Institutional setting variables

In this study, several institutional setting variables are included, namely financial system (i.e., proxied by the Islamic banking presence), overall institutional environment, contractual and informational framework, regulatory restrictions, legal origin as well as region. The variables are discussed as following:

i. Financial system

In terms of financial system, the impact of Islamic financial sector is not well explored. Following Ben Naceur et al., (2015), Islamic banking presence, is employed as the primary proxy for type of financial system in all analyses. On top of the number and size of assets in Islamic banking28 that has been suggested by Ben Naceur et al., (2015), this present study adds another indicator to gauge the Islamic banking presence, namely profitability of Islamic banking. Detail discussion on the classification of financial system (i.e., proxied by the Islamic banking presence) is presented in Chapter 6. Using the two indicators of Islamic banking, Ben Naceur et al., (2015) find that the empirical link between financial inclusion and Islamic banking is mixed, i.e., Islamic banking in OIC countries is associated with greater use of bank credit by households and by firms, primarily for investment purposes, but find no significant association with ownership of accounts by households.

ii. Overall institutional environment

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In Ben Naceur et al., (2015) study, both indicators are scaled by the adult population. Similar results were obtained when scaling by total population or as a share of total number of banks or total assets of the banking system.

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Overall institutional environment variable is gauge using the governance index. This index consists of score on six governance indicators (voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, control of corruption). Higher score correspond to better governance. Considering the prediction of institutional theory, it is expected that countries with high level of governance index will have greater financial inclusion. The findings of Beck, et al., (2007) reveal that both outreach and depth indicators are positively associated with the quality of the institutional environment.

iii. Contractual and informational framework

Combining both studies by Beck, et al., (2007) and Gimet & Lagoarde-Segot (2012), three variables are employed to examine the impact of contractual and informational framework on financially excluded. The informational environment is captured through a credit information index from the World Bank Doing Business Database, which measures rules affecting the scope, accessibility, and quality of credit information available through either public or private bureaus. Higher values of the index (ranging from one to six) represent a better informational environment. The cost of contract enforcement (also from the Doing Business Database) measures the official cost of going through court procedures, including court costs and attorney fees where the use of attorneys is mandatory or common, or the costs of an administrative debt recovery procedure, expressed as a percentage of the debt value. Beck, et al., (2007) find that outreach indicators are correlated with the credit information environment and with the cost of contract enforcement, while Beck et al., (2008)

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uncover a weak association between these two variable and the barrier indicators29. With regards legal rights in getting credit (i.e., scored on a 0–10 scale, with scores increasing with legal rights, legal right index measures the degree to which collateral and bankruptcy laws facilitate lending), Gimet & Lagoarde-Segot (2012) finds a positive and significant impact of this variable on those financially included.

iv. Regulatory restrictions

To capture regulatory restriction, index of banking restrictions is applied. This index captures government‘s control, regulations, and involvement in financial sector. Higher values indicate more banking restrictions. Beck et al., (2008) argue that bank regulations might have both a direct and indirect effect on financial inclusion. Their finding reveals that banks in economies with more restrictions on banking activities are found to discriminate those who are financially excluded in accessing deposit and lending services.

v. Interest rate

Both deposit and lending rates which are gathered from the World Development Indicators database, are used in this study. Consultative Group to Assist the Poor (CGAP) (2009) argue that usury ceilings or interest rate cap may inhibit the expansion of credit and increase actual costs paid by consumers although it designed to protect consumers. However, the evidence is remains lack and inconclusive. Sarma & Pais (2011) find negative sign for interest rate but found no significant association,

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The barrier indicators, among others are minimum balance to open checking account (percent of GDP per capita), annual checking account fees (percent of GDP per capita), minimum amount consumer loan (percent of GDP per capita) and fee for using ATM card (percent of $100).

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whereas Gimet & Lagoarde-Segot (2012) report negative relationship between the interest spread and credit.

vi. Legal origin

Following Beck, et al., (2007), this study further investigates the link between legal origin and financial access since the literature finds that economies with legal institutions based on the French Civil Code tend to be less financially developed than those that originated from the British Common Law. Following Siems (2006), socialist origin is added on top of the four legal origin classified by La Porta, et al. (1997). Beck, et al., (2007) find that legal origin and religion have a less consistent impact on financial outreach.

vii. Region

Except for Honohan (2008), as far as financial inclusion literature is concern, there is no attempt has been made before to explore the affect of region on financial inclusion in particular. Following the note from Martin (2000), this study introduces region variable to further examine the impact of this institutional setting on financial access. Six geographic regions based on World Bank database are observed, namely Africa, East Asia & Pacific, Europe & Central Asia, Latin America & Caribbean, Middle East & North Africa and South Asia.