Mobile-based Islamic Microloans: Benefits Beyond Shariah Compliance to Deepen Financial Inclusion Across Faiths

Abdigani Diriye, Jonathan Lenchner, Katherine Tryon

Digital credit products like M-Shwari, KCB M-Pesa, Equitel’s Eazzy Loan, Tala and Branch have been extremely successful at providing access to credit for millions of people in East Africa. The convenience, reach, and efficiency of these lending products has resulted in the financial inclusion of a large percentage of people who have traditionally not had access to financial services. The products are accessed either through an app or USSD. Credit worthiness is assessed based on a user’s phone usage, mobile money usage, demographics, and other factors. Upon approval, the microloan is disbursed to the user’s mobile money wallet, and they have some specified period of time, usually one to two months, to pay it back, with some fixed interest rate (~10% per month) and escalating fees if the set repayment period is not met.

While the impact these products have had cannot be disputed, there is clearly room for further innovation, to design additional varieties of digital financial products that could fit the demands of poor households, further lower interest rates, provide more flexibility with regard to their purposes and use, provide greater freedom in terms of repayment terms and loan structure, and offer greater transparency to the customer on the loan structure.

IBM Research – Africa

For the last 3 ½ years, the Inclusive Financial Services Research Group at IBM Research – Africa has been looking at ways we can design, develop and deploy new solutions and products that further extend financial inclusion. These solutions have included credit scoring methods, alternative lending platforms, and blockchain.

Islamic Finance

One area of work that we are currently exploring is the space of Islamic Finance. Unlike other forms of financial services, it is still relatively underdeveloped. On the surface, the notion of Islamic finance seems like an oxymoron.  Under Islamic Finance, it is not permissible to charge, pay or receive interest. Moreover, Islamic law (Shariah) does not recognize the time value of money and therefore one is not allowed to make money by lending. However, what is permissible is earning a return from investing money in allowable commercial activities. A rough equivalent, in Islamic finance, to an interest bearing loan (a concept that violates its core principles) is a deferred payment sale. A third-party may buy goods or services from a retailer on behalf of a customer, and resell it to the customer at a higher, agreed upon price, following a specified payment schedule.

Such a deferred payment sale represents a fundamentally different approach to the more traditional one that is focused on interest repayment, in that it focuses on buying goods rather than giving out cash. This approach can benefit individuals who are bound by Shariah law and are in need of goods and services, but who do not have the cash in the short term. There are two additional benefits beyond conformity with Shariah law; namely that the transaction is asset based, and there is a level of transparency in the transaction that does not always exist for interest based loans. Asset based loans are advantageous as they have been shown to have a lower default rate, and the loan can be directed towards more economically advantageous assets. Transparency is a significant advantage as individuals are often not clear what fees and surcharges are levied if loan timelines are not met.

We foresee this type of asset based lending filling the large gap in credit access documented above, for both the Muslim and non-Muslim communities in poor populations with similar settings in Africa. The digital aspect of the product facilitates more rapid scaling

User Study

We set to investigate the feasibility of a digital Islamic credit product with both Muslims and non- Muslims across seven cities in Kenya. We conducted qualitative studies with consumers through focus groups, and also conducted quantitative retailer surveys with over 500 retailers and households in November 2016.

Our results indicate that 43% of consumers interviewed had borrowed money recently, with a majority using it for payment of school fees for their children, utility bills, emergencies and medical costs. M-Shwari was the lender of choice, with easier access processes in comparison to traditional banking loan requirements, better payment terms and lower interest rates of 7.5% being cited as the reason for choice.

Consumers mentioned that what they disliked about current financial products was the high interest rates loan approval waiting periods, the registration process, the need for guarantors, and the lack of transparency. 65% of respondents identified interest rates as being a barrier to adoption.

We tested a digital asset financing concept that provided participants with the opportunity for asset financing to meet their needs. The majority of consumers (71%) mentioned they would consider using it. Despite the lack of previous use of Islamic Finance by non-Muslim consumers, consideration of use of Islamic financial services was not found to be linked to religion. Interestingly Islamic Finance or Sharia compliance was seen as a lower tier benefit compared to other benefits that the product offered. 61% of interviewees cited transparency (no hidden costs or charges) as a reason for using Islamic Finance, and 56% also cited the promotion of the principle of financial justice, implying an ethical consideration beyond religious considerations.

When testing the product with consumers, both the product and process for the product were rated by nearly 50% of consumers as high in absolute likability and relative likeability to other financial products available. They were also rated by nearly 70% of consumers as being unique compared to other brand products.

What Does This Mean?

The findings from the study suggest there is a need for alternatives to cash based loans at the customer as well as the retailer level. These could be asset based and have a deferred payment structure rather than the traditional interest bearing loan format. We have seen evidence that such a product could be well received by bot the Muslim and non-Muslim communities due to transparency, as long as the interest rates are not prohibitive and the processing time is as short as current alternatives. The next step in this work for IBM Research-Africa would involve running small scale deployments to evaluate its use and impact.

Originally published on the Bill and Melissa Gates Foundation website on April 17,2017