Manan Chipper - 2033324 Dissertation

Analyzing the determinants of Financial Inclusion in India
Dissertation submitted to Christ (Deemed to be University) in partial fulfillment of the
requirements for the Award of the Degree of
BACHELOR OF ARTS
IN
ECONOMICS
(HONOURS)
by
Manan Chipper
(2033324)
Under the Supervision of
Dr. Bhagavatula Aruna
Assistant Professor of Economics
DEPARTMENT OF ECONOMICS
CHRIST (Deemed to be University)
BANNERGHATTA ROAD CAMPUS
BENGALURU
APRIL 2023
II
CERTIFICATE
This is to certify that the dissertation submitted by Manan Chipper (Reg. No.
2033324) titled ‘Analyzing the determinants of Financial Inclusion in India’ is a record of
research work done by him/her during the academic year 2022 -2023 under my/our
supervision in partial fulfilment for the award of Bachelor of Arts in Economics (Honours).
This dissertation has not been submitted for the award of any degree, diploma, associateship,
fellowship, or other titles. I hereby confirm the originality of the work and that there is no
plagiarism in any part of the dissertation.
Place: Bengaluru
Date: 24/04/23
Signature of the Supervisor
Dr Bhagavatula Aruna
Assistant Professor
Department of Economics
Bannerghatta Road Campus, Bengaluru
Head, Department of Economics

III
Declaration
I, Manan Chipper hereby declare that the dissertation, entitled ‘Analyzing the determinants of
Financial Inclusion in India’ is a record of original research work undertaken by me for the
award of the degree of Bachelor of Arts in Economics. I have completed this study under the
supervision of Dr Bhagavatula Aruna, Department of Economics and Political Science.
I also declare that this dissertation has not been submitted for the award of any degree,
diploma, associateship, fellowship, or other titles. I hereby confirm the originality of the work
and that there is no plagiarism in any part of the dissertation.
Place: Bengaluru
Date: 24/04/2023
Signature of the Candidate
Manan Chipper
Reg No. 2033324
Department of Economics

IV
Acknowledgement
The process of writing this paper was both educational and informative. Over the
process of writing this research paper, I was able to educate myself on various topics. This
process, however, was accomplished effectively thanks to the help and guidance of many
people.
'I would like to thank my mentor, Dr Bhagavatula Aruna, for her consistent support
and direction. Her compassion and skill were invaluable to me throughout the process. Her
persistent involvement and support became my actual incentive for finishing this paper.
I would also like to extend my whole hearted thankfulness to Dr Aneesh M R,
Coordinator of Economics Cluster, and other professors of the economic department for
constant support, without whom this study would not have been possible.
Thirdly, I would like to thank Dr. Ananda Meher sir, one of my panel members, for
providing his valuable insights and suggestions in order to provide better shape to this study.
His inputs on how to approach the topic helped me immensely.
I would also like to thank all my friends for supporting and guiding me in my most
challenging times and providing their suggestions.
Manan Chipper
V
Abstract
This study focuses on analyzing the determinants of financial inclusion in India
during the period 1991 – 2018. Financial inclusion has been identified as the key enabler of
Sustainable Development Goals (SDGs) by United Nations. In India, financial inclusion was
considered in policy decision making aggressively only after 2004. Before that there were
initiatives to provide financial services to underprivileged section such as nationalization of
banks, opening of regional rural banks and much more but on a very small scale. The paper in
order to examine the impact of certain factors on financial inclusion, first creates a financial
inclusion index (FII) using principal component analysis (PCA). Then using the index values
as dependent variable and GDP growth rate, number of internet users, inflation rate, age
dependency ratio, and gross secondary school enrolment ratio as independent variables,
Johansen cointegration method is used to check for long run relationship between the
variables.
Keywords: financial inclusion, PCA, Johansen cointegration, inde

Table of Contents
Acknowledgement................................................................................iv
Abstract....................................................................................v
1- Introduction.......................................................................................................1
1.1 Introduction to financial inclusion and its significance.....................1
1.2 Research Questions..................................................................5
1.3 Research Objective......................................................................................6
1.4 Research Gap...........................................................................6
2- Review of Literature........................................................................................6
3. Methodology....................................................................................................15
3. Data...........................................................................16
3.2 Description of variables.......................................................17
3.3 Principal Component Analysis.....................................23
3.4 Unit root test.........................................................................25
3.5 Cointegration test..........................................................28
4- Results and Interpretation.........................................................26

Analyzing the determinants of Financial Inclusion in India ii
4.1 PCA results..........................................................33
4.2 Unit root test results..........................................................34
4.3 Cointegration results..........................................................35
5. Conclusion.........................................37
5.1 Summary Findings...............................................................................37
5.2 Limitations and scope of the study..............................................38
References.....................................................................................................39
Analyzing the determinants of Financial Inclusion in India iii
LIST OF TABLES
Table 1: Objective and Data source of variables used in the study..................................16
Table 2: Principal Component Selection table.....................................24
Table 3: Loadings table.....................................25
Table 4: Financial Inclusion Index results.....................................33
Table 5: Unit root test results.....................................34

Analyzing the determinants of Financial Inclusion in India iv
LIST OF GRAPHS
Graph 1: Age dependency ratio during 1991 - 2018.....................................32
Graph 2: GDP growth rate during 1991 – 2018 .....................................32
Graph 3: Gross secondary school enrolment ratio during 1991 - 2018...............32
Graph 4: Inflation rate as measured by CPI during 1991 – 2018............................32
Graph 5: Number of internet users during 1991 -2018 (log values of internet users is plotted
against time period) .....................................32
Graph 6: Financial inclusion over the time period (log values of financial inclusion index is
plotted against time period) .....................................32

Analyzing the determinants of Financial Inclusion in India v
LIST OF ABBREVIATIONS
PCA: Principal Component Analysis
RBI: Reserve Bank of India
BSR: Basic Statistical Returns
FI: Financial Inclusion
FII: Financial Inclusion Index
SDG: Sustainable Development Goal
GDP: Gross Domestic Product

1
Analyzing the determinants of Financial inclusion in India
Introduction
The provision of financial services to the most downtrodden section of the economy is
necessary for development in growing economies. People who reside in remote rural areas
are often deprived of formal financial services. India’s success in the recent decades lies in its
sustained economic expansion. Though it is one of the fastest growing economies in the
world, poverty remains a challenge for the nation. The high incidence of poverty has resulted
in income inequalities across the region. Financial inclusion can be the key in reducing
poverty and income inequality. Dr. C. Rangarajan defines financial inclusion "as the process
of ensuring access to financial services to timely and adequate credit where needed by
vulnerable groups such as weaker sections and low-income groups at an affordable cost"
(Rangarajan Committee, 2008)
With the advancement of the Indian economy, especially when the goal is to achieve
sustainable development, there must be an effort to incorporate the greatest number of
participants from all segments of society. Yet, the lack of understanding and financial literacy
among the country's rural population is impeding economic progress, as the bulk of the
population lacks access to formal credit. This is a critical issue for the country's economic
development. To overcome such impediments, the banking industry developed technical
advancements such as automated teller machines (ATM), credit and debit cards, online
banking, and so on. While each advent of such financial technology brought about a
transformation in urban culture, the bulk of the rural population is still ignorant of these
developments and is therefore excluded from formal banking. (Charan Singh, 2014)
2
Recent studies have indicated that financial inclusion can act as a tool to achieve
macroeconomic stability, sustainability, employment generation, better living standard, and
inclusive economic growth. Financial inclusion is distinct from social banking, and it has the
potential to benefit the poor more than social banking has in the past (Kamath, 2007). It is
important for the policy makers to distinguish between voluntary and involuntary financial
exclusion and the focus should be on involuntary financial exclusion. To increase the level of
financial inclusion, the first step is to find out what are the factors that influence financial
inclusion in India. The next step is to focus on factors that significantly affect the level of
financial inclusion. There is also a need for financial inclusion indicator which can help in
comparing it over time and across regions within a particular nation. In developing regions
like Asia, Latin America, and Africa, many individuals are involuntarily excluded from the
financial system. This results in the excluded population's loss of savings, investments, and
wealth accumulation. This is where financial inclusion comes to fill the gap and raise the
overall economic activity in an economy. The bank is the most prominent financial institution
in developing countries to provide financial services. Most studies have used three
dimensions to measure financial inclusion: penetration, accessibility, and usage. The
penetration dimension focuses on the enhanced availability of banking facilities. It includes
spreading bank branches and automated teller machines (ATMs) nationwide. The provision
of bank branches and ATM facilities in remote regions increases the incidence of poor people
using financial services easily. The poorer section lacks access to financial facilities due to
the non-availability of financial institutions near their habitat. They also face difficulty in
terms of poor literacy and inadequate collateral to easily avail of quality financial services.
An economy's financial development leads to its economic development. To establish
favourable conditions for economic growth, financial development takes either a supply-led
3
or demand-led approach. Economic growth is increased by financial deepening, which
increases access to capital for people who do not have it. Although financial depth has
improved, the breadth and visibility of structured finance have not expanded to the same
amount (Mohan 2006). As a result, financial inclusion has been a priority for Indian
policymakers, particularly after 2005. Whilst financial inclusion is not explicitly listed in the
United Nations list of 17 Sustainable Development Goals (SDGs), increased access to
financial services is a critical facilitator for several of them (Klapper, El-zoghbi, and Hess
2016). Financial inclusion is viewed as essential for inclusive development that results in
long-term progress. (Thorat, 2007)
Financial services penetration in India's rural areas remains quite low. The variables
responsible for this state may be examined from both the supply and demand sides, and the
main reason for poor financial service penetration is most likely a lack of supply. Low
demand for financial services might be due to a low income level, a lack of financial
awareness, other bank accounts in the family, and so on. On the other hand, supply side
problems include a lack of nearby bank branches, a lack of adequate goods that satisfy the
requirements of the poor, complex processes, and language obstacles. (Charan Singh, 2014)
Financial exclusion was predated by social exclusion and was primarily concerned
with geographical access to financial services, namely banking facilities (Leyshon and Thrift,
1995). Financial exclusion encompasses all sorts of persons who make little or no use of
financial services, not just those who lack physical access due to the shifting geography of
financial services. Financial exclusion refers to an individual's inability to access and/or
successfully use financial items that can assist them in participating in the variety of activities
that comprise social life. According to the European Commission (2008), "financial
4
exclusion" is "a process in which people have difficulty accessing and using financial
services and products in the mainstream market that are appropriate to their needs and allow
them to lead a normal social life in the society to which they belong." In the same context,
Kempson and Whyley (1999) and Leyshon and Thrift (1995) said that financial exclusion is a
phenomenon that disproportionately affects a minority of vulnerable and otherwise
disadvantaged people (that is, single parents, social tenants, the long-term unemployed,
members of some minority, ethnic communities and people with persistent low incomes).
(Kodan & Chhikara, 2013)
The modern economic and social development agenda is based on widespread access
to financial services for two reasons (Beck and Torre, 2006): first one being a large
theoretical and empirical literature demonstrating the importance of a well-developed
financial system for economic development and poverty alleviation (Beck et al., 2000, 2004;
Honohan, 2004); and second being access to financial services that can be viewed as a public
good allowing participation in the benefits. (Peachey and Roe, 2004). As a result, financial
inclusion/exclusion is seen as critical in terms of building a conceptual framework and
identifying the underlying issues that result in limited access to the financial system (RBI,
2008). (Kodan & Chhikara, 2013)
Inclusive growth and financial inclusion are no longer policy options; they are now
policy imperatives that will define the social and economic order's long-term financial
viability and stability in the future. We must guarantee that our countrymen and women have
simple access to the financial system and may use it to better their social and economic well-
being. (Chakrabarty, 2013).

5
In general, marginalised sectors of the population are financially excluded in
contemporary society. Most of the time, their earnings are not monetized, and they are denied
financial inclusion. Furthermore, there is a lack of information regarding the restoration of E
banking services; on the other hand, banking authorities are not fully aware of the demands
and capacities of the people in these parts. As a result, banks cannot bring people into the
financial inclusion umbrella. (Bagli & Dutta, 2012)
The data indicates variations across developing and high–income countries regarding
the use of financial services. The percentage of adult count holders at a formal financial
institution in high–income countries is almost double as compared to developing countries.
Demirguc – Kunt and Klapper (2012) found that around 50 percent of adults reported having
a formal account at some financial institution. Though having an account is not enough for
financial inclusion, it eases the transfer of wages and payments, encouraging savings and
improving credit accessibility.
The Global Financial Inclusion database was published in 2011, providing reliable
information about the global growth of the financial sector. The database is based on several
indicators which account for the poor people excluded from the formal financial system.
More than 97 percent of the world's population in more than 140 countries was surveyed to
construct the database. (Global Findex Methodology, 2011, 2014).
Research Questions
• What are the factors that affect financial inclusion in India?
• What variables can be used to define and measure financial inclusion?
• What mechanism can be employed to include number of variables to construct a
financial inclusion index?

6
Research Objectives
• To construct a composite financial inclusion index for India
• To empirically analyze the determinants of financial inclusion in India by checking
for long run relationship between the independent variables and the financial
inclusion index.
Research Gap
There has been consensus among the researchers on the concept of financial inclusion
even though their definition on financial inclusion differs. The previous literature differs in
the way of measuring financial inclusion based on their type of the study, area of the study.
The lack of macro level data on financial inclusion and its indicators has left us without any
standard measure for calculating financial inclusion. The previous studies have mostly
covered cross country analysis of determinants of financial inclusion, financial inclusion and
its impact on poverty reduction, income inequality. Though there are few studies that focus
on country specific analysis yet it is very less. This paper attempts to analyze the factors that
affect the level of financial inclusion in India by constructing a novel financial inclusion
index by using indicators that truly defines financial inclusion in developing country like
India.
Literature review
Omar and Inaba (2020) in their study examine the relationship between financial
inclusion, poverty reduction, and income inequality. The sample for this empirical study
includes developing countries with more emphasis on Asia, Latin America, Africa, and the
Caribbean. For the study, they construct a new composite financial inclusion index by
7
considering three dimensions – penetration, availability, and usage. The study investigates the
factors affecting financial inclusion in developing countries by regressing the level of
financial inclusion on per capita real GDP, the ratio of internet users, age dependency ratio,
inflation, income inequality, secondary enrollment ratio, total population, and the rule of law.
The results show that per capita real GDP and the percentage of internet users have a positive
effect on financial inclusion. On the other hand, inflation, age dependency ratio, and income
inequality negatively affect financial inclusion.
Park and Mercado (2015) studied the relationship between financial inclusion,
poverty reduction, and income inequality in developing Asia. Closely following the
methodology of Sarma (2008), they constructed a financial inclusion indicator based on
availability and usage dimension for 37 countries in the Asia region. The paper analyzed the
variables that influence financial inclusion in the area and found that per capita income,
demographic factors (population size, age dependency ratio), and the rule of law significantly
affect financial inclusion.
Rafiq and Adewale (2019) studied financial inclusion by taking panel data from 30
regions across India for five years, from 2009 to 2013. The authors believed that the level of
financial inclusion is affected by certain state-specific factors, which is why they did not
study India as a whole. A regression model with one dependent variable and eight
independent variables have been used to analyze the factors determining financial inclusion.
Unlike other papers, they have used number of deposits as a proxy for financial inclusion.
The paper's findings show that the number of factories (a proxy for industrialization) and
outstanding credit positively influence financial inclusion.

8
Uddin et al. (2017) have used generalized dynamic methods of moments (GMM) and
quantile regression to study the determinants of financial inclusion in Bangladesh. The study
classified the determinants of financial inclusion into bank-specific factors and
macroeconomic factors. Data on bank-specific factors was collected from 25 banks in
Bangladesh, and the rest data on macroeconomic variables was collected from World bank
database. The study found out that size of the bank, literacy rates, deposits rates have a
positive influence on the level of financial inclusion. While age dependency ratio, cost to
income ratio and loan rates negatively affect the financial inclusion level in Bangladesh.
Chitra and Selvam in their paper attempted to measure the inter state variations in
financial access. For this purpose, they used the composite financial inclusion index
constructed by Sarma (2008). Further the paper aims to identify and analyze the factors
affecting financial inclusion. The study uses secondary data to regress the financial inclusion
index on banking variables, socioeconomic variables, and infrastructural variables.
Massey (2010) emphasizes the role of financial institutions in enhancing financial
inclusion in developing countries. The government needs to motivate and activate capital
market players to strengthen the level of financial inclusion. Though the economies of
developed and developing countries differ in their structure, along with differences in the
behavior of their population, countries can learn from the experiences of other nations
undertaking financial inclusion. The financial inclusion task force in the United Kingdom
(UK) has identified access to banking, access to free face-to-face money advice, and access to
affordable credit as three priority areas.
Collins, Morduch, Rutherford, and Ruthven (2009), after studying the financial diaries
of more than 250 low-income individuals in India, Bangladesh, and South Africa, found that
9
the usage of informal financial instruments by households is significant. Since the cash
turnover for these transactions was substantial, it suggests that barriers to formal financial
services exist for low-income people.
Beck, Demirguc – Kunt, and Levine (2007) compiled and observed variations in bank
loan and deposit data for 57 countries using surveys of bank regulators. With the increase in
per capita income, the ratio of deposit and loan accounts increased relative to the population.
Conversely, with income, the average deposit or loan account balance decreased relative to
per capita income. This suggests that poor people and small enterprises in high-income
countries use these accounts better.
There have been studies to study financial inclusion in India. Bhanot et al. (2012)
focused their study on two northeast Indian states (Assam and Meghalaya). They attempted to
explore factors affecting financial inclusion in India's remote areas. Financial literacy, income
level, level of education, and information about self-help groups (SHGs) influenced financial
inclusion. The study also found that the proximity of financial institutions like banks, post
offices, and microfinance institutions increases financial inclusion. In the last two decades,
microfinance, that is, providing credit to low-income households, has been used to enhance
financial inclusion in developing countries. Mendoza (2009) studied financial inclusion in
Madhya Pradesh and found that microfinance significantly affects financial inclusion.
Microfinance institutions (MFIs) and non-governmental organizations helped to enhance
financial inclusion in remote areas in Madhya Pradesh.
Gupte et al. (2012) constructed a financial inclusion index for the Indian context by
taking four critical dimensions. Outreach dimension as measured by ATM penetration, bank
branch penetration, and a number of deposit and loan accounts per 1000 adults. Usage
10
dimension based on the volume of deposits and loans. And the other two dimensions were
ease of transaction and cost of transaction dimension as indicated by annual fees charged for
ATM card usage or any other service. The study found a geographic branch and ATM
penetration to be essential factors affecting financial inclusion. Kumar (2013), in his research,
found branch networks to impact financial inclusion significantly. The penetration of
financial services was determined by the proportion of factories and employee base factors.
The region-specific factors like socioeconomic and environmental associations shaped the
banking practices of people in India. The elements that significantly improve financial
inclusion in India were emphasized by Kohli (2013). The author found a link between India's
levels of financial inclusion and human growth. Socioeconomic characteristics and individual
income levels influenced the level of financial inclusion in India. On the other hand, it was
discovered that technology and knowledge of banking services also significantly affect
financial inclusion in India.
According to Chakravarty and Pal (2013), geographic branch network penetration and
credit penetration were the two main techniques for promoting financial inclusion in India.
During 1977–1990, it was discovered that the social banking policy affected the promotion of
financial inclusion significantly in all Indian states. Later, the speed of financial inclusion has
been negatively impacted by the shift toward pro-market banking sector reorganization. The
possibility that India may have increased its level of financial inclusion during the past 20
years was also emphasized. While agriculture and related activities were negatively
connected with financial inclusion in India, the level of financial inclusion was strongly
influenced by regional economic development.

11
Some studies have solely focused on the construction of a composite financial
inclusion index using various dimensions. Amidžić, Massara, and Mialou (2014) used to
outreach, usage, and quality dimensions to construct the index. The outreach dimension
focuses on geographic and demographic penetration, the usage dimension on deposit and
lending, and the quality dimension is based on disclosure requirements, dispute resolution,
and the cost of using financial services. All the measures are aggregated to form the
composite index by assigning a weight ta each one of them after successfully normalizing and
statistically identifying each dimension. The weighted geometric mean is used to aggregate
the sub-indices. Sarma (2008) builds the indicator using a different methodology. For each
aspect of financial inclusion, he first calculated a dimension index. He then aggregated each
index as the normalized inverse of Euclidean distance, measured from an ideal reference
point, and normalized it by the total number of dimensions. This method has the advantages
of being simple to compute and not imposing different weights for each dimension.
Honohan (2008) constructed the financial access index combining household survey
and financial institutions datasets for 160 economies. He also analyzed the country-specific
characteristics that might influence financial access. The variables that he chose included age
dependency ratio, aid as a percent of GNI, and population density, that negatively influenced
financial access; on the other hand, mobile phone subscription, and quality of services of
financial institutions positively influenced financial access.
Financial inclusion is a multidimensional concept that encompasses all initiatives,
from both supply and demand sides, within the financial sector. They include provision of
appropriate and quality financing that is both accessible and affordable to low-income and
other vulnerable households. Notably, they target groups traditionally excluded from the
12
formal financial sector (Tiriki & Faye, 2013). The Global Partnership for Financial Inclusion
(G-20) assesses financial inclusion on three dimensions: access to financial services, use of
financial services, and product and service delivery quality. Similarly, the Alliance for
Financial Inclusion (2013) defines three characteristics of financial inclusion: access,
utilisation, and quality. In addition, Stein et al. (2011) established three essential factors that
constitute financial inclusion: products, features, and channels.
The existing literature on the creation of composite indices either use parametric or
non-parametric approaches. Non-parametric methods were used in studies by Chakravarty
and Pal (2013) and Sarma (2008, 2012). Similarly, Cámara and Tuesta (2015) and Amidi et
al. (2014) constructed composite indexes using parametric approaches such as PCA and
factor analysis, respectively. With the non-parametric technique, weights are chosen based on
experience or the researcher's instinct.
According to Lockwood (2004), non-parametric approaches for constructing
composite indices are limited and weights are assigned subjectively. Steiger (1979)
confirmed that parametric approaches such as factor analysis neglect some dimensions by
making specific assumptions on raw data that are not necessary.
Using data from the World Bank's 2016 Ethiopian Socioeconomic Survey, Gashaw
and Gebe (2017) investigated the condition of financial inclusion in Ethiopia. They reveal
that being in a city, being Christian, being financially aware and capable, being younger, or
being married all enhance the chance of holding an account. Additionally, they demonstrate
that having a college degree, residing in rural regions, and preferring formal financial
institutions improves the chance of utilising formal accounts for saving. They reveal that
being female, older, single, frightened of covering unexpected expenditures, and having little
13
financial capabilities reduces the likelihood of account use. Apart for being female or older,
the remaining characteristics are statistically inconsequential. Females, the elderly, Muslims,
the financially illiterate, and those with little financial capabilities have a lower chance of
using an account to save than their peers. The only relevant variable, however, is financial
competence. Individuals in rural areas are more inclined than their peers to utilise their
accounts to save. They also demonstrate that financial aptitude and education are the most
significant determinants of financial inclusion.
Financial inclusion cannot be described by a single measure of accessibility,
penetration, or usage. In their study titled Financial Inclusion and Human Development in
Indian States: Evidence from the Post-Liberalization Periods, Lenka, Barik, and Parida
(2022) employed Principal Component Analysis (PCA) to build the financial inclusion index.
The article used a panel regression model to examine the influence of financial inclusion on
human development across Indian states, and it then tested for reverse causality from human
development to financial inclusion.
Without a question, financial inclusion has emerged as the key development concern
in recent years. Yet, a substantial body of studies on the relationship between financial
inclusion and socioeconomic progress does not provide a clear answer. Previous research has
found that nations with better financial systems tend to expand quicker. The theoretical
foundation may be traced back to Bagehot (1873), Schumpeter (1934), Goldsmith (1959),
and Gurley and Shaw (1961). (1955). They consistently contributed to the discussion.
Additionally, Levine (1997) showed a substantial positive correlation between the
performance of the financial sector and long-run economic development employing the
Generalized Method of Moments (GMM) estimate approach for a sample set of 44 developed
14
and less developed nations from 1975 to 1993. The research suggests a substantial positive
relationship between the components of banking development and growth.
Pal and Pal (2012) discovered that the degree of financial exclusion is relatively
severe across families of all income levels, and that income-related disparities in financial
inclusion vary greatly throughout India's sub-national regions. Similar findings have been
seen in studies such as Singh and Naik (2017). According to Alter and Yontcheva (2015),
Chibba (2009), and Karlan (2014), financial development in general, and financial inclusion
in particular, are crucial facilitators of social and economic growth.
Cámara and Tuesta (2015) presented a two-stage principal component analysis (PCA)
to assess the level of financial inclusion in a nation or area using a composite index. They
observed that per capita GDP, education level, financial system performance, and financial
strength are major determinants of financial inclusion. Moreover, Yadav and Sharma (2016)
chose an index of financial inclusion (IFI) with many dimensions using TOPSIS and ranking
Indian states and union territories. They confirmed that literacy, population density, improved
infrastructure, farmer suicides, and agricultural contribution to GDP are important factors
influencing financial inclusion. A slew of research have proved that individuals benefit
economically when they are integrated in the financial system.
Fungácová and Weill (2015) analyse financial inclusion in China using the 2012
Global Findex and discover that richer, better educated, older males are more likely to be
financially involved. When it comes to financial inclusion obstacles, poorer individuals are
more worried with their lack of money and the fact that another member of the family has an
account, whereas more educated people are concerned with cost and faith in the banking
system. Because of a lack of documentation or because another member of the family has an
15
account, women are less likely to be financially integrated. Lastly, for financial,
geographical, and religious reasons, elderly people are more worried. They also discover that
wealth and education impact the decision to use formal or informal credit, although education
does not lead to increased formal credit in China. Women appear to be discriminated against
because they do not swap formal credit for informal credit.
Allen et al. (2016) show that national factors influence financial inclusion. More
financial inclusion is brought about through high-quality institutions, effective legal
regulations, robust contract enforcement, and political stability. Also, features of the financial
sector play an important effect. Formal inclusion is hampered by the high expenses of
obtaining and operating bank accounts, as well as the great distance and transparency
requirements. Trust in the financial industry can also have an impact. The establishment of a
deposit insurance plan as well as tax incentive schemes contributes to increase financial
inclusion.
Methodology
The first objective requires to create a financial inclusion index (FII). To achieve this
objective the paper uses Principal Component Analysis (PCA) which is a method that helps
to create an index by incorporating several variables.
The second objective requires to analyze the impact of some variables on financial
inclusion in India from 1991 to 2018. The variables used in the analysis are – GDP growth
rate, number of internet users, inflation rate as measured by CPI, age dependency ratio, and
gross secondary school enrolment ratio.
Data
16
For the first objective of constructing a financial inclusion index, the study uses five
variables to construct the index. The variables are - number of bank employees, number of
bank branches, amount of credit, amount of deposit and number of saving bank accounts. The
data is collected for Scheduled Commercial Banks (SCBs) from Basic Statistical Returns
(BSR), Reserve Bank of India (RBI) for the time period 1991 to 2018.
The second objective is to analyse the determinants of financial inclusion in India.

The five determinants that the study uses are – GDP per capita (for analysis GDP growth rate
will be used), Inflation rate as measured by Consumer Price Index (CPI), Gross secondary
school enrollment ratio, Age Dependency ratio and internet users. The source of data on these
variables is World Development Indicators database and the time period for which it is
collected is 1991 to 2018.
Table 1: Objective and Data source of variables used in the study
Variables Objective Data Source

Number of saving bank To construct FII Basic Statistical Returns
accounts (BSR), RBI
Number of bank employees To construct FII Basic Statistical Returns
(BSR), RBI
Number of bank branches To construct FII Basic Statistical Returns
(BSR), RBI
Amount of deposit To construct FII Basic Statistical Returns
(BSR), RBI
Amount of credit To construct FII Basic Statistical Returns
(BSR), RBI
Age dependency ratio To analyze the impact on World Development
financial inclusion Indicator database
Number of internet users To analyze the impact on World Development
Inflation rate (CPI) To analyze the impact on World Development
17
GDP per capita To analyze the impact on World Development

Gross Secondary School To analyze the impact on World Development
Enrollment ratio financial inclusion Indicator database
Description of the Variables
Variables used to create Financial Inclusion Index
Accessibility to basic banking services is an important dimension of financial
inclusion. The number of saving bank accounts is an important indicator of accessibility
dimension and for that reason is included in the financial inclusion index. Individuals without
saving bank account indicate lack of access to formal financial services, which reflects in
their limited opportunities for saving, investing, and accessing credit. Saving bank accounts
are equally important for facilitation of financial transactions and create a financial history.
This in turn helps in accessing other financial products and services like loans and insurance.
Saving accounts allows individuals to manage their money effectively and participate in
saving and investing. As a result, including the number of savings bank accounts in the
financial inclusion index is a helpful approach to gauge how much access to essential
financial services there is and to spot any gaps.
The second indicator which has been used in creating the index is the number of bank
branches. It is a good indicator of the penetration dimension of the financial inclusion as it
reflects the physical presence of formal financial institutions in a particular area or region.
Bank branches can make it easier for people to acquire financial services, especially if they
have limited access to digital or internet banking options. Additionally, bank branches may
assist clients grow their financial aptitude and enhance their financial literacy by offering
18
crucial financial education and support. For various financial services and goods including
loans, insurance, and investment products, bank branches can serve as a crucial distribution
channel. As a result, including the number of bank branches in the financial inclusion index
might provide light on the extent of a certain area's or region's access to formal financial
institutions and services. Additionally, it can be used to pinpoint geographic regions where
there may be a dearth of physical access to banking services and where improvements to
financial inclusion may be necessary.
Another key indication of financial inclusion is the number of bank employees.
Larger banks may be able to offer more individualised services, which can increase client
confidence and trust in conventional financial institutions. Additionally, banks with greater
employees may be better able to assist clients with more complicated financial demands, such
as small business owners or people with a wider variety of financial assets. These consumers
might need more specialised help and guidance, which a bigger number of bank workers can
offer. Indicators of employment growth and economic expansion can also be found in the
number of bank workers. There may be an increase in demand for banking services and a
corresponding rise in employment opportunities as the banking industry develops and more
people have access to formal financial services. As a result, incorporating the number of bank
employees in the financial inclusion index can shed light on how well formal financial
institutions are able to serve clients with a variety of demands while also giving a more
comprehensive view of the economic effects of financial inclusion.
The next indicator is the amount of deposits. Because it shows how much people are
utilising official financial systems to save money, the deposit amount can be a significant
indicator of financial inclusion. A higher volume of deposits may be a sign of better financial
19
security and trust in established financial institutions. Additionally, having access to a savings
account and the ability to make regular deposits can assist people in increasing their savings
and strengthening their financial stability. For those with low incomes, who might have fewer
financial resources and might be more susceptible to unforeseen financial costs or economic
shocks, this can be especially crucial. The quantity of deposits might also reveal information
about the general level of economic activity in a given area or region. Higher levels of
deposits could indicate increased economic activity and investment, which would be
advantageous for nearby companies and jobs. As a result, including the volume of deposits in
the financial inclusion index can offer crucial insights into how much people use formal
financial services to save money and strengthen their financial resilience. It can also offer a
wider perspective on the economic impact of financial inclusion.
The last indicator used in the financial inclusion index formation is the amount of
credit. Because it shows how readily available formal credit facilities are to both individuals
and enterprises, the amount of credit can be a significant measure of financial inclusion. By
allowing people to start enterprises, invest in education, and buy assets like homes or cars,
formal credit facilities can significantly contribute to economic growth and the reduction of
poverty. Furthermore, having access to credit can assist people and organisations manage
cash flow and deal with unforeseen expenses, which can be especially crucial for those who
are low-income or have erratic income sources. Access to credit can also assist people in
developing credit histories, which can enhance their future credit access and support greater
financial inclusion. Insights regarding the general level of economic activity in a certain area
or region can also be gained from the credit amount. Greater economic growth and
investment may be linked to higher levels of credit, which may benefit employment and other
economic indicators. As a result, incorporating the loan amount in the financial inclusion
20
index can offer crucial insights into how much access people and enterprises have to formal
credit facilities and can also offer a broader perspective on the economic impact of financial
inclusion.
Description of the variables used for analyzing the determinants of financial inclusion
GDP per capita (constant LCU): (Gross domestic product divided by midyear
population equals GDP per capita. GDP at buyer's prices is calculated as the total of all
resident producers' gross value added, plus any applicable product taxes, minus any subsidies
not reflected in the price of the goods. It is estimated without taking into account the
deterioration and depletion of natural resources or the depreciation of manufactured assets.
Data are always expressed in local currency.
Gross Domestic Product (GDP) in theory exerts a positive effect on financial
inclusion. Higher GDP correlates with greater financial inclusion as a result of higher income
for individuals to engage with financial services. Financial institutions in countries with high
GDP offer more diverse financial products and services and have the incentive to invest in
infrastructural upgrading (which includes increasing ATM branches, expanding branch
networks, investing in digital banking technologies). In contrast to this, financial institutions
in countries with low GDP per capita tend to invest a lot less in infrastructural upgrading as
the cost of building out infrastructure and offering new financial products and services is
generally high. Thus, barriers to access financial services are more in these countries. GDP
per capita is an important factor affecting financial inclusion in a country and thus is used as
one of the independent variables. Though it is not the only factor yet it changes the incentives
for financial institutions to invest in expanding access to financial services.

21
Age dependency ratio: The age dependency ratio measures the proportion of
dependents—those aged 15 to 64—to the working-age population. Statistics are presented as
the number of dependents per 100 people who are working age. Dependency ratios indicate
the reliance burden that the working-age population bears relative to children and the elderly
by capturing differences in the proportions of children, elderly, and persons in the working
age group. Dependency ratios, however, simply reflect a population's age structure and do not
reflect economic dependence. Many people of working age are not in the labour force, but
some children and elderly people are. Age dependency ratio in theory works against the
financial inclusion as a high dependency ratio puts a pressure on the resources of working age
population and thus reduces their ability to access and engage with financial services.
Whereas low age dependency ratio results in more opportunities for financial inclusion. Low
dependency ratio means lesser number of people are dependent on others, which in turn
allows working class to save, invest and engage more with financial products and services.
There are other factors which need to be taken into account while understanding the impact
of age dependency ratio on financial inclusion into account such as the level of economic
development, the quality of financial infrastructure and the availability aspect of financial
services. These factors work by wither amplifying or reducing the impact of the age
dependency ratio on financial inclusion.
Gross secondary school enrolment ratio: Total enrollment regardless of age, to the
population in the age group that is considered to formally correspond to the level of education
shown is known as the gross enrolment ratio. The goal of secondary education is to provide
the groundwork for lifetime learning and human development by giving more subject- or
skill-oriented training with more specialised teachers. Secondary education completes the
basic education delivery that began at the elementary level. Secondary school enrollment
22
ratio positively impacts the financial inclusion theoretically. Financial literacy is important
for achieving greater financial inclusion. Education improves the financial literacy and
numeracy skills of individuals which help them to make informed and calculated decisions.
Individuals will understand different financial products and services more efficiently and
make a informed decision. Secondary education can affect financial inclusion by improving
the employment opportunities and income levels. With higher income levels, individuals are
likely to open accounts, invest in stock or mutual funds, or take out loans to start a business.
Secondary education can inculcate a culture of savings and encourage people to utilize
financial services by facilitating access to financial education programmes and financial
services offered by education institutions, government, or NGOs. Thus, high levels of gross
secondary school enrolment ratio can lead to an increase in financial inclusion and help
people improve their financial well-being.
Inflation: Inflation is the general rise in prices of goods and services over the period.
Consumer Price Index (CPI) measures the inflation by accounting for change in the cost of
basket of goods and services for a consumer. The basket of goods and services is subject to
change at specific intervals based on the consumers taste and preferences or representative of
the consumer spending pattern. High inflation results in people spending a greater proportion
of their income on basic amenities like food, housing, and healthcare. This reduces the
disposable income with them and thus the savings. High inflation rates also reduce people’s
purchasing power of savings and investment by the means of currency devaluation. Financial
institution finds it more expensive to operate and maintain their infrastructure during high
times of high inflation, which results in higher fees or lower interest rates on loans and
deposits. Thus, inflation impacts the availability, affordability, and accessibility of financial
services.
23
Internet Users: It describes the total population that has access to internet facilities to
the total population. The introduction of internet has made it easier for people to access and
engage with financial products and services with the development of digital banking
technologies. With the advent of technological innovation in financial sector, traditional
barriers to financial inclusion such as physical distance, high transaction costs, and limited
financial literacy have been overcome. The introduction of mobile banking applications,
online banking has helped people to access banking services remotely. These services include
making payments, checking balance, deposit of loans or premiums, transferring money, etc.
People who have limited access to traditional banking infrastructure, especially rural
households can particularly benefit from this. It has also resulted in development of new
financial products and services like peer – to – peer lending platforms, crowdfunding
platforms etc that cater to the needs of underprivileged or marginalized population. This
makes it easier to access to loans or investment opportunities that otherwise have been
difficult to obtain through traditional banking channels. In brief, growth of internet users has
a profound impact on financial inclusion.
Principal Component Analysis
Prior research has mostly computed the financial inclusion index using either the
analytical and hierarchical procedure or the axiomatic approach. These methods were
criticised for their effectiveness even though they occasionally seemed quite enticing because
of their flawed and constrained weighting processes. This study uses the PCA approach to
address these limitations. PCA provides a special and impartial way of allocating weights to
various indicators, in addition to allowing for the inclusion of a large number of indicators.
24
For the present study we have used five indicators which will be used to form the financial
inclusion index. The data on these five variables is taken for Scheduled Commercial Banks.
The factor scores (weights) are initially determined by their eigenvalues. Each variable's
factor score (weights) are then calculated and multiplied by the corresponding original
variable. In contrast to other techniques, PCA gives every variable the same amount of
weight. (Kendall 1939; Lenka & Barik 2018). The composite index value for the ith state for
the given time period t is then obtained by adding them all together. According to PCA
procedure, FI can be expressed as:
FIIi = 𝑊1i 𝑆𝐵𝐴i + 𝑊2i 𝐵𝐵i + 𝑊3i 𝐵𝐸i + 𝑊4i 𝐷𝐸𝑃i + 𝑊5i𝐶𝑅𝐸i
Where FIIi is the index of financial inclusion of ith year and W1, W2…W5 are the respective
weights (factor scores) of different factors.
Table 2: Principal Component selection table
Component Eigenvalue Difference Proportion Cumulative
Comp1 4.48049 3.99268 0.8961 0.8961

Comp2 0.487806 0.459869 0.0976 0.9937
Comp3 0.0279376 0.024908 0.0056 0.9992
Comp4 0.00302956 0.0022934 0.0006 0.9999
Comp5 0.0007362 . 0.0001 1
Using E-views, the principal component analysis was carried out. Based on the cumulative
variance and eigenvalues, we can decide how many principal components to take. According
to the cumulative variance, the number of principal components to retain is to choose the
number of components that explain at least 70 percent of the total variance. The cumulative
variance is the total amount of variance explained by all of the retained principal components
up to a given component. And for the eigenvalues, the rule of thumb is to retain the number
25
of principal components whose eigenvalues are greater than 1. The above table shows that the
first principal component explains 89.61 percent of the total variance. Also, only the first
component has a eigenvalue greater than 1. Both the cumulative variance and eigenvalue
methods conform to the same number of principal components to retain, that is, pc1.
Table 3: Loadings table
Variable Comp1 Comp2 Comp3 Comp4 Comp5 Unexplained
Number of saving
bank account 0.467 -0.125 -0.769 0.418 0.0104 0
Number of bank
branches 0.469 -0.156 -0.153 -0.848 -0.117 0
Number of bank
employees 0.359 0.9301 0.0734 0.011 0.0212 0
Amount of
deposit 0.465 -0.23 0.3975 0.1255 0.7465 0
Amount of credit 0.466 -0.206 0.4705 0.3009 -0.655 0
This table that is generated by E-views is the table of loadings for each principal component.
Loadings is basically the weights assigned to each original variable in each principal
component. Since the first principal component is to be retained, the weights for each of the
variables are given by comp1 in the loadings table. These weights will then be multiplied by
their respective variable observation and then summed up as was described in the equation.
That will give us the required financial inclusion index.
Unit Root test
To analyse the determinants of financial inclusion the paper uses time series data for 4
different independent variables and financial inclusion index which is the dependent variable.
Using time series data poses it's own difficulty. Before running any model first we need to
check for stationarity of time series data. Time series data with constant mean and variance
26
over the time period is stationary while a data set whose mean or variance or both changes
over time is said to be non- stationary. Non- stationary time series will result in the problem
of spurious regression. Spurious regression or nonsense regression occurs when there is no
actual statistical relationship between two variables but the results of a regression show
otherwise. Dickey fuller, Augmented Dickey fuller, or Phillips perron test can be used to
check for presence of unit root. If there is a unit root then that implies that the time series is
non-stationary. For our study we have used the Augmented Dickey Fuller test to check for
stationarity.
Null Hypothesis: AGE_DEPENDENCY_RATIO has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=6)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -5.305347 0.0002

Test critical values: 1% level -3.711457
5% level -2.981038
10% level -2.629906
*MacKinnon (1996) one-sided p-values.
Using E Views, the data on Age dependency ratio was checked for stationarity by
running the Augmented Dickey Fuller (ADF) test. The test results show that Age dependency
ratio is stationary at levels, that is, its mean and variance are constant over the time period.
In ADF test, the null hypothesis states that the variable has a unit root. Using the t-
statistic value and the p-value, one can reject or accept the null hypothesis. If the p-value is
less than 0.05 then one can reject the null hypothesis.
For Age dependency ratio the p-value is 0.0002 which is less than 0.05, hence we
reject the null hypothesis. Thus, age dependency ratio is stationary.

27
Null Hypothesis: GDP_GROWTH_RATE has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.981038
10% level -2.629906
*MacKinnon (1996) one-sided p-values.
The absolute values of GDP per capita were not stationary even at second difference,
so we take GDP growth rate as our independent variable for our analysis. On subjecting GDP
growth rate to ADF test at levels, the p - value at levels is 0.0033 which is less than 0.05. This
means that GDP growth rate is also stationary at levels.
Null Hypothesis: D(GROSS_SECONDARY_SCHOOL_ENROLLMENT_RATIO) has a unit ...

Exogenous: Constant
t-Statistic Prob.*

5% level -2.981038
10% level -2.629906
The ADF test results for Gross Secondary School enrolment ratio at levels shows it to
be non-stationary with the p-value being 0.99. Then we check unit root at first difference and
the above table shows the results. Gross secondary school enrolment ratio is stationary at first
difference with p- value 0.0007 which is less than 0.05. So this means for the analysis, the
independent variable will be the first difference of the gross secondary school enrolment
ratio. First difference is basically the difference between the current year value minus the
previous year value.

28
Null Hypothesis: D(INFLATION__CPI___IN___) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.981038
10% level -2.629906
Inflation rate as measured by CPI has a unit root at levels, with p – value being 0.06.
Like the gross secondary school enrolment ratio, inflation rate too is stationary at first
difference. At the first difference level, the ADF test returns with a p – value of 0.000007.
Thus, at first difference we can reject the null hypothesis of presence of unit root.
Null Hypothesis: INT has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.981038
10% level -2.629906
The last independent variable is the number of internet users. Taking the logarithmic
value of the number of internet users and then checking for unit root through ADF. The p –
value is 0.0003, less than 0.05, so it concludes that logarithmic series of number of internet
users is stationary at levels.
Cointegration
Time series analysis was carried out by running linear regression before the
introduction of cointegration tests. Granger and Newbold criticized this approach as linear
regression of time series data can produce spurious correlation. In 1987 Engle and Granger,
formalized the cointegrating vector approach. A statistical test, used to assess if two or more
non-stationary time series variables are cointegrated, which means they have a long-term
29
relationship that is not influenced by short-term variations. In econometrics and time series
analysis, cointegration is a key concept since it enables us to comprehend the long-term
linkages between economic variables that could have an impact on forecasting and policy
decisions.
Given there are two time series variables, Xt and Yt and both are integrated of the first
order. That is Xt and Yt are I (1) and if there exists a α such that Yt - α Xt, a linear
combination of two non-stationary series is I (0), that signifies Xt and Yt are cointegrated. To
put it another way, cointegration of Xt and Yt denotes that Xt and Yt share a stochastic trend
and that this trend may be removed by making a particular difference between the series that
makes the resulting series stationary.
There are two methods for cointegration analysis – first is the Engle Granger cointegration
test and the other is the Johansen test.
Engle Granger test
In the first step of the Engle-Granger two-step procedure, residuals based on static
regression are created, and then the residuals are examined for the presence of unit-roots.
When examining time series, it employs the Augmented Dickey-Fuller Test (ADF) or other
tests to look for stationary units. The Engle-Granger approach will demonstrate the
stationarity of the residuals if the time series is cointegrated. The Engle-Granger technique
has the drawback of potentially revealing several cointegrating connections when there are
more than two variables. The fact that it is a single equation model is another drawback.
Johansen test
30
Johansen cointegration test is used to check for the existence of a long – run
relationship between a set of time series variables that are non – stationary. The number of
cointegrating relationships are determined by first estimating a vector error correction model
(VECM) and then based on the eigenvalues and eigenvectors of the residual matrix, the
number of cointegrating relationships is established. The Johansen test over the Engle
Granger test is used when there are more than two non-stationary time series data and allows
for more than one cointegrating relationship. One of the pre – requisite for this test is large
sample size as it is subject to asymptotic properties.
Johansen’s test comes in two main forms, i.e., Trace tests and Maximum Eigenvalue test.
Trace test: For the trace test, the null hypothesis is given as:
H0: K = K0
And the alternative hypothesis is given as:
H0: K > K0
Where K denotes the number of cointegrating relationships among the variables. K0 is a pre –
specified value which is set to zero in the trace test. If the null hypothesis is rejected, it
implies that there is at least one cointegrating relationship among the variables.
The trace test functions by calculating the sum of eigenvalues and then comparing
those values to a set of critical values. Null hypothesis of no cointegration is rejected if the
sum of eigenvalues exceeds the critical value, and it is concluded that there are cointegrating
relationships among the variables. Based on how many numbers of eigenvalues exceeded a
certain threshold, number of cointegrating relationships is determined. Trace test is thus

31
essentially a statistical test used in the Johansen cointegration test to find the number of
cointegrating relationships among a set of non – stationary time series variables.
Maximum Eigenvalue test: The next test in the Johansen cointegration test is the maximum
eigenvalue test which is used to determine the number of cointegrating relationships between
the time series variables.
The Maximum eigenvalue test works by comparing the largest eigenvalue of the
residual matrix to a set of critical values. In this null hypothesis of no cointegrating is rejected
when the largest eigenvalue exceeds the critical value and thus it is concluded that there
exists at least one cointegrating relationship between the set of time series variables. Here
also the number of cointegrating relationships are determined by finding how many
eigenvalues exceeded a certain threshold.
On comparing the two tests under Johansen cointegration analysis, the maximum
eigenvalue test is a more robust and powerful test when the time series variables are large
relative to the sample size. But if the sample size is large enough, trace test is more useful.
Log FII = 𝛼1 𝐺𝐷𝑃_𝑔𝑟𝑜𝑤𝑡ℎ_𝑟𝑎𝑡𝑒 + 𝛼2 𝑖𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛_𝑟𝑎𝑡𝑒 + 𝛼3 𝑎𝑔𝑒_𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑐𝑦_𝑟𝑎𝑡𝑖𝑜 + α4

log internet_users + α5 GSSER
This equation is used for cointegration analysis.
Graphical representation
32
Age Dependency Ratio GDP growth rate

75 .08
70 .07
.06
65
.05
60
.04
55
.03
50 .02
45 .01
92 94 96 98 00 02 04 06 08 10 12 14 16 18 92 94 96 98 00 02 04 06 08 10 12 14 16 18
Gross Secondary Sc hool Enrollm ent Ratio Inflation (CPI) (in %)

80 14
12
70
10
60 8
6
50
4
40 2
92 94 96 98 00 02 04 06 08 10 12 14 16 18 92 94 96 98 00 02 04 06 08 10 12 14 16 18
Internet Users LNFI

2.8E+10 16.5
2.4E+10 16.0
2.0E+10 15.5
1.6E+10 15.0
1.2E+10 14.5
8.0E+09 14.0
4.0E+09 13.5
0.0E+00 13.0
92 94 96 98 00 02 04 06 08 10 12 14 16 18 92 94 96 98 00 02 04 06 08 10 12 14 16 18
The graphical representation of the time series variables used in the study is given in
the above diagrams. The graphs shows that age dependency ratio has decreased over the
period, while gross secondary school enrolment ratio, number of internet users and financial
inclusion has increased during the period from 1991 – 2018. Inflation has fluctuated a lot and
is at a lower level during 2018 than 1991. GDP growth rate shows a positive trend.
33
Optimal Lag Length Selection
VAR Lag Order Selection Criteria

Endogenous variables: AGE_DEPENDENCY_RATIO GDP_GROWTH_RATE G...
Exogenous variables: C
Date: 04/10/23 Time: 14:21
Sample: 1991 2018
Included observations: 25
Lag LogL LR FPE AIC SC HQ
0 -671.0359 NA 1.34e+16 54.16287 54.45540 54.24401

1 -438.2602 335.1971 2.14e+09 38.42081 40.46853 38.98876
2 -366.8527 68.55115* 2.26e+08* 35.58822* 39.39111* 36.64298*
* indicates lag order selected by the criterion

LR: sequential modified LR test statistic (each test at 5% level)
FPE: Final prediction error
AIC: Akaike information criterion
SC: Schwarz information criterion
HQ: Hannan-Quinn information criterion
In order to analyze the determinants of financial inclusion in India, we used
cointegration analysis which was then followed by Vector Error Correction Model (VECM).
To run the cointegration, we first checked for optimal lag length using AIC criteria. Though
the AIC shows the optimal lag length to be two since the Johansen cointegration test did not
allow for lag length to be two, we have taken one lag.
Results and Interpretation
PCA Result
Table 4: Financial Inclusion Index
Years FII
1991 647049.8
1992 674144.3
1993 705669.1
1994 743389.4
1995 793471
1996 842663.6
1997 887981.3
34
1998 957531.4
1999 1027316
2000 1127889
2001 1201058
2002 1296804
2003 1447741
2004 1359215
2005 1834646
2006 2199354
2007 2645755
2008 3124728
2009 3626965
2010 4235455
2011 4970217
2012 5693569
2013 6610207
2014 7503023
2015 8236830
2016 9131056
2017 9931902
2018 10710902
The above table gives the values of the financial inclusion index from 1991 to 2018. The
weights for respective components are given as - 0.467 for number of savings bank accounts,
0.469 for number of bank branches, 0.359 for number of bank employees, 0.465 for amount
of deposits, and 0.466 for amount of credit.
Unit Root Test Result
Table 5: Unit root test results
Variables ADF (Levels) p-value ADF (first p-value
difference)
35
Age -5.3053 0.0002
dependency
ratio
GDP growth -4.1793 0.0033
rate
Inflation rate -2.8832 0.0605 -6.6773 0.0000
Log of internet -5.1131 0.0003
users
Gross 0.7168 0.9903 -4.7945 0.0007
secondary
school
enrolment ratio
Log of financial 1.6609 0.9993 -4.0967 0.0040
inclusion index
The results indicate that age dependency ratio, GDP growth rate, and log values of number of
internet users are stationary at levels. While inflation rate, gross secondary school enrolment
ratio, and log values of financial inclusion index are stationary at first difference levels. Thus,
some variables are integrated of the first order while the rest have zero order of integration.
Cointegration results
36
Date: 04/16/23 Time: 12:55

Sample (adjusted): 1994 2018
Included observations: 25 after adjustments
Trend assumption: Quadratic deterministic trend
Series: LNFI AGE_DEPENDENCY_RATIO GDP_GROWTH_RATE GROSS...
Lags interval (in first differences): 1 to 1
Unrestricted Cointegration Rank Test (Trace)
Hypothesized Trace 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.893445 158.0466 107.3466 0.0000

At most 1 * 0.819650 102.0692 79.34145 0.0004
At most 2 * 0.681624 59.24776 55.24578 0.0213
At most 3 0.578554 30.63470 35.01090 0.1364
At most 4 0.294320 9.033103 18.39771 0.5767
At most 5 0.012650 0.318259 3.841465 0.5727
Trace test indicates 3 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values
Unrestricted Cointegration Rank Test (Maximum Eigenvalue)
Hypothesized Max-Eigen 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.893445 55.97738 43.41977 0.0014

At most 1 * 0.819650 42.82143 37.16359 0.0101
At most 2 0.681624 28.61306 30.81507 0.0908
At most 3 0.578554 21.60160 24.25202 0.1079
At most 4 0.294320 8.714843 17.14769 0.5255
At most 5 0.012650 0.318259 3.841465 0.5727
Max-eigenvalue test indicates 2 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values
Cointegration analysis was run to check a long run relationship between the variables
used in the study. Thes variables are log of financial inclusion index, age dependency ratio,
GDP growth rate, inflation rate as measured by CPI, number of internet users, and gross
secondary school enrolment ratio. Trace test shows that there are three cointegrating
equations while the maximum eigenvalue test shows that there are two cointegrating
equations at 0.05 level. Since both the test confirm to at least two cointegrating equations, the
study can conclude that there is a long run relationship between the dependent variable, that
is, financial inclusion index and the independent variables.

37
1 Cointegrating Equation(s): Log likelihood 97.55790
Normalized cointegrating coefficients (standard error in parentheses)

LNFI AGE_DEPE... GDP_GRO... GROSS_S... INFLATION_... LNINT
1.000000 0.750879 -4.871731 0.002120 -0.006945 -0.071788
(0.11172) (0.71716) (0.00648) (0.00463) (0.01995)
The normalized cointegrating coefficients table shows that there is a significant negative
relationship in the long run between age dependency ratio and financial inclusion index. GDP
growth rate and number of internet users positively affects the financial inclusion index in the
long run. Inflation also positively affects financial inclusion but the relationship is not
significant. While gross secondary school enrolment ratio has a non-significant negative
relationship with financial inclusion.
Conclusion
Summary findings
The study examined the factors that might affect the financial inclusion in India for
the time period ranging between 1991 – 2018. In this context, a composite financial inclusion
index was constructed using five different indicators. The variables whose impact on
financial inclusion would be investigated were GDP growth rate, Inflation as measured by
CPI, number of internet users, age dependency ratio, and gross secondary school enrolment
ratio. Since the study was a time series analysis, stationarity test was run for all the variables.
Age dependency ratio and GDP growth rate were stationary at levels, while all the other
variable and the financial inclusion index was stationary at first difference. For estimation,
Johansen cointegration test was used to check for long run relationship between the
dependent and independent variables.

38
Limitation and scope for further research
Lack of a standard measure for financial inclusion globally is an area where
researchers must work. A standard measure is required so that countries can compare their
financial inclusion level with other countries along with comparing their own growth path of
financial inclusion. Financial inclusion is an important factor in inclusive economic growth,
economic development, better living standard. The method used for creating the financial
inclusion index in this paper has been used by many other researchers with different variables
but none of them can be regarded as the perfect measure for financial inclusion. Another
difficulty in carrying out research related to financial inclusion is the lack of data. The data
on indicators like number of ATMs, informal financial services, and other financial inclusion
indicators is missing or available for limited time period. Analyzing the determinants of
financial inclusion, impact of financial inclusion on poverty, inequality, economic growth can
give a better perspective to policy makers in deciding on policies going forward. Hence there
is still a lot of scope in studying financial inclusion at microeconomic level, that is, at district,
state, region, and country level.

39
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42
Appendix
Years Age Dependency Ratio Gross Secondary School Enrollment Ratio GDP per capita (constant LCU) Internet users (% of population) Inflation (CPI) (in %) GDP growth rate Population Internet Users
1991 71.96 45.11 28585.94 0.000000 13.87 888941756
1992 71.38 45.23 29534.09 0.000111 11.79 0.033168659 907574049 101020.2522
1993 70.81 45.34 30310.09 0.000218 6.33 0.026274659 926351297 202107.6206
1994 70.19 45.65 31681.66 0.001070 10.25 0.045251338 945261958 1011016.27
1995 69.50 45.35 33409.25 0.026229 10.22 0.054529459 964279129 25291960.6
1996 68.75 45.28 35237.10 0.046334 8.98 0.054711081 983281218 45559329.34
1997 67.95 45.83 35967.17 0.070768 7.16 0.020718733 1002335230 70933108.2
1998 67.13 44.12 37477.40 0.139027 13.23 0.041989212 1021434576 142007320.8
1999 66.27 43.04 40045.11 0.273224 4.67 0.068513334 1040500054 284289875
2000 65.41 44.87 40832.37 0.527532 4.01 0.019659524 1059633675 558991148.7
2001 64.55 45.15 42035.02 0.660146 3.78 0.029453194 1078970907 712278735.1
2002 63.70 47.07 42865.59 1.537876 4.30 0.01975908 1098313039 1689068804
2003 62.85 49.63 45444.61 1.686490 3.81 0.060165206 1117415123 1884509398
2004 61.96 51.37 48231.55 1.976136 3.77 0.061326062 1136264583 2245413907
2005 61.06 53.97 51224.80 2.388075 4.25 0.06206011 1154638713 2757363845
2006 60.12 54.88 54516.53 2.805500 5.80 0.064260447 1172373788 3289094504
2007 59.16 57.28 57838.56 3.950000 6.37 0.060936258 1189691809 4699282646
2008 58.21 60.36 58781.78 4.380000 8.35 0.016307806 1206734806 5285498450
2009 57.28 59.61 62527.19 5.120000 10.88 0.063717094 1223640160 6265037619
2010 56.36 63.12 66912.33 7.500000 11.99 0.070131746 1240613620 9304602150
2011 55.45 66.25 69467.09 10.070000 8.91 0.038180731 1257621191 12664245393
2012 54.56 69.01 72288.03 11.100000 9.48 0.040608236 1274487215 14146808087
2013 53.70 68.76 75912.99 12.300000 10.02 0.050146119 1291132063 15880924375
2014 52.89 74.14 80533.19 13.500000 6.67 0.060861802 1307246509 17647827872
2015 52.15 73.87 85945.88 14.900000 4.91 0.067210676 1322866505 19710710925
2016 51.41 75.09 91945.76 16.500000 4.95 0.069809897 1338636340 22087499610
2017 50.68 73.48 97065.60 18.200000 3.33 0.055683335 1354195680 24646361376
2018 50.02 74.13 102212.42 20.081300 3.94 0.053024087 1369003306 27491366144
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Analyzing the determinants of Financial Inclusion in India

Dissertation submitted to Christ (Deemed to be University) in partial fulfillment of the

requirements for the Award of the Degree of

Under the Supervision of

Dr. Bhagavatula Aruna

Assistant Professor of Economics

CHRIST (Deemed to be University)

BANNERGHATTA ROAD CAMPUS

2033324) titled ‘Analyzing the determinants of Financial Inclusion in India’ is a record of

plagiarism in any part of the dissertation.

Signature of the Supervisor

CHRIST (Deemed to be University)

Bannerghatta Road Campus, Bengaluru

Head, Department of Economics

CHRIST (Deemed to be University)

Bannerghatta Road Campus, Bengaluru

supervision of Dr Bhagavatula Aruna, Department of Economics and Political Science.

and that there is no plagiarism in any part of the dissertation.

Signature of the Candidate

Reg No. 2033324

CHRIST (Deemed to be University)

Bannerghatta Road Campus, Bengaluru

I would also like to extend my whole hearted thankfulness to Dr Aneesh M R,

His inputs on how to approach the topic helped me immensely.

challenging times and providing their suggestions.

This study focuses on analyzing the determinants of financial inclusion in India

initiatives to provide financial services to underprivileged section such as nationalization of

Keywords: financial inclusion, PCA, Johansen cointegration, inde

1.1 Introduction to financial inclusion and its significance.....................1

1.2 Research Questions..................................................................5

1.3 Research Objective......................................................................................6

1.4 Research Gap...........................................................................6

3.2 Description of variables.......................................................17

3.3 Principal Component Analysis.....................................23

3.4 Unit root test.........................................................................25

3.5 Cointegration test..........................................................28

4- Results and Interpretation.........................................................26

4.1 PCA results..........................................................33

4.2 Unit root test results..........................................................34

4.3 Cointegration results..........................................................35

5.1 Summary Findings...............................................................................37

5.2 Limitations and scope of the study..............................................38

Table 1: Objective and Data source of variables used in the study..................................16

Table 2: Principal Component Selection table.....................................24

Table 3: Loadings table.....................................25

Table 4: Financial Inclusion Index results.....................................33

Table 5: Unit root test results.....................................34

Graph 1: Age dependency ratio during 1991 - 2018.....................................32

Graph 2: GDP growth rate during 1991 – 2018 .....................................32

Graph 3: Gross secondary school enrolment ratio during 1991 - 2018...............32

Graph 4: Inflation rate as measured by CPI during 1991 – 2018............................32

against time period) .....................................32

plotted against time period) .....................................32

PCA: Principal Component Analysis

RBI: Reserve Bank of India

BSR: Basic Statistical Returns

FI: Financial Inclusion

FII: Financial Inclusion Index

SDG: Sustainable Development Goal

GDP: Gross Domestic Product

Analyzing the determinants of Financial inclusion in India

(Rangarajan Committee, 2008)

sustainable development, there must be an effort to incorporate the greatest number of