ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC FINANCE – Book Sample
Financial inclusion is about availing financial products and services to those who do not have access to them. All those without a bank account— or access to any other financial services—with a formal financial institution such as a bank, credit union, cooperative, post office, or microfinance institution are among the financially excluded.
In practice, there is a continuum of inclusion spanning those who use no financial services, those who use only informal services, those who use some mix of informal and formal services, and those who use exclusively formal services. Recent concepts of financial inclusion do not only refer to access, but also the usage and quality of financial services.
Even those with access to some formal financial service may be partially excluded by the lack of access to others. It is also important to note that some people are voluntarily excluded from the financial system because they have no rewarding use of it or are content with informal alternatives.
About half of the world’s adult population does not have an account at a formal financial institution and extreme disparities in access to and usage of formal financial services across and within countries (World Bank 2014). Financial inclusion can be a key driver of economic growth and poverty alleviation, as access to finance can boost job creation, reduce vulnerability to shocks, and increase investments in human capital.
In Indonesia, the main goal of its financial inclusion thrust is to achieve economic welfare through poverty reduction, redistribution of income, and overall financial stability. Bank Indonesia believes it can be achieved by creating financial systems that can be accessed by all people in its country at an affordable rate.
The financial inclusion program in Bank Indonesia is being run as part of the financial system stability pillar, where “financial system stabil- ity” is characterized by a strong financial system capable of withstanding economic shock and that is able to ensure intermediary function, settlement of payments, and diversification of risks.
In this chapter, we discuss a multidimensional approach to make financial inclusion work, and list the five key areas that need to be developed in order for us to position ourselves advantageously in the bid to secure a just and prosperous future for all.
The critical components of the financially inclusive future are financial literacy and access to financial services; income and wealth redistributive instruments; development of micro, small, and medium enterprises (MSMEs); a sound legal and enforcement system grounded in a universal set of ethical and moral values; and, lastly, an adequate metric set to measure performance and progress.
The main thrusts to achieve financial inclusion and shared prosperity are covered in Sect. 2.2 under five subsections which expand on each of these critical components. Section 2.3 discusses what and why there are psychological biases to financial inclusion and economic inequality. It also looks at why there are more behavioral issues concerning financial access. Finally, we focus a possible solution by taking a behavioral approach to financial inclu- sion and provide inputs to effective implementation.
2.2 Why Is FInancIal InclusIon so Important?
The poor are far more often excluded from conventional financial services. Of the 2.5 billion “unbanked” people, most live in developing countries (World Bank 2014). An estimated 59% of adults in developing countries are unbanked, compared to only 11% in developed countries. According to the World Bank, of those living on $2 per day, fully 77% lack a bank account. Household income, education, and whether one lives in a rural area are factors that are strongly related to the extent of financial inclusion, even more so in developing countries.
Park and Mercado (2015) emphasize that financial inclusion is important because it is a necessary condition for sustaining equitable growth due to the fact that it provides the poor with opportunities to build savings, make investments, and understand uses of credit. More importantly, access to financial services helps the poor to insure themselves against income shocks and equips them to meet emergencies such as illness, death in the family, or loss of employment.
The focus of financial inclusion is basically on the poor, unbanked, and rural populations with the aim to reduce pov- erty and lower income inequality (Dusuki 2008; Hannig and Jansen 2010). The poor face tremendous financial challenges and require access to financial services to meet essential needs, more so than the nonpoor. The income of the poor is not only lower but also more volatile.
People who live on average on $2 per day, make $4 one day, $2 the next, and $0 the day after, as they rely on a range of often unpredictable jobs and often lack salaried employment; or big earnings even come only once a season with, for instance, harvest income (Banerjee and Duflo 2007). Portfolios of the Poor (Collins et al. 2009) found that managing day-to-day cash flow was one of the main three drivers of financial activities of the poor. Transforming irregular income flows into a dependable resource to meet daily needs is a central challenge for the poor. Access to formal financial institutions can bring needed reliability, while informal services may be unreliable, risky, costly, and unsafe (Collins et al. 2009; Roodman 2012).
Also, as financial inclusion has the potential to benefit the poor through an array of channels—managing day-to-day resources through credits and savings to smooth consumption, improve the condition of housing, or enhance the productivity of a very small or micro enterprise through savings or credit—its implementation may have other benefits too like implications for financial stability (see Morgan and Pontines 2014).
In its inclusive development, the Indonesian government has adopted a triple-tracked strategy, that is, “pro-growth,” “pro-job,” and “pro-poor.” With respect to pro-poor strategies, the government has various programs to alleviate poverty directly or indirectly. The implementation of these programs complements economic growth as the main engine to eliminate poverty, rather than being a substitute for it.
The most popular program is the National Self-Reliant Community Empowerment Program (Program Nasional Pemberdayaan Masyarakat Mandiri). It empowers people directly at the level of subdistrict and village enabling them to decide on the development priorities of their respective regions (Tambunan 2012). Other pro-poor programs include Unconditional Direct Cash Assistance (Bantuan Langsung Tunai), Public Health Insurance (Jamkesmas), School Operational Support, the provision of subsidies (e.g., rice, fertilizers, and program credits), and the Family Hope Program (Program Keluarga Harapan), which are earmarked for poor and near-poor families all over the archipelago.
The Family Hope Program is implemented to meet the basic needs of households that are unable to meet them in any other way. Some of the programs, such as the Program Nasional Pemberdayaan Masyarakat Mandiri, are in the form of the “fishing rod,” to empower disadvantaged communities through the provision of funds up to Rp3 bil- lion per subdistrict per year, the use of which is determined by the people themselves at the village level, according to Tambunan.
In addition, the government also allocates a budget for MSMEs in the form of subsidized credit, and the banking sector has been requested to channel a certain por- tion of their funds as credit for MSMEs. This MSME credit policy is a key element of Indonesia’s policies for financial inclusion (Tambunan 2015).
ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC FINANCE, ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC FINANCE, ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC FINANCE, ENHANCING FINANCIAL INCLUSION THROUGH ISLAMIC FINANCE
2.3 property rights and economic equality
Economic, legal, and political institutions—the rules, laws, and customs that guide behavior—help determine living standards around the world. Using conventional tools of the trade like cross-country regressions, instrumental variables, and more nuanced institutional economics methods, several well-cited studies1 have asserted the importance of private property for economic growth. Taking this one step further, economist Hernando de Soto put forth the boldest and most articulate version of the property rights claim: “not only are stable, secure and well-defined property rights incidental to growth, but they are necessary for it.”
Similarly, Acemoglu and Johnson (2005) revealed that among these institutions, well-defined and enforced property rights are most important in shaping long-run economic growth and thus prosperity. In any economy there are two key rules of the game: property rights institutions, which include protections against expropriation by the government, and contracting institutions, which facilitate private contracts between citizens. Acemoglu and Johnson found that when property rights institutions protect people from expropriation (e.g., via high taxes, price controls, or outright confiscation), individuals can profit from investment in both physical and human capital.
This investment produces higher rates of growth, which eventually yield much higher living standards. In the other key rule, the authors find that contracting institutions (such as those determining how difficult it is to resolve contractual disputes through the legal system) have little effect on measures of long-term prosperity. Instead, when contracting institutions are weak or flawed, but property rights are protected, individuals seem to simply alter the terms of their contracts to avoid most of the adverse effects of such flaws.
However, the only sure way to avoid predation by the state in the face of weak property rights is to refrain from investing in the first place— which incurs poverty in the long run.
From the Islamic perspective, property rights are to be protected and respected between human beings. Property is not a means of exclusion but inclusion in which the rights of those less able are redeemed from the income and wealth of the more able (Iqbal and Mirakhor 2013).
One of the goals of laying down Islamic law via Islamic jurisprudence is to develop an egalitarian, just, and prosperous economy with a social structure where all members of society can maximize their intellectual capacity, improve their well-being, and actively contribute to the economic and social development of their society.
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