How Islamic Finance Promotes Financial Inclusion

by Qardus Team

Islamic finance has historically played a significant role in financial inclusion in countries where Islam is a major religion, but it has not been accessible to Muslims in the West until very recently.  The growth of Islamic finance has catapulted financial inclusion in previously overlooked groups and has ensured that businesses operating under Islamic principles have opportunities to access funding options and scale their growth. 

The foundations of Islamic finance that rest on the principles of anti-usury and no interest have traditionally seemed to be at odds with the concept of successful business and entrepreneurship. After all, usury - leveraging interest rates – is a key component of traditional business growth.  However, when it comes to Islamic finance one of the central foundations is that money should not make money, hence receiving or paying interest is not permissible.

In recent years the financial sector has realised the potential of Muslim entrepreneurship and investment, and has offered more inclusive Sharia-compliant financial services.  The Islamic finance sector is growing up to 25%[
1] each year, and this shows the demand is there for Sharia-compliant finance and banking.

Islamic Finance Principles

What are the main Islamic finance principles that impact on businesses? Islamic finance includes certain prohibitions, rules, and restrictions:
  • Gambling (maisir): any form of gambling or speculation is prohibited.
  • Contractual ambiguity (gharar): contracts with too many uncertainties or risks are considered gharar.
  • Payment and receipt of interest (riba) is not permissible. 
  • Endowment (Waqf): this refers to a philanthropic actions where the benefit serves specific beneficiaries.
  • Interest free loan (qard) where there is no interest payable by the borrower on the loan. 
  • Insurance (takafuI) refers to a common pool or fund where monies are redistributed to members as and when the need arises.
Combined with the principle of charity (zakah) these Islamic finance principles are centred on inclusion and social solidarity. Promoting socio-economic inclusion, benevolence, and growth via the redistribution of wealth is one of the central concepts of any Islamic finance system.  

Islamic Financing Arrangements

Examining the Islamic finance principles above, it is easy to wonder how financial institutions that offer finance based on Islamic Sharia principles actually make money.  The answer is that the different types of financial vehicles enable financiers to make money through various financing arrangements.  These arrangements facilitate profit sharing and risk management [2].The most common Islamic Financing arrangements include:
  • Murabaha: this refers to an arrangement based on profit and loss sharing where both financier and businesses share in the profits and losses.  This principle is applied in mortgage transactions where the bank would typically buy the property and resell it to the customer for a price that includes a profit margin. 
  • Musharakah: this is a joint venture arrangement where both parties contribute capital and agree on the share of profits. 
  • Ijarah relates to leasehold arrangements whereby the lessor leases the property to a lessee in return for rental payments. 
Financial organisations that offer risk-sharing financial solutions, and interest-free banking help to achieve financial inclusion. As you can see from the principles mentioned above, the structure of the arrangement means the bank can make their money by charging rent, sharing profits, or agreeing on a price above market value. 

What is Financial Inclusion?

Financial inclusion is defined by The World Bank as a concept that ensures that people and businesses ‘have access to useful and affordable financial products and services’.

When it comes to Islamic finance, one of the key principles that facilitates financial inclusion is ensuring that there is access to savings and credit that is compliant with Sharia law. Research has found that in Muslim-majority countries up to 13% of people do not use conventional banks due to religious reasons 
[3].  The figures relating to financial inclusion in non-Muslim countries are likely to be much higher. 

The United Nations and G-20 have both stated that financial inclusion is high on the agenda if globally we are to achieve sustainable development goals.  Financial inclusion, therefore, goes beyond finances and relates to social and economic inclusion.

Why Is Financial Inclusion Important?

Financial inclusion is imperative because access to financial services is a driver of development, growth and opportunity. For Muslims, conventional financial services that are not compliant with Sharia law can result in a period of self-exclusion [4]. What Islamic finance facilitates and promotes is the inclusion of those who have been excluded on the grounds of religion.  There cannot be equality of opportunity, access and sustainability without financial inclusion.  

Financial services that are affected by self-exclusion:
  • Lending and financing
  • Insurance
  • Savings 
  • Credit history
Evidence from countries such as Malaysia and Saudi Arabia has shown that Islamic finance not only improves outcomes for businesses but also helps the economy and presents opportunities for investors.  Financial inclusion is an enabler of growth that is inclusive, compliant, and sustainable.   

How does Islamic Finance Promote Financial Inclusion?

A system of well-designed financial services based on Islamic principles will not only enable Muslims to build financial resilience but ensure that they become active economic participants in the countries they live in. 

 Digital finance and mobile technologies mean Islamic finance is more widely accessible.  The World Bank survey (2017) found that Muslims can often exclude themselves from using the formal financial institutions in place due to religious reasons [5].  

Islamic finance is against the concept of asymmetric risk where one party has to lose if another gains.  Instead, Islamic finance promotes risk-sharing that is not rooted in interest rates and speculative deals [6].  Certainly, in terms of micro-finance, Islamic finance is an emerging and fast-growing niche that aims to redress the current global imbalance when it comes to micro-finance and enabling marginalised groups to access financing options that work for them. 

Islamic finance promotes financial inclusion, and by default creates significant financial migration.  It provides an avenue for people with religious boundaries and principles to access financial services that were previously inaccessible to them.  Islamic finance is not only about financial inclusion for businesses and individuals, it also attracts Islamic investors.  This results in positive impacts at a local, community and global level.

Islamic finance is one of the fastest-growing industries in the finance sector.  Governments and organisations including the World Bank and United Nations have all recognised that financial inclusion is imperative if global economic and sustainability goals are to be met.  Also, if governments (particularly in the West) want political participation and empowerment for Muslims then financial inclusion is key to achieving that inclusion.

It is also important to remember that Shariah-compliant services are based on principles of equality and social justice.  Therefore, financial inclusion and Islamic finance really do have the same end goal in mind – social equity. 



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