Can Islamic finance boost financial inclusion?

Evidence suggests Islamic financial services can encourage Muslims to take advantage of banks and other formal financial institutions for services such as loans. 

In a Muslim majority country like Jordan, offering a Sharia-compliant loan boosted application rates from 18 to 22 percent, according to a recent study by Dean Karlan, professor of economics at Yale University. Karlan spoke at a recent MENA Chief Economist Office Seminar Series entitled “Understanding Demand for Sharia-Compliant Financial Products.”

Generalizing this finding is not so straightforward. To begin, look at the data detailing penetration of formal financial services among adults in Muslim majority countries.

You’ll find that financial inclusion often falls short among Muslim-majority nations. According to the 2014 Findex Database, while 57 percent of adults in Turkey have a bank account, in Jordan the share is 25 percent, and in Pakistan just 13 percent (Figure 1).

Figure 1: Varying levels of account penetration in selected Muslim countries

(Adults with an account (%), 2014)

global_20170608_finance_chart1Image: Global Findex database

Such disparities lead us to ask if there are larger systemic and institutional factors, including ones that go beyond cultural or religious norms, at play when we create new financial products. Non-religious factors play a role.

When adults without a bank account in select Muslim-majority countries were asked about barriers to account ownership, 13 percent said religion was an obstacle. In some cases, the obstacle could be that the financial service did not comply with Islamic law, under which collecting or paying interest is prohibited.

Religion, however, wasn’t the main barrier. More than a fifth of those who were unbanked said:

  • The accounts were too expensive.
  • The financial institution was too far away.
  • They lacked the necessary documentation.

Sixteen percent of adults also reported a general lack of trust in the banking sector.

In short, adults in Muslim countries are just as likely to report non-religious barriers to account ownership as religious concerns.

Yet the Islamic finance industry has grown by 10-12 percent annually and can play a significant role in narrowing the financial inclusion gap in Muslim countries. What could be done to harness this growth to ensure that adults in emerging Muslim countries get access to formal financial services, ranging from digital payments and savings accounts to loans and insurance?

In an update to a previously published paper, “Islamic Finance and Financial Inclusion: Measuring Use of and Demand for Formal Financial Services among Muslim Adults” (Review of Middle East Economics and Finance 10(2), January 2014), we looked at a host of financial services in a sample of countries with Muslim populations (less than 95 percent and greater than 5 percent). In general, we found that Muslims are significantly less likely than non-Muslims to own an account or save at a formal financial institution such as a bank or through a mobile money provider—this after controlling for other individual and country-level characteristics.

When we analyzed formal credit, however, we found no significant evidence that Muslims are less likely than non-Muslims to borrow formally.

That leads us to believe that structural forces are at play. When factoring in a country’s GDP per capita, for example, Muslims in richer nations are more likely to borrow formally than Muslims in poorer countries.

Knowing this, we can work to find some solutions to strengthen the financial infrastructure in emerging Muslim countries to ensure everyone has access to a bank account to store and save money. At the same time, technological innovations can provide alternative channels to spur ownership and use of bank accounts among Muslim adults.

Global experience suggests at least two potential solutions.

Leveraging high mobile phone penetration

A mobile phone or the internet can allow people to connect to otherwise inaccessible formal financial services. Most Muslim nations enjoy near universal mobile penetration (Figure 2). The internet, while relatively less available, is still widely used in some countries.

This well developed technology infrastructure can be leveraged to introduce, among other things, mobile banking; digital payments for utilities, Zakat, wages, etc.; and branchless baking through mobile agents

Encouraging the use of mobile phones and the internet to access such services not only attracts new account holders, but it also taps into the existing account holders who do not use their accounts for formal savings or credit services.

Figure 2: Nearly universal mobile phone penetration

(Adults with mobile or internet (%), 2016)

global_20170608_finance_chart2*Note: The height of the bar indicates total mobile phone penetration

Image: Gallup World Poll

Formalizing savings

Formal savings allow poor people to put away money for future expenses: a large purchase; investments in education or a business; a financial cushion to handle possible emergencies. While adults in Muslim countries save funds for such expenses, very few report using formal methods (Figure 3). Saving is a universal tendency, and focusing on introducing equity-based Islamic finance can help people meet their savings targets. Saving products can provide a first entry point to the formal financial system and, from there, users can be attracted to increasing the use of their accounts through other Islamic finance products for appropriate credit, housing finance, and more.

 Figure 3: Few adults report using formal methods to save

(Adults who report saving in the past year (%), 2014)

global_20170608_finance_chart3 *Note: The height of the bar indicates total savings

Image: Global Findex database