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BRIEF Financial Inclusion and Stability:

What Does Research Show?
A growing body of research suggests that whether broad-based access to formal financial
services promotes financial stability depends on how that access is managed within
the regulatory and supervisory framework, especially in terms of financial integrity and
consumer protection. Four factors come into play: financial inclusion, financial consumer
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protection, financial integrity, and financial stability. These factors are inter-related and,
under the right conditions, positively related. Yet failings on one dimension are likely to
lead to problems on others. This Brief explores what research to date shows about the
linkages and potential beneficial relationships among these factors, and it identifies gaps
that remain to be explored.

Focus to date: linkages among financial periods. 3 Multiple studies have documented a
development and economic growth, reduction of robust negative relationship at the country level
income inequality, and poverty alleviation. There is between indicators of financial depth and the
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limited empirical work exploring the specific linkages level of income inequality as measured by the Gini
between financial inclusion and financial stability. coefficient.4 Financial depth is also associated with
Studies have focused largely on the impact of financial increases in the income share of the lowest income
development on growth, income inequality, and quintile across countries from 1960 to 2005 (Beck,
poverty reduction. The evidence strongly indicates Demirgüç-Kunt, and Levine 2007). It comes as little
that, when effectively regulated and supervised, surprise, therefore, that countries with higher levels
financial development spurs economic growth, of financial development also experienced swifter
reduces income inequality, and helps lift households reductions in the share of the population living on
out of poverty.1 less than $1 per day in the 1980s and 1990s. The
magnitude of the impact is also large. Controlling
Most cross-country evidence relates to the benefits for other relevant variables, almost 30 percent of
of financial depth rather than to broad financial the variation across countries in rates of poverty
inclusion. Deep financial sectors are not necessarily reduction can be attributed to cross-country
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inclusive ones, if financial access is tilted heavily variation in financial development (Beck, Demirgüç-
toward the wealthy. Our lack of knowledge about Kunt, and Levine 2007).
the macro-level effects of financial inclusion stems, in
part, from the challenges associated with measuring The benefits work not only through direct use of
it on a consistent basis both across countries and over financial services, but through the indirect positive
time based on surveys of users and potential users effects that financial development has on low-
of those services.2 In contrast, the effects of financial income population segments, especially through
depth have been studied extensively precisely labor markets. For example, careful empirical studies
because data from suppliers of financial services are have shown that the deregulation of bank branching
readily available. can not only intensify competition and improve bank
performance, it can also boost the incomes of the
Macroeconomic evidence indicates that well- poor, tightening income distribution by increasing
developed financial systems have a strong positive relative wage rates and working hours of unskilled
impact on economic growth over long time workers. 5 Financial development is therefore

1 See World Bank (2008) for an overview.

2 See Cull, Demirgüç-Kunt, and Morduch (2012), especially chapter 1, for discussion.
3 See Levine (2005) and Demirgüç-Kunt and Levine (2008) for reviews of the literature on the causal effect of financial development on growth.
4 See Clarke, Xu, and Zhou (2006); Li, Xu, and Zou (2000); and Li, Squire, and Zou (1998).
May 2012 5 For the United States, see Jayaratne and Strahan (1998) and Beck, Levine, and Levkov (2010).
2

pro-poor not only in the sense that economic tools needed by the poor. The “wrong” financial
growth lifts households above the poverty line, but tools—or irresponsibly delivered financial services—
also in a relative sense because it narrows income have been correlated with adverse effects, such as
differentials. Do narrower income differentials lower levels of educational attainment,9 suggesting
and improved labor prospects for low-income the importance of effective consumer protection
households contribute to a more cohesive, stable in particular to ensure positive effects on micro
society and thus to market stability in the broader stability.
sense? Likely so, though that link could be explored
more explicitly, as could the possible connection to Another link between inclusion and micro stability
financial system stability. is through the entry, capitalization, and growth of
new nonfinancial firms. At the firm level, the macro-
Which broad channels of financial inclusion level evidence shows that financial development is
promote income equality and reduce poverty? associated with more efficient allocation of capital
While the challenges associated with measuring (Wurgler 2000). The entry rate of new firms and their
financial inclusion are now being better met, we still growth are also positively associated with financial
lack clear understanding about the specific ways in development (Klapper, Laeven, and Rajan 2006),
which financial inclusion promotes income equality and the effects of relieving financial constraints are
and reduces poverty6—though recent user studies in especially strong for small firms’ growth rates (Beck,
individual developing countries are beginning to offer Demirgüç-Kunt, and Maksimovic 2005). Moreover,
important clues.7 For example, field experiments recent evidence, for example with respect to the
based on randomized controlled trials are helping portfolios of Chilean banks,10 suggests that losses
to identify the causal pathways through which access on small loans pose less systemic risk than the
to formal financial services improves the lives of the large, infrequent, but also less predictable, losses
poor in developing countries, especially with respect associated with large loans. Thus, greater financial
8
to savings products. Savings bolster stability at the inclusion in terms of access to credit might also
individual and household level and, given their very coincide with greater stability at the level of providers
large numbers, small savers potentially contribute of financial services.
to stability at the financial system level—though
stability effects of savings at both levels could be What are the macro-level links between financial
explored in greater detail, especially at the level of inclusion and financial stability, and what about
the financial system. financial exclusion? At the country level, evidence
suggests that financial inclusion can lead to greater
What are the micro-level links among financial efficiency of financial intermediation (e.g., via
access, improved livelihoods, and financial intermediation of greater amounts of domestic savings,
stability? If financial inclusion leads to a healthier leading to the strengthening of sound domestic savings
household and small business sector, it could and investment cycles and thereby greater stability)
also contribute to enhanced macroeconomic (and (Prasad 2010).11 Greater diversification in clientele
financial system) stability, though again we are served associated with financial inclusion might also be
unable to point to specific research that supports expected to lead to a more resilient and more stable
that conjecture at this point. Also more research economy. The reduction of income inequality through
needs to be done to identify the specific financial financial development and inclusion could lead to

6 On improved measurement of financial inclusion, see Demirgüç-Kunt and Klapper (2012).

7 On the effects of bank branch expansion, see Burgess and Pande (2005) for India and Bruhn and Love (2009, 2012) for Mexico.
8 On the effects of commitment savings devices in Africa see Dupas and Robinson (2011) and Brune et al. (2011). See also Citi Foundation (2007).
9 Zhan and Sherraden (2011) find that the accumulation of nonfinancial and financial assets by parents is generally associated with greater
educational attainment by children, but their unsecured debt is negatively related to children’s college completion.
10 See Adasme, Majnoni, and Uribe (2006).
11 We acknowledge that savings accumulation associated with greater financial inclusion does not always lead to more efficient intermediation.
Whether it does so depends crucially on the quality of financial infrastructure, regulation, and supervision.
 3

greater social and political stability, which in turn could In addition to FATF’s recent recognition that financial
contribute to greater financial system stability (though exclusion poses risks in combating money-laundering
here, too, the links merit further exploration). and terrorist financing, the soon-to-be-completed
revision of the Basel Core Principles (BCPs) has
If financial inclusion can promote greater stability, offered an opportunity for the Basel Committee on
could financial exclusion likely lead to greater Banking Supervision (BCBS) to work the principle
instability? Evidence here is not well developed, of proportionality (i.e., the balancing of risks and
but it is clear that financial exclusion imposes at benefits against costs of regulation and supervision
the very least large opportunity costs. Also, the and allocating supervisory resources accordingly)
evidence suggests that underdeveloped financial into all the relevant BCPs, permitting consideration
systems have disproportionately negative effects of (1) the changing risks and benefits of increased
on small firms and low-income households, which financial inclusion, given the expanding and changing
in turn is likely to have adverse effects on societal set of providers and products involved, and (2) the
cohesion. Moreover, the Financial Action Task Force adaptability of BCBS standards and guidance to
(FATF) has recently explicitly acknowledged financial widely varying country contexts (especially with
exclusion as an important risk in its efforts to respect to supervisory capacity). The recently
12
combat money-laundering and terrorist financing, revised Insurance Core Principles of the International
underscoring the link between financial integrity Association of Insurance Supervisors offer a similar
and pro-stability financial inclusion. Additionally, opportunity in the insurance realm. Finally, the
in countries with high levels of financial exclusion, recent financial crisis has further underscored the
the informal financial services that households (and importance of promoting consumer protection and
small firms) must rely on can be poor substitutes for financial literacy and capability, a role that is relevant
formal services (Collins et al. 2009). In the extreme, for multiple SSBs.
informal services can themselves be a source of
instability. For example, pyramid schemes organized Evidence gaps and the road ahead. Notwithstanding
as informal savings and investment opportunities the progress SSBs have made and the substantial
have been known to trigger both political and volume of empirical research reviewed above,
social unrest and lack of confidence in the banking important gaps remain, including the following:
13
system.
• How does financial inclusion contribute to political
Standard-setting bodies (SSBs) and the virtuous and social stability, and in turn to financial stability?
circle linking financial inclusion, financial consumer What threats to financial stability flow from financial
protection, financial integrity, and financial stability. exclusion?
Until recently, most of the relevant empirical research • What specific contributions to making financial
and evidence on links between financial inclusion and inclusion pro-stability do effective financial
financial stability has come from research institutions, consumer protection and financial integrity offer?
and not from policy makers, regulators, supervisors, How do we measure responsible financial inclusion
or global SSBs. Yet SSBs—and policy makers, (i.e., quality, not just quantity)?
regulators, and supervisors attempting to follow • What financial “tools” best suit the needs of
the SSBs’ standards and guidance while pursuing excluded households? What consumer protection
a financial inclusion agenda—are both among the and financial capability measures will ensure
most interested parties and also among the best responsible delivery?
positioned to contribute to articulating the research • What channels of financial inclusion work best to
questions that will help SSBs consider financial promote income equality and reduce poverty?
inclusion in their work while remaining true to their • What specific impact can increased formal savings
core mandates. have?

12 See FATF (2011).

13 See CGAP (2011) for discussion.
 Demirgüç-Kunt, Aslı, and Ross Levine. 2008. “Finance,
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Acknowledgments and Timothy Lyman, senior policy adviser, Government

and Policy, CGAP. The authors express their gratitude
The authors of this Brief are Robert Cull, lead economist, to H.R.H. Princess Máxima of the Netherlands, the UN
Finance and Private Sector Development, Development Secretary General’s Special Advocate for Inclusive Finance
Economics Research Group, World Bank; Aslı Demirgüç- for Development and Honorary Patron of the G-20 Global
Kunt, director, Development Policy, Development Partnership for Financial Inclusion, for suggesting this
Economics Vice-Presidency and Chief Economist, Finance literature review, and to Kathryn Imboden and Kate Lauer
and Private Sector Development Network, World Bank; for their review of the manuscript.

AUTHORS:
Robert Cull, Aslı Demirgüç-Kunt, and Timothy Lyman