WP# 1437-01
Islamic Finance, Financial Inclusion Policy and Financial Inclusion: Evidence from Muslim Countries
Muhamed Zulkhibri
26 Rabi 1437H | January 6, 2016
IRTI Working Paper Series
Islamic Economics and Finance Research Division
2
IRTI Working Paper 1437-01
Title: Islamic Finance, Financial Inclusion Policy and Financial Inclusion: Evidence from
Muslim Countries
Author(s): Muhamed Zulkhibri
Abstract
This paper examines the interlinkage between financial inclusion and the Islamic
financial services industry in Muslim countries using qualitative analysis and case study.
The finding shows that despite financial sector growth in many Muslim countries over
the past decades, many individuals and firms are still financially excluded. Analysis of
the usage of and access to financial services by adults and firms also shows that most
Muslim countries lag behind other emerging economies in both aspects, with only 27
percent of financial inclusion. Cost, distance, documentation, trust and religious beliefs
are among important obstacles. On the other hand, not surprisingly, the outreach of
Islamic microfinance is very limited, small by international standards, and of a limited
coverage, which accounts for a small fraction of microfinance supply, about 0.5 percent
of global microfinance and lack of cost-efficient service model. However, the study
suggests that Islamic distributive instruments such as zakah, sadaqa, awqaf, and qard-al-
hassan, can play a role in bringing more than 40 million financially excluded populations
due to religious reasons into the formal financial system. However, it is still a long way
for the Islamic financial services industry to be able to improve financial inclusion in
many Muslim countries due scale and relatively weak infrastructure.
Keywords: Financial Markets; Financial Inclusion; Institutions and Growth
JEL Classification: G20; G21; G28
_____________________________________________
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8111 King Khalid St. Al Nuzlah Al Yamania Dist., Jeddah 22332-2444
Kingdom of Saudi Arabi
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Islamic Finance, Financial Inclusion Policy and Financial Inclusion: Evidence from Muslim Countries
Muhamed Zulkhibri1
1. Introduction
Financial inclusion has become an important global agenda and emerging priority for
policymakers and regulators in financial sector development in ensuring sustainable long-term
economic growth. This significant development reflects the importance and global recognition
of financial inclusion to socioeconomic development and inclusive growth. The Group of
Twenty (G20) Summit in 2010 has recognized financial inclusion as one of the core pillars of
the global development agenda. Financial inclusion has also become an integral part of many
development institutions and multilateral development banks (MDBs) in efforts to promote
inclusive growth.
Financial inclusion, within the broader context of inclusive development is viewed as
an important means to tackle poverty and inequality and to address the Sustainable
Development Goals (SDGs). Financial inclusion is defined as a process that ‘ensures the ease
of access, availability and usage of formal financial services’.2 It is a state in which all
members of the society have access to a full set of financial services at an affordable price and
in a convenient manner. Inclusive financial sector development makes two complementary
contributions to poverty alleviation: financial sector development is a driver of economic
growth, which indirectly reduces poverty and inequality; and appropriate, affordable, financial
services for poor people can improve their welfare. In advanced economies, financial
inclusion is more about the knowledge of fair and transparent financial products, while in
emerging economies, it is a question of both access to financial products and focus on
financial literacy.
Despites the debate amongst specialists around the term of financial inclusion, there is
no widely approved definition of financial inclusion, but the challenges associated with
1 Senior Research Economist, Islamic Research and Training Institute (IRTI/IDB). The paper was partly written
while the author was attached with the Economic Research and Policy Department, Islamic Development Bank.
E-mail: [email protected].
2 Sarma, Mandira and Jesim Pais. 2008. Index of Financial Inclusion. ICRIER Working Paper No. 215.
4
measuring financial inclusion are now being overcome. On the other hand, there is still lack of
clear understanding about the specific ways in which financial inclusion promotes income
equality and reduces poverty (Demirgüç-Kunt and Klapper, 2012), though recent studies in
individual developing countries are beginning to offer more important clues.3 The benefits of
financial inclusion (above and beyond of financial depth) are relatively strong in the area of
savings (Dupas and Robinson, 2009; Ashraf, et al., 2010). They are also strong for payments
services, although the impact of payments access on increased savings appears relatively
small in some studies (Mbiti and Weil, 2011). Regarding access to credit, some studies
suggest positive effects (Burgess and Pande, 2005; Banerjee et al., 2010; Karlan and Zinman,
2010), while others provide cautionary evidence on the pitfalls of microcredit (Roodman,
2011) and the drawbacks of consumer credit (Bar-Gill and Warren, 2008).
The objective of the paper is to provide an assessment of the interlinkage between
financial inclusion and Islamic financial services industry in Muslim countries. The paper
aims to answer three key questions: i) what are the stylized facts about financial inclusion and
the role of Islamic financial services in Muslim countries; ii) what are the financial inclusion
frameworks and initiatives employed by Muslim countries and the policy needed for Muslim
countries in advancing the state of financial inclusion; and iii) does the existence of Islamic
financial services industry improves financial inclusion?
This paper is set out as follows: Section 2 provides the stylized facts of financial
inclusion, poverty and Islamic finance in Muslim countries. Section 3 describes the recent
development of financial inclusion strategy in selected Muslim countries namely Bangladesh,
Indonesia, and Nigeria. Section 4 draws key lessons from the Islamic financial industry in
effort to promote and enhance financial inclusion. Finally, Section 5 offers concluding
remarks for Muslim countries in improving the state of financial inclusion.
2. Financial Inclusion and Islamic Finance: Stylized Facts
Many studies in economic development and poverty reduction suggest that financial inclusion
matters. For instance, many empirical evidences suggest that improved access to finance not
only is pro-growth and reduces income inequality and poverty, but also is pro-poor (Beck, et
3 On the effects of bank branch expansion, see Burgess and Pande (2005) for India and Bruhn and Love (2009,
2012) for Mexico.
5
al., 2008, 2009). On the conceptual level, a range of theoretical model has been used to
demonstrate that lack of access to finance can lead to poverty traps and inequality (Banerjee
and Newman, 1993; Galor and Zeira, 1993; Aghion and Bolton, 1997). More recently, applied
general equilibrium models provide new insights into the microeconomic underpinnings of
the relationships among financial inclusion, poverty reduction, income inequality, and
economic development (Buera, et al., 2012).
In the literature, there has recently been a boom in new research due to improved
availability of data. The recent availability of new datasets to measure inclusion, such as the
Global Findex database, offers a new opportunity to distinguish between use of financial
services versus access for individuals, and therefore to probe deeper into the subject of
financial inclusion. For instance, using a new micro dataset, Demirguc-Kunt and Klapper
(2012) find that the likelihood of owning an account is higher among richer, older, urban,
educated, employed, married individuals, with greater trust in banks. Furthermore, expanding
financial inclusion can potentially reduce informality in an economy with related benefits
such as an increased tax base.
2.1 The State of Financial Inclusion in Muslim Countries
Figure 1 exhibits that financial inclusion varies widely across regions, individual
characteristics and income groups. Globally, 50 percent of adults have an account at a formal
financial institution (World Bank, 2014). However, 2.5 billion of adults reported do not have
access to formal financial system though not all the unbanked need financial services.
Globally, adults reported having saved at a formal financial institution accounted for 22
percent, while 9 percent having borrowed a new loan from a bank, microfinance institution or
credit union.
In the Muslim countries, low number of bank accounts (only 27 percent) can be
explained by absence and uneven access to financial services and instruments that are
Shari’ah- compliant.4 The lowest numbers of adults (above the age of 15+) having accounts in
formal financial institutions is in Sub-Saharan Africa (SSA), with only 15.3 percent (Figure
2). There is sufficient evidence that, if carried out correctly, enhancing access to and the use
of various financial services can help both eradicate poverty and its severity (Beck, et al.,
4 See Appendix 1 for the state of financial inclusion in Muslim countries by region.
6
2007). Many of the poor in Muslim countries without access to financial services will
continue to be trapped in poverty for the foreseeable future.
Indicators of financial use show a positive but imperfect correlation with indicators of
financial depth such as credit to the private sector over GDP (Figure 3). This correlation
shows that access really is a distinct dimension. The positive but imperfect correlations
between financial depth and financial services imply that depth of financial systems alone is
not sufficient to delivering access to all. The correlations also suggest that there might be
room to improve the level of financial inclusion through financial policy reforms (World
Bank, 2008). Greater financial depth is likely to be associated with greater access for both
firms and households, making them better able to take advantage of investment opportunities,
smooth their consumption, and insure themselves (Beck, et al. 2008).
Figure 4 shows that financial inclusion is positively and significantly correlated with
access points measured as commercial bank branches per 100,000 people. One of the main
obstacles to financial inclusion is the great distance between the communities and a bank
branch especially in rural areas. However, bringing financial services to rural consumers is
one of the major challenge on the financial inclusion agenda. Poor infrastructure, low
Figure 1. Global Trends in Financial Inclusion (2012)
Source: Global Financial Inclusion (Global Findex) Database 2013, World Bank
Adults with accounts at a formal financial institution
High Income OEDC and non-OECD
87.1%
Sub-Sahara Africa
20.9%Latin America and
Caribbean
32.1%
Europe and Central Asia
40.7%East Asia and
Pacific
42.0%
South Asia
31.3%
Middle East & North Africa
26.6%
7
telecommunication technology, and significant branch regulation restrict the geographical
expansion of bank branches (CGAP, 2009). Most of Muslim countries, particularly in SSA
economies, are scattered at the low end of the cluster with low number of commercial bank
branches per 100,000 adults and low account penetration.5
5 See Appendix 1 for details on the state of financial inclusion in Muslim countries.
Figure 3. Correlation between Account Penetration and Financial Depth
Source: Global Financial Inclusion (Global Findex) Database, World Bank
NigerSenegal
BeninMauritania
Comoros
AlbaniaAlgeria
Turkey
Qatar Malaysia
Oman
Kuwait
Japan U.K
Denmark R² = 0.5021
0
10
20
30
40
50
60
70
80
90
100
0 50 100 150 200
Acc
ou
nt
Pe
ne
trat
ion
Domestic Credit to Private Sector (% of GDP)
Figure 2. Financial Inclusion* in Muslim Countries by Region (in %)
Note: *Account at a formal financial institution (% age 15+)
Source: Global Financial Inclusion (Global Findex) Database, World Bank
15.3 16.4
27.0 28.9
43.7
91.2
0
10
20
30
40
50
60
70
80
90
100
SSA CIT MuslimCountries
ASIA MENA High IncomeOECD
8
2.2 Financial Inclusion and Islamic Finance Industry
From an Islamic economic perspective, the concept of financial inclusion and income equality
are not new. These ideas form the basis of risk-sharing contracts and are the main reason
behind the prohibition of riba’ and speculative activities. Islamic financial services can
address the issue of financial inclusion from two approaches - through promoting risk-sharing
contracts, which provide a viable alternative to conventional debt-based financing, and
through specific wealth redistribution instruments - among the society. For instance, the role
of Islamic microfinance for supporting micro-entrepreneurs and the poor. On the other hand,
redistribution refers to post-distribution of income from wealthy, privileged, and able
Muslims to defined poor and needy groups through either voluntary or involuntary levies. It
not only ensures social justice in society, but also mobilizes resources and making them
available to the poor and thus improving the productive capacity of the community.
Table 1 shows the state of Islamic banking and financial inclusion in Muslim
countries. The degree of religiosity6, on average is about 85 percent in the Muslim countries,
implies the
6 Percentage of adults in a given country who responded affirmatively to the question, “Is religion an important
part of your daily life?” in a 2010 Gallup poll.
Figure 4. Correlation between Account Penetration and Access Points
Source: Global Financial Inclusion (Global Findex) Database, World Bank
R² = 0.4458
0
10
20
30
40
50
60
70
80
90
100
0 20 40 60 80 100
Acc
ount
Pen
etra
tion
No. of Commercial Bank Branches per 100,000 Adults
9
Table 1. Islamic Banking and Financial Inclusion in Selected Muslim Countries
Note: 1/ Percentage of adults in a given country who responded affirmatively to the question, “Is religion an important
part of your daily life?” in a 2010 Gallup poll; 2/3/ Number of adults and percentage of adults that point to a religious
reason for not having an account at a formal financial institution; 4/ Islamic assets per adult (US$): Size of the Islamic
assets in the banking sector of an economy per its adult population.
Source: Bankscope; Global Findex; World Development Indicator; Global Financial Development Report (2014)
Eco no myR eligio sity
(%) 1/
A cco unt at a
fo rmal
f inancial
inst itut io n
(%, age 15+)
A dults with no
acco unt due to
religio us
reaso ns (%,
age 15+) 2 /
A dults with no
acco unt due to
religio us
reaso ns
( tho usands,
age 15+) 3 /
N umber
o f IF Is
Is lamic
assets per
adult (US$ ) 4 /
N umber o f
IF Is per 10
millio n
adults
N umber o f
IF Is per
10,000 km2
Afghanistan 97 9 33.6 5,830 2 1.1 0.03
Albania 39 28.3 8.3 150 1 4 0.36
Algeria 95 33.3 7.6 1,330 2 0.8 0.01
Azerbaijan 50 14.9 5.8 355 1 1.4 0.12
Bahrain 94 64.5 0 0 32 29,194 301.6 421.05
Bangladesh 99 39.6 4.5 2,840 12 14 1.2 0.92
Benin 10.5 1.7 77 0 0 0 0
Burkina Faso 13.4 1.2 98 1 1.1 0.04
Cameroon 96 14.8 1.1 114 2 1.7 0.04
Chad 95 9 10 573 0 0 0 0
Comoros 97 21.7 5.8 20 0 0 0 0
Djibouti 98 12.3 22.8 117 0 0 0 0
Egypt 97 9.7 2.9 1,480 11 146 1.9 0.11
Gabon 18.9 1.5 12 0 0 0 0
Guinea 3.7 5 279 0 0 0 0
Indonesia 99 19.6 1.5 2,110 23 30 1.3 0.13
Iraq 84 10.6 25.6 4,310 14 98 7.4 0.32
Jordan 25.5 11.3 329 6 1,583 15.4 0.68
Kazakhstan 43 42.1 1.7 126 0 0 0 0
Kuwait 91 86.8 2.6 7 18 28,102 87.2 10.1
Kyrgyz
Republic72 3.8 7.3 272 0 0 0 0
Lebanon 87 37 7.6 155 4 12.4 3.91
Malaysia 96 66.2 0.1 8 34 4,949 16.8 1.03
Mali 95 8.2 2.8 218 0 0 0 0
Mauritania 98 17.5 17.7 312 1 76 4.7 0.01
Morocco 97 39.1 26.8 3,810 0 0 0 0
Mozambique 39.9 2.3 189 0 0 0 0
Niger 99 1.5 23.6 1,910 0 0 0 0
Nigeria 96 29.7 3.9 2,520 0 0 0 0
Oman 73.6 14.2 78 3 14.4 0.1
Pakistan 92 10.3 7.2 7,400 29 40 2.5 0.38
Qatar 95 65.9 11.6 64 14 13,851 86.5 12.08
Saudi Arabia 93 46.4 24.1 2,540 18 1,685 9.2 0.08
Senegal 96 5.8 6 411 0 0 0 0
Sierra Leone 15.3 9.9 287 0 0 0 0
R eligio sity and f inancial inclusio n Islamic f inancial inst itut io ns ( IF Is)
10
important role of religion in the daily life and society. The financial exclusion due to religious
reasons accounts for about 9 percent in the Muslim countries. Hence, Islamic finance can play
a role in bringing more than 40 million financially excluded population because of religious
reasons into the formal financial system. On the other hand, the number of banks in a country
that offers Shari‘ah-compliant financial services per 10 million adults is very low except for
few countries such Kuwait, Bahrain, Qatar and Malaysia. Similarly, low number of banks in a
country that offers Shari‘ah-compliant financial services per 10,000 km2 makes it difficult for
Islamic finance to offer the alternative to this financially excluded population. Efforts to
increase financial inclusion in Muslim countries with Muslim populations thus require
sustainable mechanisms to provide Shari‘ah-compliant financial services to all residents,
especially the Muslim poor and near poor, estimated at around 700 million people who are
living on less than $2 per day.
Voluntary or involuntary levies, such as zakah, sadaqa, qard-al-hassan, and awqaf,7
enable the idiosyncratic risks of the poor to be shared by the rich through which the
economically more able segment of the society shares the risks facing the less able segment of
the population, thus helping to reduce the correlation between the poor income and
consumption. Islam places great emphasis on redistribution of income and wealth and
legislates institutions using these instruments to enhance financial inclusion. These levies in
no way are to be considered charity as often misunderstood by many Muslim. However, these
important instruments are less formally developed in most of the Muslim countries. Islamic
MSMEs funding could also enhance financial inclusion through the usage of the Islamic
financial products and services and help in poverty alleviation, which create jobs for the
active poor.
The Islamic legal system (Shari’ah) has its own guidelines and regulations regarding
the financial transactions (mu’amalah) for Muslims. Many Muslim households as well as
MSMEs may be voluntarily excluded from formal financial markets due to religious
requirement or lack of Shari’ah-compliant products and services. Such requirements are the
prohibition of interest-bearing loans and the requirement for financial services provider to
share in the profit and loss of the business activities. Table 2 shows that about 9 percent of
respondents without a formal bank account in Muslim countries cite religious factors for their
7 Zakah is a form of giving to those who are less fortunate. It is obligatory upon all Muslims to give 2.5 % of
wealth and assets each year (in excess of what is required) to the poor; sadaqa is a voluntary charity; qard-al-
hassan is zero-return loans that the Qur’an encourages Muslims to give to the needy.
11
lack of an account compared to 4 percent in the rest of the world. For this group, the majority
of conventional financial services do not meet these two main requirements. Therefore,
conventional financial service providers are irrelevant to most Muslim individuals and firms
in need of bank account or financing.
Table 2. Reasons for Financial Exclusion in Muslim Countries
All
(%)
Muslim Countries
(%)
MENA Region
(%)
Rest of the World
(%)
Have an account at a formal financial institution 50 27 18 51
Do not have an account due to ……
religious reasons 5 9 12 4
distance 20 33 8 21
account too expensive 25 29 21 26
lack of documentation 18 22 10 19
lack of trust 13 13 10 14
lack of money 65 75 77 64
family member already having one 23 11 9 24
Source: World Bank, Global Financial Inclusion Database (the Global Findex).
Demirguç-Kunt et al. (2013) undertake a study on preference and use of Islamic
banking services across five countries (Algeria, Egypt, Morocco, Tunisia, and Yemen) with
only 2 percent of report using an Islamic banking service. On average, 48 percent report
having heard of Islamic products or offered Islamic banking services in their country, with the
range varying from 35 percent in Algeria to 57 percent in Tunisia. Only 8 percent of those
having an account at a formal financial institution or having borrowed from a formal financial
institution in the past year report using an Islamic banking service. About 45 percent reports a
preference for the more expensive Islamic bank loan, while 27 percent reports a preference for
cheaper conventional bank loan. About 54 percent of Moroccans are most likely to pick the
Islamic bank loan, while 40 percent of Tunisians are most likely to choose the conventional
loan. In Nigeria, according to EFinA (2010), 78 percent of the population never heard about
Islamic banking.
12
Despite the apparent difficulties in applying the Islamic banking principles in practice,
Islamic banking may indeed play an important positive role in improving financial inclusion.
The uniqueness of risk sharing principle should be applied to the more traditional and rural
areas in Muslim countries. The risk sharing and risk diversification element in Islamic finance
instruments also help individuals to mitigate their idiosyncratic risks. Figure 5 shows a
positive correlation between distance and exclusion due to religiosity, whereas a negative
correlation between number of accounts and exclusion due to religiosity. In addition, World
Bank (2014) study shows that the number of Islamic banks per 100,000 adults is negatively
correlated with the proportion of firms identifying access to finance as a major constraint.
This suggests that increasing the number of Shari‘ah-compliant financial institutions can
make a positive difference in the operations of small firms (0–20 employees) in Muslim
populated countries by reducing the access barriers to formal financial services.
Microfinance is believed to be one of the tools for poverty alleviation.8 Microfinance
has played a significant role in extending the outreach to more than 100 million poor and low-
income and becoming increasingly integrated with the formal financial system across the
globe. MFIs continue to growth despite the economic turmoil with total loans standing at
US$43.8 billion in 2008 (CGAP, 2008). Demand for microfinance remains high, for instance,
8 Some positive impacts of microfinance as explained by Chowdhury (1996), Obaidullah (2008), Hulme and
Mosley (1996), Brower and Dijkema (2002), SMERU (2005) and Rachmat et al. (2006). Some negative impacts
of microfinance as explained by Woodley et al. (2006), Deubel (2003), and Phlong (2009) and Bateman (2010).
Figure 5. Correlation between Account Penetration, Access Points and Religiosity
Source: Global Findex Database, World Bank
Religiosity (%) and adults with no account due to religious reasons (in %)
Distance of IFIs and adults with no account due to religious reasons (in %)
0
5
10
15
20
25
30
35
40
0 20 40 60 80 100
0
5
10
15
20
25
30
35
40
0 2 4 6 8 10 12 14
13
in the Arab region alone, the outreach gap is estimated to be 19 million borrowers (Sanabel,
2010). On the other hand, the outreach of Islamic microfinance is very limited. Islamic MFIs
account for a small fraction of microfinance supply, about 0.5 percent of global microfinance,
despite an estimated 650 million Muslims living on less than US$2 a day. Of the 1.28 million
Islamic microfinance clients served, commercial banks serve 60 percent, while rural banks
serve only 16 percent (CGAP, 2008; 2013). For example, Islamic MFIs in Syria comprise
only 3 percent of outstanding microfinance loans.9 The figure also implies a lower coverage
rate of Shari’ah-compliant microfinance in all the Muslim countries.10
On the other hand, CGAP (2012) study shows that 20-40 percent cite religious reasons
for not accessing conventional microfinance. Similarly, IFC (2011) market studies suggest a
strong demand for Islamic microfinance products: More than 60 percent of low-income
survey respondents in the West Bank and Gaza claim a preference for Islamic products over
conventional products.11 In Jordan, 24.9 percent and 32 percent, respectively, of those
interviewed cite religious reasons for not seeking conventional loans.12 In Algeria, a 2006
study revealed that 20.7 percent of microenterprise owners do not apply for loans primarily
because of religious reasons.13 In Yemen, an estimated 40 percent of the poor demand Islamic
financial services, regardless of price. In Syria, a survey revealed that 43 percent of
respondents considered religious reasons to be the largest obstacle to obtaining microcredit.
Accordingly, constraints to Islamic microfinance sector are mostly related to i) the lack of
capacity to design authorized Islamic finance products that meet the needs of consumers; and
ii) micro-level transactions need to be keep at a very low costs.
There are 255 financial service providers offering Shari’ah-compliant microfinance
products around the world. Approximately 28 percent of these providers are concentrated in
the Middle East and North Africa, which is one of the two regions representing almost 92
percent of all providers. In 2011, 82 percent of the global outreach of Islamic microfinance
was dominated by three countries namely Indonesia, Bangladesh, and Sudan. The types of
9 The top 5 MFIs in MENA represent 43 percent of total outreach in the region.70 percent of MFI branches are
in Morocco. On the other hand, microcredit is not well developed in the Gulf Cooperation Council (GCC)
countries, where only Saudi Arabia and Bahrain have microfinance institutions. 10 Aga Khan Agency and AGFUND and have set-up MFIs in Egypt, Bahrain, Jordan, Syria and Yemen. For
example, Al Amal microfinance bank established under the Yemen microfinance law to offer deposit and
lending services to low-income clients, including MSMEs. 11 PlaNet Finance (2007). 12 Studies done by USAID (2002) and IFC/FINCA (2006). 13 Study by Frankfurt School of Finance and Management (2006).
14
institutions offering Shari’ah-compliant microfinance services vary, serving 1.28 million
clients in 19 countries, but majority (in terms of absolute number) are rural banks. Murabaha
is the Islamic microfinance product with the largest outreach (672,000 customers and total
portfolio of assets of approximately US$413 million (Figure 6). The limited range of products
offered to the Muslim communities will continue to exclude low-income individuals and
small enterprises from access to Shari’ah-based finance.
Despite spectacular growth of microcredit particularly in Bangladesh and its
replication around the world (see Box 1), the program has faced criticism because of the high
interest charged (30-32 percent effective rate), which may have led to over-indebtedness of
borrowers. Some critics have also cited coercive tactics used by some conventional and
Islamic MFIs and the worry about future sustainability (high overhead costs). According to
AFI (2014)14, globally, almost 75 percent of MFIs charged around 25 – 28 percent interest,
very few charged above 30 percent. There are few MFIs able to charge below 25 percent and
lower the cost due to increased operational efficiency.
14 Determining Appropriate Service Charges Based on Microfinance Institutions (MFIs) Operational Cost Data,
a report by the Microcredit Regulatory Authority, Bangladesh and the AFI Financial Inclusion Data Working
Group, 2014.
Figure 6. Global Islamic Microfinance
Note: MENA stands for Middle East and North Africa; EAP stands for East-Asia Pacific; ECA stands for
Europe and Central Asia; SA stands for South Asia; and SSA stands for Sub-Saharan Africa. Research data
do not include Shari’ah-compliant cooperatives (Baitul Mal Wat Tamwil [BMTs]) in Indonesia. Product
breakdown is not available from Islamic Bank of Bangladesh Ltd. and some small institutions operating in
Africa. The sample covered in this survey does not include respondents from Iran or Malaysia.
Source: CGAP (2013)
72
164
3 12 4
MENA EAP ECA SA SSA
413
156
402 17
Murabaha Qard Hassan Musharaka/Mudaraba Salam Others
No. of Institutions Type of Products (US$ million)
15
Although microfinance has provided most of the access to financial services, it is still
largely separate from the overall financial systems. There is further scope of increasing the
level of access to financial services. The expansion of financial inclusion can be made
possible by means of introducing innovative financial products, developing efficient and
effective financial service delivery mechanisms, and increasing the financial literacy of the
potential users of financial services. In the process of expanding financial access, MFIs can
Box 1. National Microfinance Strategies [1] Over 30 countries, mostly in Africa, have national microfinance strategies [2]. Developing a
national microfinance strategy usually involves four stages: (i) conducting a diagnostic/gap
analysis of the microfinance sector; (ii) consulting with stakeholders; (iii) drafting a document,
usually by a consultant in cooperation with government; and (iv) adopting and implementing the
strategy, including approval by a governmental body and defining actions to put the strategy into
practice.
Benefits of Microfinance Strategy
Improved dialogue. The broad consultative process that often accompanies the
development of a national microfinance strategy has fostered improved
communication among practitioners, donors, and policymakers.
Increased knowledge of the sector. The diagnostic has sometimes led to a deeper
understanding of the opportunities and constraints for increasing financial access.
Commitment to good practices. National microfinance strategies have gotten
governments and other stakeholders on the record to adopt good practice principles
and abandon unsound policies.
Challenges of Microfinance Strategy
Weak diagnostics. Diagnostics of the sector too often lack breadth and depth. The
diagnostics often neglect the financial infrastructure or the political economy, omit
key actors (such as commercial banks) or do not assess their performance.
Isolation from broader financial sector. With their focus on microfinance, many
strategies do not properly take into account (or create links to) the broader financial
sector.
Inadequate government leadership and capacity. The responsibility for national
microfinance strategies is often placed with a government body that lacks technical
capacity and/or the political or legal power to successfully implement the strategy.
Unrealistic and “template” action plans. About half of the national microfinance
strategies include action plans for reform, many of which have unrealistic targets.
________________________ [1] CGAP Brief (June 2008) National Microfinance Strategies.
[2] Africa: Benin, Burkina Faso, DRC Congo, Cote d'Ivoire, Ethiopia, Gambia, Ghana, Liberia, Madagascar, Mali,
Malawi, Mauritania, Mozambique, Niger, Nigeria, Rwanda, Sierra Leone, Senegal, Tanzania, Togo, Uganda,
Zimbabwe; Asia: Cambodia, Indonesia, Lao PDR, Nepal, Pakistan, Philippines; Europe and Central Asia: Kyrgyz,
Russia, Uzbekistan; MENA: Egypt, Jordan, Yemen.
16
work further to include the unbankable poor women in the financial sector and provide the
financial services in a cost-effective and sustainable way to the households.
On the other hand, Islamic microfinance businesses in most Muslim countries are still
being developed and no performance benchmarks have been established. Pricing of some
Islamic microfinance Shari’ah-compliant products are too closely parallels or higher than
pricing of conventional products. The poor must be convinced of the authenticity of Islamic
financial products if Islamic microfinance is to reach its full potential. In addition, capacity
building is needed at all levels to realize the full potential of Islamic microfinance and product
diversity is needed to serve poor people who have diverse financial requirements, and for
many, savings or housing products may be more urgent needs.
3. Financial Inclusion Frameworks in Muslim Countries
Over the years, there has been substantive development in the architecture and thinking on
financial inclusion framework. While there is no “one-size fits all” financial inclusion strategy
or approach, it is important to recognize few core or necessary and sufficient conditions that
are needed to maximize the benefits derived from such strategy. The diversity of
demographics, regulatory environments, and other factors preclude a simple, off-the-shelf
solution for improving financial inclusion. Improving access to financial services across a
wide number of areas is best to be initiated by the government. Generally, financial inclusion
strategy can be defined as agreed plan of actions, crafted at the national or sub-national level
in line with financial inclusion targets and preferably prepared by public sector in partnership
with the private sector to encourage wide-ranging innovation and development.15
Approach to financial inclusion must be pragmatic and comprehensive and must
address at least three aspects - access, usage and quality - of financial services and products.16
These three important aspects should benefit the consumers as the results from financial
choices and options within a sustainable (financial capability) and a reliable (consumer
protection) framework. To address different barriers to financial inclusion, these strategies can
be integrated into public and private sector actions, and focus on high-priority and high-
impact areas such as SME finance or financial education.
15 World Bank (2012). Financial Inclusion Strategies Reference Framework. Washington, DC: World Bank. 16 World Bank (2012). Financial Inclusion Strategies Reference Framework. Washington, DC: World Bank.
17
3.1 Overview of Global National Financial Inclusion Strategies
Globally, 56 countries of which 13 are Muslim countries have committed to formal targets for
financial inclusion and have published explicit financial inclusion strategies.17 Financial
inclusion policy and strategy among Muslim countries have become one of the important
policy agenda as more countries have introduced their financial inclusion policy framework in
recent years. These commitments and strategies also reflect a growing recognition of the role
of financial inclusion in boosting shared prosperity and eradicating poverty. These countries
have also made formal commitments under the Alliance for Financial Inclusion’s Maya
Declaration18 or have been identified as having significant national strategies by the Financial
Inclusion Strategy Peer Learning Group.
In principle, many of the national financial inclusion strategies have common
similarities. The overall aim of the national financial inclusion strategies pointed towards
empowering people by improving their access to financial services and products. Generally, a
financial inclusion strategy can be characterized by six implementation stages: a) data and
diagnostics; b) targets and objectives; c) strategy building or revision; d) public sector
policies, regulation, and financial infrastructure; e) private sector actions; and f) progress
monitoring. The strategies generally comprise a mix of commitment of policy areas and
numeric targets such as expansion of mobile financial services, financial literacy, improving
consumer protection, and microfinance. Anchored in the above strategy, the general
approaches for the financial inclusion strategy are as follows:
i. Promote an enabling environment based on the proportionate application of accepted
and sound regulatory and supervisory principles. It is important that all players and
financial service providers are proportionately and sufficiently regulated to ensure
financial system stability and integrity as well as consumer protection.
ii. Enable the delivery of a wide range of services, such as savings, credit, insurance,
payment services, and remittance to reach all markets, including those that have been
17 See Appendix 2 for details on National Strategy and Policy Framework in Muslim countries. 18 The Maya Declaration is the first global and measurable set of commitments by developing and emerging
country policymakers to unleash the socioeconomic potential of the 2.5 billion poorest people through greater
financial inclusion. More than 80 institutions from developing and emerging countries – representing over 75%
of the world’s unbanked population – have endorsed the declaration.
18
previously unbanked. These services must be appropriately designed and priced and
have capacity to safely and effectively provide or deliver to the consumers.
iii. Allow banks and non-banks to leverage linkages and partnerships to expand their
range of products and services as well as strengthening their delivery channels to reach
the financially excluded population more widely and effectively.
iv. Facilitate useful products and services innovation to operate in an environment where
sound principles are prudently and proportionately applied to cater for the associated
risks, and such innovations are sufficiently understood by the consumers.
These four approaches should be anchored with the foundation and framework of a
comprehensive and effective consumer protection and financial education along with a robust
financial inclusion data framework. In order to ensure financial inclusion efforts become
successful, there is a greater need for the public, especially new participants in the financial
system, to be equipped with the necessary knowledge, tools, skills, and mechanisms to ensure
that they are adequately informed and protected. The latter will ascertain that policies are truly
evidence based and progress can be effectively measured.
Specifically, most of the national strategy contains several common policy areas with
a clear defined commitment as follows:19amending the regulatory framework to enhance
financial access; improving financial literacy; increasing consumer protection; enhancing data
collection and measurement; and expanding mobile financial services. There are also
similarities in formulating institutional framework for financial inclusion. In most cases, the
central bank is more likely to be a lead agency in the respective countries where it also acted
as an integrated financial sector supervisor. In 40 out of 56 countries, the central bank is the
lead agency for implementing financial inclusion strategy, while other institutions also
involved include financial supervision related agencies or ministry of finance.
Although there are some common similarities, the national financial inclusion
strategies differ greatly in the level of detail, breadth of coverage, and degree of specificity.
Primarily, the country-specific circumstances reflect some of the differences among the
strategies, but there is sufficient scope for re-alignment in the strategies. Broadly, there are
three difference approaches: (a) stand alone; (b) integrated in financial/development strategy;
19 World Bank (2014). The 2014 Global Financial Development Report: Financial Inclusion.
19
and (c) specific strategies for specific areas. However, countries with specific numeric targets
and timelines for achieving the targets only account for about one-third of the total strategies
(19 out of 56). The others provide general goals, for instance increasing financial inclusion,
without specific numeric targets and timelines commitments.20
Due to existing barriers to financial inclusion and country-specific characteristics,
several elements of the national financial inclusion strategies are specific to a few countries.
Fifteen countries strive for providing alternative financial products such as special savings
accounts or mobile money platforms to better cater for the requirements of the populations.21
The others have focused on increasing the access through banking correspondents and
provision to microfinancial products and services. Four countries focus on setting-up credit
informational systems to encourage responsible lending and to provide borrowers credit
information, while 13 countries focus on transforming payment system strategy, which
involves efforts such as channeling social payments and remittances through financial
accounts.
3.2 Indonesia: Toward Broader Financial Inclusion Strategy
Despite the commitment of the Indonesian government to financial inclusion and its
pioneering reputation in microfinance that dates back to the early 1980s, the achievements are
far from satisfactory. Rosengard and Prasetyantoko (2011) find that about 50 percent of
Indonesians have only limited access to affordable formal financial services, particularly in
semi-urban and rural areas. Most of these excluded people have a daily expenditure of less
than US$1 per person, while SMEs are still facing a credit crunch even though commercial
banks in Indonesia are liquid, solvent, and profitable.
In Indonesia, the government has long recognized the problem of accessibility to
formal financial markets. It has attempted to improve accessibility for otherwise excluded
groups. From the era of the Suharto presidency to the present, many government-sponsored
credit schemes have attempted to help low-income families improve their finances. The
government has been encouraging and facilitating microfinance institutions, banking and non-
banking, to grow rapidly and serve small borrowers’ demand for credit, which the existing
20 See Appendix 3 for overview of Malaysia financial inclusion framework. 21 Cihak, M. and P. Singh (2013). An Analysis of National Financial Inclusion Strategies.
20
banking system cannot make available. Currently, Indonesia is a global leader in microfinance
outreach and innovation with over 94,000 MFIs operating all over Indonesia (Bappenas,
2011).
The government has taken several steps in reviving the progress toward greater
financial inclusion – recognizing its integral importance in facilitating inclusive economic
growth and poverty alleviation. Indonesia has declared financial inclusion as a national
agenda in 2010. Specifically, the Indonesian government has introduced a new National
Strategy for Financial Inclusion with new incentives to encourage diversity – particularly in
terms of developing savings products – and reduced barriers to entry for providers. It has also
re-examined the regulatory framework and introduced credit guarantees to banks for their
loans, enabling them to serve MSMEs that would otherwise remain financially excluded.
The conceptual policy framework for developing an inclusive financial system for
Indonesia is shown in Figure 7. Bank Indonesia (BI) has designed the six pillars of financial
inclusion policies: i) financial education; ii) consumer protection; iii) mapping on financial
information; iv) public financial facility; v) supporting regulation and policy; and vi)
intermediary and distribution facility. The strategy is expected to provide a consistent
framework and clear guidance on financial inclusion for policymakers and financial
institutions in both public and private sectors. In supporting financial inclusion, saving
mobilization has been conducted in Indonesia through a range of programs including Bank
and Self-help Group Projects; My Saving Program (TabunganKu); Rural Bank Saving
(TAPRINDO); Simpedes (Saving in rural areas); and other microfinancial products.
The government, the financial industry, and communities are Indonesia’s financial
inclusion stakeholders and each plays a different role. The government is a regulator and
supervisor; the financial industry, including MFIs are service providers and the community -
particularly the low-income poor, working poor, and near poor - are targeted by financial
inclusion programs. Indonesia has made remarkable progress in improving financial inclusion
and has taken a number of major initiatives that are in line with the G20 Principles for
Innovative Financial Inclusion. One of the key focuses of the government has been
introducing incentives that encourage diversity and innovation in products and services,
including changes in the law and government-backed initiatives. This has led to the
development of new savings and financial products that comply with Shari’ah principles
Figure 7. Indonesia’s Financial Inclusion Policy Framework.
Source: Bank Indonesia (2013)
and meet the needs and requirements of many more Indonesians.
In order to fully harness the relationship between financial inclusion and poverty
reduction, Indonesian policymakers further strengthened their focus on access to, and use of, a
broader range of financial services rather than just credit. Evidence strongly suggests that the
financially excluded particularly demand effective access to convenient and safe savings
services at affordable prices. Therefore, the current emphasis on improving access to reliable
and safe savings facilities should be reinforced as much as possible. Given that people in
many remote areas still lack such access, the policies and programs need to pay more
attention to unbanked areas. However, the use of innovative new technology (i.e. mobile
payment), may help bring the financially excluded into the formal financial system in those
areas at relatively low cost.
Formulation of a legal and regulatory framework for microfinance and improvement
of supervision and regulation of cooperatives also help advance the development of financial
services for the poor and rural communities particularly in remote rural areas. As stated by
Seibel (2011), despite of the rapid development, the performance of Islamic rural bank and
microfinance is very poor compared to the conventional rural bank, which has been stagnant
for a while (see Box 2). This might be reflected on the inability to provide a full range of
products and support services to their members as well as the absence of regulation and
supervision from the government.
Policy attention on the development of insurance markets for the poor, low-income
households and MSMEs must also be substantially increased. This is particularly important
given that a vast majority of low-income people do not have easy access to appropriate
insurance products and services and therefore remain unprotected. It may also be useful to
examine the feasibility of index-based insurance for the farming community. Along with these
measures, consumer empowerment programs need to be broadened to improve insurance
literacy and insurance capabilities among poor and low-income households.
Access must be improved for a broad range of financial services not just for credit.
The current legal, regulatory, and policy framework for branchless banking requires
significant improvements. The government is keen to address these issues in a systematic
manner and Bank of Indonesia (BI) is currently studying the branchless banking model in
23
collaboration with the World Bank and IFC and reviewing the existing regulatory framework
with a view to making it branchless-banking friendly. Moreover, Indonesia plans to promote
use of new technology and public-private partnerships in payment services, money transfers,
and micro-insurance, among other things.
3.3 Nigeria: Financial Inclusion Strategy with Specific Targets
Although the number of financially excluded adults between 2008 and 2012 dropped by 10.5
million, Nigeria still lags behind many of African countries in term of the provision for
financial services. Only 46 percent of Nigerian adults have access to or use formal financial
services, while another 17 percent rely on informal services. The exclusion rate is much
higher in rural areas where half of the population lives. In collaboration with other
stakeholders, the Central Bank of Nigeria (CBN) launched the National Financial Inclusion
Box 2. Islamic Microfinance Conditions in Indonesia
Islamic Micro/Rural Banks (BPRS):
Regulated Islamic and conventional rural banks have evolved over 15-year period
comprising of 84 BPRS.
Islamic rural banks have remained small. The volume of their services is negligible,
compared to conventional rural banks, accounting for only 4% of the number, 1.5% of
the assets and outreach, and 1.2% of deposits of the rural banking sector.
Islamic rural banks growth has stagnated in recent years and growth in assets has
remained far behind that of conventional rural banks.
Among the reasons of stagnation: governance and management problems, inadequate
internal control (by absentee commissioners), lack of external auditing, lack of popular
demand for Islamic banking services, emphasis on the informal sector to the neglect of
more profitable market segments, and lack of mastery of overly complex Islamic
banking practices.
Islamic Financial Cooperatives:
The cooperative sector has historically suffered from a complete lack of regulation and
supervision, including excessive government interference and subsidies, which have
distorted rural financial markets and undermined self-help.
The majority of Islamic cooperatives are reportedly dormant or technically bankrupt.
Outreach and volume of Islamic cooperatives services are negligible compared to
conventional cooperatives, accounting for 7.2% of all financial cooperatives, but less
than 1% of borrower outreach of the sector
The savings of depositors are at great risk due to lack of monitoring and the
authorisation to accept savings from non-members.
No remedy is in sight except in the framework of a total overhaul of the cooperative
system.
Source: adapted from Seibel (2011)
24
Strategy in October 2012 following Nigeria’s commitment to the Maya Declaration of the
Alliance for Financial Inclusion aimed at reducing the exclusion rate to 20 percent by 2020.
Under the Nigeria’s Financial Inclusion Strategy (FIS), the specific target is to
increase adult Nigerians with access to payment services from 22 percent in 2010 to 70
percent in 2020, while those with access to savings to increase from 24 percent to 60 percent.
Access to credit from 2 percent to 40 percent, insurance from 1 percent to 40 percent and
pensions from 5 percent to 40 percent. The targets are based on international benchmarking
exercise against peer countries, while taking into account critical growth factors of the
country-specific characteristics. The central bank also established the Micro, Small and
Medium Enterprises Development Fund (MSMEDF) to bring down financial exclusion and
achieving the overall target of financial inclusion from the current 46 percent to 20 percent by
2020.
The preferred model adopted by Nigerian government is a combination of all five
models – branch, retail agent, mobile payment, microfinance bank (MFB/MFI) linkage, and
client empowerment (Figure 8). It leverages on the existing global best practices to increase
financial inclusion to target levels. It also focuses on technology-driven low-cost channels that
can be deployed easily to ensure that access is significantly increased in a way that is
profitable for both the financial services providers and end users. In order to meet the targets
in 2020, the preferred model would require 4,100 branches, 3,400 mini-branches, 51,800
ATMs, 122,000 retail agents and 55,200 mobile agents.
Combining various elements from each of the models helps to overcome the existing
gaps and barriers to people using financial services. Based on the EFInA Access to Financial
Services Survey (2010) each challenge is addressed by specific elements in the Preferred
Model: income – addressed by the client empowerment element; physical access – addressed
by the retail and mobile payments elements; financial literacy – addressed by the linkage and
client empowerment elements; affordability – addressed by the retail and mobile payment
elements; eligibility – addressed by the client empowerment element.
25
The major tools for driving the financial inclusion strategy include: a) agent banking;
b) financial literacy and consumer protection; c) tiered know-your-customer requirements; d)
linkage banking implementation of the MSMEs Development Fund; and e) credit
enhancement programs such as Agricultural Credit Guarantee Scheme (ACGS), Nigeria
Incentive-Based Risk Sharing System for Agricultural Lending (NIRSAL), Commercial
Agricultural Credit Scheme (CACS), Refinancing and Rediscounting Facilities for SMEs,
Small and Medium Enterprise Credit Guarantee Scheme, Entrepreneurship Development
Centers and Mobile Money Operation.
As of 2010 according to CBN (2012), Nigeria has a combined total of 5,797 bank
branches, 11,223 point-of-sale (POS) terminals and 9,958 ATMs. Although the banked
population has grown faster than the bank branch network, the infrastructure is operating
below its potential and has the capacity to meet the require demand from clients. The average
number of clients per branch in Nigeria is 3,882 compare to 3,922 in Kenya and 8,595 in
Tanzania. Although not much work has been done to promote financial inclusion in Nigeria,
the CBN financial inclusion strategy (2012) and the CBN microfinance banking policy (2005)
are two fundamental state interventions put in place to promote financial inclusion.
Figure 8. Nigeria’s Financial Inclusion Preferred Model
Source: Central Bank of Nigeria (2012) National Financial Inclusion Summary Report.
26
According to EFInA Access to Financial Services Survey (2010), distance to a bank
branch is the third biggest barrier to having a formal account in Nigeria, after the issues with
irregular income and unemployment. Notwithstanding that the emergence of agent and mobile
banking in Nigeria has potential to reduce costs and get closer to the customer, the number of
transactions through mobile phones and POS terminals are still very low. The CBN currently
is actively promoting a cash-lite society, but the outcome will depend on the incentives and
the execution of the policies. In the last two years, the CBN has licensed multiple mobile
money operators, but they are yet to issue e-money services. To date, only 0.5 percent of the
Nigerian adult population is registered with a mobile money operator.
In recent years, several banks, both large commercial banks and microfinance banks
(MFBs), have failed in Nigeria. The events have led to substantial mistrust in the society
towards financial service providers, and become key challenges to getting people banked. The
CBN has introduced more rigorous capital requirements for MFBs to address some of the
pitfalls under the Microfinance Policy Framework (2011) with a deadline for compliance at
the end of 2012. However, many MFBs remain small and local and only serve 5 percent of the
banked population. The CBN has also reminded the banks of the intention to withdraw
licenses when needed. These measures along with the provision to strengthen and consolidate
the remaining MFBs and encourage alliances with other service providers are expected to
improve the outreach, image and performance of the financial service providers.
The strategy has been put in place equally targeted to improving delivery channels for
the financial services between 2010 and 2020:22 deposit money bank branches to increase
from 6.8 units to 7.6 units; ATMs from 11.8 units to 203.6 units; microfinance bank branches
to increase from 2.9 units to 5.5 units; mobile agents from 0 to 62 units; POSs from 13.3 units
to 850 units (all per 100,000 adults). In the meantime, arrangements are also being developed
among government, MFBs or MFIs, commercial banks, and mobile money operators to
expand the services to a larger population (see Box 3). For instance, the Nigerian Postal
Service (Nipost) can play a role in expanding access, given its country-wide presence
especially in rural areas and can be turned into a super-agent for mobile money.
22 Central Bank of Nigeria (2012), National Financial Inclusion Strategy. Abuja, 20 January 2012.
27
A lot of work still needs to be done to ensure that affordable financial services are
made available to those who are under-banked and unbanked in Nigeria. Financial inclusion
strategy is a public-private intervention that seeks to overcome the friction that hinders the
functioning of the market mechanism and operate in favor of the poor and underprivileged.
Financial inclusion intervention is an explicit strategy for poverty eradication and accelerated
growth in Nigeria. However, the success of the strategy depends on the commitment and
workable action plan to coordinate and harness the potential of each stakeholder as well as
efficiency improvement in guiding the efforts by the Financial Inclusion Secretariat and
Financial Inclusion Committee.
4. Improving Financial Inclusion through Islamic Finance
Islamic finance operates based on Shari’ah principles by observing the pillars and conditions
of contract in its operational mechanism. Its grounding principles are the objectives (Maqasid)
of Shari’ah, which are to realize human well-being and to repel harms and difficulties in
people’s lives. It is also a sound model for financing development due to the philosophical
Box 3. Financial Inclusion Coordination Mechanisms by the Central Bank of Nigeria
In Nigeria, the Central Bank has put in place various mechanisms to ensure coordination,
including:
stakeholders in the financial system. The steering committee includes members from the Central
Bank, Federal Ministry of Finance, Nigeria Deposit Insurance Corporation, National Insurance
Commission, National Pension Commission, Securities and Exchange Commission, and the
Nigerian Stock Exchange.
nsultative Committee, chaired by CBN, coordinates on
issues related to microfinance. It includes representatives from the Federal Ministries of Finance
and Agriculture, National Planning Commission, National Poverty Eradication Program, Small
and Medium Enterprises Development Agency of Nigeria, Bankers’ Committee, National
Association of Microfinance Banks, Nigeria Association of Small and Medium Enterprises, and
Nigeria Deposit Insurance Corporation.
Board (MAB). MAB includes mainly
donors such as GTZ, DFID, UNDP, USAID, Ford Foundation, European Union, AfDB, the
World Bank, National Association of Microfinance Banks, as well as other government agencies
and NGOs.
Insurance Commission, National Pension Commission, Nigerian Communications Commission,
GIZ, National Identity Management Commission, Federal Ministry of Education, National
Planning Commission, Bankers Committee, Apex Associations as well as other affiliate members.
______________________ Source: Fathallah, S. and D. Pearce, (October 2013) Coordination Structures for Financial Inclusion Reforms and
Strategies, World Bank.
28
foundation of an Islamic financial system goes beyond the interaction of factors of production
and economic behavior and the essence of Islamic finance emphasize the principle of justice
to all including social justice.23 These concepts are manifested in the model of Islamic
finance, inextricably tied to inclusive growth, thus a strong alternative proposition for
financing development.
The central economic tenant of Islam is to develop a prosperous, just, and equal
economic and social structure in which all members of society can maximize their intellectual
capacity, preserve and promote their health, and actively contribute to the socioeconomic
development of society. Islam emphasizes financial inclusion more explicitly. However, two
distinct features of Islamic finance differentiate its path of development significantly from
conventional financial models: the notions of risk sharing and redistribution of wealth. Islamic
finance provides a comprehensive framework to advance financial inclusion by promoting
microfinance, micro-insurance and SME financing structured on the principles of risk sharing,
and through Islam’s redistributive channels, which are grossly under-utilized in many Muslim
countries.
In the case of Islamic banking, rather than attempting to adopt debt-based contract for
the entire Islamic financial system similar to conventional banking system, the principle of
profit and loss sharing should be encouraged and applied to wider traditional and rural areas
to advance financial inclusion in the Muslim world. However, many Muslim countries do not
have enabling environments to support Islamic banks. Figure 9 exhibits Islamic finance
infrastructure in Muslim countries with only few countries, such as Malaysia, Indonesia and
GCC countries, having relatively developed infrastructure. The Islamic profit-sharing concept
helps to foster economic development in rural areas by encouraging equal income distribution
which results in greater benefits for social justice and long-term growth. In this way, Islamic
banks could play the role of rural Islamic development banks. Experience from the Sudan and
Indonesia seems to indicate that Islamic development banking in the rural area has been
successful (Stiansen, 1995).
23 Social justice in Islam refers to economic justice and distributive justice: i) fair and equitable distribution of
wealth; ii) provision of necessities of life to the poor and needy, iii) protection of the vulnerable against
economic exploitation.
29
There are four reasons why Islamic financial services based on profit-sharing is more
likely to be successful for advancing financial inclusion particularly in rural areas than in
modern cities: (i) cheating is likely to be less of a problem in small, transparent societies such
as rural communities; (ii) rural people may be more conservative with religion than the urban
and city population; (iii) financial institution with an Islamic profile is a necessary tool to
integrate rural population into the national financial system; and iv) the need for Islamic
banking as a means of improving income distribution may be greater in rural communities.
Thus, small-scale Islamic rural banks or MFIs in the rural areas are an alternative source of
finance and products (i.e. microsaving, microtransfer, microcredit, microtakaful) to poor or
near-poor rural communities.
In this context, Islamic solidarity-based instruments need to be institutionalized by
formalizing and standardizing operations and management of each instrument. For example,
for zakah and qard-al-hassan, a formal network of institutions is needed to collect, distribute,
and recycle the funds in the most efficient and the most transparent ways. In some countries,
points of sale mechanisms such as cash-dispensing machines or ATMs or internet banking
could be used to give the consumers the choice and to make it easier and convenient for them
to make contributions and donations on the spot. The financial service providers can play a
Figure 9. Islamic Finance Infrastructure
Source: Ernst and Young (2012-13)
30
role in collecting and aggregating funds and then distributing to needy poor through selected
channels. By utilizing domestic zakah collection through proper management, recent
estimates show that 17 out of 39 Muslim countries can take the poorest living under US$1.25
per day out of the poverty by tapping the large pool of zakah potential. However, the potential
remains unrealized as actual zakah mobilized falls short of its potential in most Muslim
countries.24
In terms of developing Islamic MFIs, development partners’ support can be useful if it
paves the way for commercialization and private sector involvement, either as part of private-
public sector consortiums or standalone. Currently, Islamic MFIs are too focused on
providing microcredit using Murabaha and dependent on both donor and government-funded
programs. Development Finance Institutions (DFIs) can provide support by brokering new
banking relationships, by offering incentives for the entry of commercial institutions in
offering microfinance, by taking equity positions in Islamic MFIs, by providing credit
enhancement on capital market transactions and by promoting international investment funds.
Integrating zakah collection or subsidies can work for Islamic microfinance borrowers and
institutions in certain circumstances, but subsidies are best used to build Islamic MFI systems
and staff capacity and to cover operating costs. Moreover, it can take some years for MFIs to
reach the efficiency and scale needed to cover their own costs.
DFIs can choose to implement financial inclusion outreach and programs via Islamic
MFIs provided that: (i) MFIs are able to evolve business models and growth strategies
(economies of scale) to reach out to poor clients on a sustainable basis; (ii) transformation of
NGOs into MFIs by helping in properly leveraging funding and supportive prudential
regulatory framework; (iii) enhance the ability of MFIs to access financial markets through
proper funding mechanism and via a number of instruments; (iv) developing supportive
infrastructure for nurturing financially healthy of MFIs via rating agencies and credit
information bureaus to assess risks associated with microfinance operations and their clients;
(v) forming strategic alliances of MFIs with financial markets in which MFIs can engage with
a wide variety of financial market participants; (vi) having proper governance of MFIs to
safeguard stakeholder interest, in particular depositor funds and donors; and (vii) able to
24 According to Islamic Social Finance Report (2014), actual zakah collection in Indonesia is about 0.025 percent
of GDP, 0.06 percent of GDP in Pakistan with the exception of Malaysia, which zakah collection stood at 0.24
percent of GDP.
31
provide greater products diversification and expand the volume of sales through lower
average costs.
5. Conclusion
In a nutshell, many empirical evidences suggest that poverty reduction strategies are
successful if countries adopt inclusive financial policies. Building inclusive financial systems
that are both financially and socially sustainable is a fundamental requirement of any poverty
reduction strategy. Expanding financial inclusion is a challenging task since it is not a matter
of removing bureaucratic, physical, and financial barriers, but also requires addressing the
underlying structural causes. Nevertheless, rising income at the bottom of pyramid, measures
to improve contestability of financial systems and underlying information and regulatory
environment, and the introduction and adoption of new products, processes and technology
may help further lessen these barriers and further increase financial inclusion.
Many factors hinder the access and use of financial services among the population
particularly poor segment in Muslim countries. The main obstacles can broadly be
characterized, as follows: i) social, macroeconomic, and infrastructure features; ii)
institutional weakness; iii) obstacles arising from banking activities; and iv) regulatory
distortion. Governments are not solely responsible for designing an appropriate policy
framework that encourages access to financial services, but financial institutions offering
these services must also play a decisive role. Specifically, MFIs such as financial NGOs can
play a bigger role in mobilizing savings from the public compared to other institutions that
focus exclusively on credit.
Despite the recent financial sector growth in many of Muslim countries over the past
decades, many individuals and firms are still excluded from access to financial services.
Analysis of the usage of and access to financial services by adults and enterprises shows that
most Muslim countries lag behind other developing economies in both aspects, and that cost,
religious belief, distance, and documentation requirements are among important obstacles.
However, as per capita GDP rises some of these barriers to financial inclusion tend to decline.
Barriers faced by both households and enterprises also tend to be lower in countries with more
competitive, open-market oriented and well-regulated financial systems with more developed
contractual and informational infrastructures.
32
The paper proposes six policy recommendations to address the demand and the supply
side dimensions for improving financial inclusion via strengthening and widening Islamic
financial services and products, as follows: i) strengthen policy target to promote financial
inclusion beyond microfinance through national financial inclusion framework and Islamic
financial service providers in line with the 10-Year Framework of Islamic Financial Services
Industry Development; ii) create a diverse range of Islamic financial products, services and
channels tailored to meet the needs of the Muslim and the poor segment of the society through
competition, technology and innovation; iii) design scalable, sustainable and inclusive Islamic
social financing programs targeted at the financially excluded; iv) develop redistributive
institutions and revitalize Islamic redistributive instruments to reach out financially excluded
Muslim populations; v) ensure a level playing field and sustainable framework for Islamic
microfinance; and vi) improve Islamic financial capability, awareness and mechanism for
consumer education and protection.
33
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Appendix 1. The State of Financial Inclusion in Muslim Countries
Figure A. Usage of Account by Region
Source: Global Financial Inclusion (Global Findex) Database, World Bank
0
10
20
30
40
50
60
SSA CIT All ASIA MENA High Income
Remittances Business Purposes Government Payments Wages
Figure B. Mobile Payments and Electronic Payments by Region
Source: Global Financial Inclusion (Global Findex) Database, World Bank
0
10
20
30
40
50
60
SSA CIT All ASIA MENA High Income
E-payment M-payment (bills) M-payment (money)
37
Figure C. Origination of New Loans by Regions (Muslim Countries)
Source: Global Financial Inclusion (Global Findex) Database; World Bank
0 10 20 30 40 50 60 70
SSA
CIT
All
ASIA
MENA
High Income
Financial Institution Private Lender Employer Store Credit Family/Friends
Figure D. Firm Access to Credit and Account by Region (Muslim Countries)1/
Note: 1/ World Bank Classification - EAP: East Asia and Pacific, ECA: Eastern Europe and Central Asia,
LAC: Latin America and the Caribbean, MENA: Middle East and North Africa, SA: South Asia, SSA: Sub-
Saharan Africa.
Source: Global Financial Inclusion (Global Findex) Database; Enterprise Survey, World Bank
0
10
20
30
40
50
60
70
80
90
100
MENA SA EAP SSA ALL EECA LAC
Firms with a checking/savings account Firms with a bank loan/line of credit
38
Figure E. Saving Behaviour by Regions (Muslim Countries)
Source: Global Financial Inclusion (Global Findex) Database; World Bank
0
5
10
15
20
25
30
35
40
45
SSA CIT All ASIA MENA High Income
Formal Savings Informal Savings
Appendix 2. Financial Inclusion: National Strategy and Policy Framework in Muslim Countries.
Source: Based on AFI (Alliance for Financial Inclusion), World Bank
Country Bangladesh Guinea Indonesia Malaysia Morocco Mozambique Nigeria Pakistan Senegal Sierra Leone Togo Turkey Uganda
National
Strategy
Financial Inclusion
Strategy (in place or in
process)
Yes No Yes Yes in process in process Yes in process No No No in process in process
Commitment Under
Maya Declaration1 1 1 1 1 1 1 1 1 1 1
Maya Commitment Date Sep-12 Sep-11 Sep-12 Sep-12 Sep-13 Sep-12 Sep-11 Sep-11 Sep-12 Sep-13 Sep-11
Maya Member Agency
Microcredit
Regulatory
Authority,
Bangladesh
Banque
Centrale de la
Republique de
Guinee
Bank Indonesia
(BI)
Bank Negara
Malaysia
(BNM)
Bank Al-
Maghrib
Morocco
Banco de
Mocambique
Central
Bank of
Nigeria
State Bank of
Pakistan
Ministere de
l'Economie et
des Finances du
Senegal
Bank of Sierra
Leone
Bank of
Uganda
Commitment Under
FISPLG (Financial
Inclusion Strategy Peer
Learning Group)
1 1 1 1 1 1
Institutions Involved
Microcredit
Regulatory
Authority and
Bangladesh
Bank
Banque
Centrale de la
Republique de
Guinee
Vice President's
Office, Ministry of
Finance and Bank
Indonesia(BI)
Bank Negara
Malaysia
(BNM)
Bank Al-
Maghrib
Morocco
Banco de
Mocambique
Central
Bank of
Nigeria
State Bank of
Pakistan
Ministere de
l'Economie et
des Finances du
Senegal
Bank of Sierra
Leone
Ministere de
l'Economie et
des Finances
du Togo
Republic of Turkey
Prime Ministry,
Undersecretariat
of Treasury
Bank of
Uganda
Central Bank
Involvement1 1 1 1 1 1 1 1 1 1
Central Bank Lead? 1 0 1 1 1 1 1 1 1
FAS deposit account
average annual growth
rate (%)
5.49 5.92 4.59 3.27 11.86 16.47 8.41 8.27 9.44 9.91
Proportion of Adults (age
15+) with Bank Account
Access
39.55 3.69 19.58 66.17 39.07 39.90 29.67 10.31 5.82 15.34 10.19 57.60 20.46
Numeric Targets 1 1 1 1
Number of Concrete
Targets 7 4 6 8 2 3 10 6 7 1
Number of Concrete
Targets Achieved by 20131 0 0 4 0 1 2 2 0 0
Maya
Declaration
Institutions
Involved
Financial
Indicators
Targets
40
Appendix 2. Financial Inclusion Policy Framework (con’t).
Source: Based on AFI (Alliance for Financial Inclusion), World Bank
Country Bangladesh Guinea Indonesia Malaysia Morocco Mozambique Nigeria Pakistan Senegal Sierra Leone Togo Turkey Uganda
Mobile Financial Services 1 1 1 1 1
Consumer Protection 1 1 1 1 1 1
Financial Literacy 1 1 1 1 1 1 1
Microinsurance 1 1 1
Microsavings 1 1
Microcredit 1 1 1 1 1 1 1
Agent Banking 1 1 1 1
Credit Information
Systems1
Dedicated Financial
Inclusion Unit in
Regulator or Ministry of
Finance
1
What is dedicated
Financial Inclusion Unit
called?
Data and Measurment 1 1 1 1 1 1
Progress Monitoring 1
Regulatory Framework 1 1 1 1 1 1 1 1
Alternative Financial
Products and E-money
Framework
1 1 1
Payment System Strategy
(Channeling social
payments through
financial accounts and
remittance strategy)
1
Financial Identity 1
SME Development 1 1
Women Empowerment
Expansion of Financial
Services Infrastructure1 1
Policy Areas
of
Commitment
41
Appendix 3. Malaysia Financial Inclusion Policy Framework
Source: Bank Negara Malaysia
2 3 4 51 5432
Create a
diverse range
of financial
service
providers
Enhance
distribution
channels to
ensure
widespread
access
Ensure
minimum level
of banking
products and
services at
reasonable costs
Improve
financial
literacy,
awareness,
and consumer
education
Strengthen the
supporting
financial
infrastructure
and enabling
environment
Conducive environment for greater financial inclusion
