Financial inclusion, governance, institutions and profit-sharing finance banking

This paper argues that strong economic governance and institutions are important elements in improving financial inclusion especially for the poor segment of the society because markets, and economic activity and transactions more generally, cannot function well in their absence. 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. Many factors hinder the access and use of financial services among the population in many parts of the world. The main obstacles can broadly be characterised 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.

The literature on financial inclusion has identified two major factors that drive financial inclusion across countries: i) structural factors, which primarily determine the costs of providing financial services to the population; and ii) policy-related factors have also been found to be relevant in creating an enabling environment for financial inclusion (Love and Martínez Pería 2012). However, research addressing the latter is limited particularly pertaining to profit-sharing finance institutions. Without deeper understanding of these issues, ill-informed policy may be created designs. Hence, this paper contributes to the literature by examining the interlinkage between financial inclusion, institutions, governance and the profit-sharing financial services industry using panel data analysis. The research will provide an understanding on the impact surrounding governance and institutional factors, particularly for the profit-sharing financial system, in improving financial inclusion.

This paper utilizes the data on individuals’ characteristics in the Global Findex database of the World Bank to examine how these different characteristics are associated with financial inclusion. Then, this paper uses data from Worldwide Governance Indicators and The Heritage Foundation to proxy for governance and institutional characteristics. The baseline model uses probit estimations to explain measures of financial inclusion and we augment the model with governance and institutional variables. The result is expected to answer to what degree do financial inclusion patterns vary across different countries and individual-level characteristics. In addition, the result is expected to draw conclusions on the importance of governance and institutional factors, and to what extent profit-sharing banking matters in improving financial inclusion particularly for the poor segment of the society.