Financial Inclusion and Its Effects on Financial Stability, Income Inequality and Monetary Policy Effectiveness: The case of Africa

Abstract

Inclusive financial systems, whereby everyone enjoys the benefits of financial services, has become one of the top global priorities. Notwithstanding the emphasis on the role of financial inclusion (FI), a large proportion of adults across the world in general, and in low-income countries in particular, are without access to formal financial services. Africa performs worse in terms of FI compared to other developing regions. In addition to ensuring inclusive financial systems, a global consensus has been recently reached regarding the role of inclusive economies in achieving stable and sustainable growth. To ensure inclusive economies, the reduction of inequality within and across countries has become one of the top priorities of the United Nations’ Sustainable Development Goals. Africa is the second most unequal continent; while it has demonstrated strong economic growth over the past two decades, that growth has not been “pro-poor”. Against such a background, this thesis aims to achieve five major objectives in the context of Africa. Firstly, the thesis multidimensionally develops a measurement of FI using two-stage indexing approach. The results show that extensive margin and geographic coverage of financial services contribute to much of the variation in FI. Secondly, employing an endogenous panel threshold estimation approach, the thesis examines the effect of foreign banks presence on FI and demonstrates that foreign bank presence reduces financial inclusion; however, the negative effect is observed only after a threshold of foreign bank presence is reached. Moreover, it shows that the effect of foreign bank presence depends on institutional quality of the host countries. The results further demonstrate that foreign bank presence enhances the intensive margin but reduces the extensive margin of financial services. Thirdly, employing panel semiparametric regression, this thesis analyses the effect of FI on financial stability and demonstrates that FI below (above) threshold enhances (reduces) financial stability. Moreover, the thesis employs panel quantile regression and finds that the effect of FI depends on initial levels of financial stability. The thesis further shows that the effect of FI on financial stability is reinforced in a competitive financial market structure. Fourthly, using endogenous panel threshold estimation, the thesis examines the effect of FI on income inequality and shows that only FI above a threshold reduces income inequality. Employing panel quantile regression, this thesis finds that the effect of FI depends on initial levels of income inequality. It further demonstrates that the favourable distributional impact of FI is reinforced at higher levels of institutional quality. Finally, by employing a heterogenous panel estimation approach, the thesis analyses the relationship between FI and effectiveness of inflation targeting monetary policy. The results demonstrate that common shocks do not have significant effect in the case of full sample countries and nonmonetary union countries. In the case of monetary union countries, West African Economic and Monetary Union (WAEMU), the thesis finds that idiosyncratic, common and composite shocks have significant impacts, with varying magnitudes, signs, times of response and persistence. Emphasizing on WAEMU, this thesis demonstrates effectiveness of monetary policy is differently associated with the dimensions and indicators of FI. Overall, FI shocks temporarily increase inflation; deposit shocks reduce inflation; and credit shocks increase inflation. Central bank policy rate increases to credit shocks indicating that the monetary authority responds to credit shocks by implementing contractionary monetary policy. The findings of the thesis imply that, in Africa, promoting financial inclusion is crucial to achieve stable financial system, inclusive economy, and effective monetary policy. The results indicate that while promotion of FI in general is important, an emphasis on the extensive margin and geographic outreach of financial services is crucial. The results also highlight that competitive financial structure is vital for reinforcing the positive effect of FI on financial stability. The results further imply that improving institutional quality is critical to reinforce income inequality reducing effect of FI, and to utilize foreign bank presence as an opportunity to enhance an inclusive financial system amidst ever-increasing financial globalization.