The Singapore Economic Review, Vol. 63, No.

1 (2018) 1–7
© World Scientific Publishing Company
DOI: 10.1142/S0217590818020022

FINANCIAL INCLUSION, FINANCIAL STABILITY AND

INCOME INEQUALITY: INTRODUCTION

Published 2 November 2017

1. Introduction
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Since the early 2000s, financial inclusion has been receiving increasing attention for its
potential to contribute to economic and financial development while fostering more in-
clusive growth and greater income equality. G20 leaders approved the Financial Inclusion
Action Plan in 2010 and established the Global Partnership for Financial Inclusion to
promote the financial access agenda. As a part of the Universal Financial Access 2020
initiative, the World Bank Group — the World Bank and the IFC — has committed to
enabling 1 billion people to gain access to a transaction account through targeted inter-
ventions. The Asia-Pacific Economic Cooperation (APEC) Finance Ministers’ Process has
created a dedicated forum for examining financial inclusion issues, and the Association of
Southeast Asian Nations (ASEAN) Framework on Equitable Economic Development has
made promotion of financial inclusion a key objective (ASEAN, 2014). The Asian De-
velopment Bank approved 121 projects (amounting to $2.59 billion as of 2012) to support
microfinance in Asia and the Pacific (ADB, 2012). Many individual Asian economies have
also adopted strategies on financial inclusion as an important part of their overall strategies
to achieve inclusive growth.
One key indicator of household access to finance is the percentage of adults who have
an individual or joint account at a formal financial institution, such as a bank, credit union,
cooperative, post office or microfinance institution (MFI), or with a mobile money pro-
vider. According to the World Bank’s Global Findex database for 2014, Asia’s statistics
show that there is still much to achieve toward access to finance, as East Asia, the Pacific,
and South Asia combined account for 55% of the world’s unbanked adults, mainly in India
and the People’s Republic of China (Demirgüç-Kunt et al., 2015).
Moreover, within emerging economies in Asia, there is a high degree of variation of
the percentage of adults who have accounts. Account penetration is nearly universal in
Singapore and the Republic of Korea, but is much lower in some other economies — less
than 2% in Turkmenistan and less than 20% in Afghanistan, the Kyrgyz Republic, Pakistan
and Tajikistan (Demirgüç-Kunt et al., 2015). A similarly wide range can be found for other
indicators of financial inclusion, such as having a loan from a formal financial institution or
the share of small firms having a bank loan.

1
 2 The Singapore Economic Review

2. Definitions of Financial Inclusion

Financial inclusion broadly refers to the degree of access of households and firms,
especially poorer households and micro, small and medium-sized enterprises (MSMEs),
to financial services. Such services typically include deposits, loans, payment, remittances
and insurance. However, there are important variations in terms of usage and nuance. The
World Bank defined financial inclusion as “the proportion of individuals and firms that use
financial services” (2014: p. 1), while the Asian Development Bank stated it is “ready
access for households and firms to reasonably priced financial services” (2015: p. 71).
Atkinson and Messy define it as:
the process of promoting affordable, timely and adequate access to a wide
range of regulated financial products and services and broadening their use by all
segments of society through the implementation of tailored existing and innovative
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approaches including financial awareness and education with a view to promote

financial well-being as well as economic and social inclusion (2013: p. 11).
The World Bank definition focuses on the actual use of financial services, while the
other definitions focus more on the potential ability to use such services. Moreover, “ac-
cess” does not mean any kind of access, but implies access at reasonable cost and with
accompanying safeguards, such as adequate regulation of firms supplying financial
services, and laws and institutions for protecting consumers against inappropriate products,
deceptive practices, and aggressive collection practices. Of course, it is difficult to define
“reasonable cost” in cases where amounts involved are small or information asymmetries
exist. Therefore, a key question is the extent to which the government should subsidize
such services or otherwise intervene in the market. This perspective also highlights the need
for adequate financial education and consumer protection, as consumers cannot take proper
advantage of access to financial services if they do not understand them properly.

3. Benefits of Financial Inclusion

There are numerous arguments about the benefits of promoting financial inclusion. Poor
households are often severely cash-constrained, so innovations that increase the efficiency
of their cash management and allow them to smooth consumption can have significant
impacts on welfare. Also, many studies find that the marginal return to capital in MSMEs
is large when capital is scarce, which suggests that they could reap sizeable returns from
greater financial access (Demirgüç-Kunt and Klapper, 2013). This is particularly important
in Asia due to the large contribution of MSMEs to total employment and output.
Greater financial inclusion can also contribute to reducing income inequality by raising
the incomes of the poorest income quintile (Beck et al., 2007). It may also enhance
financial stability by increasing the diversity of, and thereby decreasing the risk of, bank
assets and by increasing the stable funding base of bank deposits (Khan, 2011; Morgan and
Pontines, 2014). Easier financial access can also support shifts by governments to cash
transfer programs away from wasteful subsidies. Greater transparency associated with
electronic funds transfers can help reduce corruption.
 Financial Inclusion and Financial Regulation 3

Considerable evidence indicates that the poor benefit greatly from access to basic
payments, savings and insurance services. For firms, particularly the small and young ones
that are subject to greater constraints, access to finance is associated with innovation, job
creation and growth. However, dozens of microcredit experiments paint a mixed picture
about the development benefits of microfinance projects targeted at particular groups in the
population (World Bank, 2014: p. 3).

4. Need for Financial Regulation

Efforts to promote financial inclusion provide many challenges for financial regulators,
and creative responses to these challenges can contribute to promoting financial inclusion.
Traditionally, regulators were skeptical of financial inclusion due to higher credit risks and
lack of documentation associated with small borrowers. Khan (2011) cited a number of
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ways in which increased financial inclusion can contribute negatively to financial stability,
including a reduction in lending standards (such as for sub-prime loans), a loss of bank’s
reputational risk if they outsource various functions, such as credit assessment, to reach
smaller borrowers, and possible systemic financial risks arising from increased lending
by under-regulated groups, i.e., shadow lending.
However, more recent literature has identified some positive effects of financial inclu-
sion on financial stability. Khan (2011) suggested three ways in which greater financial
inclusion can contribute positively to financial stability. First, greater diversification of
bank assets as a result of increased lending to smaller firms can reduce the overall riskiness
of a bank’s loan portfolio. Adasme et al. (2006) found that non-performing loans (NPLs) of
small firms have quasi-normal loss distributions, while those of large firms have fat-tailed
distributions, implying that the former have less systemic risk. Morgan and Pontines
(2014) found evidence that an increased share of lending to SMEs tends to reduce
measures of financial risk such as bank Z-scores or NPL ratios.
Second, increasing the number of small savers would increase both the size and stability
of the deposit base, reducing banks’ dependence on non-core or wholesale financing,
which tends to be more volatile during a crisis. Third, greater financial inclusion can
improve the transmission of monetary policy, contributing to greater economic and
financial stability. Hannig and Jansen (2010) argued that low-income groups are relatively
immune to economic cycles, so including them in the financial sector will tend to raise the
stability of the deposit and loan bases. Han and Melecky (2013) found that a 10% increase
in the share of people who have access to bank deposits can reduce the deposit growth
drops (or deposit withdrawal rates) by 3–8 percentage points, which supports this view.
The rise of financial technology or “FinTech,” such mobile phone and internet banking,
presents a further set of challenges to regulators. They must keep pace with fast-developing
technologies that cross borders between finance and other sectors such as tele-
communications. On the other hand, FinTech holds great promise for increasing financial
inclusion at low cost. Therefore, regulators must strike a balance between the need to
encourage new technologies to expand financial inclusion, while guaranteeing the stability
of the financial system and protecting consumers.
 4 The Singapore Economic Review

5. Papers
The purpose of this special issue is to present recent research on topics related to financial
inclusion and financial regulation. The papers address the following topics: the determi-
nants of financial inclusion, especially with respect to savings and financial investment
behavior; the relationship between financial inclusion and export activity by SMEs;
the relationship between financial inclusion and financial stability; and the relationship
between financial inclusion and income inequality.
Tambunlertchai analyzes the savings aspect of financial inclusion in Myanmar. Her
paper first examines the factors that determine use of formal savings products. Second,
it identifies the barriers to saving. Using data from a nationally representative survey of
5100 individuals, the paper applies econometric estimation and qualitative data analysis
methods. The findings show a low level of saving in Myanmar, and that formal savings
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increases with income, education and keeping a budget, among other factors. Policy
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recommendations to increase saving behavior in Myanmar include the design of financial

literacy programs that are suitable to the country’s context, and improving physical access
to financial institutions.
Yang, Wang and Xie use the China Household Finance Survey data of 2011 to in-
vestigate the effects of social insurance programs on households’ rate of time preference
and stock investment. The estimation results imply that respondents with a higher rate of
time preference have a significantly higher probability of investing in stocks. The social
insurance programs and insurance policies held by the family will have a significantly
positive direct effect to encourage the stock investment, and will also have a significant
positive effect on the respondent’s time preference, which could further indirectly increase
the family’s stock investment. These results show that the social safety net consisting of
social security and commercial insurance built by the Chinese government is very likely to
attract more investors with short-term time preference into the stock market. These em-
pirical results show the effects of such Chinese policies on increased household investment
in financial assets.
Chen, Zhang and Yin study the education premium in the online peer-to-peer (P2P)
lending marketplace in which individual lenders bid on unsecured microloans applied for
by individual borrowers. This has become a burgeoning source of alternative funding in the
People’s Republic of China and other countries. Using more than 100,000 consummated
and failed listings from the largest online P2P lending marketplace in China — Paipaidai.
com, they examine whether loan applicants with higher education levels obtain lower
interest rates and have lower risks of default. They find that, controlling for other char-
acteristics of borrowers, borrowers with bachelor’s degrees obtain average loan interest
rates 0.141% points lower than those obtained by borrowers with associate’s degrees.
Moreover, female borrowers’ education premiums were higher than their male counter-
parts. With regard to loan performance, borrowers with bachelor’s degrees were found to
be 13% less likely to default than borrowers with associate’s degrees. Therefore,
the education premium in the P2P lending marketplace is rational.
 Financial Inclusion and Financial Regulation 5

Based on survey data, Ren, Li, Zhao and Zhou analyze the level of exclusion from
digital finance in the rural areas of three Chinese provinces — Beijing, Tianjin and Hebei.
They use a censored probit model to examine whether there is financial exclusion and the
degree of financial exclusion for the rural residents. They find that the significant factors
influencing financial exclusion in digital finance include the personal characteristics of the
rural residents, the understanding of digital finance, availability of digital financial infra-
structure, the development of digital finance, and the social environment. They conclude
that taking account of the precise characteristics of the excluded groups in rural areas,
including age, education and income, could be helpful for making policies to reduce
financial exclusion.
Amornkitvikai and Harvie analyze the effect of sources of finance on the export
participation and export intensity of SMEs and other firms in the Thai manufacturing
industry. The paper also identifies other key factors contributing to SME manufacturing
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firm export activity. The empirical results confirm that the Export-Import bank of Thailand
and the Department of International Trade Promotion both play a significant role in en-
hancing SME and other manufacturing firm export participation and export intensity. Local
and foreign commercial banks, however, are not found to have a significant effect on their
export participation and export intensity. In addition, SMEs and other manufacturing firms
receiving funds from friends and family are found to participate less in foreign markets
compared to those which do not receive any funds from their friends and family. With
respect to the importance of type of ownership for export activity, foreign ownership can
help promote the export participation and intensity of SMEs and other manufacturing
enterprises. Technological innovation activity also helps them to participate in foreign
markets. The empirical evidence also points out that financial institutions in Thailand
remain reliant on collateral-based lending and financial transparency. A key finding from
this paper is that manufacturing SMEs are likely to perform worse in terms of export
participation, export intensity and access to finance compared to large manufacturing
enterprises.
Morgan and Pontines address the issue of whether greater financial inclusion tends to
increase or decrease financial stability. Their study uses macro-level data to estimate the
effects of the share of bank lending to SMEs on two measures of financial stability — bank
NPLs and bank Z scores (a measure of the risk of a bank’s insolvency). They find some
evidence that an increased share of lending to SMEs aids financial stability by reducing
NPLs and the probability of insolvency by financial institutions. However, there were not
enough data points to test whether the effect is non-linear or not.
Morgan and Zhang use bank-level microdata to examine the relationship between
financial inclusion and financial stability, where the share of mortgage lending in total
lending is taken as the measure of financial inclusion, and find evidence of a nonlinear
relationship between the two. They estimate the effect of the share of mortgage lending by
individual banks (together with some control variables) on two measures of financial
stability — the bank Z-score and the NPL ratio — for a sample of 397 banks in 19
emerging Asian economies for the period 2003–2014 from the Bankscope database. They
find evidence that an increased share of mortgage lending is positive for financial stability,
 6 The Singapore Economic Review

specifically by lowering the probability of default by financial institutions and reducing the
NPL ratio, for levels of mortgage shares up to 23–65%. However, for higher levels of
mortgage lending shares, the impact on financial stability turns negative. This suggests
that, up to a certain point, there is a risk diversification benefit from increased mortgage
lending, but higher shares lead to concentration rather than diversification, and the impact
on financial stability turns negative. Therefore, the challenge is to balance the expected
improvement in financial stability due to asset diversification against negative impacts that
might result from easier lending standards or too rapid increases in mortgage lending that
could trigger a bubble in the housing market. This highlights the need for prudent
monetary policy and macroprudential policy measures to forestall the development of
such bubbles.
Yoshino and McNelis analyze asset price and household income/consumption dynamics
in a small open economy subject to terms of trade shocks, under two financial regimes. The
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first is a pure banking regime, in which firms borrow from banks to finance the costs of
labor, investment and intermediate goods for both the relatively riskless natural resource
traded sector and the non-traded sector. The second regime is a more financially advanced
one which includes both banking and crowdfunding financing options, in which the
households directly receive returns to capital from pooled lending to home-goods firms in
the case of crowdfunding. Simulation results show that the banking regime better insulates
the economy from negative shocks but limits the upside gain from positive shocks which
would take place in the banking-crowdfunding regime.
Garcia-Herrero and Turegano analyze empirically whether financial inclusion con-
tributes to reducing income inequality when controlling for other key factors, such as
economic development and fiscal policy. They find that financial inclusion contributes to
reducing income inequality to a significant degree, while the size of the financial sector
does not have a similar effect. These results support earlier arguments that fostering fi-
nancial inclusion has an additional side benefit of reducing income inequality. More
specifically, given the broad definition of financial inclusion used in their analysis,
promoting financial inclusion implies facilitating the provision of credit to both low-
income households and small and MSMEs.
Mercado and Park extend the existing literature on financial inclusion by analyzing the
factors affecting financial inclusion and assessing the impact of financial inclusion on
poverty and income inequality in the world and Asia. They construct a new financial
inclusion indicator to assess various macroeconomic and country-specific factors affecting
the degree of financial inclusion for 177 economies, including 37 from developing Asia.
They estimate the effect of financial inclusion, along with other control variables, on
poverty and income inequality. This is done both for the full sample of countries and for
developing Asia economies to determine which factors are relevant for the full sample and
for developing Asia specifically. The estimation results show that per capita income, rule of
law and demographic characteristics significantly affect financial inclusion for both world
and Asia samples. However, primary education completion and literacy significantly in-
crease financial inclusion only in the full sample, not in the Asian sample. The findings
also indicate that financial inclusion is significantly correlated with lower poverty and
 Financial Inclusion and Financial Regulation 7

income inequality levels for the full sample. For developing Asia, however, there appears
to be no link between financial inclusion and income inequality.

NAOYUKI YOSHINO
Asian Development Bank Institute,
Tokyo, Japan
nyoshino@adbi.org

PETER J. MORGAN
Asian Development Bank Institute,
Tokyo, Japan
pmorgan@adbi.org
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