Projecting the Impact of Financial Inclusion and Islamic Financing on Poverty Alleviation: Insights from Indonesia

The purpose of this study was to observe the impact of financial inclusion and Islamic financing on poverty alleviation in Indonesia, focusing on the poverty gap index. Using data from 2015 to 2023, it analyses key financial inclusion proxies such as third-party funds (TPF), the number of ATMs, and branch offices, along with internal Islamic bank factors like return on assets (ROAs), non-performing financing (NPF), Islamic financing distribution (FIN), exchange rate (Kurs), and M2. This study used Vector Error Correction Model (VECM) to evaluate the short- and long-term effects of independent variables on poverty reduction. The findings reveal that financial inclusion, particularly through Islamic bank variables, significantly reduces poverty in the long term. However, the allocation of TPFs tends to favour middle- and upper-income groups, limiting its effectiveness in alleviating poverty for lower-income populations. Impulse-response function (IRF) analysis further shows that financial inclusion proxies and Islamic financing have significant long-term impacts on poverty reduction, although these effects take time to emerge. This research enhances our understanding of how financial inclusion and Islamic financing can be leveraged to combat poverty in developing countries. It concludes by offering policy recommendations to improve financial service access for lower-income groups, strengthen Islamic financial infrastructure, and implement sustainable long-term strategies to optimize the benefits of financial inclusion.