To close the severe gaps in financial inclusion in the Middle East and North Africa, more and more governments are starting to develop national financial inclusion strategies driven by evidence-based dialogue among public and private stakeholders. Evidence is produced by market diagnostics that identify demand- and supply-side barriers to financial inclusion. But what if the evidence is contradictory – even in state-of-the-art surveys?
So far, demand studies on Islamic finance have produced mixed results. Earlier studies suggested that around a third to half of individuals in Arab countries refrain from using conventional financial services, or prefer services that comply with their beliefs. However, according to a recent Findex Note, “religion does not appear to be a major barrier to account ownership.”
To examine the distinction between preference and actual choice, CGAP, Yale University and Tamweelcom took a novel approach to the study of demand for Islamic and conventional loans in Jordan. Under real conditions, they tested different product features on groups of randomly selected people, measuring the effects on people’s buying decisions. The randomized experiment thus reveals insights into the real demand for Islamic microloans. The findings are striking.
Loan Take-Up. According to the experiment in Jordan, more people opt for the Islamic microloan than the conventional one when offered both (17% versus 2%). Notably, however, overall loan take-up seems to be lower when people are confronted with both the Islamic and the conventional offer instead of one type of loan. This suggests that the buying decision is adversely affected by multiple choice (the “paradox of choice”) due to “inner paralysis,” as psychologist Barry Schwartz puts it. If proven valid in further contexts, the impact of decision fatigue on financial access might be particularly relevant for financial policy makers facing the choice of designing a regulatory framework for fully fledged Islamic finance providers or allowing conventional financial institutions to offer Islamic services as well through a designated window.
Sharia Certification. The decision to take up an Islamic microloan is not affected by whether a government body, a sharia supervisory board with the provider or a local religious figure has certified that the product is sharia-compliant. Sharia certification appears to have no significant impact on loan take-up at all. One possible interpretation of this finding from Jordan is that sharia certification is of low or no importance for financial inclusion. However, further qualitative research needs to uncover whether people’s attitudes to certification in any given market are due to the prevailing financial literacy gaps in that country. Financial regulators might in any case choose to standardize compliance with sharia through a national body to avoid confusion among clients and to reduce the regulatory burden for providers.
Religiousness. Another striking finding of the study is that, in Jordan, people who are more religious are willing to pay a higher price for an Islamic microloan. This might come as good news for providers that generally have higher transaction costs due, for example, to the widely offered traditional Murabaha type of loan, which involves the purchase and resale of assets. However, clients’ willingness to pay more in Jordan or elsewhere should not hinder product innovation and the development of inclusive, responsible Islamic microfinance. On the contrary, lower price elasticity might even prove beneficial for financial products with greater impact such as the risk-sharing product Musharakah or the trade-type product Salam. These products, in spite of a higher price, provide a more responsible and attractive proposition for clients to take up formal funding and to become involved in economic activity.
With these findings from Jordan adding to earlier research, the methodology of the randomized experiment shows promise. Where evidence is particularly ambiguous and questionnaires fall short, as in the case of the demand for Islamic microloans, this type of research can provide greater insights into barriers to financial access and the use patterns of the unbanked in light of preference and choice.
Applied broadly and replicated across countries, randomized experiments will start to yield more valid data in different domains and could become a powerful tool for policy makers in developing effective financial inclusion strategies. Banks, microfinance institutions and associations can randomize product features to optimize products and market activities in a client-centric and cost-effective way.
We therefore ask public and private players from the Arab region and beyond to explore and apply this tool further as a valuable addition to financial market diagnostics on both a large and small scale. This will help to refine the methodology and to contribute to a clearer picture of the demand side – in Islamic and conventional finance alike.