metadata: authors: 0: author: Karlan,Dean S.
1: author: Osman,Adam Mohamed
2: author: Shammout,Nour Musallam
count: World
docna: 0: docna: Increasing Financial Inclusion in the Muslim
            World : Evidence from an Islamic Finance Marketing Experiment
docty: Policy Research Working Paper
subtopic: Microfinance,Rural Microfinance and SMEs,Financial Sector Policy,Islamic Finance,Legal Reform,Regulatory Regimes,Legislation,Social Policy,Legal Products,Judicial System Reform,Educational Sciences
teratopic: Social Development,Law and Development,Governance,Rural Development,Public Sector Development,Finance and Financial Sector Development,Education
abstracts: cdata!: Low utilization of household credit in
            developing countries may be partially due to religious
            considerations. In a randomized marketing experiment in
            Jordan, this paper estimates the effect of sharia-compliant
            loan features on demand for credit. To comply with Islamic
            law, the sharia-compliant product uses a bank fee rather
            than an interest payment structure, while keeping the rest
            of the product features very similar. Sharia-compliance
            increased the application rate for loans from 18 percent to
            22 percent, an increase in demand that is equivalent to a 10
            percent decrease in interest rates. This study also randomly
            varied the price of the sharia-compliant loan and finds that
            less religious individuals are twice as elastic with respect
            to price as the more religious. By comparing reasons for
            refusal across treatment groups, this paper estimates that
            survey measures that try to assess the importance of
            religious objections to conventional credit overestimate the
            importance of this type of objection by a third.
repnme: repnme: Increasing Financial Inclusion in the
            Muslim World : Evidence from an Islamic Finance Marketing Experiment
display_title: Increasing Financial Inclusion in
            the Muslim World : Evidence from an Islamic Finance
            Marketing Experiment
listing_relative_url: /research/2020/04/31924153/increasing-financial-inclusion-muslim-world-evidence-islamic-finance-marketing-experiment
topicv3: Islamic Law m1326357 2070,Education m1327048 470,Microfinance m1327227 367,Islamic Finance m1327451 324,Financial Inclusion m1327456 363
publishtoextweb_dt: 2020-04-02T00:00:00Z
dois: 10.1596/40782
historic_topic: Social Development,Law and Development,Governance,Rural Development,Public Sector Development,Finance and Financial Sector Development,Education
origu: DEC-Knowledge and Strategy (DECKS)
no_of_pages: 44
author_keys: 0: author_key: 659793
1: author_key: 1552297
2: author_key: 1253864
model_extractions: Policy Research Working Paper 9200 Increasing Financial Inclusion in the Muslim World Evidence from an Islamic Finance Marketing Experiment _Dean Karlan Adam Osman Nour Shammout_ Development Economics Knowledge and Strategy Team April 2020
Policy Research Working Paper 9200

# **Abstract**

Low utilization of household credit in developing countries may be partially due to religious considerations. In a randomized marketing experiment in Jordan, this paper estimates the effect of sharia-compliant loan features on demand for credit. To comply with Islamic law, the sharia-compliant product uses a bank fee rather than an interest payment structure, while keeping the rest of the product features very similar. Sharia-compliance increased the application rate for loans from 18 percent to 22 percent, an increase in demand that is equivalent to a 10 percent decrease in interest rates. This study also randomly varied the price of the sharia-compliant loan and finds that less religious individuals are twice as elastic with respect to price as the more religious. By comparing reasons for refusal across treatment groups, this paper estimates that survey measures that try to assess the importance of religious objections to conventional credit overestimate the importance of this type of objection by a third.

This paper is a product of the Knowledge and Strategy Team, Development Economics. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at aosman@illinois.edu.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
Increasing Financial Inclusion in the Muslim World: Evidence from an Islamic Finance Marketing Experiment Dean Karlan, Adam Osman and Nour Shammout<sup>*</sup> <mark>Keywords: Islamic finance; microcredit; religion; credit elasticity; marketing</mark> <mark>JEL: D12; G21; O12; O16; Z12</mark>

> * This work was supported by the Consultative Group for Assistance to the Poor (CGAP). Author contact information: Dean Karlan, Professor of Economics and Finance, Kellogg School of Management, Northwestern University, IPA, J-PAL, and NBER, <u>karlan@northwestern.edu,; Adam Osman (corresponding author), Assistant Professor of</u> Economics,  University Illinois at Urbana-Champaign, J-PAL, <u>aosman@illinois.edu,; Nour Shammout, Senior Policy</u> Manager, J-PAL, <u>nshammout@povertyactionlab.org. Approval from the University of Illinois Human Subjects</u> Committee, IRB15488. The authors thank Nouf Abushehab, Ziad Al Rifai, Miranda Beshara, Kareem Haggag, Kelsey Larson, Abdelrahman Nagy, Dana Shaat, Ala' Sahawneh, Izzat Shamroukh, for their support throughout the implementation of the project. We also thank Alec MacMillen for research assistance, Mayada El-Zoghbi for her support in catalyzing this study, and the senior management and staff at Tamweelcom for their support and collaboration throughout this project. The authors would like to thank the editor, Eric Edmonds, and three anonymous referees for helpful comments as well as Martin Kanz, Cynthia Kinan, David McKenzie, and Bilal Zia. The authors retained full intellectual freedom to report and interpret the results throughout the study. All errors and opinions are our own.
1. Introduction

Finding cost-effective ways to improve and expand access to formal financial services is a priority for many policymakers around the world.<sup>1</sup> In economics and finance, researchers typically model demand for financial services using variables such as interest rates, income, investment opportunities, risk, etc., but non-economic factors may also play an important role. One such non-economic factor is religious beliefs and practices which could limit utilization of financial services in certain contexts.

Indeed, about 25 percent of adults reported religious reasons as a barrier to having a bank account (DemirgüçKunt et al. 2015). This is common in Muslim-majority countries, which constitute over 1.4 billion people, due to the Islamic prohibition of dealing with interest<sup>2</sup> . Financial inclusion data support these survey results: in a crude crosscountry analysis, after controlling flexibly for GDP, Muslim-majority countries have a 24 percent lower rate of participation in active borrowing from banks (10.5% versus 7.9%) and a 29 percent lower rate of having a bank account (40.2% versus 28.6%)<sup>3</sup> .

However, surveys that merely ask individuals why they do not borrow or cross-country comparisons of financial sector participation may over- or under-attribute lack of borrowing to religion. There is a lack of non-survey

> 1 See Cull, Ehrbeck, and Holle (2014) for an overview of why financial inclusion is a priority for many policymakers and international organizations. This is often motivated both by micro-level evidence about the impact on households and communities from improved access and usage of financial services (Burgess and Pande 2005; Bruhn and Love 2014) as well as macro-level evidence about the role of a healthy banking sector in the development of the country (Jayaratne and Strahan 1996; Black and Strahan 2002; Levine 2005; Beck, Demirgüç-Kunt, and Levine 2007).

> 2 Many interpret Islamic law to prohibit dealing with _riba,_ often translated as usury. In practice this includes prohibiting receiving interest on savings, as well as paying interest on borrowing. Historically the Jewish and Christian faiths also prohibited usury ( _Bible, Exodus 22:25_ 2009; Moehlman 1934).

> 3 See Appendix Table A1. Data on religious populations around the world are taken from the World Religion Dataset (Maoz and Henderson 2013), while data about financial inclusion come from the World Bank’s global findex database (Demirgüç-Kunt et al. 2015). While both borrowing from and saving at banks is lower, borrowing from stores (which is more limited but also more likely to be Sharia-compliant) is higher in Muslim countries.

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evidence describing how borrowers would interact with financial institutions who adhere to religious law in the real world. This lack of evidence is not merely an academic point. It may also be what holds banks back from incurring the fixed costs of experimenting on new products meant to reach this market segment, especially when products that adhere to religious law may cost more to offer due to increased transaction and loan processing costs, depending on the structure of the product.<sup>4</sup> At the same time potential borrowers may shun the formal financial system because products that meet their needs do not exist. Together this could lead to an under-provision of new products, unmet demand and lower levels of financial inclusion.

Through a randomized marketing experiment in collaboration with a microcredit institution (MFI) in Jordan, this study tests how religious certification and pricing impact the decision to apply for a loan. The MFI was introducing a new loan product that adheres to the Islamic prohibition on the use of interest costs in lending through the use of a <mark>bank fee structure. All marketing activities were done individually, not in community meetings as is often common in other microlending operations.</mark><sup>5</sup> We use this opportunity to study how borrowers respond to variations in the new product. Enumerators conducted face-to-face marketing in residential areas and markets and the specifics of the product were randomized at the individual level. The primary outcomes of interest are whether an individual applies for a loan, the loan amount requested and the composition of borrowers (i.e., riskiness based on observables).

When pricing of the two products is identical, 18.4% of individuals offered a conventional loan apply, whereas 22.0% of individuals offered an Islamically permissible (“sharia-compliant”) product apply (p-value on t-test of equality of proportions = 0.002). This increase in demand is about the same as the increase in demand we estimate from a 10% decrease in the interest rate (i.e., from 1.9% per month to 1.75% per month).

This study also tests whether demand for the sharia-compliant product depends on the entity authorizing its religious permissibility. Like many other types of products, when consumers come across something new they must assess whether or not the claims made of the product are accurate. Here, borrowers must assess whether the loan product satisfies religious law, and different types of authorizations may help in that regard. In this context consumers turn out not to be particularly discerning when it comes to the identity of the certifying entity, with no statistically

> 4 Our discussions with management at several banks in Muslim countries corroborate this concern.

> 5 <mark>However, all individuals did need to obtain a guarantor. Section 5 discusses how this may affect interpretation of the</mark>

> <mark>results from the experiment.</mark>

3
significant differences in application rates between a government approval, a local religious leader’s approval, the bank’s religious board’s approval, and no named approval at all.

This paper also estimates price sensitivity and how it interacts with variation in religiosity by offering some borrowers the option of either a conventional product or a sharia-compliant product that is either less expensive, equal in price, or more expensive, than the conventional product. We also collect a simple proxy for religiosity (asking directly about religiosity is socially inappropriate)—whether or not the individual watches religious television. This paper finds that as the price of the sharia-compliant loan increases, the quantity demanded for that product decreases, in line with basic economic theory. On the other hand, religious individuals are half as price sensitive: their quantity demanded for the sharia-compliant product goes down more slowly as the price increases.

In addition to impacts on loan application rates, this paper also examines requested loan size and the composition of borrowers. On average, there is no difference in requested loan size between those who apply for the conventional loan and those that apply for the sharia-compliant loan. However, there are small increases in requested loan size for those clients who are informed of the religious authorization associated with the sharia-compliant loans, which may be evidence of moral licensing, i.e., using the authorization to justify more intensive utilization of the credit opportunity.

There are no differences across any of the treatment arms in the composition of borrowers along many dimensions: age, gender, education, marital status, whether loan is for home repair, employment status, home ownership, bank account ownership, and prior borrowing status. This suggests that this new product is successful in bringing more people into the financial sector, without necessarily pulling in those individuals who are observably more risky for the lender.

In our discussion, we compare how important these religious concerns are in comparison to other levers that financial institutions can use to increase utilization of credit. Based on responses regarding why individuals did not apply for the loan we find that religious concerns are equally as important as the economic characteristics of loans. We then discuss several alternative interpretations for the underlying mechanism behind the revealed preference for the sharia-compliant product (aside from desire to adhere to religious law), including peer signaling via the loan guarantee requirement, differential inference on behavior of and trust in the lending institution, and experimenter demand effects.

4
Although the marketing occurred with the intent of delivering loans, delays in the start of the lending program prevented any Sharia-compliant loans from being issued (although those offered non-Sharia compliant loans were able to borrow, and many did). The lack of loan data in the treatment groups means no further outcomes are viable, such as actual borrowing amount, repayment, future borrowing, or any household impacts. This is of course an important limitation of this study. Questions such as whether the Sharia-compliant loans altered the unobservable riskiness of borrowers are not answerable in our context, and would be important factors for a lender to know about in deciding whether and how to scale Sharia-compliant credit offerings.

This study contributes to several different strands of the economics literature. First, it relates to the literature on the importance of religion to economic decision making (Stulz and Williamson 2003; Bénabou and Tirole 2003; Campante and Yanagizawa-Drott 2015; Iannaccone 1998; McCleary and Barro 2006; Hilary and Hui 2009; Bursztyn et al. Forthcoming). Similarly, in a lab experiment, Benjamin, Choi and Fisher (2016), show that religious salience in the lab can affect contributions to a public good. This paper also relates to the literature on how non-financial characteristics can impact take-up of a financial product (Kumar, Niessen-Ruenzi, and Spalt 2015; Benartzi and Thaler 2004; Bertrand et al. 2010; Madrian and Shea 2001). We add to this literature by showing how religious features can impact the decision to apply for a loan, and can, in certain cases, be more effective than changing the monetary parameters of a loan. Finally, this paper contributes to the literature on Islamic Finance (Zaher and Kabir Hassan 2001; M. A. El-Gamal 2006; Baele, Farooq, and Ongena 2014; M. El-Gamal et al. 2014; Johnes, Izzeldin, and Pappas 2014; Berg, El-Komi, and Kim 2016). While nearly all prior work took a historical or observational approach to describing differences between Islamic and conventional finance, we contribute to this literature by providing evidence from a field experiment on the differences in consumer behavior in response to sharia-compliant features, certification authorities and pricing.

2. Religious Law and Local Context Islamic Law prohibits the payment or receipt of usury<sup>6</sup> , commonly interpreted as a prohibition on financial products, including both credit and savings products, which use conventional interest rates and operational forms. An “Islamic Finance” sector has developed in an effort to provide access to financial services while still adhering to the

> 6 The Arabic transliteration for usury is “ _riba”_ . For a more complete treatment of the economics of Islamic Finance

> see El-Gamal (2006)

5
religious prohibition of interest. These financial providers have developed products that are in line with some scholarly interpretations of Islamic law and these Islamically permissible products are commonly referred to as shariacompliant.

Sharia-compliant products often have the same goal as conventional products, but change parts of the operational details so as to avoid the direct use of interest. To take an example closest to our setting, a conventional loan will normally be a cash-for-cash transaction, where the lender provides the capital and the borrower will return the capital and additional interest fees over time. In contrast, one common sharia-compliant financing product is _murabaha_ , otherwise known as a cost plus markup sale. In a _murabaha_ transaction the lender will provide the capital, usually in-kind (where the lender buys the item on behalf of the borrower), and the borrower will pay back the cost of the capital along with a _murabaha_ fee. Often times these fees come out to cost the borrower about the same as (or more than) the interest in a conventional loan.

From an economic standpoint, these two forms of a loan are very similar. In fact, some lenders provide shariacompliant products that seem no different from conventional products other than in terminology. In the example above, one clear difference between the conventional loan and the sharia-compliant loan is that the sharia-compliant loan is provided by the lender to the borrower _in-kind_ , and then repaid with cash. Other lenders will provide the borrower with the funds in cash as long as the borrower promises to use the cash to buy the items that they claim they will use the loan for. This difference is often sufficient for some Islamic scholars to permit this type of transaction.<sup>7</sup> Another difference is in how late payments and default are treated. There is variation in lender policies, some lenders will levy fees that do not compound over time, while others will structure the loan in a way in which late payments are financially penalized in the same way as in conventional loans.

_Religion and Access to Finance_ Even if the practical difference is sometimes small, the religious difference between the loans is important to many. In Muslim majority countries financial inclusion rates are particularly low, especially among low-income populations. Despite a growing Islamic Finance sector, access to Islamic financial products is still scarce (El-Zoghbi

> 7 While the differences can be quite small, they can be sufficient under Islamic Law. Consider, for instance, the differences between a civil marriage and a religious marriage. Often the practical differences amount to changes in location and wording, with the concept and end result being exactly the same.

6
and Alvarez 2015). In Jordan, where our study takes place 32 percent of respondents gave religious reasons for not seeking conventional loans, and in Syria a survey found that 43 percent of respondents cite religious reasons for not obtaining microcredit (Karim, Tarazi, and Reille 2008, reporting on draft IFC reports). Hence, no matter what the economics are behind the products, there is a large reported preference for sharia-compliant products among Muslims.

It is important to note that the above referenced surveys are not able to explicitly test whether individuals are actually turning down access to conventional financial products for religious reasons, or if they are simply claiming that religion is the reason why they are turning down these products alongside other considerations like price. Since many sharia-compliant products require additional layers in order to be religiously permissible (such as providing a loan in-kind), this can increase the cost, and subsequent price, of the loan. It may be the case that borrowers have access to sharia-compliant products but are unwilling to pay for them, and claim religious reasons as it may feel like a more acceptable answer for them to provide to surveyors.

Further evidence regarding the importance of religion in utilization of financial services comes from a crude cross-country comparison, reported in Appendix Table 1<sup>8</sup> . The table includes five different measures of financial inclusion across all countries in the developing world,<sup>9</sup> and regresses financial inclusion on an indicator variable equal to one if the country is majority Muslim, including a control for a third order polynomial of GDP per capita. People in Muslim majority countries are 3 percentage points less likely to have borrowed from a bank in the past year (a 24 percent decrease compared to countries that are not Muslim majority), and 1 percentage point less likely to borrow from an informal lender. On the other hand they are more likely to buy items on credit from a store and to borrow from family. The latter two behaviors are usually seen as more religiously acceptable forms of borrowing. The table also reports an 11 percentage point decrease in the likelihood of having any formal account with a bank (a 29 percent decrease). While cross-country regressions do not allow us to interpret these differences causally, and much may be omitted from our sparse specification, they provide suggestive evidence that religion contributes to reduced utilization of formal financial services in equilibrium.

> 8 Material in the supplementary appendix is available with this article at _The World Bank Economics Review_

website.

> 9 We use the International Monetary Fund’s definition of developing countries.

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Another potential worry for consumers is the authenticity of the sharia-compliant service (El-Zoghbi and Alvarez 2015). There is significant variation across the Muslim world in the interpretation of Islamic law and corresponding variation in what types of financial products are accepted as sharia-compliant and which are not. Since there is no central authority in Islam, different places follow different religious interpretations, and may have different thresholds for whether a product is sufficiently “Islamic”. Even if individuals have access to sharia-compliant loans, and the price is in line with their expectations, they may worry that the product is not different enough from conventional products and so not actually religiously permissible and they will continue to turn down sharia-compliant loans for religious reasons.

Returning to the larger literature on financial inclusion, in an analysis of the patterns across several microcredit evaluations, Banerjee, Karlan and Zinman (2015) notes how low take-up is an important issue facing providers across a variety of contexts. Similarly Field et al. (2013) showcases how traditional microfinance products may lead to less than optimal outcomes for borrowers. One way to interpret these two facts is to say that there is a need to develop new modes of microcredit that address the needs of borrowers, both from the side of personal preferences (e.g. religious beliefs, behavioral biases, etc.) and personal financial needs (e.g. in-kind loans, longer grace periods, etc.). This experiment allows us to investigate how products that address personal preferences of borrowers in a particular context can contribute to improving the outreach of financial products to the poor, and in turn shed light on potential mechanisms that are also important in more advanced economies.

_The Cultural and Financial Landscape in Jordan_ Only a quarter of adults in Jordan had any account at a financial institution, with this proportion decreasing to 16% for the poorest forty percent of the country. While 14% had borrowed from a financial institution during 2014, 32% had borrowed money in general, with the difference being made up by borrowing from friends and families as well as informal lenders (Demirgüç-Kunt et al. 2015). Part of the reason for these low rates of financial inclusion could be because there are important information asymmetries– only 2.5% of the population is covered by the country’s public credit registry, making it difficult for lenders to assess credit risk (World Bank Group 2016). Microfinance institutions are often seen as one avenue through which countries can increase access to financial services.

In Jordan, 97% of the population of 7.5 million identify as Muslim. The World Bank estimates that 14% of the population lives in poverty. Religion plays a large role in the country. Most of the populace, 85%, say that religion 8
is very important in their lives, 71%, favor making religious law the law of the land, and 93% agree that religious judges should have the power to decide family law and property disputes (Pew Research Center’s Religion & Public Life Project 2013). Unlike much of the Western world, religious leaders in the Muslim world can issue religious rulings and opinions that can be binding in certain cases. Usually, most religious opinions ( _fatwa_ ) are non-binding, but a prominent religious leader’s ( _imam_ ) opinion can hold a lot of weight in the decisions made by an observant Muslim.

The importance of religion in everyday life manifests itself in financial decisions according to surveys exploring issues of financial inclusion. As discussed above, survey evidence points to religion having nontrivial impacts on financial decisions in Jordan. While there are several Islamic banks in Jordan there were no official Islamic microfinance institutions in Jordan at the time of the study.<sup>10</sup> A large proportion of the population is too poor to avail themselves of financial services from large banks. Taken together this leads to many of the poor being financially underserved, setting the stage for natural demand for religious products, including Islamic lending.

Even though the law allows the Central Bank of Jordan the right to regulate Islamic banking differently from conventional banks, they do not treat them any differently with respect to the normal levers that central banks regulate like lending limits, liquidity ratios and capital adequacy ratios (Abdel Al, 2004). This is slowly changing, with a new set of regulations put into place in 2017, but even those regulations are lax. This is partially due to the wide range of religious opinions about what is permissible. No country is known to regulate the Sharia jurisprudence used to determine whether a product is actually sharia compliant (CGAP, 2008).

This study choses Jordan as the site of our study for several reasons. First the context is one that is common across many Muslim-majority countries. Jordan has nearly the median GDP per capita for middle income countries as defined by the World Bank. While it contains a sizeable middle-class, there are still many individuals who do not have access to formal finance, as is the case with many Muslim majority countries. Second, religion continues to play an important role in people’s lives with evidence that it directly impacts their financing decisions. Finally, we were fortunate to find a partner who provided conventional loans and was in the process of expanding operations to begin providing sharia-compliant loans which allows us to test both at the same time, as discussed below. There are not

> 10 The first official Islamic MFI in Jordan was the entity that was begun by the founders of our partner bank after the

> completion of this study: http://www.islamicfinance.de/?q=node/8055

9
many institutions that provide sharia-compliant consumer loans, and so the search for a suitable partner was nontrivial.

# 3. Experimental Design

# _Partner Institution and Financial Product Descriptions_

The research team partnered with a Jordanian microcredit institution, Tamweelcom, to evaluate market demand for sharia-compliant loans. Tamweelcom was established in 2000 as a non-profit and is one of the country’s largest and fastest growing microcredit institutions. As of December 2014, when the experiment began, it had over 56,000 active borrowers, more than 94 percent of whom were women.<sup>11</sup> The average loan size in 2014 was 315 Jordanian Dinars (approximately 445 USD) and the repayment rate exceeded 95 percent.

Tamweelcom focuses on individual lending. Most new accounts (outside of this experiment) were by individuals who had heard of Tamweelcom and went to ask for a loan directly. They would determine loan eligibility by looking at proof of income. Individuals also had to secure a guarantor for the loan. As mentioned above, the public credit agency only covers 2% of the population, and so most people do not have a credit history.

At the time of the experiment, Tamweelcom was in the process of establishing a subsidiary entity that would provide sharia-compliant products to the market. This entity eventually became the first sharia-compliant microcredit institution in Jordan. At the time, they were interested in knowing how the level of demand for sharia-compliant loan products compares with the demand for the conventional products they had been providing to the marketplace for over a decade.

The lender designed a sharia-compliant product similar in price and terms to the conventional product, but different in its contractual form. The two products shared many features including the type of asset allowed to be financed (i.e. household assets like stoves and refrigerators), the range of loan sizes (300-1500 JD), the allowable loan term (a maximum of 20 months), and the price (1.9% interest per month for the conventional loan and a 1.9% per month _murabaha-fee_ which was calculated in the same way as the interest rate). The lender also dealt with late payment and default the same way, using a daily fee structure for each day late, as opposed to compounding interest. The main difference between the two products was that in the sharia-compliant case the lender would pay the retailer of the household asset directly (and so would be providing the loan in-kind), whereas in the conventional product the

> 11 Tamweelcom Annual Report 2015

10
lender would provide the money to the borrower only after the borrower identified the asset and retailer they planned to buy it from.

# _Experimental Details_

In collaboration with Tamweelcom, the research team hired and trained new marketing specialists to market the two loan products to households and individuals in the six largest cities in Jordan: Amman, Irbid, Zarqa, Aqaba, Madaba, and Al-Salt. The marketers used a tablet programmed with SurveyCTO software which would randomly select and display one of eight different marketing and pricing pitches (exact scripts can be found in the Appendix). The marketers were trained to use the tablet, and were provided with a detailed orientation session about the eight different pitches. They would then go to different markets and residential areas and ask individuals if they were interested in hearing about a loan product<sup>12</sup> . If individuals said “no”, marketers moved on and the individual was not included in our sample. If the individual said “yes”, marketers asked a few basic demographic questions (e.g. age, education, marital status, etc.) and read the randomly assigned marketing pitch. This sampling strategy could lead us to underestimate the true demand for sharia-compliant loans if there is a group of “sharia-compliant only” borrowers who say they are not interested in hearing about the loan because they assume that we will offer them a conventional loan (since sharia-compliant loans are rare in this context).

The eight different marketing and pricing pitches constitute the different treatment arms in our experiment. In the first pitch, which serves as the control group, individuals were offered a conventional loan to finance household asset purchases from “the Jordan Microfinance Company” the legal name of Tamweelcom, and a known brand in the market. This conventional loan is an actual product that was being offered by Tamweelcom at the time and was closest in practice to the sharia-compliant loans that Tamweelcom’s new subsidiary was going to be providing. They were told that the loan carried a monthly interest rate of 1.9 percent, a maximum loan term of 20 months and could range from 300-1500 JDs (423 – 2,115 USD). It was an individual liability loan with no grace period. They were then asked if they were willing to fill out a preliminary application for the loan with the marketer. If they said “no” they were asked why not; if they said “yes” they were then asked several more questions that are part of Tamweelcom’s standard

> 12 Both conventional loans and sharia compliant loans are referred to in Arabic as “qard”, allowing this questions to

> be sufficiently generic for our purposes.

11
loan application. Their decision as to whether or not to apply for the loan after they heard the marketing pitch serves as our main outcome variable.<sup>13</sup> The remaining seven treatments offered a sharia-compliant loan in some form. The first treatment pitch is a simple mirror of the conventional loan pitch. The potential borrower was offered a basic sharia-compliant loan, to finance the purchase of a household asset. The loan would have a monthly _murabaha fee_ of 1.9 percent with the same loan term and range of credit amount as the conventional loan.<sup>14</sup> The second, third, and fourth treatment groups were offered a similar sharia-compliant loan, but the marketing pitch also included a statement about the religious authority that approved the product. The three religious authorities were commonly used authorizing entities: a government appointed sharia board, a local religious leader, and the bank’s sharia board. After they heard the pitch the potential borrowers were asked if they were interested in filling out a preliminary loan application, just like the control group.

The final three treatment groups were offered the choice between a conventional loan or a sharia-compliant loan with no mention of an authorizing entity. We randomized the price of the sharia-compliant loan so that it was either cheaper (1.75%), equal in price (1.9%), or more expensive (2.2%) than the conventional loan. Individuals in these treatments were asked which of the two types of loans they preferred and whether or not they actually wanted to apply for the loan.

All treatments that included a sharia-compliant loan were offered under the lender name Tathmeer instead of the Jordan Microfinance Company. This was done because there is a concern that banks that provide both conventional

> 13 Due to regulatory delays in the availability of the partner’s sharia-compliant products they did not follow up with the majority of the sample in a timely manner and so our outcome is preliminary applications, instead of the proportion of the sample who actually took out a loan. Tamweelcom did follow up with a subset of control group individuals at our request and many did take out a loan, showcasing that our outcome of preliminary applications is indicative of the true intent to borrow.

> 14 There was no explicit mention of the fact that the sharia-compliant loans would be in-kind. This is generally understood when the term _murabaha_ is used. Individuals were free to ask more details about the product and in those cases the in-kind nature was made more clear. Individuals only asked for more details a handful of times. The conventional loan was focused on financing assets for the home, so while not directly in-kind it was meant to cover the same type of purchases.

12
and sharia-compliant loans are less authentic than banks that specialize in sharia-compliant products. Tathmeer was not a lender known in the market, and was the intended name of the new Sharia-compliant subsidiary to be opened by Tamweelcom. The word “Tathmeer” means “to be fruitful” and does not have any religious connotation. Jordan Microfinance Company, on the other hand, is a known brand in the community.

In a separate, auxiliary marketing experiment, we tested whether the name brand (Jordan Microfinance Company) generated higher demand than the unknown brand (Tathmeer), but strictly for conventional loans. The name brand generates higher demand than the unknown brand. Section 4 discusses the ways in which this can affect the interpretation of the results.

# _Baseline Balance_

Table 1 displays the basic demographics of those recruited in the sample. Column 1 shows that individuals average 36 years old, and 57 percent are male. A third of the sample lives in Amman, the capital of Jordan, and a bit more than half the sample have a high school education or less. Sixty-five percent are married, 98 percent are Jordan nationals, and 11 percent plan to use the loan for home repair. Because it was important that respondents were not aware that they were part of a study we were unable to implement a large baseline survey which could have allowed us to collect detailed data on religiosity and financial literacy. Instead, we asked individuals whether or not they watch religious television programming<sup>15</sup> , in an effort to find a simple proxy for religiosity: 80 percent of the sample claim to watch any religious TV<sup>16</sup> . Half way through the study we updated our religiosity question to allow for a response on a 5 point scale. This allows us to identify individuals who claimed to “mostly” or “always” watch religious TV as “very religious”, which about 20% of our sample claim to do. Our results are qualitatively similar using either

> 15 We considered other types of proxies such as whether women wore the head-scarf or men had a beard, but these are often considered to be more cultural artefacts than religious. Asking about actual religious adherence (e.g. “How many times a day do you pray?”) is considered culturally inappropriate by many.

> 16 World Bank data report that 97% of households had a TV in 2002. We were unable to find more recent data as there seems to be a shift towards collecting data on internet connectivity. The near universal ownership of TVs makes us less worried that TV watching is proxying for other important characteristics.

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religiosity variable, but in one case we must interpret results for those that are religious and in the other case we interpret the results for those that are “very religious”.

Subsequent columns in Table 1 present the differences between the control group and each treatment arm, with the p-value from a joint test of all the variables<sup>17</sup> reported in the third to last row. None of the seven treatment arms are statistically significantly different from the control group in the aggregate test. Likewise, the final column of Table 1 compares all of the treatment arms to the control group and shows that we cannot reject equivalence of means of all treatments with control. Appendix Table 2 repeats this analysis without including marketer fixed effects, and finds that one of the seven group tests (the sharia compliant group with no authority identified) is jointly significantly different from control. This paper presents the results both with and without surveyor fixed effects and finds largely the same impacts<sup>18</sup> .

4. Results The randomization allows for estimation of the impacts of each of the marketing pitches on the behavior of potential borrowers by comparing the means of the treatment groups to the mean of the control group. In the following analysis, we first utilize the following econometric specification: 1 a a a a a 2a a a ii ii ii<sup>+ δδ</sup> mm<sup>. +εε</sup> ii<sup>,</sup> where is the outcome variable, such as whether or not they applied for the loan, yy = αα+ ββ SSha tt + ββ aaC aatta aaCCaaSSha 1 represents estimate of the average ii treatment effects for all four groups that offered a sharia compliant loan and yy 2 is the average treatment effect for all ββ three groups that had a choice between a conventional loan and a sharia compliant loan. The group that was offered ββ only the conventional loan serves as the omitted category. We estimate each with and without marketer fixed effects, denoted above as . While the tables report robust standard errors we have also utilized randomization inference to mm estimate Fisher p-values all of which are consistent with the reported standard p-values. δδ Table 2 presents the impacts of the different treatment arms on the loan application rate. The first column shows the impacts when combining the four treatment arms that offer a sharia-compliant loan with the control group.

> 17 The joint test does not include the “very religious” variable because we only have it for half the sample. When we do the joint test on only that half of the sample we find the same qualitative results.

> 18 We had seven different marketers. The randomization was done on the spot by the survey tablet and was not able to be stratified by marketer.

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There is a 4.3 percentage point (se=1.4) increase in loan application rates when individuals are offered a shariacompliant loan relative to when they are offered a conventional product. This represents a 23.4 percent increase in demand relative to the control group. Column 2 removes the marketer fixed effects, and finds a 3.6 percentage point (se=1.5) increase in demand. When individuals have a choice between the conventional loan and a sharia-compliant loan, relative to the control group this increases demand for loans by 3.7 percentage points (se=1.5) with marketer fixed effects, and 2.3 percentage points (se=1.7) without marketer fixed effects.

Next, Table 2 reports the differential impacts of the separate marketing pitches as well as the price sensitivity of demand for microcredit. It does this using a slightly more involved econometric specification: 1 a a a a a a a a a a ∗A ii ii kk ii kk,ii yy = αα+ ββ SSha tt + �ββ SSha tt ttha aattiiaatta aa kk 2a a a 3<sup>a</sup> ii<sup>+ ββ</sup> ii<sup>∗IIaattCCaaCCIIttIIaattCC</sup> ii<sup>+δδ</sup> mm<sup>. +εε</sup> ii<sup>.</sup> This specification shows the differential impacts of the authorization messages when compared to the sharia-compliant + ββ aaC aatta aaCCaaSSha<sup>aaCaattaaaaCCaaSShaa</sup> message without any mention of authorizing entity. It also allows the estimation of the elasticity of demand with respect to the price of the sharia-compliant loan.

There is no evidence that the certifying authority matters when individuals consider whether or not to apply for a loan, as shown in Columns 3 and 4 in Table 2. In the base marketing pitch there is no mention of which entity claims that the product is sharia-compliant. Marketers were instructed to simply say that they were offering the opportunity to apply to a sharia-compliant loan with no further details. The three other treatments added details about which entity provides support to the claim that the product was sharia-compliant. The estimates for all three treatment arms are negative, but not statistically significant. This implies that, at best, additional authoritative support has no impact on take up of sharia-compliant products. Individuals seem to want something that is sharia-compliant but are not worried about the details.

Table 2 also reports on the impacts of having a choice between a sharia-compliant loan and a conventional loan in columns 3 and 4. The conventional loan was offered at a constant rate of 1.9% per month, while the price of the sharia-compliant loan was randomized between 1.75% and 2.2% per month. Estimates show that having the option between a sharia-compliant loan and a conventional loan leads to an increase in demand for credit over only having the option of a conventional loan.

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While the point estimate for having a choice between the two types of loans is both statistically and economically significantly greater than only having the conventional option, it is actually lower than only having the sharia-compliant option. While the difference is not statistically significant it does lead to additional questions regarding whether having additional options may complicate the application decision, leading to a type of choiceparalysis seen in the behavioral economics literature (Iyengar and Lepper 2000; Iyengar, Huberman, and Jiang 2004; Bertrand et al. 2010).

_Estimating the Price Elasticity of Demand for Sharia-Compliant Loans_ The estimates for the price elasticity of demand are reported in columns 3 and 4. As the price of the shariacompliant loan increases, the likelihood that an individual would apply for any type of loan decreases. Although this relationship is not statistically significant it is likely due to the fact that in the treatments where the price of the shariacompliant loan varied, the price of the conventional option stayed the same. To overcome this challenge we now turn to considering consumer preferences when choosing between the two types of loans.

In the three treatment arms where we varied the cost of the sharia-compliant loan, individuals had the ability to choose between a conventional loan of fixed price or the sharia-compliant loan at the price of the group they were randomized into. In the analysis of this choice we use an outcome variable which takes the value of one if the individual preferred the sharia-compliant loan<sup>19</sup> and zero if they preferred the conventional loan. The first row in Table 3 shows how the proxy variable for religiosity relates to their preferred loan type. Table 3 shows that religious individuals are 10.8 percentage points (se=2.6) more likely to prefer the sharia-compliant loan (compared to a mean of 75.3 percent in the non-religious group). This shows that there are strong preferences for sharia-compliant products in general, but that there is still significant heterogeneity in product preferences based on religiosity. This result holds when the study considers the half of the sample where we have finer data on religiosity (proxied by if they “mostly” or “always” watch religious TV).

> 19 Surveyors asked everyone in the three treatment arms that were given a choice between loan types which loan they preferred whether or not they applied for the loan. The regressions in Table 3 include the preferences of individuals even if they did not apply. When we restrict to only those individuals who applied for the loan, the estimates remain statistically significant, but the p-value for “Religious vs Non-Religious” increases to 0.038. If we restrict the outcome variable to those that preferred the sharia-compliant loan and applied for the loan we find no significant difference.

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The remaining rows in Table 3 show how preferences for the sharia-compliant product vary with the price. Recall that the final row of Table 2 shows a small amount of price sensitivity of demand for applying for any loan, this table instead shows strong evidence that as the price of the sharia-compliant loan increases, the likelihood that an individual prefers that product over the conventional product decreases significantly. In particular, Column 1 shows that as the price increases by 0.1 percentage points (i.e. from 1.9% a month to 2.0% a month), demand for the sharia compliant product goes down by 4.2 percentage points (se=0.4). This corresponds to a 5.1% increase in price, and a 5.5% decrease in demand.

Next this paper showcases important heterogeneity in the elasticity of demand by religiosity. When the implied interest rate is interacted with dummies for whether or not an individual is religious the price elasticity of demand for non-religious individuals is nearly twice as large as the elasticity of those who are labeled as religious. In particular, while a 0.1 percentage point increase in price leads to a 7.5 percentage point (se=1.3) decrease in demand for the non-religious, it only leads to a 3.5 percentage point decrease in demand for the religious. This shows that religious individuals are less price sensitive to increases in the costs of microcredit when the product is in line with their religious beliefs.

It is possible that the measure of religiosity may instead be capturing some other characteristics that affect a borrower’s price elasticity of demand. Although we cannot test whether the measure is a proxy for some non-religious unobservable, we can examine whether any correlation with observed demographics is driving the core result. To do this, we first calculate the residual from a regression of the religiosity variable on all of the other baseline covariates, then we compare the elasticity for those with above median residual value, compared to below median, and find that the relationship between the measure of religiosity and the elasticity continues to hold.

_Impact of Sharia Compliant Loans on Loan Size and Borrower Type_ Table 2 also reports how sharia-compliant loans impact requested loan size and the observable characteristics of borrowers. Columns 5 and 6 show that there is no statistically significant difference in requested loan size between the groups offered a sharia-compliant loan compared to the requested loan size of the group offered a conventional loan. Columns 7 and 8 show a small positive effect of the different types of authorization on requested loan size, suggesting that while authorization may not impact the choice to borrow, it may provide cover for increasing utilization of otherwise socially questionable behavior when an authority can be seen providing support. However, the 17
estimates from columns 7 and 8 may also be driven by differential selection on unobservables in applying for the loan. Thus caution should be exercised when interpreting.

This paper further explores compositional effects in Table 4, which follows the same interaction regression specification as Table 2 but changes the outcome variables to the average characteristics of the borrowers in each group who have applied for the loan. In the case of no compositional effects (i.e. the type of people that are applying for the loan in each case is the same on average), we would see no difference in average characteristics between groups due to the random assignment of treatment. If, on the other hand, sharia-compliant loans are more likely to attract more highly educated people for example, then we should see that the average level of education in the shariacompliant group would be higher than the average education level in the conventional loan group. We utilize this specification because we have several characteristics that we only have data for conditional on submitting an application (e.g. employment status, prior loans, etc). Since we do not have these data for everyone in the sample we cannot use simple interaction effects on the treatment assignments.<sup>20</sup> There is no evidence of compositional effects of any of the treatment arms individually or jointly across ten different observable characteristics (age, gender, education, marital status, whether loan is for home repair, employment status, home ownership, bank account ownership, and prior borrowing status). This implies that even though sharia compliant loans can impact both take up of financial products, as well as requested loan amount, it does not seem to do so by attracting observably different people. There is an increase in the likelihood that the applicant is religious. However, since individuals did not actually get loans in the end, we are unable to assess if actual repayment behavior would have differed.

_Impact of Brand Name on Demand for Conventional Loans_ Table 5 reports the results of the independent, auxiliary marketing experiment that tested the impact of the known brand name Jordan Microfinance Company relative to the unknown brand name Tathmeer. Note that in the

> 20 These regressions only include individuals who applied for the loan, and not those that listened to the pitch but decided not to apply. The key point is that while the randomization insures that the average characteristics of the entire group are the same as any other group, this is not the case when we restrict to those who applied for the loan within each group. If there is selection into applying for a particular product (for example men prefer the conventional loan) we would detect an increase in the proportion of those people in the group that applied for the loan.

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main experiment, surveyors used the Jordan Microfinance Company name for the conventional loan option, and the Tathmeer name for the sharia-compliant loan option. The primary purpose of this auxiliary experiment is to test whether the “known” entity of Jordan Microfinance Company was trusted, by comparing it to an unknown entity, and keeping all else (including the lack of sharia-compliance) constant. This is not a dispositive test of trust, however, as we discuss in section 5. The unknown name “Tathmeer” led to 2.2 percentage point (se=1.1) lower take up than the control group known name “Jordan Microfinance Company.” This may lead to underestimating the demand for the sharia-compliant loan due to the difference in the brand of the financing entity.

5. Discussion of Results and Alternative Interpretations The results contribute to our understanding of demand for financial products in several ways. In this context there is clear evidence that consumer choice is dependent on more than just the economic fundamentals of the product. The actual economics and contract requirements of the two loan products are very similar for the consumer. This paper shows that low take-up is due not just to standard explanations of desirable economic product characteristics like prices, terms and borrowing requirements, but also whether or not the product is in line with the social and religious considerations of the consumer.

While there is strong evidence that borrowers had greater demand for the sharia-compliant loan, they were not influenced by which entity (if any) was declaring the loan sharia-compliant. In this context Islamic microcredit was still new and there were no certifying entities that would lead consumers to assume that any loan was legitimate. We expect that this result may differ in different contexts. For instance, in places where all loan products are under strict control by the state then certification may not matter. On the other hand, other contexts may follow versions of Islamic law that are more concerned with following the letter of the law which may make consumers more concerned with the certifying entity.

This paper also provides evidence that individuals who are more religious are willing to pay more to adhere to their religious obligations. While there is evidence of demand for microcredit products that adhere to Islamic law, there are not many sharia-compliant products available to individuals, even in Muslim-majority countries. Anecdotal evidence points to many lenders in the financial sector worrying about the added costs associated with shariacompliant products making those products uncompetitive in the marketplace. Our evidence shows that this may not necessarily be the case, and that even when the price of the sharia-compliant product is 16% higher than the conventional product (2.2% vs 1.9% monthly interest) three quarters of the sample still prefer the sharia-compliant 19
loan. While only half of non-religious loan applicants prefer the sharia-compliant loan when it is more expensive than the conventional option, 82% of the religious prefer the more expensive sharia compliant loan when available. _Explaining Low Take Up_ While this study was able to increase demand for loans, there were still at least 78% of respondents who were not interested in applying for the loan. What else explains this low rate of take up? When individuals declined to apply for the loan we asked them for the main reason they were uninterested. Table 6 reports the different reasons that were cited by the sample. Responses are split into three types: the first are those who did not refuse and actually applied for the loan, the second are economic or social reasons for refusal, and a third type are more generic reasons for refusal.

The most common reason across each group was that they simply “didn’t need a loan now”. Of those offered the conventional loan 31.7% gave this reason while 31.8% of those offered the sharia-compliant loan claimed the same thing, along with 32.9% of those offered the choice between the two types of loans. The second most common was that they did not like dealing with loans. Both of these reasons are issues that a financial institution cannot do much about, and constitute more than half of the reasons for low take up.

The remaining issues are things that the bank is able to affect through changes in their products and activities. 9.1% of the control group claimed that the main reason they were uninterested was that the loans were too small, only 0.1% claimed that the price was too high, 9.1% claimed that they did not apply for religious reasons, and 3.7% said it was because they didn’t trust the loan offer. We can use these data to help further interpret the magnitude of the increase in demand estimated in the marketing experiment. By focusing on the things that a financial institution can affect, about 40% of the reasons for refusal were religious in nature, 40% were economic in nature and 20% were about trust. Taking these data at face value, they imply that religious reasons for low take up are equally as important as economic reasons in this context.

Column 4 shows how these answers changed when people were provided a sharia-compliant option, either by itself or when they were given a choice between a conventional and sharia-compliant loan. The largest change is a 6.5 percentage point decrease in the set of individuals who claimed religious reasons as the main reason for refusal. While this is a large decrease it’s worth noting that there are still about 2.6% of people who continue to claim religious issues even when offered a sharia-compliant loan, implying that religious authorization continues to be an important topic.

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We can try to follow where the 6.5 percent of respondents who no longer claim religious reasons for refusal went<sup>21</sup> . On average, 3% actually decided to apply for the loan, an additional 0.8% said they did not trust the offer, 1.4% continued to refuse the loan but on economic grounds instead of religious grounds, and the remaining 1.3% changed their response to a generic reason for refusal.

We can further use these shifts to compare the experimental measures of the importance of religious considerations to the survey-based measures that are more widely used. Of those in the control group that claimed religious reasons for not applying for the loan, about one third of them shifted into applying for the loan, about one third continued to claim religious reasons for not applying, and the final third changed their answer to something else, close to evenly across economic reasons and to generic reasons. Together this implies that nearly two thirds of those that claim religious reasons for not taking out loans seem to act consistent with religious objections being the main reason for not applying for a loan, while the remaining third shift to a different excuse when the religious angle is addressed. This suggests that survey data on financial exclusion due to religious objections may be overestimating the importance of this characteristic by a third.

# _Alternative Interpretations_

This study has several limitations. The label of “sharia-compliant” may do more than merely represent adherence to religious considerations. We identify six potential alternatives.

First, if an individual does not trust financial institutions, the sharia-compliant label may signal trustworthiness and thus increase the take-up rate by consumers. This issue was the motivation for the independent auxiliary experiment on the branding of the conventional loan. In this auxiliary experiment, we learn that the known brand name (Jordan Microfinance Company) generates 2.2 percentage point (se=1.1) higher take-up rates than the unknown brand name (Tathmeer) for a conventional loan, all else constant. This is important because branding does matter, and that the control group in the main test (Jordan Microfinance Company conventional loan) did perform better than an unknown brand, suggesting that respondents did, at least to some extent, trust the financial institution. If trust were a simple binary variable, this would allow us to argue that the sharia-compliant loan (marketed under the

> 21 To do this we need to first assume that the same type of people are not shifting their reasons for refusing the loan for any reason other than the religious aspect of the product. This requires people’s non-religious preferences to be stable in the face of a choice between a conventional and religious product.

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unknown name Tathmeer) was not succeeding merely because of trust, and that we are underestimating the impact of providing a religious product. But, our auxiliary experiment is an imperfect test, first because trust is obviously not a binary variable, and second because brand names do far more than create trust. Brand names also simplify choice by providing information, and potentially influence the experience of a product through social or self-signaling (Keller and Lehmann 2006). Thus, we cannot break apart how much of the increase in the application rate comes from demand for the product itself versus increased trust (if any) in the financial institution because it is providing a religiously permissible product.

Second, it is possible that the borrower may think that banks that provide sharia-compliant products behave differently than banks that provide conventional loans. For example, if clients believe that a sharia-compliant bank is more likely to approve their loan, or would be more lenient in cases of default, then that may explain a part of the difference in application rates. On the other hand, if applicants believe that sharia-compliant lenders are less likely to approve a loan, then the results would be underestimates of the true impact on demand due to sharia-compliance.

Third, the sharia-compliant loan may provide individuals a means to signal to peers their piousness. Because this is individual lending, not group lending, we believe this is unlikely to be a strong explanation for the increased demand in the sharia-compliant loans. However, the presence of the guarantee requirement does mean that the individual has to tell at least one person about their desire to take out a loan. If they thought that applying for a shariacompliant loan would make it easier for them to convince a co-signer to agree to help them then they may have been more likely to apply for the loan. Unfortunately, the data and design do not allow for observing whether this happens. Furthermore, if individuals saw value in signaling their piousness to the marketing person, for social reputation reasons individuals may have expressed higher levels of interest (although in surveying, asking individuals about religiosity is difficult as it is deemed culturally sensitive).

Fourth, a standard experimenter demand effect may be present: if individuals believe the experimenters (the bank, in this case, because the marketers presented themselves as bank employees, not researchers) _wanted_ a certain outcome, and that pleasing the bank would afford them some future benefit, they may have expressed more interest in what they perceived the bank as preferring. We believe this is unlikely to be a noticeable effect in this context, particularly for the treatments that do not offer multiple products over which to choose and instead provide just one product to either accept or reject. It is also possible that by asking the sample if they watch religious TV before telling 22
them about the loan products may have primed them to be more accepting of the sharia-compliant product, leading us to over-estimate true demand.

The main outcome variable is applications for the loan but due to the implementation delays from the partner we were unable to see observe how this would have translated into actual loans made to those in the sample. It is possible that the preliminary application rates could have differed from the final disbursement. It is difficult to predict in which direction this potential difference may have gone.

Relatedly a lack of repayment data limits the ability to make strong statements about selection on unobservables and profitability for the bank. Although there is no evidence of compositional observable differences between those that apply for the sharia-compliant product and those that apply for the conventional loan, there may be unobservable differences. Unobservable characteristics could lead to adverse or advantageous selection. For example, those who take up sharia-compliant loans may be more pious and thus creditworthy, and thus less likely to engage in moral hazard behavior particularly at the repayment decision; on the other hand, those who take up shariacompliant loans may default more, as they could be used to more forgiving faith-based services. In the latter case, the increases in application rates would actually be detrimental to the financial institution.

6. Conclusion This paper shows that demand for sharia-compliant loans from borrowers in a Muslim-majority country is stronger than demand for conventional loans. This study also provides evidence that individuals are willing to pay more for this type of product, even though its financial characteristics are very similar to its conventional counterpart. While there seems to be no impact from different types of authorizing entities on demand for this product, this study finds that price elasticity differs by religiosity, as proxied by whether or not the respondent watches religious TV.

When comparing these impacts to what is implied by survey data, we show that survey data overestimate the exclusionary power of religious objectives by about one third, and that religious and social considerations are at least as important as economic factors like loan size and interest rates when we consider the reasons why individuals claim that they are not utilizing credit.

Together, these findings imply several lessons for improving financial inclusion across the world, and lead to several avenues for future research. First, improving our understanding of how non-financial preferences impact financial decisions can be an effective way to increase access to financial services for those that turn them down for social reasons. Second, even if the preferences are for products that are more costly than the conventional alternative, 23
there can be heterogeneity in willingness to pay that can cover these added expenses. In other words, even if a product has a small base of potential users, if it is targeted correctly it may still be economically feasible to provide it to those who demand it most. This in turn can impact equilibria in the credit markets, bringing more people into the financial markets who otherwise would have refused to use formal financial services due to non-financial reasons.

Future research could delve deeper into understanding the underlying reasons for the power of these religious considerations. For instance, this paper cannot explain how much of the effect that it finds is due to the borrower’s desire to showcase their religiosity to others opposed to their personal desire to follow religious law. Further research could also help expand on how to best identify the non-financial preferences that are most important in improving access to worthwhile services. Additional work should explore how non-financial aspects of loan offers influence selection on unobservables, as well as key questions for market development, such as improved targeting and optimal long-term pricing for a market that depends on religious certification. Lastly, further work on the product itself is ripe for exploration. As some sharia-compliant products attempt to be more like equity than debt contracts, there is still much to learn about how to overcome obvious information asymmetries when offering financing to households and informal enterprises.

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