Economic Research Forum (ERF)

Financial inclusion, financial stability and inequality

1958
Are programmes aimed at promoting financial inclusion in the countries of the Middle East and North Africa (MENA) leading to less poverty and income inequality and more financial stability? This column outlines the evidence from a study of eight MENA countries.

In a nutshell

Lack of access to finance adversely affects growth and poverty alleviation, as the poor find it difficult to accumulate savings, to build assets to protect against risks and to invest in income-generating projects.

Financial inclusion reduces income inequality in MENA countries, but has insignificant effects on poverty, in part because banking structures are not well developed enough in terms of access to financial services.

Broadening the use of banking services can have a direct impact on income distribution.

Over the past three decades, MENA countries have registered some of the highest rates of unemployment in the world. Frustrated by years of economic and financial exclusion, political instability and marginalisation, and income stagnation, young people have taken to the streets and ignited revolutions in Egypt, Libya, Syria, Tunisia and Yemen. In response, several governments in the region have rushed to implement programmes that reduce economic and financial exclusion, primarily among the poor segments of the population.

At the highest levels of political governance, there is now a clear recognition that financial stability and financial inclusion represent two sides of the same coin. The pursuit of financial inclusion aimed at drawing the ‘unbanked’ population into the formal financial system represents a recent preoccupation for policy-makers in the region (Pearce, 2011). There is a realisation that lack of access to finance adversely affects growth and poverty alleviation, as the poor find it difficult to accumulate savings, to build assets to protect against risks and to invest in income-generating projects.

The onus on policy-makers is to create effective opportunities for financial inclusion. Key to such interventions are policies that accelerate the introduction of innovative technology, regulatory reforms, and the acquisition of infrastructure that reduce transaction costs and allow the delivery of financial services more rapidly, efficiently and conveniently to broad sections of the population.

Several recent studies (including Honohan, 2004; and Demirguc and Klapper, 2012) have established a strong link between financial access to banking services and economic development and growth. Empirical evidence indicates a distinct rise in income levels of countries with higher number of bank branches and deposits. Higher number of bank branches and accounts are more observed in high-income countries than countries in the low- and middle-income categories.

While these studies show that financial inclusion boosts the growth rate of per capita GDP, they do not necessarily suggest that financial inclusion helps the poor. The low access to banking services of the poor is evident in several MENA countries, where there is a perception that financial inclusion increases the average growth rate of GDP only by increasing the incomes of the rich and leaves behind those with lower incomes. How financial inclusion affects income inequality and how it could improve income distribution in the region is not clear (Dhrifi, 2013).

Our recent study examines the effects of financial inclusion on income inequality and poverty in eight MENA countries (Neaime and Gaysset, 2018). We also explore the effects of financial liberalisation and integration on financial stability. Our results show that while financial inclusion reduces income inequality in MENA countries, population size and inflation increase income inequality.

Our other empirical results show that financial inclusion has no effects on poverty, whereas population, inflation and trade openness significantly increase poverty. The insignificant effect arising from financial inclusion on poverty is because MENA’s banking structure is not developed enough in terms of access to financial services to affect poverty effectively in a positive way.

What is more, the benefits of having a relatively well-developed banking system, as the region does, seem not to have reached the poorer segments of the population. The efficiency of the banking sector will have to be enhanced to increase bank penetration, with more support for small and medium enterprises. The lack of entrepreneurial activities in the MENA region is another factor explaining the insignificant effect of financial inclusion on poverty.

What about the link to financial stability? Our empirical evidence indicates that while uncoordinated financial integration is a contributing factor to financial instability in MENA, financial inclusion contributes positively to financial stability. We also show that greater access to financial services is positively contributing to the resilience of the banking system’s deposit funding base. This is particularly important during times of financial crises.

Enhanced resilience of bank funding supports the overall financial stability of the banking sector and the entire financial system. But the most recent debt and financial crises have shown that financial liberalisation and inclusion in MENA may not always be conducive to poverty reduction and financial stability improvements. For a detailed discussion of the recent debt and financial crises and their spillover effects on the MENA region, see Neaime (2005, 2008, 2012, 2015a&b, 2016), Neaime and Gaysset (2017) and Guyot et al (2014).

We argue that MENA policy-makers face trade-offs in whether to focus on reforms to promote financial inclusion, innovation and financial access, or whether to focus on further improvements in financial stability. At the same time, there are potential synergies between promoting financial inclusion and financial stability. Some MENA governments have focused on financial openness and integration as opposed to financial innovation as a mean to promote financial stability.

Financial integration has, however, contributed negatively to financial stability. The lack of strong political and economic institutions to supervise and regulate financial markets, especially those that have initiated the liberalisation of their markets, has been a contributing factor in financial instability. The absence of these institutions could trigger a financial and economic crisis, further widening economic inequality and poverty.

A case in point is the 2008 global financial crisis, which had devastating consequences for the financial markets of Egypt, Jordan, Qatar, Saudi Arabia and the United Arab Emirates. Other MENA governments, including in Algeria, Morocco and Tunisia have favoured improving financial innovation and inclusion as a way to reduce poverty and inequality. Some reduction in income inequality has been registered in Morocco and Tunisia but not in Algeria. Poverty remains high in Algeria and Morocco.

The results of our study could help foster a better policy to reform the financial sector by demonstrating how broadening the use of banking services can have a direct impact on income distribution.

Further reading

Demirguc-Kunt, Asli, and Leora Klapper (2012) ‘Measuring Financial Inclusion: The Global Findex Database’, World Bank.

Dhrifi, Abdelhafidh (2013) ‘Financial Development and the Growth-Inequality-Poverty Triangle’, International Journal of Economics, Finance, and Management 2(7).

Guyot, Alexis, Thomas Lagoarde-Segot and Simon Neaime (2014) ‘Foreign Shocks and International Cost of Equity Destabilization: Evidence from the MENA region’, Emerging Markets Review 18: 101-22.

Honohan, Patrick (2004) ‘Financial Sector Policy and the Poor: Selected Findings and Issues’, World Bank.

Neaime, Simon (2005) ‘Portfolio Diversification and Financial Integration of MENA Stock Markets’, in Simon Neaime and Nora Ann Colton (eds) Money and Finance in the Middle East: Missed Opportunities or Future Prospects? (Research in Middle East Economics, Volume 6) Emerald Group Publishing.

Neaime, Simon (2008) ‘Twin Deficits in Lebanon: A Time Series Analysis’, Lecture and Working Paper Series No. 2, Institute of Financial Economics, American University of Beirut.

Neaime, Simon (2012) ‘The Global Financial Crisis, Financial Linkages and Correlations in Returns and Volatilities in Emerging MENA Stock Markets’, Emerging Markets Review 13(2): 268-82.

Neaime, Simon (2015a) ‘Sustainability of Budget Deficits and Public Debts in Selected European Union Countries’, Journal of Economic Asymmetries 12: 1-21.

Neaime, Simon (2015b) ‘Twin Deficits and the Sustainability of Public Debt and Exchange Rate Policies in Lebanon’, Research in International Business and Finance 33: 127-43.

Neaime, Simon (2016) ‘Financial Crises and Contagion Vulnerability of MENA Stock Markets’, Emerging Markets Review 27: 14-35.

Neaime, Simon, and Isabelle Gaysset (2017) ‘Sustainability of Macroeconomic Policies in Selected MENA Countries: Post Financial and Debt Crises’, Research in International Business and Finance 40: 129-40.

Neaime, Simon, and Isabelle Gaysset (2018) ‘Financial Inclusion and Stability in MENA: Evidence from Poverty and Inequality’, Finance Research Letters, (forthcoming).

Pearce, Douglas (2011) ‘Financial Inclusion in the Middle East and North Africa: Analysis and Roadmap Recommendations’, World Bank.

Tags: , , , ,

Most read

Trust in Lebanon’s public institutions: a challenge for the new leadership

Lebanon’s new leadership confronts daunting economic challenges amid geopolitical tensions across the wider region. As this column explains, understanding what has happened over the past decade to citizens’ trust in key public institutions – parliament, the government and the armed forces – will be a crucial part of the policy response.

Growth in the Middle East and North Africa

What is the economic outlook for the Middle East and North Africa? How is the current conflict centred in Gaza affecting economies in the region? What are the potential long-term effects of conflict on development? And which strategies can MENA countries adopt to accelerate economic growth? This column outlines the findings in the World Bank’s latest half-yearly MENA Economic Update, which answers these questions and more.

Climate change: a growing threat to sustainable development in Tunisia

Tunisia’s vulnerability to extreme weather events is intensifying, placing immense pressure on vital sectors such as agriculture, energy and water resources, exacerbating inequalities and hindering social progress. This column explores the economic impacts of climate change on the country, its implications for achieving the sustainable development goals, and the urgent need for adaptive strategies and policy interventions.

Assessing Jordan’s progress on the sustainable development goals

Global, regional and national assessments of countries’ progress towards reaching the sustainable development goals do not always tell the same story. This column examines the case of Jordan, which is among the world’s leaders in statistical performance on the SDGs.

Small businesses in the Great Lockdown: lessons for crisis management

Understanding big economic shocks like Covid-19 and how firms respond to them is crucial for mitigating their negative effects and accelerating the post-crisis recovery. This column reports evidence on how small and medium-sized enterprises in Tunisia’s formal business sector adapted to the pandemic and the lockdown – and draws policy lessons for when the next crisis hits.

Unleashing the potential of Egyptian exports for sustainable development

Despite several waves of trade liberalisation, Egypt’s integration in the world economy has remained modest. In addition, the structure of its exports has not changed and remains largely dominated by traditional products. This column argues that the government should develop a new export strategy that is forward-looking by taking account not only of the country’s comparative advantage, but also how global demand evolves. The strategy should also be more inclusive and more supportive of sustainable development.

The threat of cybercrime in MENA economies

The MENA region’s increasing access to digital information and internet usage has led to an explosion in e-commerce and widespread interest in cryptocurrencies. At the same time, cybercrime, which includes hacking, malware, online fraud and harassment, has spread across digital networks. This column outlines the challenges.

Rising influence: women’s empowerment within Arab households

In 2016 and again in 2022, a reliable poll of public opinion in the Arab world asked respondents in seven countries whether they agreed with the statement that ‘a man should have final say in all decisions concerning the family’. As this column reports, the changing balance of responses between the two surveys gives an indication of whether there been progress in the distribution of decision-making within households towards greater empowerment of women.

Macroeconomic policy-making for sustainable development in Egypt

In recent years, economic policy in Egypt has been focused primarily on macroeconomic stabilisation to curb inflation, to reduce the fiscal deficit and the current account deficit, and to increase GDP growth. As this column explains, this has come at the expense of the country’s progress on the Sustainable Development Goals, which is rather modest compared with other economies in the region or at the same income level. Sustainable development needs to be more integrated with the conception and implementation of fiscal and monetary policies.

Economic consequences of the 2003 Bam earthquake in Iran

Over the decades, Iran has faced numerous devastating natural disasters, including the deadly 2003 Bam earthquake. This column reports evidence on the unexpected economic boost in Bam County and its neighbours after the disaster – the result of a variety of factors, including national and international aid, political mobilisation and the region’s cultural significance. Using data on the intensity of night-time lights in a geographical area, the research reveals how disaster recovery may lead to a surprising economic rebound.