Financial inclusion : a development need for developing countries

This dissertation contains three independent, but related chapters based on the measurement of financial inclusion, its relationship with economic development and the impact of foreign bank entry on financial inclusion. The World Bank (2017) has defined financial inclusion as 'access of business/individuals to useful and affordable financial products and services that meet their needs such as transactions, payments, savings, credit and insurance'. Therefore, understanding the relationship of financial inclusion with economic development and income inequality is of vital importance.

The first study aimed to develop an extended financial inclusion index to capture financial inclusion's multidimensionality and discusses the existing documented financial inclusion indices and their limitations. The extended financial inclusion index proposed in this study incorporated the variables relevant to online banking transactions. The extended financial inclusion index was constructed for 189 economies from 2010 to 2015, and the proxies used to measure it covered the maximum available information from users and providers of financial services. This extended index showed that the level of financial inclusion was stagnant across developing economies over those years. Bangladesh appeared highly financially inclusive among the lower-income South Asian countries, while Afghanistan appeared the least financially inclusive; among the higher-income countries, Korea was highly financially inclusive. Among the top 50 highly financially inclusive countries, 34% were from Europe and Central Asia, whereas only 4% were from South Asia. Most of the countries in South Asia could not provide an inclusive financial system for a significant proportion of their populations.

The second study explored the relationship between economic development and financial inclusion for 187 countries from 2010 to 2015. The index of financial inclusion proposed in the first study was used as a proxy for financial inclusion. In this study, we also analysed the relationship between financial inclusion, income inequality and banking stability. We applied the generalised method of moments (GMM) technique proposed by Arellano and Bond (1991) to estimate a panel data model. The GMM technique assisted in handling endogeneity issues. We found evidence suggesting a positive and significant relationship between financial inclusion and economic development, and this relationship varied across countries with different income levels. One significant finding that emerged from this study was that high access to financial services was associated with lower income inequality. There is an argument in the literature that greater access to financial services might affect banking stability or increase the banking sector's non-performing banking assets. However, this study did not find any adverse effects of greater access to financial services on banking stability.

The purpose of the third study was to explore the relationship between foreign bank entry and financial inclusion across developing economies. Recent evidence has suggested a gradual increase in the share of foreign bank assets across developing economies. These economies are more attractive for foreign banks, as they face less competition in developing economies and receive higher returns because the average banking spread is higher in developing economies than in higher-income countries. Moreover, the share of foreign bank assets among total banking assets is higher in lower-income countries than in lower middle-income and upper middle-income countries. Despite its policy Significance, extant literature has offered little evidence of the effect of foreign banks' financial inclusion. Therefore, this study analysed the effect of foreign bank entry on the level of financial inclusion across 62 developing economies by using the GMM developed by Arellano and Bond (1991).

The empirical findings show that foreign bank entry helps to increase the level of financial inclusion. The results also show that foreign bank presence across developing economies induces competition in the banking sector. In addition, there is a negative effect of overhead costs on financial inclusion that indicates that the higher overhead costs of the banking sector are a hurdle in enhancing financial inclusion across developing economies. Finally, the results also show that foreign bank entry contributes more towards an inclusive financial system across lower-income countries than across lower middle-income and upper middle-income countries.