-sized enterprise sectors
In the MENA region,59 the formal MSME sector comprises 4.5 to 7 million
firms. Approximately 77% are micro enterprises, 16% are small and 7% are
medium-sized enterprises. However, the different markets in the region have
different MSME landscapes. Egypt, for instance, has 2.5 million MSMEs, of
which 98% are micro enterprises and 2% are SMEs. When the informal sec-
tor is taken into account, the total number of MSMEs in the region is esti-
mated at 19 to 23 million.60
3.2 Financial sector development
By international standards, the MENA region has a moderate level of FSD.
Financial systems are dominated by relatively large banking sectors while
the non-bank financial sectors (MFIs, cooperatives, investment firms etc.)
are mostly underdeveloped. However, at the sub-regional level, financial
systems show different degrees of size and depth. The Gulf Cooperation
Council (GCC) is composed of oil-exporting HICs which have larger bank-
ing sectors than the non-GCC, mostly MICs, which are more diverse.61
The different stages of FSD in the sub-regions are reflected by the varying
degrees of financial sector depth (see figure 3): Credit to the private sector
relative to GDP, indicating the financial system's ability to direct savings to
59 This paper uses the World Bank's definition of the MENA, according to which the re-
gion includes Algeria, Bahrain*, Djibouti, Egypt, Iran, Iraq, Israel, Jordan, Kuwait*, Lebanon, Libya, Malta, Morocco, Oman*, Qatar*, Saudi Arabia*, Syria, Tunisia, United Arab Emirates* (UAE), Yemen. The Palestinian territories are also included. *Countries of the Gulf Cooperation Council (GCC).
60 The segmentation of the regional MSME sector is an approximation, as country defini-tions can vary. Medians of formal MSME sub-groups are 89.1%, 9.2%, 1.6%, respec-tively. In Egypt, 1.7% are small and 0.1% are medium-sized enterprises (IFC 2010b; MSME Country Indicators). IFC (2010a); Kushnir et al. (2010); Stein et al. (2010).
61 Rocha et al. (2011), pp. 67-69/73-75; Anzoategui et al. (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 15
the economy, has stagnated in the non-GCC sub-region.62 The lower ratio
indicates a higher degree of government financing by banks.63 Within the
non-GCC, Morocco, Tunisia and Jordan are in the lead in financial depth
(with credit-to-GDP ratios above the GCC average); Egypt has dropped be-
low the average (figure 4). Different dimensions of financial depth and cor-
responding GDP growth rates across countries indicate that FSD, which re-
duces financing constraints of MSMEs, positively impacts the economy.64
Related to financial development (Appendix III), remittance inflows relative
to GDP in the MENA region are among the highest worldwide. The region
has both sending (GCC) and receiving (non-GCC) countries. For example,
Egypt received half of its remittances from Saudi Arabia in 2011.65
3.3 Legal and regulatory framework and financial infrastructure
Whereas banks in the majority countries generally name macroeconomic
issues as the primary challenge to providing financial services to smaller-
scale firms, the main impediments for banks in the MENA are a weak legal
or contractual framework and financial infrastructure. Both strengthened
creditor rights (e.g. collateral enforcement) and credit reference bureaus are
seen as priority issues to improve MSME lending in the region. The regula-
tory framework is generally less of a concern for banks, but is seen as an
important determinant for MSME finance in the MENA.66 However, in
some countries of the region investors are reluctant or unable to finance
MFIs, or MFIs are restricted from taking deposits (except in Syria and
Yemen) due to lacking or inadequate legislation and regulation.67
62 FSD is commonly described by financial depth, the size of a financial sector compared
to the economy. It is measured by the volume of credit to the private sector relative to GDP. Beck/Witte (2013); World Bank (2013a); Beck et al. (2011a); footnote 15, p. 5.
63 Average deposit volumes are similar in both sub-regions; average credit-to-deposit ratio is lower in the non-GCC. Zaki (2013); Rocha et al. (2011), pp. 74/77.
64 Beck et al. (2011a); Beck et al. (2005); Rajan/Zingales (1998). 65 CGAP (2013a); IMF (2012); Cirasion/Nicoli (2010). 66 World Bank (2011); Beck et al. (2011b/2008); De la Torre et al. (2010); Farazi et al.
(2010); IFC (2010a). 67 MIX/Sanabel (2011), p. 14; Pearce (2011), pp. 19 ff.; Sanabel (2010a), p. 17.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 16
3.4 Financial institutions and other intermediaries
Banking sectors in the MENA region, relative to size and depth, are less
competitive compared to other world regions due to strict regulations for
bank entry or weak credit information. Competition, which would contribute
to improving MSME finance, is even worse in the GCC.68 It is the saturation
of traditional markets, the profitability of SMEs and the motive to diversify
risks that push banks into the market of smaller-scale enterprises. Despite
state banks being very present (e.g. covering half of banking assets in
Egypt), neither the ownership nor the size of banks plays a primary role in
financing (M)SMEs. Instead, large branch networks and separate, dedicated
units are the main characteristics of banks conducting (M)SME finance, in-
dicating that relationships compensate for a weak financial infrastructure.69
The outreach of MFIs has remained limited. Microfinance providers are
primarily present in Morocco, Egypt (over 400 NGOs, a few microfinance
companies (MFCs), four banks), Jordan, Palestine, Iraq, Tunisia, and Yem-
en.70 Compared to other regions, the sector is relatively small and receives
the fewest funds from foreign investors, making it largely dependent on do-
nations. Contrary to global developments, the region has witnessed a reduc-
tion in investments by MIVs in recent years.71 Finally, regional investment
funds are rather small. Equity and IF funds as well as investment firms are
found primarily in the GCC.72
The global IF industry (see figure 5) is largely composed of banks. Almost
two-thirds of global Islamic banking assets are concentrated in the GCC.
68 In contrast to some theories (Petersen/Rajan 1995), competition is negatively correlated
with prices, positively correlated with access. World Bank (2013a); Anzoategui et al. (2010); Beck et al. (2006/2004); Cetorelli/Strahan (2006); Koskela/Stenbacka (2000).
69 State banks are present in the non-GCC. Egypt has five state banks; a total of 39 banks. Zaki (2013); Farazi et al. (2011/2010); De la Torre et al. (2010); IFC (2010a).
70 In Egypt, MFCs Reefy and Tanmeyah offer microloans to MSEs in cooperation with banks (that have a stake in the MFC). Banks providing microloans are ADIB, Banque du Caire, Banque Misr, Bank of Alexandria (EFSA 2010).
71 El-Zoghbi/Gonzalez (2013); Lahaye/Rizvanolli (2012); MIX/Sanabel (2012/2011); Symbiotics (2012); Rocha et al. (2011), pp. 69 ff./84/109.
72 Rocha et al. (2011); Mako/Sourrouille (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 17
Islamic banks in the MENA (GCC) have a market share of 14% (20%). In
Egypt, three Islamic banks and eleven conventional banks with dedicated
divisions account for 5% of the market.73 Murabaha, with a market share of
75%, is the dominant instruments in the MENA. PLS (mudarabah) is of-
fered in Saudi Arabia (30%) but is barely used elsewhere.74
IM on the other hand is concentrated in a few countries (figure 6). The re-
gion covers about 28% of the estimated 255 to 300 providers and only 14%
of the 1.3 million clients worldwide. Egypt accounts for 1% of clients.
IMFIs are mostly (unregulated) NGOs and relatively small. They only con-
tribute a fraction to overall microfinance supply. Products are largely lim-
ited to murabaha and qard hassan loans both in terms of portfolio volumes
and of number of clients. Banks offering IM have a wider outreach. A few
banks have scaled down, providing PLS instruments (Appendix IV).75
3.5 Financial access
Financial inclusion in the region has improved in recent years. There still
remain overall weaknesses, and most countries underperform in providing
smaller-scale firms with financial services compared to financial sector
depth and to other economies with similar GDP levels.76 Over 60% of the
approximately 23 million formal and informal regional MSMEs has neither
a loan nor an overdraft account, while more than a half have a deposit or
savings account. The situation is similar for the 2 million formal SMEs.
73 In terms of assets. Around half (a third) of banks in the GCC (non-GCC) offer IF prod-
ucts. In Egypt, Faisal Islamic Bank, Al Baraka Bank, ADIB are full-fledged Islamic banks; others such as Ahli United operate Islamic banking windows. CBE (2012); Ernst & Young (2012); Standard & Poor's (2012); Zawya (2012); Farazi et al. (2010).
74 2008 data. Ali (2011). 75 PLS can be found in Indonesia, Sudan and Malaysia. El-Zoghbi/Tarazi (2013); Zawya
(2013); Sanabel (2012); Pearce (2011); Seibel (2011); Karim et al. (2008). 76 Financial depth and access are recognized as being two separate dimensions of FSD that
are assumed to be correlated. Pearce (2011); Rocha et al. (2011), pp. 95 ff.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 18
Around 40% of SMEs in the region as well as in Egypt cite access to fi-
nance as a major constraint to growth, which is above the global average.77
The regional MSME funding gap is estimated at USD 200 billion. The fund-
ing gap for SMEs is estimated at USD 110 to 140 billion. As SMEs make up
a smaller share of all MSMEs, the funding gap is not evenly distributed. The
MSME funding gap in the MENA region is not the largest in absolute terms
compared to other regions, but it is among the largest relative to the number
of firms (see figure 2). The SME funding gap (referred to as the missing
middle) is one of the largest relative to outstanding credit.78 Bank credit is
the dominant source of external finance for SMEs to fund investments.79
However, banks lend predominantly to large enterprises, despite having an
interest in entering the SME market: on average, SME lending accounts on-
ly for 8% (5%) of the regional (Egyptian) bank portfolios.80
Access to finance is even worse for micro and informal enterprises, roughly
three quarters of which are said to be unserved or underserved. They are
harder and more expensive to serve due to the lack of a track record, insuffi-
cient collateral, a lower revenue potential or their location in rural areas, re-
sulting in interest rates on loans of around 27% on average.81 Microcredit
from MFIs is limited in scale relative to GDP and bank credit in the region.
Loans and borrowers are concentrated in Morocco and Egypt (0.9 million
clients) and in a small number of MFIs; the SME portfolio accounts for 5%
of the total portfolio of MFIs in the region.82
77 Based on Egypt's MSME definition. Specifically, 40.5% and 38.9% of small and medi-
um-sized enterprises in the region (45.5% and 27.9% of SMEs in Egypt), respectively. World Bank Group (2013); Rocha et al. (2011), pp. 96/97; Stein et al. (2010).
78 Stein et al. (2010), pp. 3-6. 79 Rocha et al. (2011), pp. 73 ff.; cf. World Bank Group (2013). 80 In the non-GCC, SME lending is highest in Morocco, Lebanon, Tunisia; lowest in Egypt
and Syria. Farazi et al. (2010); Beck et al. (2008). 81 Ford et al. (2013), p. 21; EFSA (2010), pp. 7/8; Stein et al. (2010), pp. 3/7. 82 The MENA reveals a loan portfolio of USD 1.5 billion and between 2.3 and 3 million
borrowers (2011), i.e. around 2% of the working age population and half the penetration in South Asia/Latin America. MIX/Sanabel (2012); Pearce (2011); Rocha et al. (2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 19
4 Criteria for a viable micro, small and medium-sized
enterprise financing scheme
4.1 Income generation or enterprise development
Below, four criteria for a viable MSME financing scheme are presented: in-
come generation or enterprise development, information asymmetry and risk
mitigation, cost efficiency and sustainability, legal and regulatory feasibil-
ity.83 The first criterion for the development and assessment of a financing
scheme concerns its capability to facilitate income generation (or enterprise
establishment), which aims to help clients escape from the poverty trap, or
enterprise development, which fosters sustainable income and productivity
growth.84 Both the delivery and the type of finance matter for the use of
funds and their impact. For instance, the concept of microfinance, as pro-
moted by the economist Muhammad Yunus since the 1980s, emerged as a
tool to financially support poor individuals in performing income-generating
activities. The extension of microloans for the formation of (informal) mi-
cro-enterprises at the low-income level aimed at eradicating poverty and
promoting economic development from the bottom up.85
However, critics point out that the industry has deviated from this original
goal, and furthermore that there is still no firm evidence that microloans
have a positive impact.86 The commercialization of the industry and the shift
of focus of many MFIs to maximizing profits have led to rapid portfolio
growth, excessive lending (e.g. multiple loans, loans for consumption) and
exorbitant interest rates at the expense of client protection, resulting in over-
indebted borrowers, defaults, loss of assets or social tragedies.87
83 The criteria are interdependent, and assigned indicators (see tables 2 and 3) that are used
for the analysis in the subsequent chapter. A financing scheme basically includes finan-cial instruments, intermediaries, sources and the provision of funds.
84 Bateman (2012/2010); Bateman/Chang (2012); Glisovic/Martinez (2012); Banerjee/Duflo (2011); Beck/Demirgüç-Kunt (2006).
85 Bateman (2012); Bateman/Chang (2012); Aghion/Murdoch (2005); Murdoch (1999). 86 Bateman/Chang (2012); Duvendack et al. (2011); Bateman (2010). 87 E.g. in Bolivia, Morocco, Pakistan, Nicaragua, India. Bateman (2012); Schicks (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 20
Regarding the type of finance, debt and equity reveal different characteris-
tics in the presence of market frictions (an important aspect regarding all
four criteria). According to theoretical economists, the choice of capital in
corporate finance matters in that the value of a levered firm exceeds that of
an unlevered firm due to tax deductible interest. Contrary, debt is risky,
causing financial distress.88 In practice, debt is generally well suited to man-
age cash flows on a short-term basis, but needs to be regularly serviced and
so requires regular returns. Not only does balancing the debt-to-equity ratio
prevent over-indebtedness. Although less suited on a short-term basis, equi-
ty enables risk-sharing and long-term finance. For example, as a real option
in ventures, seed capital is used in early-stage finance.89
4.2 Information asymmetry and risk mitigation
In practice, MSME finance is adversely affected by information asymmetry
and exposed to the risks of adverse selection (ex ante) and moral hazard (ex
post).90 The more so, if the financial infrastructure doesn't effectively facili-
tate the reduction of information asymmetry, and hence of transaction costs
(see sections 2.1 and 3.3). A financing scheme depends on effective mecha-
nism to reduce this type of market friction, i.e. to produce information, or to
mitigate the risks thereof in order to ensure access.91 Theories in the optimal
contract literature, for example, suggest that debt reduces the costs of ex
post state verification in the presence of asymmetric information.92 Equity
capital, under certain conditions, stipulates signaling thereby revealing in-
formation, but inevitably causes agency costs.93
88 Villamil (2008); Myers (2001); Miller (1977); Kraus/Litzenberger (1973); Modiglia-
ni/Miller (1963/1958). 89 Ashta et al. (2012); Glisovic/Martinez (2012); Shaikh (2010a); Stein et al. (2010); Dar et
al. (1999). Microloan/interest (re)payment generally starts after disbursal (EFSA 2010). 90 Eisenhardt (1989); Stiglitz/Weiss (1981); Leland/Pyle (1977); Akerlof (1970). 91 Relationships e.g. positively impact finance (Petersen/Rajan 1994; cf. Everett 2010). 92 Diamond (1984); Townsend (1979). 93 Control and monitoring costs and the residual loss due to potential conflicts of interest
between investors and entrepreneurs as well as between investors/entrepreneurs and lenders. Myers (2001), pp. 95 ff.; Krasa/Villamil (2000); Jensen/Meckling (1976).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 21
In practice, the importance of risk assessment and mitigation is evident at
different levels. Governments deploy partial credit guarantee schemes.
Banks improve outreach to MSMEs through improved risk assessment
methods (e.g. credit scoring; rating SMEs) and relationship lending (cross-
selling; multi-period lending).94 Instead of requiring collateral, MFIs extend
microloans by applying risk mitigation mechanisms such as group-based
lending (peer selection and monitoring), savings requirements (collateral
substitute), granting prospective loans if current loans are duly repaid
(prompt and regular repayment) while increasing loan amounts ("dynamic
incentives").95 VC and PE are considered supplementary finance for
MSMEs, particularly for start-ups without a track record, sufficient collat-
eral or regular cash flows.96
4.3 Cost efficiency and sustainability
In due consideration of the first two criteria, a financing scheme needs to be
cost efficient, at least in the long term,97 and secure financial sustainability
to ensure affordability and supply.98 Empirical evidence shows that operat-
ing (personnel and administrative costs) and funding costs are main deter-
minants of efficiency, generally accounting for the largest components of
interest rates.99 Banks improve their operational efficiency while aiming to
expand financial access by developing new business models, including effi-
cient distribution channels (e.g. mobile or branchless banking), the in-
creased use of information technology (IT), a strategic focus on a particular
MSME sub-group and an adequate organizational set-up.100
94 Arvai et al. (2011); Pearce (2011); De la Torre et al. (2010); Farazi et al. (2010); IFC
(2010a); Stein et al. (2010). 95 Murdoch (1999), p. 1582; cf. CGAP (n.d.). 96 IFC (2010a); Stein et al. (2010). 97 Costs measured relative to e.g. loan portfolio, borrower or dollar spent. Ford et al.
(2013); Gonzalez (2007); cf. Schreiner (2003); cf. Murdoch (1999), pp. 1593 ff. 98 The sustainability of microfinance given the discrepancy between its social mission and
a push for profitability has been much debated. Bateman (2012/2010); Murdoch (1999). 99 Beck et al. (2011a), p. 50; Gonzalez (2010/2007). 100 Pearce (2011); De la Torre et al. (2010); Farazi et al. (2010); Stein et al. (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 22
Regarding MFIs, operating costs are determined, among other things, by the
learning curve and the size of lenders, the size of loans, the mobilization of
savings, and probably by access to credit information systems, which reduc-
es transaction costs.101 Commercial funds tend to increase financial expens-
es, but donations stress sustainability.102 Overall, with technological pro-
gress and the use of alternative funding sources in LICs and MICs, efficien-
cy and sustainability are expected to improve.103
4.4 Legal and regulatory feasibility
Lastly, a financing scheme needs to be legally feasible: the parties, instru-
ments and modalities involved need to comply with the laws, regulations
and other rules "that define the scope and depth of all the financial institu-
tions, instruments, and markets operating in a given country."104 Inconsist-
encies or uncertainties are risky and costly.
It is widely accepted that laws and regulations crucially affect market devel-
opment and financial access while, at the same time, they have to dictate
prudential rules for market actors in order to safeguard financial stability.105
However, the focus here is primarily on the financial setup in the context of
relevant requirements, bans and rules governing IF and CF. The analysis
may reveal any deficiencies in the legal and regulatory framework.
101 Transaction costs are e.g. screening and enforcement costs (Oviatt 1988, p. 215). Except
for savings mobilization, factors are negatively correlated. Ford et al. (2013); Gonzalez (2010/2007); Kneiding/Mas (2009).
102 Despite their alleged purpose of covering start-up costs, donations contradict the aim of financial sustainability in the long run. E.g. El-Zoghbi/Tarazi (2013); Murdoch (1999).
103 Sophistication of IT (e.g. management information systems) and ICT led to efficient, innovative business models (cf. CGAP 2013a). Impact funds and remittances, for exam-ple, are seen as complementary funding sources in the light of decreasing foreign aid budgets, shallow local capital markets (El-Zoghbi/Gonzalez 2013; Rocha et al. 2011).
104 IFC (2010a), p. 28. 105 IFC (2010a); Cirasino/Nicoli (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 23
5 Analysis of profit-and-loss sharing instruments and
crowdfunding for micro, small and medium-sized en-
terprise finance with a focus on Egypt
5.1 Benefits of applying profit-and-loss sharing instruments
PLS financial instruments and CF as a funding channel are assessed by
means of indicators (see table 2 and 3), that are assigned to the four criteria
from the previous chapter, beginning with the main benefits of PLS.
First, 79% of survey respondents (hereinafter "experts") agree that PLS
would be beneficial for financing SMEs (figure 7). In line with the regional
status, a larger number of SMEs in Egypt has a relationship with a bank
(above 60%) than access to credit (around 10%). SMEs cite collateral re-
quirements as well as high interest rates as the challenges to accessing cred-
it.106 Cash-based PLS instruments require neither an underlying asset (thus
avoiding transaction costs of murabaha) nor collateral (compared to con-
ventional loans) and thus represent a suitable alternative.
However, the bulk of MSMEs, over 2 million firms, are micro enterprises.
More than 70% of experts believe that PLS promotes income generation and
is suitable for financing the establishment of micro enterprises. Funds must
be used for productive activities (section 2.2).107 PLS instruments can be
convenient for both new businesses and existing, financially underserved
micro enterprises that prefer cash (or lack collateral).108 Anecdotal evidence
from Abu Dhabi Islamic Bank (ADIB) Egypt and Al Baraka Bank suggests
that PLS can be a viable instrument in MSE finance. These banks profit
from their large branch networks and their ability to cross-sell products
(Appendix IV).
106 World Bank Group (2013); Zaki (2013); Stein et al. (2010) 107 Investor and investees (mudarabah) or partners (musharakah) agree upon a PSR and
share the profits accrued accordingly (and losses) (Ahmed 2007, pp. 55 ff.). Cf. Iqbal et al. (2011), Khaled (2011), Saad/Razak (2011), Shaikh (2010a/b), Sadique (2008).
108 Disregarding agency issues, uncertainty in cash flow streams and transaction costs aris-ing e.g. from inaccurate financial records of (informal) micro enterprises.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 24
By providing the investor (mudarabah) or partners (musharakah) with a
stake in equity, PLS contracts constitute longer-term financial arrangements.
They are not terminated until the venture is liquidated or one partner buys
the other out.109 They therefore represent a complementary long-term fi-
nance option for MSME growth (cf. figure 1). 68% of the experts agree with
this. Moreover, the gradual buyout in MM offers the investor an exit strate-
gy and the entrepreneur a bearable repayment method.110
Most of the experts (82%) think of the risk-sharing and partnership features
of PLS as being favorable to MSME finance. As it represents equity capital
(in the form of going-concern capital) that absorbs losses during the course
of business, PLS allows for the sharing of risks between investors and inves-
tees (section 2.2).111 Furthermore, information or participatory rights of
partners in musharakah or MM might reduce information asymmetry.112
With the entrepreneur contributing capital (e.g. with a preceding savings
program), agency costs could be lowered.113 Group-based lending, which
can be found in microfinance in Egypt, could be used in PLS as a joint-
guarantee mechanism; for peer selection and monitoring purposes.114
Finally, compliance of PLS instruments with the principles of IF enables
providers not only to reach those clients who make financial decisions on
the basis of their beliefs, but also to attract IF-related funds from the GCC
countries. While this section looked at the benefits of PLS instruments, the
following section examines the challenges to their implementation.
109 IFSB-2, title C.5, sec. 1, para. 168-170; title C.6, sec. 1, para. 182-184; Usmani (1998). 110 Cf. Saad/Razak (2011); cf. Ahmed (2007). 111 Balancing the debt-to-equity ratio, PLS can reduce the risk of over-indebtedness and the
likelihood of bankruptcy during economic downturns. The investor "bears most of the risk not the entrepreneur (unless a share in capital is taken (...)). However, the entrepre-neur is not an employee of the [investor] (...). Being a residual claimant, the entrepre-neur effectively becomes a joint owner of the enterprise." (Dar et al. 1999, p. 53).
112 Still, investors or managers must obtain control to avoid conflicts of interest (Hart/Moore 1998). Partners in musharakah may opt for a sleeping partnership status.
113 Ali (2011); Arifin et al. (2011); Hanif (2011); Ismail/Smolo (2011); Khaled (2011); Hanif/Iqbal (2010); Shaikh (2010a); Yatim (2010); Obaidullah (2008); Ahmed (2007/2002); Rahman (2007).
114 The religious duty to repay and the concept of Islamic brotherhood (joint guarantee; social collateral) are assumed to induce high repayment rates. Ahmed (2007/2002).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 25
5.2 Primary obstacles to applying profit-and-loss sharing instru-
ments
5.2.1 Legal and regulatory framework
The surveyed experts primarily cited laws/regulations pertaining to financial
institutions (42%) and instruments (55%) as two of the most critical factors
affecting the application of PLS in MSME finance (see figure 8). Laws and
regulations are considered to be the main determinants of the development
of IF and the expansion of financial access in the MENA region.115 First of
all, PLS schemes have to be applied by providers that adhere to IF princi-
ples (IF institutions or their conventional counterparts through separate divi-
sions to keep separate accounts). At present, the Egyptian banking law
doesn't contain rules tailored to Islamic banks.116 Banks offering IF products
are not yet required by the Central Bank of Egypt (CBE)117 to comply with
the international standards issued by the Islamic Financial Services Board
(IFSB) or to have a Sharia Supervisory Board overseeing the conformity of
their activities with these standards. This can give rise to uncertainty among
market participants, to the risk of (perceived) non-compliance with IF prin-
ciples and to increased compliance costs in general, and of PLS instruments
in particular.118
Furthermore, Islamic banks deploy so-called profit equalization reserves to
partly absorb investment risks (Appendix IV). But there exist neither an ex-
plicit depositor savings insurance scheme, nor one compliant with IF princi-
ples (takaful). This can basically threaten financial system stability and im-
pede the application of PLS.119
115 Ali (2011), p. 22; Pearce (2011), p. 19; Farazi et al. (2010), p. 28. 116 Central Bank Law 88/2003 and Executive Regulations of Law 88/2003 (Decree
101/2004). Banks may engage in securities activities through subsidiaries (World Bank's Bank Regulation and Supervision Survey; World Bank 2013b).
117 The CBE is the banking licensor/regulator/supervisor. The Egyptian Financial Supervi-sory Authority (EFSA) is the regulator/supervisor of non-banking financial markets.
118 El-Zoghbi/Tarazi (2013), p. 6; Zawya (2012). 119 World Bank (2013b); Zawya (2012).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 26
In addition, NGO MFIs are not permitted to practice "any profit-oriented
activity",120 which theoretically puts into question the applicability of PLS
in microfinance. Legal provisions complicate external funding of these insti-
tutions.121 New regulations further prohibit MFIs or MFCs from taking de-
posits (and providing remittance services), calling into question not only
growth prospects but also the permissibility of PLS investment accounts.122
The experts further cited investor/creditor rights (50%) as one of the most
critical factors to applying PLS. Egypt ranks 82nd among 185 economies
(above the regional average) on the World Bank's investor protection in-
dex.123 Contrary, its score in the legal rights index (measuring creditor
rights) equals the regional average, which is the lowest of all regions. This
indicates that the legal framework is not facilitating the provision of finance
well in general and that weaknesses constrain financial deepening.124
5.2.2 Financial infrastructure
Accounting and auditing practices (63%) and credit reporting systems
(53%) are primarily cited by experts as elements of the financial infrastruc-
ture that are most critical to applying PLS in MSME finance. Both foster
access to finance by disclosing financial information on firms, thereby re-
ducing transaction costs and the risks that arise from information asymme-
tries. The MSME sector in Egypt is largely comprised of enterprises that
typically keep books poorly or not at all (see section 3.1 and table 1), which
also calls for other ways to declare profits in PLS schemes. 120 Except for those contributing to their purpose. NGO Law 84/2002, article 55 and 11. 121 According to NGO Law 84/2002, article 61, NGO funding from 3rd parties (e.g. dona-
tions, PE) is subject to approval by the NGO supervisor, the Ministry of Social Solidari-ty. That is why banks struggle to fund NGO MFIs and explains the existence of MFCs.
122 Draft General Rules For MFCs in Egypt; cf. Pearce (2011), p. 20; cf. Sanabel (2010a). 123 The region stands at 97. Although the investor protection indicator considers publicly
traded corporations, it is used at this point as a rough proxy for the regulations offering (minority) investor protection (on a scale from 0 to 10 (highest): EGY: 5.3; MENA: 5.0; OECD HICs: 6.1) (World Bank 2013c, pp. 47 ff.; World Bank 2013d, pp. 59 ff.).
124 Measuring the degree of protection of borrower/lender rights through collateral and bankruptcy laws, this index indicates the degree of a legal framework facilitating the provision of funds (on a scale from 0 to 10 (highest): EGY: 3; MENA: 3; OECD HICs: 7) (World Bank 2013c, pp. 41 ff.; World Bank 2013d, pp. 52 ff.; World Bank 2013e).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 27
Public credit registries and private credit bureaus are recognized as being of
considerable importance for the improvement of MSME finance in the re-
gion (section 3.3). With regard to PLS, they are important in that they would
provide financial institutions with access to the financial history of potential
investees. Egypt has one of the most extensive and accessible credit infor-
mation systems in the region and beyond, according to the World Bank's
credit information index.125 This finding has to be accepted with caution,
however, as the data reveals a relatively limited breadth overall and weak-
nesses in the public credit registries. MFIs in particular, although they will
soon be required to provide data to credit bureaus, tend to suffer from an
information gap due to their less advanced IT systems,126 which would
eventually constrain the cost efficiency of PLS at the microfinance level.
5.2.3 Financial institutions
Regarding financial institutions, the surveyed experts cited operational effi-
ciency (61%), staff capacity (55%) and risk assessment/management tech-
niques (66%) as the most critical factors. Differences in cost efficiency be-
tween conventional and Islamic banks in general are driven less by their
type than by country-specific differences.127 However, any PLS scheme
would basically face the problem of generally rather inefficient financial
institutions in Egypt, and may in fact detrimentally affect their efficiency.
On a provider basis, state and non-GCC banks are less efficient than private
and GCC banks, respectively. Around half of Egypt's banking sector is con-
trolled by state banks. Furthermore, scale economies tend to play an im-
portant role: On average, Saudi Arabian Islamic banks are more efficient
than their regional, mostly smaller counterparts despite having by far the
125 This index measures the scope and accessibility of information (on a scale from 0 to 6
(highest): EGY: 6; MENA: 4; OECD HICs: 5) distributed by public credit registries (in-dividuals/firms covered in population: 4.3%; 12.6%; 31.5%) and private credit bureaus (16.4%; 26.4%; 74.6%) (World Bank 2013c, p. 41; World Bank 2013d, p. 52).
126 Draft General Rules For MFCs in Egypt, article 17; MIX/Sanabel (2011), p. 4; Pearce (2011), p. 23; Rocha et al. (2011), pp. 146/147.
127 Beck et al. (2010), p. 3.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 28
largest share of PLS in offered products.128 Finally, the operating costs of
regional MFIs are among the highest globally. Within the region, however,
the efficiency of Egyptian MFIs is among the highest.129 Critically, there are
extremely few IMFIs in Egypt (see section 3.4).
On a product basis, as opposed to loans, the conduct of investment activity
through PLS can be associated with additional administrative charges (sec-
tion 2.2). The staff would need to carry out due diligence to screen potential
investees: assess risks (through financial records, credit information and rat-
ings or scorings, if available), project cash flows or evaluate business plans.
A lack of experience with PLS and of skilled personnel would further con-
strain efficiency in the short term.130
Banks primarily use internal ratings and credit scoring procedures in SME
finance. MFIs apply group lending, while particularly NGOs, the primary
type of MFI in Egypt, tend to lack advanced risk techniques and historical
data.131 However, applying interest-free, longer-term PLS instruments in the
absence of collateral would require a specific focus on future cash flows,
entrepreneurial skills, business activity and model and market conditions;
and the appropriate techniques to manage default or investment risk (or cap-
ital impairment risk), liquidity, operational and mark-up risk.132
5.2.4 Financial access
Risks play an especially important role when reaching out to smaller-scale
firms (see sections 2.1 and 3.5): yet, 47% of the experts consider the riski-
ness of investments in MSMEs as being critical to applying PLS. They fur-
ther point out entrepreneurial skills (53%) as the most critical factor in fi-
nancing MSMEs in through PLS instruments. While this opinion coincides
128 Ali (2011), pp. 31/32; Farazi et al. (2011). 129 Egypt has the lowest operating costs relative to revenues despite loan size being among
the smallest. MIX/Sanabel (2012); MIX (2011); Sanabel (2010b); Ford et al. (2013). 130 Cf. Ford et al. (2013), p. 13. 131 Glisovic/Martinez (2012); Farazi et al. (2010). 132 Besides market, political and compliance risk. IFSB-1, sec. 2.2, 3.2, 5.2, 6.2, and 7.2;
Febianto (2009); Ahmed (2008/2007); Dar et al. (1999).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 29
with the universal characteristics of MSEs (table 1), field research is needed
to assess the country-specific magnitude of this obstacle.
Another, related obstacle is the ease of registering a business, which im-
proves access to formal financial services. On the corresponding index,
Egypt stands at 26 in the global ranking – far above regional average. How-
ever, the underlying methodology assumes small firms.133 Evidence from
Egypt suggests that entrepreneurs face difficulties with the rules and proce-
dures for entering the formal sector (section 5.3), despite recent reforms.134
42% of the experts cite strategy and organizational setup of providers as a
critical factor. Generally, specialization in (a particular sub-group of)
MSMEs by decentralized units along with back office support within the
organization tend to improve financial access and operational efficiency of
down-scaling banks and up-scaling MFIs (section 4.3; Appendix IV).135 On
average, Egyptian MFIs have larger office networks and far more loan of-
ficers per office than their regional counterparts – besides their higher effi-
ciency.136 These officers are dedicated to microfinance clients. Specializing
on small enterprises is a secondary challenge. The primary challenge would
basically be to serve financially excluded, informal micro enterprises
through PLS in the face of screening (e.g. due to a lacking or inadequate fi-
nancial records) and agency costs (section 4.2), factors that 47% and 42% of
experts, respectively, consider to be critical.
133 By IFC's definition; medium-sized by Egypt's definition. World Bank (2013a), p. 14. 134 OIM (2010), p. 23. 135 Buhl/Range (2013); Glisovic/Martinez (2012); BFC (2011); De la Torre et al. (2010). 136 On average, Egyptian (regional) MFIs have 17 (14) offices and around 12 (8) loan offic-
ers per office, not considering the outlier Morocco (MIX 2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 30
5.3 Benefits of applying crowdfunding
Over 70% of surveyed experts agree that (cross-border) CF is beneficial in
providing MSMEs with access to additional funding sources (see figure 9).
In Egypt, CF represents an alternative or complementary funding scheme to
banks and MFIs. More specifically, it is well documented that CF is suitable
to finance micro enterprises.137 Initial evidence from cross-border CF shows
that this is basically the case in MICs (and LICs), too. CFPs may be located
there or may partner with financial intermediaries to further lower the barri-
ers to entry (section 2.3). CF can provide finance for SMEs, where they
"have difficulty accessing funding from traditional financial institutions"138.
In light of the surveyed experts' ambiguous sentiments, evidence is needed
to demonstrate that CF can provide long-term finance for MSME expansion,
which apparently is more likely for CI (Appendix II).139
In addition, 55% of experts think that CF is useful for attracting funds from
accredited or institutional investors such as regional or international angel,
VC or PE investors, MIVs or SME funds looking for profitable, high-
growth or impact investment opportunities.140 Experts also agree (55%) that
funds could be used as collateral for (conventional) bank credit. Donations
(or zakat and sadaqah) could be used as a guarantee (tabarru) for capital
provided by a financial institution in a PLS setting. Both options could basi-
cally incentivize finance, particularly to micro enterprises.141
The wisdom of the crowd, which through the concept of crowdsourcing has
been used by companies to reduce costs, is an integral part of CF (section
2.3). Against the background of asymmetric information, particularly with
regard to smaller-scale firms and a weak financial infrastructure, this leads
to three further beneficial aspects. These are screening and monitoring or 137 E.g. Belleflamme et al. (2013a/b); De Buysere et al. (2012); Giudici et al. (2012). 138 De Buysere et al. (2012), p. 20. 139 Growth finance through CI can be assumed from angel investments and VC (cf.
Larralde/Schwienbacher 2010). 140 "Some platforms operate on a co-investment model, whereby an investment fund com-
pletes the investment of crowds" (De Buysere et al. 2012, p. 17). 141 IFSB-2, title C.6, sec. 1, para. 185.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 31
control by the crowd (around half of experts agree with each) and mentor-
ship (68%). First, financial intermediaries might be reluctant or unable to
screen some, especially smaller, firms due to transaction costs and limited
resources. Letting a large group of individuals (who put their money at
stake) evaluate pre-selected project proposals by peer reviewing venture de-
tails ("social information")142 could provide entrepreneurs with a validation
of their business concepts and save the field partner or the CFP (administra-
tive) costs in the selection process, other things being equal. However, the
quality of the results of the crowd, the aggregated (funding) decisions, de-
pends on its heterogeneity and the individuals' use of private information.143
Second, investors could monitor the progress of the business through up-
dates on the CFP in addition to on-site visits by a field partner, ideally in-
centivized by a share in profits. The dissemination of reports by investees on
a regular basis requires having appropriate terms and convenient proce-
dures, such as mobile reporting of core data. Third, crowdfunders or volun-
teers could provide entrepreneurs making early-stage decisions with advice
in their field of expertise. The CFP's staff and angel or VC investors could
do so while pre-selecting investment opportunities prior to due diligence.144
61% of experts think that CF offers a cost-efficient distribution channel.
Theoretically, it brings together capital providers and firms in need of capi-
tal (investor and financial inclusion) regardless of geographical and institu-
tional barriers in the light of search and screening costs.145 Still, a field part-
ner or the CFP's staff is required to ensure access in practice. To address the
problems of having an immense investor base, Shekra for example limits the
142 The exchange of information among crowdfunders in the screening and funding process
(Belleflamme et al. 2013a, p. 12 with reference to Kuppuswamy/Bayus 2013). 143 Hornuf/Klöhn (2012); cf. Ahlers et al. (2012), De Buysere et al. (2012), Kleemann et al.
(2008). "[C]rowds may at times be more efficient than individuals(...); the more diverse it is, the more efficient it can be.(...) [T]he 'wisdom of crowd' is due to crowd’s solutions aggregating to each other, as opposed to averaging out" (Larralde/Schwienbacher 2010, p. 7 with reference to Brabham 2008, Howe 2008, Surowiecki 2004).
144 Cf. Belleflamme et al. (2013a), Lehner (2013), pp. 17/18, Ashta et al. (2012). 145 Hornuf/Klöhn (2012), pp. 256/257.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 32
number of investors (Appendix II).146 Furthermore, 58% of experts agree
that the cost of funding is beneficial. However, the cost of capital decreases
as the investment objective of crowdfunders (and other impact investors)
shifts from expected financial proceeds only to social and environmental
returns (or gratification) from desirable or financially sustainable projects.147
Besides, investments in public goods are additionally facilitated by a fund-
ing conditional on reaching a target (all or nothing vs. free riding), as is
practiced by many CFPs including Shekra.148
Around half of experts think that integrating remittances in cross-border CF
could benefit MSMEs – only a fifth suggest them as a funding source for a
CI scheme (section 6.6). However, there are voluminous remittance trans-
fers within the region, as the majority of Egyptian migrants reside in GCC
countries (Appendix III). CF could serve as a corridor to direct migrant re-
mittances to recipients that would like to start or manage a business. Egyp-
tian remittance senders, being mostly highly-educated and skilled, could
pool and track the use of funds as well as provide advice to project initiators
in order to facilitate productive investments in their country of origin. How-
ever, the "majority (79%) of migrant-sending families [surveyed in Egypt]
do not invest"149 remittances. They cite challenges such as difficulties with
rules and procedures pertaining to starting a business (76%), and risks asso-
ciated with the political climate (20%). Apparently, CF cannot solve these
issues. But it can offer remittance recipients, 57% of whom would like to
invest in a business and 39% of whom are financially constrained, a start-
ing-point to obtain both funds (or collateral) and advice.150 In this regard,
"community-based experiences"151 can play an important role.
146 Brown (2012). 147 An "emotional rate of return" (De Buysere et al. 2012, p. 9; cf. Ashta et al. 2012, p.
366). Dapp (2013); El-Zoghbi/Gonzalez (2013); Lehner (2013); Ashta et al. (2012). 148 Hornuf/Klöhn (2012), p. 258. 149 IOM (2010), p. 51. 150 IOM (2010), pp. 30 ff.; cf. CGAP (2013a); cf. Fransen et al. (2013). 151 Belleflamme et al. (2013a), p. 2. Diaspora investments might be linked to community
experiences, if geographical distances really play a reduced role in CF (cf. Belleflamme et al. 2013a with reference to Agrawal et al. 2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 33
5.4 Primary obstacles to applying crowdfunding
5.4.1 Legal and regulatory framework
CF isn't explicitly regulated in almost all of the jurisdictions in which it can
be found, including Egypt.152 This is one of the most pressing obstacles at
present. Almost 70% of surveyed experts confirm that laws and regulations
are critical to applying (cross-border) CF in MSME finance (see figure 10).
The lack of a harmonized approach to regulation further challenges CF
across borders. Depending on a country's legal and regulatory framework,
various rules can apply.153 While CFPs, enterprises and crowdfunders could
theoretically be spread across different jurisdictions, the laws and regula-
tions of the jurisdiction in which the first two are based are of particular im-
portance. And, depending on the type of CF, legislation and regulation can
apply differently, with CI – apparently, the riskiest CF model – generally
being subject to the strictest provisions safeguarding investor protection
(section 2.3 and Appendix I).
The application of CI in Egypt as the home country of both the CI portal
(CIP) and the entrepreneurs showcases the primary challenges. Although, CI
is treated differently across jurisdictions, the status, rights and obligations
with respect to CIPs, enterprises and instruments, and investors commonly
affect its application.154 In Egypt, CI is not illegal per se, as Shekra's busi-
ness model affirms (Appendix II). Given the relatively small amounts in-
volved in CI, however, certain provisions have to be considered in order to
avoid costly compliance with requirements that are tailored to traditional
financial intermediaries or impede CI in micro and very small enterprises.
Thus, CIPs must not exercise any banking activity that is subject to registra-
152 Except for Italy and, in the foreseeable future, the USA (Appendix I). 153 Aschenbeck-Florange et al. (2013); Degabriel (2013); Bradford (2012a/b); De Buysere
et al. (2012); Hornuf/Klöhn (2012); Röthler/Wenzlaff (2011). 154 Concerning e.g. the provision of banking or investment services; the enterprise's legal
form and ownership, prospectus requirements, the solicitation of offerings; investment thresholds for investors. Aschenbeck-Florange et al. (2013); Degabriel (2013); Bradford (2012a/b); Hornuf/Klöhn (2012); Röthler/Wenzlaff (2011).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 34
tion, regulation and supervision by the CBE.155 Also, CIPs must not provide
investment brokerage (in a narrow sense), payment/settlement, asset man-
agement, or investment advisory services. Otherwise, they would constitute
entities that in a legal sense engage in non-banking financial activities sub-
ject to licensing/registration requirements and supervision by the Egyptian
Financial Supervisory Authority (EFSA).156 That is why, for instance,
Shekra uses the services of banks and other providers, and doesn't interfere
in the decision-making of investors just like CFPs or CIPs in other countries
due to similar reasons. Still, the activities subject to EFSA supervision also
include the solicitation of securities and "mass media publicity".157 As these
form an essential part of a CIP's business model, the application of CI would
either need authorization or proper adjustments.
Furthermore, enterprises must be registered158 and must not publicly issue
securities to avoid reporting to the EFSA, disclosing prospectuses and fi-
nancial statements as well as the requirement for investors to meet increased
eligibility criteria.159 In contrast, information requirements are lower for pri-
vate placements. Finally, evidence from Shekra suggests that foreign ex-
change transfers must not exceed around USD 50,000 and that foreign
crowdinvestors must submit a letter of attorney to the CIP in Egypt.
If the CIP is headquartered in another jurisdiction, it has to adapt its opera-
tions to the respective legal and regulatory framework and possibly may not
address foreign investors. However, either an ordinary financial institution
or a field partner (e.g. a MFC, an Islamic bank, which may accept invest-
ment deposits, or a VC fund) needs to pass on funds from investors abroad
(foreign direct investments; FDIs) or to refund (informal) enterprises. A
155 Central Bank Law 88/2003, article 31. 156 Capital Market Law 95/1992, articles 27/28 and its Executive Regulations, article 120. 157 Executive Regulations of Law 95/1992, article 121. 158 As a limited liability partnership (Law of Commerce 17/1999) or a limited liability
company (Companies Law 159/1981; offers a simple registration), considering provi-sions of Law 8/1997. Enterprises with paid-in capital less than EGP 1 million might have to consider provisions of the SME Law 141/2004 (cf. IOM 2010).
159 Capital Market Law 95/1992, articles 4, 6 and 7.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 35
special purpose entity could be established in the investors' home country
(e.g. in GCC countries) in order to channel larger funding amounts.160 In
any case, further investigation and a legal review is required, taking into ac-
count capital transaction controls.
The lack of specific regulations for CF/CI causes uncertainty among stake-
holders. Disproportionate compliance costs and imminent litigation hinder
the development of the industry across borders.161 Investigation is required
on the compliance of CF schemes with anti-money laundering and counter-
terrorism financing rules, which could be neglected under current condi-
tions. Where CF/CI operates in the shadows, risks can arise for the platform
operators, entrepreneurs and investors, and possibly for the financial system.
5.4.2 Financial infrastructure
As CFPs make exclusively use of third-party services, payment and settle-
ment systems (supply and pricing) form an important part. 63% of experts
view them as critical to applying cross-border CF in MSME finance in
MICs. While there is a set of retail, electronic cross-border payment instru-
ments and services, bank credit transfers and remittances through money
transfer operators play a major role in the region. Critically, cross-border
remittances are costly relative to the small amounts involved in CF.162
While transaction fees vary depending on the corridor and service provider,
the average cost for remittances to MENA countries was 7.8% in early
2013. In contrast, money transfers from the UAE and Saudi Arabia to
160 MyMicroInvest.com collects funds in a separate entity that invests in MSEs
(MyMicroInvest n.d.). Oikocredit, an international cooperative, uses a model serving the same purpose: a non-financial entity based in the country of the investors passes on funds to the cooperative society that invests in MSMEs (Oikocredit 2012).
161 Aschenbeck-Florange et al. (2013); De Buysere et al. (2012); Hornuf/Klöhn (2012). 162 Besides, a bank account, an e/mWallet, an office to cash out and the relevant documen-
tation or IT on the receiver side are required depending on the transaction type. CGAP (2013a); World Bank (2013f); Pearce (2011); Cirasino/Nicoli (2010); IOM (2010).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 36
Egypt, for instance, cost on average 3.9% and 5.5%, respectively.163 Online
or mobile payment services appear more convenient, but can be costly.164
5.4.3 Platform operators and financial institutions
With respect to CFP operators, 63% of surveyed experts believe operational
efficiency (administrative and personnel costs) to be critical to CF in MSME
finance. Given the overall relatively small amounts in CF, efficiency de-
pends on the business model of CFPs. Broadly speaking, while donation or
benevolent debt-based cross-border CFPs such as Kiva or MicroWorld have
to search, screen and monitor local partners, such as MFIs, sign agreements,
edit and translate project proposals, and administer an accounting system,
they process a large number of relatively small projects (but they tend to
lack a stable income stream and are largely dependent on donations).165 In
contrast, local CIPs process larger projects in a comparatively small number
but they are equipped for labor-intensive tasks such as performing due dili-
gence (and they tend to charge a management fee higher than in VC, or find
other ways of being remunerated; see Appendix II).166
On the other hand, the involvement of a local down-scaling bank or MFC
that collaborates with a CFP and passes funds on to entrepreneurs is likely
associated with additional operating expenses (e.g. for the administration of
proposals).167 Half of the experts cited the efficiency of partnering financial
intermediaries as critical to CF in MSME finance.
163 Cost on average (%) for amounts of USD 200 sent using banks and money transfer op-
erators in early 2013 (World Bank's Remittance Prices Database; World Bank 2013g/h). CGAP (2013a); World Bank (2013f); Cirasino/Nicoli (2010); IOM (2010).
164 Depending on the type of service and provider. PayPal for example charges receivers a fee of around 4% for cross-border payments up to USD 3,000 to Egypt (PayPal n.d.).
165 Kiva.org covers its expenses largely through donations/grants from individuals, corpora-tions and institutions (Kiva n.d.a/b). MicroWorld.org has a slightly more sustainable model: it charges field partners a commission of 5% of funding volumes besides receiv-ing grants from sponsors and investors (MicroWorld n.d.).
166 Cf. Hornuf/Klöhn (2012), p. 246. 167 This could theoretically increase interests/expected returns from enterprises but would
more likely be compensated by an increase in management fees/prices for crowdfunders.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 37
Above all, it seems that the efficiency of CF schemes, however, is improved
along the chain by outsourcing tasks (e.g. volunteers or crowdsourcing; sec-
tion 5.3), sharing resources (e.g. information, or staff to administer the CFP
and advise start-ups), and using comparative advantages between financiers,
platform operators and partnering financial intermediaries or incubators.168
CF could be profitable for partnering financial intermediaries, if funding
expenses as well as transaction costs on the refunding (and financing) side
are reduced. Donations/benevolent loans from the crowd are basically free
of interest. The return on invested funds depends on the investors' motive
(section 5.3) and entrepreneurs' success. Transaction costs for cross-border
money transfers, for instance, can be reduced by a net billing system as the
one deployed by Kiva.169 Intermediaries must further manage to reduce their
exposure to foreign exchange risks from cross-border CF (mitigate ex-
change losses) and those risks mentioned below. 74% of experts state risk
assessment/management tools of financial institutions as critical to CF in
MSME finance, to which the challenges shown in section 5.2.3 also apply.
5.4.4 Financial access
Besides the default risk of MSMEs, which is particularly high for start-ups,
the default risk of field partners, the concentration risk and Egypt's country
risk, there are specific risks pertaining to the application of CF to
MSMEs.170 Although only 26% of surveyed experts consider adverse selec-
tion to be critical in practice, it theoretically poses a risk for investors in dif-
ferent ways. First, there is a chance that particularly risky MSMEs, which
were rejected for loans by banks or MFIs in the first place, seek funding
through CFPs, just as (unprofitable or negative net present value; NPV)
168 Cf. Hornuf/Klöhn (2012). 169 Kiva (n.d.c). 170 However, experts primarily think of strategy/organization as critical (cf. section 5.2.4).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 38
MSMEs with a negative sentiment about own future earnings are more like-
ly to seek equity, including through CIPs.171
Second, partnering financial intermediaries could forward to CFPs primarily
the loan proposals from risky clients, keeping the less risky ones in their
own portfolios (in ex post CF, this can apply to overdue clients) (moral haz-
ard of the field partner).172 Third, CFPs and CIPs can be prone to pre-
selecting as many projects as possible (including negative NPV projects), at
least in the short term, because of a commission-based remuneration model
that incentivizes such behavior given the screening costs (moral hazard of
the platform operator). After all, there could be a risk of fraud in CF: the
disclosure of information about allegedly profitable or fictitious projects.
However, various mechanisms, including online and/or offline screening by
the CFPs, field partners or crowdfunders, reduce this type of risk presuma-
bly to low levels.173
Moreover, depending on the communication design of the CFPs, social in-
formation (see section 5.3) can lead to bubbles when crowdfunders contrib-
ute capital to projects without further screening, contingent on their fellows'
decision to fund. Finally, depending on the reporting or monitoring method
used, there could be an increased risk of moral hazard of the entrepreneurs
due to the geographical distance making physical verification costly.174
171 Hornuf/Klöhn (2012), pp. 255/256. with reference to Cumming/Johan (2009), p. 39; cf.
Bradford (2012a). 172 At MicroWorld.org (many CFPs) field partners (crowdfunders) bear the default risk. 173 Hornuf/Klöhn (2012), pp. 258/259; cf. Bradford (2012a). 174 Hornuf/Klöhn (2012), pp. 258/259; De Buysere et al. (2012).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 39
6 Proposal of a financing scheme of profit-and-loss shar-
ing crowdinvesting in micro, small and medium-sized
enterprises in Egypt
6.1 Preliminary considerations
Based on the review of the literature and of CF models, on the introduction
to the region and on the analysis of the viability of PLS and CF in Egypt,
two complementary financing schemes of cross-border PLS CI in MSMEs
can be considered: a local financial intermediary operates a CIP, or a local
CIP collaborates with a financial intermediary. In either case, a financial
institution presumably expands access to MSMEs through a relatively wide
outreach and low barriers to entry, particularly for (informal) micro enter-
prises. The latter model is developed in more detail below – more as a guid-
ing framework than as a fully developed approach – because (i) it seems
more feasible for political and regulatory reasons, as the former option re-
quires the full commitment of an institution; (ii) it grants the CIP more flex-
ibility, for example, to cooperate with further partners; (iii) a larger share of
surveyed experts agrees that this model is applicable (see figure 11).
One suggestion would be to have the CIP collaborate with an up-scaling
MFI. This is the first choice of experts (figure 12). Egyptian MFIs have
large office networks (section 5.2.4). They are used to serving the segment
of the private sector that is not exclusively but known to be well addressed
by CF, namely micro enterprises (section 5.3). They could reach unserved,
informal enterprises on a larger scale. Conversely, CF could add to their
funding sources. However, the IM sector is underdeveloped (section 3.4;
just as regional cooperative sectors). And, MFIs cannot accept funds with-
out authorization, let alone any deposits (section 5.2.1), impeding the re-
funding of projects and precluding transfers to deposit accounts as well.
The model for Egypt below presented pursues a dual approach in which
primarily MSEs are financed on the basis of MM. The CIP pre-selects for-
mal MSEs, forwarding the proposals to a closed investor network. Addi-
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 40
tionally, a down-scaling bank, as favored by a third of experts, contributes
funding proposals from informal and formal MSEs. Evidence for the main
features is provided by the CIP Shekra (Appendix II). There are basic com-
monalities with other CFPs as studied for example by Hornuf and Klöhn
(2012). Supplementary considerations may be found in Appendix V.
6.2 Target enterprises
Target enterprises are primarily, but not exclusively, MSEs according to
Egypt's country definition or micro and very small firms according to the
IFC definition. In Egypt, they form a particularly large group that lacks ac-
cess to finance. CF is a suitable means to address this demand range.
6.3 Financial instrument
Finance is provided on the basis of MM, the diminishing partnership type of
PLS instruments, mainly for two reasons. First, entrepreneurs contribute an
initial amount of capital and share in (profits and) any losses – covenants
that could reduce risks arising from information asymmetries. Second, as
the entrepreneurs gradually repurchase the shares from investors a more cer-
tain exit strategy can be formulated as well as a (flexible) repayment sched-
ule with reasonable installments, optionally including an abstinence period
(see sections 2.2 and 5.1). Over 70% of experts agree that this PLS instru-
ment is the most suitable (figure 12). The partners (or investors) are entitled
to a financial return, as agreed on by the majority of experts, sharing in prof-
its (and losses) in proportion to their capital share, ideally after deducting a
management share for the entrepreneur.175 They act as silent partners waiv-
ing participatory rights to avoid conflicts of interest. For illustrative purpos-
es, table 4 presents an example of a payment schedule based on Ahmed
(2007) and Saad and Razak (2011), who propose a MM scheme (for financ-
ing assets; Appendix V) and provide ancillary notes.
175 Investors could realize capital gains, given that shares are evaluated.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 41
6.4 Crowdinvesting and financial intermediary and other partners
The CIP is headquartered in Egypt as it can use and contribute to agglomer-
ation economies (cf. Appendix II). It must restrict access to investment op-
portunities to its investor network, use banking services, and adapt to or not
conflict with other provisions of the legal framework (see section 5.4.1).176
Serving as a link between MSEs, investors, the financial intermediary and
other partners, it pre-selects proposals, facilitates the funding of formal
MSEs or the collection of funds for informal MSEs, and provides advice
and training. The basic features can be found in the IF CIP Shekra.
The role of the partnering down-scaling Islamic bank is primarily to expand
the financial access of informal MSEs. It provides the banking services for
the CIP (escrow accounts, payment services) and funded enterprises (depos-
it accounts), as endorsed by 63% of experts, pre-selects project proposals for
the CIP (58% of experts), assesses the MSEs (71%), and holds the invest-
ments in informal MSEs (42%; figure 12). Collaboration is sought with
ADIB Egypt. It is the only bank in the country with a dedicated program to
finance informal and formal MSEs by means of PLS and a large office net-
work (Appendix IV). Incubators and other partnering organizations provide
access to further MSEs besides conducting capacity-building measures, such
as training, and (co-)organizing pitch events (cf. Appendix II).
6.5 Funding
6.5.1 Private placement and financial intermediation
The CIP facilitates the private placement of equity by formal MSEs pre-
selected by the CIP and the bank, documenting the transfer of shares (ordi-
nary certificates) to the investors. This way, MSEs avoid costly compliance
with additional requirements (see section 5.4.1). Capital is provided with a
176 The CIP further uses the most adequate online payment service for cross-border transac-
tions. It must not explicitly recommend any investments or provide any other banking or financial services that are subject to authorization and supervision by the CBE/EFSA.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 42
tenure of three years, as suggested by 76% of experts (possibly up to five
years or in several funding rounds). Funding volumes for MSEs are limited
to USD 200,000, which corresponds a critical funding gap and does not in-
terfere with VC (section 2.3). For any proposed funding amount, the place-
ment is structured so that the number of investors is limited and yet the
specified minimum contribution enables investor inclusion. Funds must be
raised during a specified period (e.g. within 60 days) and in full to reap the
benefits of the screening process (section 5.3). At the closure of successfully
funded projects, investors and entrepreneurs sign standardized contracts
stipulating their rights and obligations, including to information. Funds are
transferred to the entrepreneurs' accounts at ADIB Egypt.
The bank-specific terms must be considered regarding the informal MSEs
pre-selected by ADIB Egypt. Funding volumes and tenures are limited to
around USD 7,000 and two years, respectively. The bank finances the pro-
jects that are refunded by crowdinvestors: It holds the investments while
contracts would have to be drawn up for the investors using special invest-
ment accounts (section 2.2). It may contribute capital to other MSEs
screened by investors at its discretion. This might be a lucrative alternative
as banks can struggle to refund MFIs (section 5.2.1).
6.5.2 Distribution channels
The CIP reaches target MSEs through its partners, at pitch events and
through online media. Project proposals, edited and/or pre-selected by the
CIP and ADIB Egypt, are screened and conditionally backed by contribu-
tions from investors online. Funds are eventually disbursed at ADIB Egypt.
For the MSEs, the funding phase takes place either solely online or backed
by a bank branch. That is, entrepreneurs manage their online applications
(submit the proposal and disclose necessary information during the funding
phase). Or, the bank's staff administers online applications in the name of
the MSEs that it pre-selected. The latter case applies at least to the group of
informal MSEs. 47% of experts think that the latter and the entrepreneurs
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 43
reporting online or mobile (after the funding phase) are suitable. 45% of ex-
perts agree with the bank staff also executing the reporting (see figure 13).
6.5.3 Pre-selection, risk assessment and risk mitigation
The MSEs apply through standardized forms, if available, supplemented by
business plans. If necessary, incubators and the CIP's staff provide entrepre-
neurs with advice on the application or on preparing the business plan of
promising projects. After a review of the applications, the staff pre-selects
prospective project proposals by assessing the business plan and/or a set of
criteria including the skills and characters of the entrepreneurs, the market
potential, future cash flow estimates and, if given, the accounts. MSEs that
achieve a minimum score qualify for the funding phase, which starts with
the project proposals being published on the CIP. MSEs are pre-selected
from various industries to facilitate risk diversification.
Proposals pre-selected by the bank's MSE department, including financials
in the case of existing clients, are published without further ado. MSEs that
achieve the funding target undergo a screening by the officer, including a
rating or scoring or a review if applicable, a cash flow forecast (as preferred
by 58% of experts), or a character analysis (29%). The bank could adopt
group-based funding (53%) to reduce risks and expenses (see Appendix V).
Around half of the experts think of the capital contribution by entrepreneurs
as being suitable to mitigate risks. The entrepreneurs receive training (cov-
ering bookkeeping) from the CIP's staff or third-party consultants, coupled
with on-site visits on a monthly basis, and advice from expert investors or
volunteers (figure 14). Moreover, finance can be provided on the basis of
relationships across products or funding rounds to gain more information.
6.5.4 Information
Project proposals (business plan, equity offer etc.) are accessible in full by
registered investors. Basic data is publicly available. Investors and, at least,
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 44
entrepreneurs from the MSEs pre-selected by the CIP can interact at any
time. Whether and in what way information exchange among investors leads
to better results has to be tested (social information vs. bubble formation;
see sections 5.3 and 5.4.4). Investors in any project receive basic reports
sent online or by mobile by the entrepreneurs in a specified interval. Simple
bookkeeping or mobile reporting is used to declare profits (Appendix V).
6.6 Crowdinvestors and other funding sources
Facilitating private placements, the CIP restricts access to investment oppor-
tunities to registered investors. Besides the entrepreneurs contributing capi-
tal, which two thirds of the experts agree with, capital is provided by
crowdinvestors (68%; see figure 13) such as individuals and business an-
gels. Direct funding of formal MSEs is available to both foreign (submit a
letter of attorney) and domestic investors. Refunding of informal MSEs
through the bank's investment accounts would probably be restricted to the
latter. In order to expand local investments and capacity-building activity,
the CIP promotes financial involvement by national, regional or internation-
al impact investment funds. It further facilitates the transfer of financial re-
sources by multilateral or bilateral funding sources, such as DFIs, to pro-
mote private sector investments. Only a third of the experts suggests using
public or private institutional funds. In contrast, the British government for
example contributes a total of GBP 20 million to MSEs, 20% on a project
basis, through the country's CFP Funding Circle.177 However, institutional
contributions to projects screened and (partly) funded by crowdinvestors
could be in the form of co-investments or supplementary qard hassan loans.
Funds could be invested on an automated basis, conditional on reaching the
funding target, or for MSMEs with larger funding demands. Critically, the
CIP expands its investor network primarily across the region. This way, it
could attract remittance-sending expatriates (but only a fifth of the experts
suggests this option) as well as IF-related funds from the GCC countries.
177 Funding Circle (n.d.a/b/c).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 45
6.7 Remuneration
The CIP's staff or the third-party consultants receive cash from the funded
MSEs for the training. Both intermediaries receive from the investors a
share of ownership in the MSEs they pre-selected, thereby sharing in profits
of successful MSEs. This scheme is crucial, as it aligns the intermediaries'
incentives with investors' interests and compensates the staff or the consult-
ants for the provision of advisory services (see Appendix II).
6.8 Final considerations and differentiation
The down-scaling bank and incubators have a relatively wide outreach to
MS(M)Es. The CIP facilitates the funding by retail and institutional inves-
tors. The interplay of these parties expands access to finance. It is primarily
the focus on investments, the pitch events, the capacity-building measures,
the closed investor network, and the remuneration that further distinguish
the CIP's business model from that of most CFPs. The CIP further differs
from conventional CIPs, such as the Belgian MyMicroInvest, in that it facil-
itates PLS investments. It can be particularly attractive to retail and institu-
tional investors from GCC countries, in addition to expatriates looking for
impact investment opportunities.
The differences to the CIP Shekra are in the details, but mainly consist in
the financial intermediary taking an active part, the MM instrument, and the
institutional investors: the proposed financing scheme represents more of an
integrated part of the financial system. Although there are similarities be-
tween the CIP and VC firms/funds, the major differences are that (i) funding
volumes, and yet to be defined capital contributions, are relatively small,
enabling financial and investor inclusion, respectively; (ii) the CIP neither
accepts nor manages funds; (iii) each investor decides on each investment
opportunity, while the CIP doesn't provide explicit recommendations. The
CIP's network of investors shows similarities with angel investors. The por-
tal's role is similar to that of the trustee in the direct lending concept (Zip) of
the benevolent debt-based CFP Kiva.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 46
7 Final appraisal
PLS aims at income generation. The long tenures and risk sharing enable
enterprise development while MM offers a gradual exit. In contrast, asym-
metric information is an obstacle as MSEs tend to lack adequate accounting
– banks seem less affected by an information gap. Given the risks and pre-
sumably weak capacity of MSEs, risk techniques for cash flow funding are
critical. Agency costs could be reduced through capital requirements or peer
monitoring. Cost efficiency can suffer as providers, in Egypt mainly Islamic
banks, generally lack experience with PLS. Transaction costs for the provi-
sion of finance are basically lower than in murabaha. CF can provide access
to funding sources beyond local banks or MFIs: to private individuals and
possibly to further institutional sources as well. It requires adequate means
to produce information, e.g. business plans or due diligence, but allows dis-
tributing search and screening costs among investors and intermediaries.
The PLS CI financing scheme proposed uses the benefits of MM while
providing access to funds, training and advice. The intermediaries facilitate
a sufficient extent of information. Investors collectively make investment
decisions. Capacity building and regular monitoring (visits and (mobile) re-
porting) aim at reducing risks. With the field partners' outreach and focus on
(informal) MSEs, investments can be generated on a larger scale. Compara-
tive advantages among all stakeholders aim at improving efficiency as well
as scaling down PE investments. The remuneration attempts to safeguard
sustainability and curb moral hazard. The scheme is legally feasible, as it
considers restrictions on the activities of the CIP and MSEs vis-à-vis regis-
tration requirements. The main disadvantage is that investment and valua-
tion risks remain along with the country risk and basically the bank's cur-
rency risk pertaining to cross-border CI. Moreover, the model implicitly as-
sumes that the crowd is at least as good in making decisions as a bank/MFI
officer, investors do diversify investments, investors are willing to pay a
discount, entrepreneurs can contribute capital, the value of the enterprise or
the shares (ownership interests) are known during the MM tenure.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 47
8 Conclusion
Could CF foster MSME finance by means of PLS where traditional interme-
diaries cannot? The PLS CI financing scheme proposed for Egypt aims to
do so by scaling down MM investments while using the scope of the field
partners, enabling financial and investor inclusion. The ICT on which this
scheme rests facilitates the transfer of 'wisdom' along with finance, and a
remuneration scheme used in practice enables capacity building in MSMEs.
Following an examination of MSME finance in the MENA region, the use
of PLS instruments and of cross-border CF was assessed and a complemen-
tary financing scheme was developed, focusing on Egypt to consider coun-
try-specific conditions, by using the results of a survey and desk research.
The rationale for this paper is that MSMEs face substantial financial con-
strains while PLS advocates entrepreneurship and CF provides access to
funding sources. The confluence of these areas has not yet been researched.
The regional financial sectors are moderately developed and dominated by
banks while non-bank financial sectors are undeveloped. The countries of
the GCC have larger and deeper financial systems than the more diverse
group of non-GCC countries, including Egypt. Due to deficiencies in the
legal framework and the financial infrastructure, low bank competition and
limited lending, and weak or insufficient alternatives to bank credit or
murabaha, the MSME sector severely lacks funding. Regional markets en-
compass different MSME landscapes, but they are dominated by MSEs and
informal enterprises. The peculiarities of these impede the financing by in-
stitutions, mainly because of the risks and costs involved, leaving banks
with a wide outreach and focus on (a sub-group of) MSMEs in a unique po-
sition. The large number of enterprises at the lower end of the range in terms
of firm size suffers disproportionately from the total funding gap. Financial
access underperforms relative to financial depth and peer-group economies.
PLS instruments could promote productive entrepreneurial activity, in
Egypt, mainly in micro enterprises, as well as MSME growth – more effi-
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 48
ciently than murabaha. MM stands out as the most appropriate option as it
involves bearable repayments. PLS eventually fosters responsible finance
by aligning providers' incentives with MSMEs' success. However, in Egypt
these instruments are generally inapplicable by institutions due to the specif-
ic obstacles revealed, mainly a regulatory framework that is not conducive
and a weak financial infrastructure, at least for microfinance. The IM sector
is underdeveloped. Banks generally lack experience with PLS. Risk assess-
ment and management are therefore likely weak, but they are critical given
the probably limited capacity and riskiness of smaller-scale enterprises.
CF, by means of intermediaries (CFPs), represents an alternative funding
channel – in Egypt, primarily next to banks and MFIs. CF can provide micro
enterprises access to funds from individuals and from institutional sources
across countries. It could probably do the same for SMEs as well – an opin-
ion shared by the surveyed experts. The capacity of groups of investors and
other stakeholders allows entrepreneurs to receive assistance and intermedi-
aries to reduce or distribute costs. However, the applicability of CF depends
on the business model. Donations are probably not sustainable. CIPs partly
assume the tasks of VC firms: volumes are smaller, fees tend to be higher.
The PLS CI financing scheme proposed in this paper scales down PE in-
vestments while using the field partners' outreach to MSMEs and the local
CIP as the hub, improving inclusion of both entrepreneurs and investors.
MM was determined to be the most suitable instrument. The bank, through
its dedicated program, can serve informal MSEs. The CIP and incubators
focus on pre-selecting MS(M)Es (dual approach). By allocating project pro-
posals, the CIP facilitates the screening, information exchange (mobile
where necessary), decision-making and funding by domestic or foreign re-
tail investors. It can absorb funds from public and private as well as Islamic
financial institutional sources across the region and beyond. Capacity-
building measures aim at reducing risks while the remuneration scheme at-
tempts to safeguard sustainability and reduce agency issues. Evidence for
the applicability of the essential features is provided by the CIP Shekra.
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 49
The financing scheme could advance MSME finance where banks or funds
are reluctant and MFIs are unable due to transaction costs given the limited
resources on the one hand and an information gap regarding smaller-scale
firms, primarily for micro enterprises, on the other hand. Despite the prima-
ry obstacles to PLS and CF in Egypt, the model seems viable with respect to
the selected criteria: income generation or enterprise development, infor-
mation asymmetry and risk mitigation, cost efficiency and sustainability,
and legal feasibility. Yet challenges remain: due to the lack of specific regu-
lations, let alone harmonized regulations across countries, CI is subject to
strictest provisions determining the permissible and feasible activities of
CIPs and MSMEs. International money transfers can be costly and bear cur-
rency risks. Moreover, the model is based on a few assumptions. The most
critical concerns the wisdom of the crowd: decisions made collectively can
be better, but their quality depends on the heterogeneity of the group and the
uninfluenced decision-making of its members.178
After all, a scheme such as the one proposed here or a CIP like Shekra have
yet to be proven to be effective (e.g. access desirable projects or achieve in-
come growth), competitive (pricing) and profitable. Some MENA countries
are major receivers of remittances. While their use in entrepreneurial fi-
nance is debated, remittances could leverage CI in MSMEs, just as dona-
tions (or zakat and sadaqah) can incentivize microfinance to entrepreneurs.
However, the survey results were ambiguous on this point. Another point is
that this paper did not consider rural areas, where demand for Islamic fi-
nance is likely stronger. Further research is required in these areas.
So far, donation or benevolent debt-based CF, with its low barriers to entry
and low funding volumes, has been used by MFIs for the refunding of loans
for informal, non-employer micro enterprises. Early evidence suggests that
CF can offer an alternative, including growth finance, for enterprises in
countries such as those in the MENA; it could become "a meaningful alter-
178 De Buysere et al. (2012); Hornuf/Klöhn (2012).
An Alternative Approach to Financing Micro, Small and Medium-Sized Enterprises 50
native to angel finance and venture capital".179 In the end, CI is relevant and
can only be effective if MSMEs with profitable or impactful projects do not
have access to traditional funding sources.180 Evidently, enterprises in the
MENA region to a large extent do not. Presumably, the types of firms men-
tioned above do not either. By complementing the capacity-building infra-
structure alongside facilitating funding, locally adapted CIPs such as the one
proposed can "help build a pipeline of 'investment ready' firms to narrow the
gap between [impact] investors’ appetite and absorption capacity."181
As regards Islamic finance, a multi-billion-dollar industry already exists. If
one aims to achieve socio-economic improvements for individuals that real-
ly make decisions based on their religious or cultural beliefs, then one needs
to speak their language. Efforts could be undertaken for a more intense allo-
cation of capital from GCC countries to MSMEs across the region to pro-
mote entrepreneurship while reducing differences among various Muslim
denominations in conflict-prone areas to a set of common principles.
CF is at the beginning of a convergence process of formal and informal fi-
nance. If research, regulation and education is going to accompany devel-
opments,182 retail and institutional investors will increasingly be able to
provoke private sector stimuli in developing countries, or support environ-
mentally or socially responsible projects. Indeed, investments are risky. Yet
PE, amongst other factors, facilitates entrepreneurship and the onset of in-
novation, just as it was VC, through a partnership with Matthew Boulton,
that enabled James Watt to realize his steam engine in the 18th century.183
"If the success of microcredit in alleviating poverty is debated (...) and the success of micro-enterprise is not evident, perhaps micro-enterprise needs the hand-holding role of micro-angels along with the downside risk protection afforded by microequity."184
179 Larralde/Schwienbacher (2010), p. 3. 180 Cf. Hornuf/Klöhn (2012). 181 El-Zoghbi/Gonzalez (2013), p. 3. 182 De Buysere et al. (2012). 183 Mokyr (2007); Brunt (2006); Montagna (2006). 184 Ashta et al. (2012), p. 357 with reference to Murdoch/Roodman (2009).
51
Appendix I: Legal and regulatory frameworks for
crowdinvesting
I.I The Securities Act and the CROWDFUND Act in the United
States of America
CI has been hindered from reaching scale in the USA primarily because of
the registration, prospectus and disclosure requirements, as stipulated by the
Securities Act of 1933, concerning the issuance of securities. Another factor
is the restriction on both the solicitation of the sale of equity and invest-
ments beyond certain thresholds by non-accredited investors, i.e. individuals
with an annual income less than USD 200,000 and a net worth of less than
USD 1 million. In comparison, it is primarily the prospectus requirement for
issue volumes exceeding EUR 100,000 that limits the application of CI in
Germany.185
The current SEC-drafted rules of the CROWDFUND Act186 enacted in
April 2012 will presumably exempt issuers from the registration and pro-
spectus requirement for issue volumes up to USD 1 million within twelve
months. Issuers will be subjected to disclosure requirements depending on
the funding volume given certain thresholds. For issues up to USD 100,000,
the latest income tax statement and financial statements certified by the
principal executive officer must be disclosed. Above USD 100,000 and up
to USD 500,000, financial statements certified by a public accountant must
be disclosed. For issues greater than USD 500,000, audited financial state-
ments must be published.187
185 Hornuf/Klöhn (2012), pp. 252 ff. and cf. Bradford (2012a/b); Röthler/Wenzlaff (2011),
pp. 21 ff. The European regulatory framework is harmonized for issues above EUR 5 million. Pursuant to the Prospectus Directive, national legislators formulate their own provisions for issue volumes below EUR 5 million. However, the directive purports a pan-European exemption from prospectus requirements for issues below EUR 100,000 (Directive 2003/71/EC and amendment 2010/73/EU; cf. De Buysere et al. 2012, p. 28).
186 Title III of the JOBS Act, H.R. 3606. 187 Hornuf/Klöhn (2012), p. 254; cf. Bradford (2012a/b).
Appendices 52
Non-accredit crowdinvestors will presumably be permitted to invest in en-
terprises up to a certain limit, depending on their annual income and net
worth. If the sum of these is smaller (greater) than USD 100,000, the indi-
vidual may invest up to the minimum of USD 2,000 (100,000), 5% (10%) of
the annual income, and 5% (10%) of the net worth.188
I.II New regulations for crowdinvesting in Italy
Italy was the first country to regulate CI. After relevant amendments to the
legal framework in 2012, the Italian Securities and Exchange Commission,
the Commissione Nazionale per le Società e la Borsa (CONSOB), approved
and published new regulations in July 2013.189 CONSOB sets clear rules for
platform operators and start-ups based in Italy, providing both domestic and
foreign crowdfunders with protection.
Provisions of the regulatory framework address, amongst others, (i) the reg-
istration of CFPs or CIPs; (ii) CONSOB's supervision of CI activities; (iii)
information and disclosure requirements; (iv) withdrawal and tag-along
rights for investors; (v) a minimum capital contribution of investors or incu-
bators that, according to CONSOB's definition, fall into the category of pro-
fessional investors; and (vi) the closing of a deal, beyond certain thresholds,
by registered broker-dealers.190 Aschenbeck-Florange et al. provide an
overview of the current legal and regulatory frameworks for CF or CI in se-
lected European countries.191
188 Hornuf/Klöhn (2012), p. 254; cf. Bradford (2012a/b). 189 Resolution 18592/2013. 190 Aschenbeck-Florange et al. (2013), pp. 23 ff.; Lerro (2013). 191 Aschenbeck-Florange et al. (2013).
Appendices 53
Appendix II: Case of a crowdinvesting portal offering profit-
and-loss sharing instruments – Shekra in Egypt
II.I Introduction
Desk research uncovered the CIP Shekra192 as one of at least four IF CFPs:
the other two are reward-based, and the third has ceased operation (see sec-
tion 2.3).193 As a limited liability company (LLC) headquartered in Cairo,
Egypt, Shekra started operations in late 2012. The CIP addresses potential
high-growth start-ups and established small firms. On the basis of PLS, it
facilitates the placement of equity capital and the transfer of shares while
aiming to improve financial and investor inclusion. Working on the ground
and on an ex ante basis, the CIP forwards pre-selected investment opportu-
nities to its closed network of crowdinvestors. It participates in funded pro-
jects as a partner in the PLS arrangement.
II.II Target enterprises
Shekra addresses entrepreneurs who need seed capital to launch a start-up as
well as existing smaller-scale firms in need of growth finance, both of which
suffer from a funding gap at their early stage; that is, their funding demand
is typically not, or barely, met by traditional sources (see section 2.3). So
far, three technology start-ups, each under the legal form of an LLC, have
been successfully funded in a first round in mid-2013.194 The CIP is current-
ly preparing to also reach out to Tunisian entrepreneurs.
II.III Financial instrument
The CIP enables entrepreneurs to collect funds from crowdinvestors, who
provide seed-capital or growth finance. Investors directly invest in the en-
terprises on the basis of PLS instruments, acquiring a stake in equity or an
192 The information in this appendix stems from the CIP's website, shekra.com (Shekra
n.d.), and an interview with its co-founder, Dr. Shehab Marzban. 193 Zoomaal.com (Libanon), yomken.com (Egypt) and halalfunder.com (UK), respectively. 194 Including a portfolio management software and an online retail store.
Appendices 54
ownership interest. They act as silent partners and are entitled to a share in
profits, as well as possibly realizing capital gains when they exit.
In the three projects that were funded so far, the PLS investments were ar-
ranged on the basis of musharakah with PSRs equal to investors' share in
capital and case-by-case exit proposals of around three years. Shekra de-
clared that it was preparing a number of investments based on MM, the type
of PLS instruments allowing for a diminishing partnership (see section 2.2).
Moreover, it plans to cooperate with impact investment funds in the near
future in order to provide entrepreneurs with finance on the basis of PLS
(funded by crowdinvestors) blended with qard hassan (benevolent loans).
II.IV Private placement
The CIP facilitates the private placement of equity capital in order to com-
ply with current provisions and to avoid the compliance costs of enterprises
with additional regulatory requirements (registration and information; see
section 5.4.1). The staff documents the "transfer of shares"195 (probably an
ordinary form of certificate) to the crowdinvestors to meet legal require-
ments. The total funding volume is limited to the smaller of one quarter of
the market value of equity or USD 200,000. For a given funding amount in
a project, the investment is structured using an algorithm such that the num-
ber of investors is limited and a variable minimum contribution is required
from crowdinvestors. Funds must be raised by the entrepreneurs during a
period of 60 days and up to the targeted amount (all or nothing).
Upon successful completion of the fundraising campaign, at the time of
closing the deal, the investors sign a Shareholder Agreement (with the en-
trepreneurs) stipulating their rights and obligations regarding, amongst oth-
ers, information, any increase in capital stock and the sale and transfer of
shares (tag-along and drag-along rights). Shekra doesn't accept any funds at
any time. They are transferred directly to the entrepreneurs using their bank
195 Shekra (n.d).
Appendices 55
accounts at the Arab African International Bank, which doesn't play an ac-
tive part. Foreign exchange transfers must not exceed around USD 50,000.
For the past projects, allocated funding volumes ranged from USD 20,000 to
35,000. The number of investors was limited to around 20 to 30. Average
contributions range between USD 2,000 and 3,000. The smallest contribu-
tion of a crowdinvestor was USD 1,000. The funding campaigns lasted be-
tween two days and three weeks.
II.V Distribution channels, pre-selection and information
As well as aiming to connect with entrepreneurs through online media, the
CIP's staff conducts a pre-screening of project proposals at its road shows
(pitch events for start-ups) and in collaboration with partnering organiza-
tions: a regional NGO incubator focusing on entrepreneurship among the
youth (Injaz al-Arab) and a national association of private sector representa-
tives (Egyptian Junior Business Association). Applications can also be sub-
mitted by registering online with the CIP.
In an internal screening process, the due diligence process conducted by the
staff and/or third-party consultants, potential projects are assigned a score
according to a set of criteria such as the skills and experiences of the entre-
preneurs, the business plan or model, the venture's market potential and, if
available, the ownership structure. Start-ups must meet a minimum score to
qualify for the fundraising.196 Those that qualify they sign an Entrepreneur
Agreement with the CIP that ensures that their intellectual property is sub-
ject to confidentiality and stipulates the prohibition of raising capital from
third-party sources during the funding phase.
The funding phase starts with the dissemination of the pre-selected project
proposals (containing the business plan and other media, the equity offer
196 Entrepreneurs that lack skills or do not achieve the minimum score might receive train-
ing or advisory services from the staff or partnering incubators on preparing or refining their business plans in order to raise their scores.
Appendices 56
and a proposed exit strategy) to the crowdinvestors via the CIP. While pro-
ject details are accessible in full only in the restricted section of the CIP,
basic data is publicly available and is distributed across other online media
channels. This is meant to allow project initiators to promote their proposals
outside the closed network to attract further investors or receive feedback
from a wider audience.197 Crowdinvestors can interact directly with project
initiators throughout the fundraising campaign and exchange information
with co-investors.
Entrepreneurs of successfully funded start-ups have to provide periodic re-
porting to their investors. They generally receive mentorship from Shekra's
staff or third-party consultants on a monthly basis. Fees are primarily borne,
at a discount, by the enterprises.
II.VI Crowdinvestors
Facilitating private placements, Shekra keeps its network of investors
closed. Investors join the network upon recommendation and/or application
in order to gain full access to the project proposals on the CIP. Approved
crowdinvestors are prohibited from disclosing any information and from
approaching the entrepreneurs of proposed projects outside Shekra's net-
work. Foreign crowdinvestors must submit to the staff a letter of attorney.
Investors in a particular project sign a Shareholder Agreement, as mentioned
above. So far, crowdinvestors have primarily been private individuals from
Egypt. The CIP plans to expand its network in the region, primarily to Saudi
Arabia and the UAE, as well as to selected migrant-receiving countries out-
side the region.
197 The latter is meant to induce funding effects within the network of crowdinvestors.
However, desk research could not identify incentives for an audience outside the net-work to get involved with the projects presented on the CFP.
Appendices 57
II.VII Remuneration
Unlike conventional CIPs that charge a commission of 5% to 10% that is
deducted from the raised funds, Shekra receives ex post (from
crowdinvestors) a share in raised equity of around 10%, thereby participat-
ing in the PLS investment as a co-investor.198 On the one hand, this share in
raised capital is higher than that of some conventional CFPs and CIPs and of
most, if not all, VC firms, which charge an even lower percentage manage-
ment fee due to scale economies. On the other hand, the CIP has a stake in
equity and profits from successful investments as well as receiving the cash
from start-ups to cover the costs of its above mentioned advisory services.
The CIP anticipates holding shares ex ante; this remuneration scheme seems
to better align its incentives and operations (e.g. pre-selection, due dili-
gence) with the interests of crowdinvestors (e.g. selecting profitable – i.e.
positive NPV – investments at a certain risk level).199
198 Hornuf/Klöhn (2012), p. 246. 199 Hornuf/Klöhn (2012, pp. 258/259) stress the risks of cash-based commissions.
Appendices 58
Appendix III: Migrant remittances and the Middle East and
North Africa region
The impact of migrant remittances on economic development is well docu-
mented: FSD basically fosters the availability and efficiency of remittances.
There is a growing consensus that, vice versa, remittances play an important
role for expanding financial access. Their use in promoting entrepreneurial
finance is debated.200 However, international remittances sent by around 190
million migrants to their countries of origin, USD 350 billion in 2011, form
a stable source of finance for these (developing) countries, and one of the
largest: migrant remittances are thrice the size of official development assis-
tance and represent a third of external finance.201
Remittances inflows relative to GDP in the MENA region are among the
highest worldwide. The region accounts for 13% of remittance flows to de-
veloping countries. As a comparison, it accounts for only 6% of total FDIs
in these countries.202 The region includes both sending (GCC) and receiving
(non-GCC) countries: Figure 15 shows the dimensions of remittance flows
to the major receiving countries.203
Egypt received around USD 8.5 billion in remittances in 2011, USD 4 bil-
lion of which were sent from Saudi Arabia.204 According to a survey by the
Center for Migration and Refugee Studies at the American University, Cai-
ro, the majority of Egyptian migrants (81%) resides in GCC countries such
as Saudi Arabia (47%), UAE (12%), Kuwait (11%), Qatar (7%), Oman
(3%), and Bahrain (1%). Another 10% of migrants live in non-GCC coun-
tries such as Libya (5%), Jordan (3%), Yemen (1%), and Algeria (1%).205
200 CGAP (2013a/b); Fransen et al. (2013); Mohapatra et al. (2011a/b); Cirasino/Nicoli
(2010); IOM (2010); Aggarwal (2006). Remittances represent a complementary funding source for expanding financial access given the decreasing foreign aid budgets and shal-low local capital markets (Rocha et al. 2011).
201 CGAP (2013a/b); World Bank (2013i); Ratha/Silwal (2012); Mohapatra et al (2011b). 202 From 2005 to 2010 (IMF 2012). 203 Sending countries are the UAE, Saudi Arabia, Oman etc. Cirasion/Nicoli (2010), p. 25. 204 Formal transfers. CGAP (2013a); World Bank (2013j); Cirasion/Nicoli (2010). 205 Survey of 200 remittance-receiving households in various parts of Egypt (IOM 2010).
Appendices 59
Appendix IV: Cases of down-scaling banks offering profit-
and-loss sharing instruments
IV.I Abu Dhabi Islamic Bank Egypt
The full-fledged Islamic banks ADIB Egypt and Al Baraka Bank Algeria
have scaled down, offering PLS instruments at the microfinance level.
ADIB Egypt (formerly the National Bank for Development) is one of three
Islamic banks in the country and one of four banks that offer microfinance
services alongside the over 400 NGO MFIs (see section 3.4). As the only
bank offering IM services at present, ADIB Egypt dedicated USD 29 mil-
lion to finance informal MSEs by means of both murabaha and
musharakah. Through its network of 42 branches distributed across the
country, the bank provides funding to experienced and skilled entrepreneurs,
with amounts ranging from USD 140 to 7,200, a tenure of up to two years
and no collateral requirements while using a profit equalization reserve. No
evaluations are available yet, as the program was only launched in late
2012.206
Islamic banks deploy profit equalization reserves (or investment risk re-
serves) to mitigate investment risks and smoothen returns on (special) in-
vestment accounts (section 2.2), particularly in lean times.207 Such a reserve
is built either "by drawing down on a portion of the total profit before its
division between bank owners and investment account holders" or "by
drawing on a portion of owners' share of profit".208 With the accumulation
and distribution of the reserve being positively correlated with the return on
assets, risks in investment accounts on the liability side of the balance sheet
are partly absorbed by the bank.209
206 ADIB (2012). 207 Ali/Iqbal (2007); Sundararajan (2007). 208 Ali/Iqbal (2007), p. 8. 209 Sundararajan (2007), p. 126.
Appendices 60
IV.II Al Baraka Bank Algeria
In collaboration with the Algerian Ministry for Industry, SMEs and Invest-
ment Promotion and with the assistance of GIZ, Al Baraka Bank conducted
a pilot program offering musharakah (see section 2.2) in the region of
Ghardaïa, Algeria in 2009. The region is characterized by a strong entrepre-
neurial culture, by an attachment to Islamic principles and by the fact that
traditional businesses are accustomed to musharakah financing.
Given many challenges including the country's legal and regulatory frame-
work, the financial infrastructure and the entrepreneurs themselves (no reli-
able financial records, a lack of credit history, high level of delinquency), a
separate MSME unit was set up to work together with branch managers to
implement the product. Tested risk assessment and mitigation mechanisms
include (peer) screening of clients and project proposals, assessment of en-
terprises and cash flows as well as regular monitoring by engaging commu-
nity leaders and guarantors.
Four years later, the musharakah portfolio covered 167 MSMEs and a ratio
of non-performing loans of 2.3% (portfolio at risk greater than 90 days).
Upon successful implementation of the pilot program, the bank started to
offer musharakah through its branch network at the national level and to test
murabaha (mark-up sale) and qard hassan loans (section 2.2). In the future,
the latter could enable the bank to adopt a dual approach in the provision of
finance – part PLS, part benevolent loan – for entrepreneurs.210
210 Buhl/Range (2013); Pearce (2011), p. 13; Majewski (2009).
Appendices 61
Appendix V: Additional considerations on the proposed fi-
nancing scheme of profit-and-loss sharing crowdinvesting in
micro, small and medium-sized enterprises in Egypt
V.I Target enterprises
MSEs are pre-selected from various industrial sectors. The target group in-
cludes but is not specifically limited to technology start-ups (cf. Appendix
II). These potentially high-growth enterprises can be important drivers of
innovation but they are particularly risky start-ups. As well as encouraging
crowdinvestors to diversify their investments, the portfolio of MSEs pre-
selected by the CIP should be balanced to reduce concentration risks.
V.II Financial instrument
The PLS scheme can be used to finance an asset in the form of property,
plant or equipment. For this purpose, the MM contract is combined with the
investors leasing their diminishing share in ownership on the basis of an
ijarah contract (see section 2.2) instead of participating in the venture's
profits (table 5).211 At the same time, the partnering financial intermediary
can foster the cross-selling of products.
V.III Financial intermediary and further partners
(i) ADIB Egypt's agreement to commit to the proposed financing scheme is
uncertain. Alternatively, a separate MFC with a dedicated MS(M)E depart-
ment could be established in collaboration with any another (Islamic) bank.
The parent bank would own the MFC, an unconsolidated associate or sub-
sidiary depending on the share of ownership. However, as MFCs cannot ac-
cept deposits (see section 5.2.1), the bank would still need to take this role
in the financing scheme. At first glance, community, cooperative and mu-
nicipal banks may represent a further option that, however, needs to be fur-
211 Saad/Razak (2011); Ahmed (2007).
Appendices 62
ther investigated. 42% of surveyed experts think that they would be suitable
intermediaries for a viable PLS CI financing scheme for MSMEs.
(ii) The CIP can seek cooperation with regional incubators, thereby increas-
ing its outreach, and VC firms or MFIs that are reluctant or unable to serve
MSMEs with funding needs below or above their usual funding volumes.
V.IV Funding
(i) As Shekra does, the CIP can sign an agreement with the pre-selected en-
trepreneurs that stipulates the confidentiality of intellectual property and the
ban on raising capital from other sources throughout the funding phase.
Conversely, registered crowdinvestors accept the CIP's terms of use includ-
ing the ban on disclosing any information, other than the publicly available
project profiles, beyond the closed investor network (see Appendix II).
(ii) 53% of experts think that group-based funding is a suitable form of risk
mitigation for a viable MSME financing scheme (figure 13). The bank could
deploy a group-based scheme for the provision of finance, particularly to
informal micro enterprises (section 5.1). Group lending has been successful-
ly used in microfinance to circumvent adverse selection and mitigate risks
of default and moral hazard despite having no collateral. As this has mainly
been used for loans, however, group funding would need to be adapted to
and tested in the MM scheme. The PLS contract is basically drawn up with
a group of entrepreneurs that mutually apply for funding and jointly provide
guarantee against fraud. They would have to monitor each other or appoint a
group leader to monitor the group. Peer selection and the winding up of
multiple clients could reduce the administrative expenses (transaction costs)
of the bank's MSE department. Peer monitoring could produce social collat-
eral, possibly supplemented by dynamic incentives (section 4.2), reduce
agency costs and mitigate the risk of moral hazard.212
212 Ahmed (2007), p. 62 with reference to Abdalla (1999).
Appendices 63
(iii) Moreover, 45% of experts consider relationships to be suitable to miti-
gate risks. Indeed, the bank is in an ideal position to cross-sell products (be-
sides the MM instrument) to provide MSEs with comprehensive financial
services or with finance for specific purposes. One example is mentioned
above. This way, it can use the benefits of close ties with entrepreneurs: im-
proved risk assessment and management through an informational ad-
vantage gleaned from the financial history of clients, loyalty, and long-term
or successive profit realization. Relationships can further be used by both
the bank and the CIP to enable access to finance by MSEs over multiple pe-
riods, thereby producing information about the entrepreneurs while incentiv-
izing prudential behavior by means of dynamic incentives. As is widely
known, one can find several funding rounds in seed, VC and PE financing.
(iv) So-called psychometric tests could be tentatively implemented by both
the bank's MSE department and the CIP's staff for a more precise and more
efficient analysis of an entrepreneur's personality, specifically his ability and
honesty. Such tools were developed by academics from the Entrepreneurial
Finance Lab Research Initiative at Harvard University, especially for use in
Islamic MSME finance in order to expand financial access despite the issues
of asymmetric information (section 2.2).213 However, only around a third of
experts think that psychometric tests are a suitable means of risk assessment
for a viable financing scheme.
(v) Public risk mitigation or guarantee initiatives, such as partial credit
guarantees, are seen as a market-friendly and effective intervention to stimu-
late the financing of MSMEs in the MENA region and beyond.214 Although
it hardly seems practicable, it is not implausible to place CI under the shelter
of such a scheme in order to stimulate institutional funding by mitigating
risks from asymmetric information. However, only around a third of experts
think that CI should be promoted this way (figure 14).
213 Abou-Gabal et al. (2011). 214 Arvai et al. (2011); Pearce (2011), p. 25; Farazi et al. (2010); IFC (2010a), pp. 42 ff.
Appendices 64
(vi) MSEs receive training sessions from the CIP's staff and third-party con-
sultants that include simple bookkeeping lessons where necessary. This is
crucial, as particularly micro and informal enterprises lack adequate ac-
counting skills (table 1), while profits need to be declared in PLS schemes
by some means. Alternatively, especially with respect to micro and informal
enterprises pre-selected by the bank, a mobile reporting scheme can be inte-
grated for information purposes. Such a scheme could involve the entrepre-
neurs submitting basic data, e.g., income and expenses, to the CIP's server
instantly or on a daily basis. Accounts are automatically kept and stored in
the system's data base. Entrepreneurs can pick up a copy, e.g. at the bank
branch. Crowdinvestors receive an online summary of the financial reports.
This is technically feasible in the current state of the art. Apparently, mobile
reporting per se cannot effectively mitigate risks such as moral hazard. But
when used together with on-site visits as mentioned above, it could lower
informational barriers (section 5.3).
(vii) As endorsed by the majority of experts (figure 14), the CIP enables ex-
pert investors, the partners in the MM arrangement, or volunteering experts
to form closer relations with the entrepreneurs in order to provide advice or
mentorship in their field of expertise. A construction engineer might for ex-
ample give small enterprises advice on how to efficiently build a storehouse.
V.V Funding sources
(i) Although this is seen as suitable by only a fifth of experts (see figure 13),
the CIP could establish partnerships with commercial funding sources such
as national, regional or international PE funds to attract additional capital to
projects screened and largely funded by individual crowdinvestors.
(ii) The CIP offers visitors to its site the chance to make donations or to give
zakat or sadaqah (section 2.2). These could be used as a form of guarantee
(tabarru; section 5.3) to incentivize bank finance or microfinance for infor-
mal micro enterprises. Around a third of experts thinks of these funds as
suitable for a viable financing scheme.
Appendices 65
Appendix VI: Tables
Table 1 – Stereotypical characteristics of micro, small and medium-sized enterprises
Feature Micro and small enterprises Medium-sized enterprises
Legal status • May not be formally registered • Mostly legal entity
Finances • Business and family finances fre-quently merged
• Low usage of financial services oth-er than loans
• Income can fluctuate considerably
• Finances managed professionally • Usage of a broader set of formal
financial services • Detailed past financial data and cur-
rent business plans available
Collateral • No assets that conventional banks would accept as collateral
• Property not formally registered
• Well-documented fixed assets such as land and building
Documentation • Little if any bookkeeping; no taxa-tion records
• Often lack formal paperwork
• Careful record-keeping; formal fi-nancial statements
Management • Often low level of education • Not familiar with formal finance • Decision-making based on short and
medium-term business planning
• Highly educated • Experienced with banks • Decision-making based on long-term
business planning
Source: Based on BFC (2011), p. 3 and Glisovic/Martinez (2012), p. 2.
Appendices 66
Table 2 – Indicators for assessing profit-and-loss sharing financial instruments for
micro, small and medium-sized enterprise finance
Indicators for PLS financial instruments
Benefits (1) (2) (3) (4)
Promoting income-generating activities �
Financing micro-enterprise establishment �
Financing SMEs �
Financing enterprise growth/development �
Risk-sharing/partnership between investor/investee � �
Profit-sharing, no servicing regardless of project outcomes �
Balancing debt-to-equity ratio/reducing risk of over-indebtedness �
Cash disbursal �
Profitability of product �
Cross-selling � �
Collateral requirement � �
Obstacles
Legal and regulatory framework
Laws/regulations regarding financial institutions/service providers �
Laws/regulations regarding financial instruments �
Anti-Money Laundering and Counter-Terrorism Financing rules �
Investor/creditor rights (e.g. weak contractual framework) �
Tax framework �
Financial infrastructure
Credit reporting systems (public credit registries, private credit bureaus) � �
Insolvency regimes �
Accounting and auditing �
Payment and settlement systems �
Financial institutions
Profitability of product �
Operational efficiency (administrative and personnel costs) �
Risk assessment/management techniques � �
Funding sources �
Funding costs �
Capacity of staff � �
Financial access
Strategy/organizational set-up of provider (for serving a MSME sub-group) � �
Proximity of bank branch or MFI � �
Riskiness of investment (entrepreneurial risk) �
Entrepreneurial/managerial skills � �
Adverse selection, screening costs (e.g. due to inadequate financial records) � �
Moral hazard, monitoring and control/state verification costs � �
Enforcement costs (e.g. collection method, legal actions) �
*Criteria for a viable MSME financing scheme
(1) Income generation or enterprise development
(2) Information asymmetry and risk mitigation
(3) Cost efficiency and sustainability
(4) Legal and regulatory feasibility
MSME finance criteria*
Appendices 67
Table 3 – Indicators for assessing crowdfunding as a funding channel for micro, small
and medium-sized enterprise finance
Indicators for crowdfunding as a funding source and channel
Benefits (1) (2) (3) (4)
Access to additional funding sources �
Cost-efficiency of funding �
Cost-efficiency of distribution channel �
Screening by the crowd �
Monitoring/control by the crowd �
Providing finance for micro-enterprise establishment �
Providing finance for SMEs �
Providing long-term finance for enterprise growth �
Prospect to attract further accredited/institutional investors � �
Partnership or mentorship between the crowd/investee � �
Prospect to integrate remittances �
Using raised funds as collateral �
Obstacles
Legal and regulatory framework �
Laws/regulations regarding crowdfunding platforms (e.g. registration/licensing) �
Laws/regulations regarding financial instruments (e.g. prospectus requirement) �
Anti-Money Laundering and Counter-Terrorism Financing rules �
Investor rights (e.g. investment thresholds for non-accredited investors) �
Tax framework
Financial infrastructure �
Payment and settlement systems � �
Business incubators
Crowdfunding intermediary
Operational efficiency (administrative and personnel costs) �
Transaction costs (e.g. fees for escrow and payment services) �
Field partner (financial intermediary) or escrow (financial service provider) �
Profitability of crowdfunding (e.g. service/management fee) �
Operational efficiency (administrative and personnel costs) �
Risk assessment/management techniques � �
Capacity of staff � �
Financial access �
Strategy/organizational set-up of provider (for serving a MSME sub-group) � �
Online/mobile access to financial services �
Adverse selection �
Moral hazard, state verification costs � �
Enforcement costs (e.g. collection method, legal actions) �
Refusal or denial due to ethnological/cultural reasons
*Criteria for a viable MSME financing scheme
(1) Income generation or enterprise development
(2) Information asymmetry and risk mitigation
(3) Cost efficiency and sustainability
(4) Legal and regulatory feasibility
MSME finance criteria*
Appendices 68
Table 4 – Illustration of a (re)payment schedule in musharakah mutanaqisah (diminishing partnership)
At the end of the month
Share purchase (USD)
Share capital of entrepreneur(s)
(USD) Share capital of investors (USD)
Profit (gross or net) [annual profit]
PSR of entrepreneur(s)* PSR of investors
PSR of investors (annual average)
Total payment (USD)
Total cash flow of investors
(i) (ii)=(ii)-1+(i) (iii)=(iii)-1-(i) (iv) (v) (vi) (vii) (viii) (ix)
0 500.00 4,500.00 0.10 0.90 -4,500.00
1 125.00 625.00 4,375.00 yi 0.10 0.90 125.00 125.00
2 125.00 750.00 4,250.00 yi 0.13 0.88 125.00 125.00
…
12 125.00 2,000.00 3,000.00 [Y1=Ʃ1≤i≤12 yi] 0.38 0.63 Ric1=0.76 125+0.76*Y1 125+0.76*Y1
…
36 125.00 5,000.00 0.00 [Y3=Ʃ25≤i≤36 yi] 0.98 0.03 Ric3=0.16 125+0.16*Y3 125+0.16*Y3
Total 4,500.00 4,500+Pic Pic=Ʃ1≤i≤3 (Yi*Rici)
Source: Based on Ahmed (2007), pp. 67 ff.; Saad/Razak (2011), pp. 7 ff.. Author's calculations. Note: total funding volume (USD)=5,000; share capital of investors (90%) (USD)=4,500; share capital of entrepreneur(s) (10%) (USD)=500; tenure (months)=36; monthly purchase of shares from investors (USD)=125; Ric: ratio of
profits attributable to investors' capital; Pic: profits attributable to investors' capital. *The entrepreneur(s) may receive an additional share of profits for the man-agement. In this example, profits are distributed to the investors on an annual basis.
Appendices 69
Table 5 – Illustration of a (re)payment schedule in musharakah mutanaqisah (diminishing partnership) combined with ijarah (leasing)
At the end of the month Rent (USD)
Additional share purchase (USD)
Total payment (USD)
PSR of entrepreneur(s) PSR of investors
Total share purchase (USD)
Share capital of entrepreneur(s)
(USD) Share capital of investors (USD)
Total cash flow of investors (USD)
(i) (ii) (iii)=(i)+(ii) (iv) (v) (vi)=(i)*(iv)+(ii) (vii)=(vii)-1+(vi) (viii)=(viii)-1-(vi) (ix)
0 0.10 0.90 500.00 4,500.00 - 4,500.00
1 24.00 112.41 136.41 0.10 0.90 114.81 614.81 4,385.19 136.41
2 24.00 112.41 136.41 0.12 0.88 115.36 730.17 4,269.83 136.41
3 24.00 112.41 136.41 0.15 0.85 115.91 846.09 4,153.91 136.41
…
36 24.00 112.41 136.41 0.97 0.03 135.76 5,000.00 0.00 136.41
Total 864.00 4,046.76 4,910.76 4,500.00 410.76
Source: Based on Ahmed (2007), pp. 67 ff.; Saad/Razak (2011), pp. 7 ff.. Author's calculations. Note: monthly rental payment (USD)=24.00; additional purchase of shares from investors (USD)=112.41; total monthly payment (USD)=136.41; see note to table 4.
.
Appendices 70
Appendix VII: Figures
Figure 1 – Conceptual overview of financing options for enterprises
Source: Based on Stein et al. (2010), p. 8. Author's illustration.
Figure 2 – Overview of financial access of micro, small and medium-sized enterprises
Source: Stein et al. (2010), p. 2.
Appendices 71
Figure 3 – Financial sector development in the Middle East and North Africa in com-
parison to other regions
Source: World Bank's Global Financial Development Database (World Bank 2013j). Au-thor's calculations and illustration. Note: The figure shows private credit (banks and oth-er financial institutions) relative to GDP, an indicator of financial sector development,
for selected regions. The GCC sample covers Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia (HICs). The non-GCC sample covers Algeria, Djibouti, Egypt, Iran, Iraq, Jordan, Morocco, Syria, Tunisia, and Yemen (MICs). The MENA sample covers both of these
subsamples as well as the HICs Israel and Malta, which are excluded from the non-GCC sample for the purpose of comparison.
Appendices 72
Figure 4 – Financial sector development in countries of the Middle East and North
Africa
Source: World Bank's Global Financial Development Database (World Bank 2013j). Au-thor's calculations and illustration. Note: The figure shows private credit (banks and oth-
er financial institutions) relative to GDP for selected countries in the MENA: Algeria (DZA), Djibouti (DJI), Egypt (EGY), Iran (IRN), Jordan (JOR), Morocco (MAR), Syria
(SYR), Tunisia (TUN), and Yemen (YEM). See notes to figure 3 for further infor-mation.
Appendices
Figure 5 –
Source: CeAli (20
global IFtal globindust
GCC
Figure 6 –
Source:(2013)(adviso
viders a
Islamic finance landscape: global outreach and size
Central Intelligence Agency (n.d.; percentage population2011); Azami/Dar (2011); Central Bank websites. Authol IF industry has around USD 1 trillion in assets and accoobal financial assets. It is largely composed of banks. Thstry has grown at a CAGR of 15% to 20% over the pastCC countries (ibid.). Country codes: See the list of abbre
Islamic microfinance landscape: global outreach
e: Central Intelligence Agency (n.d.; percentage populat; Zawya (2013); Sanabel (2012); Pearce (2011); Karim
isor, GIZ). Author's illustration. Note: There are an estims and 1.3 million clients worldwide. Around 80% of clie
Bangladesh, Indonesia, and Sudan (another large sha
73
ize of leading markets
on); Ernst & Young (2012); hor's illustration. Note: The ccounts for around 1% of to- The global Islamic banking st decade, primarily in the
breviations in this paper.
lation); El-Zoghbi/Tarazi im et al. (2008); Range, M. timated 255 to 300 IM pro-lients reside in Afghanistan, share in Malaysia).
Appendices
Figure 7 –
and-loss sh
(n=38)
(1) Risk-sbetwee
(4) Fina
e
(6) Balanci(risk of
(7) P
(8) No
(10) No seless of
n/a
– Survey respondents agreeing/disagreeing with be
sharing instruments in micro, small and medium
Note: Answers were not required; full data (number o
5%
8%
13%
8%
5%
8%
16%
21%
16%
18%
11%
8%
11%
8%
11%
24%
34%
39%
32%
42%
39%
61%
50%
45%
50%
42%
34%
0% 20% 40%
sharing and partnership een investor/investee
(2) Financing SMEs
(3) Promoting income-generating activities
nancing micro-enterprise establishment
(5) Financing growth/enterprise development
cing debt-to-equity ratio of over-indebtedness)
) Profitability of product(compared to loans)
o collateral requirement
(9) Cash disbursal
servicing of debt regard- of project outcomes
(11) Cross-selling
Percentage res
n/a strongly disagree disagree neutral agr
74
benefit of applying profit-
m-sized enterprise finance
of respondents):
%
39%
29%
26%
21%
18%
18%
32%
34%
26%
32%
34%
16%
11%
11%
8%
11%
60% 80% 100%
espondents
gree strongly agree
Appendices 75
Figure 8 – Survey respondents choosing factor as most critical to applying profit-and-
loss sharing instruments in micro, small and medium-sized enterprise finance (n=38)
Note: Multiple answers were possible; were not required.
55% (21)
50% (19)
42% (16)
39% (15)
21% (8)
63% (24)
53% (20)
34% (13)
18% (7)
66% (25)
61% (23)
55% (21)
53% (20)
29% (11)
18% (7)
53% (20)
47% (18)
47% (18)
42% (16)
42% (16)
34% (13)
26% (10)
8% (3)
0% 20% 40% 60% 80%
LEGAL/REGULATORY FRAMEWORK
Laws/regulations: financial instruments
Investor/creditor rights
Laws/regulations: financial …
Tax framework
AML/CTF
FINANCIAL INFRASTRUCTURE
Accounting and auditing
Credit reporting systems (public, private)
Insolvency regimes
Payment/settlement systems
FINANCIAL INSTITUTIONS
Risk assessment/management techniques
Operational efficiency (administrative, …
Capacity of staff
Profitability of product
Funding costs
Funding sources
FINANCIAL ACCESS
Entrepreneurial/managerial skills
Adverse selection, screening costs
Riskiness of investment (entrepreneurial …
Moral hazard, monitoring/control costs
Strategy/organizational set-up of provider
Enforcement costs
Proximity of bank branch/MFI
Other
Percentage respondents (number)
Appendices
Figure 9 –
border) cro
prise finan
(1
(2) Provid
(3) Providenterp
(4) Partbetwee
(7) Prosaccredite
(8) Providfor e
(
(1
(12)
n/a
– Survey respondents agreeing/disagreeing with be
crowdfunding as a funding channel in micro, small
nce (n=38)
Note: Answers were not required; full data (number o
5%
11%
5%
5%
8%
8%
5%
18%
8%
5%
16%
8%
21%
16%
16%
13%
16%
16%
16%
13%
26%
26%
32%
16%
24%
29%
29%
29%
50%
61%
45%
45%
0% 20% 40% 6
(1) Access to additional funding sources
iding finance for SMEs
viding finance for micro rprise establishment
rtnership or mentorship een the crowd/investee
(5) Cost-efficiency of distribution channel
(6) Cost-efficiency of funding
ospect to attract further ited investors and funds
iding long-term finance r enterprise growth
(9) Using raised funds as collateral
(10) Screening by the crowd
(11) Monitoring/control by the crowd
2) Prospect to integrate remittances
Percentage resp
n/a strongly disagree disagree neutral agr
76
benefit of applying (cross-
ll and medium-sized enter-
of respondents):
%
%
50%
42%
39%
39%
39%
42%
29%
24%
32%
16%
29%
24%
11%
16%
16%
16%
16%
11%
21%
21%
60% 80% 100%
spondents
gree strongly agree
Appendices 77
Figure 10 – Survey respondents choosing factor as most critical to applying (cross-
border) crowdfunding as a funding channel in micro, small and medium-sized enter-
prise finance (n=38)
Note: Multiple answers were possible; were not required.
68% (26)
53% (20)
50% (19)
45% (17)
34% (13)
63% (24)
39% (15)
63% (24)
55% (21)
74% (28)
55% (21)
50% (19)
47% (18)
66% (25)
45% (17)
32% (12)
29% (11)
26% (10)
21% (8)
0% 20% 40% 60% 80%
LEGAL/REGULATORY FRAMEWORK
Laws/regulations: CF/CFPs
Laws/regulations: financial instruments
Investor rights
AML/CTF
Tax framework
FINANCIAL INFRASTRUCTURE
Payment/settlement systems
Business incubators
PLATFORM OPERATOR
Operational efficiency (administrative …
Transaction costs
FINANCIAL INTERMEDIARY
Risk assessment/management techniques
Profitability of CF
Operational efficiency (administrative, …
Capacity of staff
FINANCIAL ACCESS
Strategy/organizational set-up of provider
Moral hazard, state verification costs
Online access to financial services
Enforcement costs
Adverse selection
Refusal due to cultural reasons
Other
Percentage respondents (number)
Appendices 78
Figure 11 – Survey respondents agreeing/disagreeing with applicability of
crowdinvesting business model (n=38)
Note: Answers were not required.
24%
11%
24%
89%
50%
0% 20% 40% 60% 80% 100%
CI backed by a local financial intermediary
CI fully conducted by afinancial intermediary
Percentage respondents
n/a no not sure yes
Appendices 79
Figure 12 – Survey respondents choosing option as most suitable for a financing
scheme of profit-and-loss sharing crowdinvesting in micro, small and medium-sized
enterprises (I) (n=38)
53% (20)
47% (18)
45% (17)
34% (13)
71% (27)
47% (18)
45% (17)
76% (29)
34% (13)
32% (12)
92% (35)
45% (17)
42% (16)
16% (6)
55% (21)
42% (16)
34% (13)
34% (13)
21% (8)
8% (3)
71% (27)
63% (24)
58% (22)
58% (22)
55% (21)
42% (16)
42% (16)
34% (13)
0% 20% 40% 60% 80% 100%
TARGET GROUP
Small enterprises (10-49 employees)
Micro enterprises (1-4 employees)
Very small enterprises (5-9 employees)
Medium-sized enterprises (50-250 …
FINANCIAL INSTRUMENT
Musharakah mutanaqisah
Mudarabah
Musharakah
TENURE(S)
Medium-term (3 years)
Long-term (5 years)
Short-term (1 year)
INVESTOR REWARD/RIGHT
Financial return
Reporting
Product itself
Participatory/control rights
None (charitable investment)
TYPE OF (FINANCIAL) PARTNER
Up-scaling MFIs
Community, cooperative, municipal banks
Down-scaling commercial banks
Investment funds, VC/PE firms
Greenfield institution
None (3rd party escrow/payment services)
ROLE OF (FINANCIAL) PARTNER
Risk assessment of clients/projects
Providing escrow/payment services
Administering CI online applications
Mentoring, training (by VC firm)
Managing CI online reporting
Holding investments, refunding
Raising funds from further sources
Co-investing
None (just escrow/payment services)
Percentage respondents (number)
Appendices 80
Figure 13 – Survey respondents choosing option as most suitable for a financing
scheme of profit-and-loss sharing crowdinvesting in micro, small and medium-sized
enterprises (II) (n=38)
Note: Multiple answers were possible; were not required; assuming that CIP was given.
47% (18)
45% (17)
37% (14)
32% (12)
58% (22)
58% (22)
53% (20)
45% (17)
45% (17)
39% (15)
29% (11)
26% (10)
24% (9)
18% (7)
68% (26)
66% (25)
37% (14)
37% (14)
34% (13)
34% (13)
34% (13)
26% (10)
24% (9)
21% (8)
21% (8)
0% 20% 40% 60% 80% 100%
DISTRIBUTION CHANNEL
Branch: CF appl.; online/mobile: reporting
Branch: CF application & reporting
Online/mobile: CF applcation & reporting
Affiliate, e.g. incubators: appl. & reporting
RISK ASSESSMENT/MITIGATION
Credit scoring, client rating
Cash flow forecast
Group-based (peer selection, monitoring)
Relationships (periodical, cross-selling), …
Capital contribution, loss-sharing in MM
Savings requirement, insurance
Psychometric test, character analysis
Participation in decision-making
PER
Mobile reporting
FUNDING SOURCES
Funds of the crowd (retail investors)
Capital contribution by entrepreneur
Donations (private)
Investment deposits of bank/MFI clients
FDIs by companies/DFIs
(Impact) investment funds
Zakat
Donations (public)
Government subsidies
Remittances
VC/PE funds, accredited investors
Percentage respondents (number)
Appendices 81
Figure 14 – Survey respondents agreeing/disagreeing with supportive measure (n=38)
Note: Answers were not required.
Figure 15 – International remittance inflows of countries of the Middle East and
North Africa
Source: World Bank's Global Financial Development Database (World Bank 2013j). Au-thor's calculations and illustration. Note: The figure shows remittance inflows relative to GDP for those MENA countries that are major receivers of remittances: Egypt (EGY),
Jordan (JOR), Lebanon (LBN), Morocco (MAR), Syria (SYR), and Tunisia (TUN). The MENA sample covers these countries as well as Djibouti, Algeria, Iran, Iraq, Libya,
Oman, Saudi Arabia, and Yemen.
42%
11%
21%
11%
37%
79%
0% 20% 40% 60% 80% 100%
Public (partial) guarantee schemes
Enabling advice/mentorship by expert investors/volunteers
Percentage respondents
no not sure yes
82
Directives, laws, regulations, and standards
Capital Adequacy Standard for Institutions (other than Insurance Institu-
tions) offering only Islamic Financial Services (IFSB-2), December
2005, the Islamic Financial Services Board.
Directive 2003/71/EC of the European Parliament and of the Council, 4 No-
vember 2003, on the prospectus to be published when securities are
offered to the public or admitted to trading and amending Directive
2001/34/EC.
Directive 2010/73/EU of the European Parliament and of the Council, 24
November 2010, amending Directives 2003/71/EC and 2004/109/EC.
Draft General Rules for Microfinance Companies in Egypt as amended by
the Egyptian Financial Supervisory Authority, November 2010, the
Arab Republic of Egypt.
Executive Regulations of the Capital Market Law 95/1992 (promulgated by
the Decree 135/1993), the Arab Republic of Egypt.
Executive Regulations of the Law 88/2003 of the Central Bank, Banking
Sector and Money (promulgated by the Presidential Decree
101/2004), the Arab Republic of Egypt.
Guiding Principles of Risk Management for Institutions (other than Insur-
ance Institutions) offering only Islamic Financial Services (IFSB-1),
December 2005, the Islamic Financial Services Board.
Jumpstart Our Business Startups Act (H.R. 3606), 112th Congress, 3 Janu-
ary 2012, enacted by the Senate and House of Representatives, the
United States of America.
Law of Capital Market (Law 95/1992), the Arab Republic of Egypt.
Law of Commerce (Law 17/1999), the Arab Republic of Egypt.
Law of Investment Guarantees and Incentives (Law 8/1997), the Arab Re-
public of Egypt.
Directives, laws, regulations, and standards 83
Law of the Central Bank, the Banking Sector, and Money (Law 88/2003
amended by Law 162/2004 and Law 93/2005), the Arab Republic of
Egypt.
Law on Development of Small Enterprises (Law 141/2004), the Arab Re-
public of Egypt.
Law On Joint Stock Companies, Partnerships Limited By Shares & Limited
liability Companies (Law 159/1981 as amended by Law 212/1994,
Law 3/1998 and Law 159/1998), the Arab Republic of Egypt.
Law on Nongovernmental Organizations (Law 84/2002), the Arab Republic
of Egypt.
Legislative Decree 58/1998, Consolidated Law on Financial Intermediation,
pursuant to Articles 8 and 21 of Law 52/1996 (as amended by Decree
Law 179/2012 (coordinated with conversion Law 221/2012) and Leg-
islative Decree 184/2012), the Italian Republic.
Regulations on the Collection of Venture Capital by Innovative Start-ups
through Online Portals as adopted by Resolution 18592/2013 in terms
of articles 50 and 100 of the Decree 58/1998, the Italian Republic.
Securities Act of 1933 (as amended through Public Law 112-106/2012), the
United States of America.
84
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