Financial inclusion In a world where financial sector growth outpaces real sector growth in some countries, half of the world’s adult population remains unbanked, especially in low-income economies and in rural areas. The rural-urban divide in providing financial services is especially pronounced in low income countries, perhaps due to physical access and financial literacy issues.
Despite the progress made in improving the supply of financial services and products in general, access to financial services remains a major challenge in some parts of the world and policymakers are working to address this issue, in the interest of ensuring a more sustainable growth path. One of the key champions of financial inclusion, the World Bank, has set a goal of universal financial inclusion by 2020 and continues to be at the forefront of research, consultative work and policy solutions, towards this goal. More recently in 2013, the leaders at the G20 (Group of 20) summit defined financial inclusion as a core priority of development. In this regard, the equitable and inclusive underpinnings of Islamic finance may be the answer to further enhancing financial inclusion, in both Muslim and non-Muslim countries. theoretically, the prevalence of more equity-based contracts enhances Islamic finance as a mechanism to promote better financial inclusion, especially in emerging economies and less developed countries, where the lower income population are usually underserved by conventional finance. In practice, however, countries witnessing the nascent rise in Islamic finance may initially lean towards the simpler sale- or lease-based contracts, before evolving to equity-based ones. In either form, Islamic contracts have demonstrated the ability to improve access to financing for the unbanked. From a supply-side view, the strong emphasis on governance and risk management support better prudential standards and financial discipline in these countries as safeguards against irresponsible practices. Taken together, these elements of Islamic finance offer enormous potential to attract the unbanked population, especially those in Muslim countries, and significantly raise standards of living of these households. Regarding the industry itself, Islamic finance is a USD2tln industry in terms of assets, after experiencing strong growth in the past decade, especially in banking and sukuk. e growth story of Islamic finance is characterised by extensive geographical expansion – Islamic finance has a presence in as many as 70 countries with more than 600 financial institutions (FIs) offering various forms of Shari’a-compliant financial products. By comparison, the industry’s assets base was a modest USD150bln in the 1990s, with approximately 144 financial institutions offering Islamic financial services, concentrated in a few countries in the Gulf Cooperation Council (GCC) and Asia.
Of importance, the increase in the number of FIs offering Islamic financial services is not restricted to full-edged Islamic finance entities, as major players of the global conventional finance industry have ventured into Islamic finance either through subsidiaries or window operations.This augurs well for countries which are just starting to adopt Islamic finance, due to the low capital requirements to set up Islamic window services (compared to full-edged Islamic banks); as well as the experienced management and supporting services in these banks. Broadly, Islamic finance offers solutions for both Muslim and non-Muslim populations. For non-Muslim populations, the appeal of Islamic finance is mainly due to ethical issues facing conventional finance, in addition financial considerations such as return on investment and financing rates. In some countries with successful and large Islamic finance industries such as Malaysia, which operates an Islamic financial system alongside a conventional one, non-Muslims account for a large share of Islamic banks’ customer base due to the value propositions, and comparable returns and service standards provided by these banks. Elsewhere, predominantly non Muslim European countries such as the UK, Germany and France have encouraged the growth of Islamic finance to support financial inclusion of their growing Muslim population. Now, close to 40 banking institutions have Islamic banking operations across the European continent. In the UK, out of the 20 international banks that engage in Islamic banking, six are fully- fledged Shari’a compliant institutions.
Furthermore, the UK government has supported the use of Islamic financial contracts for public financing programs such as the “Help to Buy” mortgage scheme, and; is exploring the possibility of providing Shari’a compliant education loans, to ensure that the religiously observant Muslim population are treated equally in matters of home ownership and education. Importantly, in the journey towards enhancing financial inclusion, the “low hanging fruit” for the Islamic finance industry and policymakers alike are Muslim households in countries where Islamic finance has not made great strides yet. Global financial inclusion statistics clearly indicate that Muslims are less likely to engage in formal financial services including accounts, savings products and credit. e reasons for this vary across countries, including barriers such as insucient income and pricing. Notably, religious barriers to account ownership are usually highlighted by observant Muslims.
In countries where the population has indicated that it strongly prefers Shari’a compliant financial services, many Muslims remain unbanked due to religious preferences amid the unavailability of Islamic finance options in these countries. A Gallup poll on the relationship between account penetration and “religiosity” found that Muslims are more likely than non-Muslims to report religion as an issue preventing access to financial services. However, this result is not uniform across countries. Respondents in Tunisia and Morocco were more likely to cite religious reasons (27% of respondents in both countries), compared to only 3% of respondents in Kuwait and UAE. To some extent, this may be related to prevalence of Islamic banking in a country. While Islamic banking is a nascent growth industry in Tunisia and Morocco, these banks enjoy a widespread presence in many GCC economies, providing ample Shari’a compliant financial alternatives. Similar to non-Muslims, Muslims alsocite cost, distance, and documentation as barriers to account ownership. Apart from Islamic deposit and financing oered by banks, the financial inclusion agenda may be better served by Islamic microfinance institutions (Islamic MFIs) and wealth redistribution mechanisms such as Zakat and Waqf. In many ways, the challenge of financial inclusion is most profound in poorer populations – a sole proprietor in a remote area, a farmer with few assets except his agriculture produce, and many others. To improve financial inclusion, the growth of Islamic microfinance should be encouraged, as the industry supports low-income households and micro enterprises by providing soft financing terms, usually for working capital and asset purchase. Based on the 2007 Consultative Group to Assist the Poor (CGAP)1 survey, it was estimated that less than 130 Islamic microfinance institutions (MFIs) were serving 500,000 customers (CGAP 2008). Within a span of five years, these figures have more than doubled. By 2012, there were 256 Islamic MFIs with 1.3 million active clients (CGAP 2013).
Zooming into Islamic microfinance in selected countries, jursidictions with notable Islamic microfinance presence include Bangladesh, Pakistan and Indonesia. Bangladesh, in particular, has made tremendous progress over several decades – the microfinance sector in Bangladesh has been widely credited with playing a key role in alleviating poverty, amid broader efforts to assist the low-income population. As a result, the share of population living below the national poverty line declined significantly within less than 20 years, from 56.6% in 1992 to 31.5% in 2010. In 1995, the Islami Bank of Bangladesh (IBB) developed the Rural Development Scheme (RDS), an Islamic microfinance program designed to support Muslims rural areas, who were left out from conventional microfinancing due primarily to religious considerations. Beginning as a small pilot project spanning only four villages in 1995, the RDS expanded and became a widely recognised model in poverty alleviation. As at end-2013, the RDS had benefited more than 800,000 people. e scheme uses Islamic modes of investment based on the profit and loss sharing methodology. Meanwhile, Indonesia is home to both conventional and Islamic microfinance models. Islamic finance commenced in Indonesia relatively recently since 1990, with the establishment of Ridho Gusti, an Islamic cooperative in Bandung. Generally, there are three types of Islamic microfinance institutions in Indonesia, namely microfinance divisions of Islamic banks, Islamic rural banks (BPRS) and Islamic
financial cooperatives that are not part of the formal financial sector. ese are referred to as Baitul Maal wal Tamwil (BMT). Islamic credit cooperatives (BMT) are an increasing important part of
microfinance in Indonesia, comprising of grassroots development programmes, funded by donations from Muslims. BMTs usually operate on the principle of profit-loss sharing instead of charging interest rates, and use Islamic moral suasion and group solidarity to encourage repayment of loans. Notably, the BMT movement has expanded without regulatory sup
Private business activities in Indonesia are usually driven by microenterprises and Small and Medium Enterprises (SMEs). Microenterprises prefer using BMTs due to their convenience and faster loan approval. As a community financial institution, BMTs complement their Shari’a compliant products with services to support microenterprises such as training and social empowerment programmes. Apart from the commercial-based contracts listed above, wider usage of re distributive instruments such as Zakat, Sadaqah, Waqf and Qard Al Hassan could improve access to finance for the poor and vulnerable segments of society. Qard Al Hassan, for example is a benevolent to the hardcore poor with soft repayment periods. Akhuwat, the largest Islamic MFI in Pakistan disbursed loans using the Qard Al Hasan model since 2001 (80 branches in 49 cities). A nominal service charge may be imposed, but generally, operation costs are quite low. The source of funds is usually from donations and voluntary contributions (Sadaqah). the complementarities between Islamic finance principles and financial inclusion back the notion that policymakers and the industry have much to gain from the rapid growth of Islamic finance. To further support the expansion of Islamic finance, especially in countries where religious considerations prevent households from accessing financial services, certain key enablers have to be in place. Of importance, regulatory clarity and perhaps incentives may be needed to jump start the Islamic finance sector in countries with low financial inclusion. On the demand side, favourable demographics, rising incomes and increased availability of Shari’a-compliant instruments will support eorts to boost financial inclusion
in these countries. By geographical region, the growth drivers for Islamic banking as a mechanism to enhance financial inclusion vary. Amongst the more progressive Islamic finance domains such as the GCC, Malaysia and Turkey, perhaps the next step in enhancing access to finance is to further promote Islamic fund management and takaful, as well as more innovative forms of Islamic financing and deposits. Meanwhile, European countries are expected to further encourage the development of Islamic finance, especially retail banking, to cater to the non-Muslim population. Elsewhere, several Asian countries such as Bangladesh, Indonesia, Pakistan and Afghanistan have established a solid Islamic microfinance network which is expected to expand further as economic activity intensities. In the African region, where the unbanked population is significant, the presence of Islamic fonancial institutions in both predominantly Muslim and non Muslim countries such as Nigeria, Kenya, South Africa and Tunisia allude to strong demand for Shari’a compliant services. In the decades to come, the Islamic finance industry’s geographical expansion is likely to contribute to better financial inclusion on a global scale.