Revisiting financial inclusion-stability nexus: cross-country heterogeneity

Abstract

Purpose

This paper aims to investigate the debated nexus of financial inclusion (FI) and financial stability (FS) in a comprehensive way, with several indicators of FI, considering nonlinearity and cross-country heterogeneity.

Design/methodology/approach

The authors introduce several indexes for FI by applying principal component analysis (PCA) and explore their impact on stability for a sample of 108 countries and subsamples based on income grouping as well as for pre- and post-crisis episodes over the period 2004–2017. To address the heterogeneity and endogeneity, the authors use the two-step quantile regression (2SQR), three-stage least square (3SLS) and two-step system-GMM (System-GMM).

Findings

The findings reveal that the relationship of FI and stability depends on the measurement of FI used and the heterogeneity of different macroeconomic factors. Besides, there is nonlinearity, irrespective of the measurement of inclusion used. The findings also confirm that the effect of FI is more prominent in countries with strong governance. The results are robust to several robustness validations, which could be useful for policymakers to align the divergence of these policies and ensure FS while expanding access to formal financial services.

Originality/value

This study makes an attempt to explore the reasons behind the debated empirical findings of the existing literature by revisiting the nexus using several disaggregated indexes, each representing individual dimension and a multidimensional index, examine the possible nonlinearity and investigate the conditioning effect of different macroeconomic factors that might play a significant role in this relationship.

Citation

Saha, M. and Dutta, K.D. (2022), "Revisiting financial inclusion-stability nexus: cross-country heterogeneity", Journal of Financial Economic Policy, Vol. 14 No. 5, pp. 713-742. https://doi.org/10.1108/JFEP-06-2021-0162