Financial inclusion, financial stability and inequality

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Simon Neaime
January 30, 2018

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.

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