key: cord-0706509-xk023o57
authors: Thi-Hong Van, Loan; Nguyen, Nhan Thien; Vo, Duc Hong
title: Financial Inclusion and Stability in the Asian Region Using Bank-Level Data
date: 2020-07-04
journal: nan
DOI: 10.1016/j.bir.2020.06.003
sha: 51fa5238fd0ced7f3a40ce9321fca12543a1f254
doc_id: 706509
cord_uid: xk023o57

Abstract Financial inclusion drives human development by supporting inclusive growth, economic development, and financial deepening. It has become a key enabler in reducing poverty and boosting prosperity. Financial inclusion can provide billions of currently unbanked adults with access to and active use of affordable financial products and services for their needs from transactions, payments, savings, credit, and insurance. The Asian region is generally considered to have a low level of financial inclusion. In addition, financial inclusion has mostly been ignored in current academic studies on the region. The governments in the region have expressed their concerns about macroeconomic instability associated with extensive financial inclusion. As such, this paper examines the linkage between financial inclusion and financial market stability using a dataset of 3,071 banks in the Asian region over the period from 2008 to 2017. This paper uses a generalized method of moments (GMM) approach. Findings in this paper indicate that the higher level of financial inclusion from providing access to banking facilities contributes positively and significantly to stability in the banking sector, leading to greater bank resilience. Financial inclusion can help banks increase revenue, reduce cost, and expand their market share. Policy implications are outlined based on the findings in this paper.

The world has witnessed a remarkable economic transformation of Asia into a global economic powerhouse. Over the period 1970 to 2016, the growth rate of the gross domestic product (GDP) in Asia was more than double the rate in the industrialized countries (Deepak, 2019) . This rapid growth, which gained momentum in the 1990s, led to a sharp reduction in absolute poverty in Asia. Asia is expected to contribute 50 percent of global GDP by 2040, representing a real shift in the world's center of gravity (McKinsey, 2019) . In addition, the Asian region has the youngest population in the world. Half (2.2 billion) of the world's internet users are in Asia, and China and India together account for one-third (McKinsey, 2019) . For a decade, Asia has been the world's largest banking market, with USD700 billion in pretax profit, accounting for 37 percent of global banking profit in 2018 (McKinsey, 2019) . Given this economic growth miracle in the region, financial inclusion, which is arguably one of the most effective tools for reducing poverty and the wealth gap between the rich and the poor, has attracted considerable attention from governments, practitioners, and academics. Financial inclusion is generally defined as the process of ensuring timely access to financial services and adequate credit where needed by vulnerable groups, such as disadvantaged segments and low-income groups at an affordable cost (Rangarajan, 2008) . However, financial inclusion can also threaten the stability of the financial system, as seen, in particular, after the financial crisis in 2008. Potential risks arising from borrowing by low-income segments of the population are mentioned because their participation in the financial sector incurs higher information and transaction costs. In addition, financial instability might increase when low-income borrowers have a poor credit history. The latest

World Bank estimates indicate that more than two-thirds of the adult population have access to banking and mobile bank accounts, whereas nearly 1.7 billion adults remain unbanked (Global Findex Database, 2017) . Global Findex Data for 2017 reveal that only 69 percent of adults (people age 15 and above) in the world have at least one bank account in the formal financial system. Fifty-six percent of the unbanked adults are women. Cost and distance were each cited by about a quarter of those responding to survey questions. A similar proportion responded that they did not have an account because a family member already has one (World Bank, 2017) . This indicates that the benefits of financial inclusion can be wideranging. Financial inclusion reduces liquidity risk and increases the stability of deposits and monetary transmission. Any country seeking to enhance economic growth and development and to reduce poverty must find the right balance between financial inclusion and financial stability.

Financial inclusion is characterized by rapid change and technology innovation in the finance sector, including new products and new forms of payment. In this development context in Asia, the banking sector plays an essential role as a driving force for financial inclusion activities. Banks are required to acquire new customers and have more interaction with current customers through the ecosystem. However, a significant portion of the population is still unable to access and use formal financial services, especially the underprivileged, such as the poor or people living in a remote area.

This paper examines the relationship between financial inclusion and bank stability with a focus on the stability and profitability of the banking sector in the Asian region, using bank-level data. This paper uses a sample of 3,071 banks across countries in Asia in the period 2008 to 2017.

This paper makes the following contributions to the literature. First, the analysis focuses solely on the Asian region, one of the most dynamic economic regions in the world, with the most up-to-date dataset at the bank level. Our findings have direct policy implications for countries in the region. Second, our empirical analysis takes into account crucial aspects of financial inclusion, including bank characteristics and macroeconomic conditions. Third, in addition to conducting standard ordinary least squares (OLS) regressions, we use the GMM method, taking into account the endogeneity problems with panel data to ensure the robustness of the findings.

The paper is structured as follows. Following this introduction, Section 2 outlines a brief literature review. Section 3 presents the methodology and data. Empirical findings are presented and discussed in Section 4. Section 5 summarizes the main conclusions and policy recommendations based on the analysis.

Interaction between financial inclusion and macroeconomic stability has generally been divided into two strands of research. The first strand of academic papers supports a view that financial inclusion will enhance and improve macroeconomic stability, in particular stability of the banking sector for the economy. The second strand of papers with findings supports the view that further financial inclusion will destabilize the banking sector. In this review, each of these strands of academic papers is discussed in turn below.

Several studies have confirmed the positive impact of an increase in financial inclusion on financial stability. Findings in these papers show that financial inclusion leads to more extensive and efficient savings as well as a more stable base of retail deposits. Morgan and Pontines (2014) together with low financial literacy, low income, and insufficient formal jobs, prevent rural customers from using digital and more advanced financial services. Internet banking gradually plays a role as automatic teller machines in transmitting money over long distances at a lower cost. As a complement to cash, internet banking could also be used as an informal payment method.

Meanwhile, Okpara (2011) observed a bidirectional correlation between financial stability and inclusion, claiming that long-run causality exists between them. Neaime and Gaysset (2018) investigated how financial inclusion influences financial stability, income inequality, and poverty in Tunisia, Libya, Egypt, Yemen, and Syria. The region is an interesting case study of countries that have achieved a high economic growth rate, associated with a stable financial system. However, the region has diverse and segmented demographics.

Findings in the paper indicate that financial inclusion is negatively associated with income inequality but positively related to financial stability. This line of thought assumes that the level of financial inclusion is mainly driven by sociological factors. In addition, lowerincome groups voluntarily access the available financial resources to improve their economic conditions. On that basis, financial inclusion mitigates income inequality by giving poor households an economically beneficial motivation to strive for improvement, rather than leading to persistent poverty (Linyang, 2019) . In an attempt to investigate the level of financial inclusion and its determinants in China and the BRICS (Brazil, Russia, India, China, and South Africa) countries, Fungáčová and Weill (2015) confirmed the contribution of demographic factors (e.g., education, age, and income) to differences between the level of financial inclusion in China and the BRICS countries.

Other rationales for supporting a higher degree of financial inclusion have also been introduced to illustrate how financial inclusion can enhance financial stability. From a macroeconomic perspective, greater access to finance can produce a more diversified funding base at financial institutions. In addition, greater access to finance also leads to a broader spectrum of economic agents who contribute to a more resilient economy. The importance of sustainable economic development based on equity and comprehensiveness has recently attracted attention. Van This brief overview of the literature on financial inclusion and macroeconomic stability highlights several issues that are important in our empirical investigation, described below.

Previous studies appear to have largely ignored the role of financial inclusion in stability when the focus is on the Asian region and the study uses data at the bank level. Unlike previous studies, which focus on macroeconomic characteristics, our analysis focuses on groups of characteristics, such as bank characteristics, macroeconomic characteristics, and financial inclusion -which is our variable of interest.

In this study, the data to construct the financial inclusion index come from various sources, including balance sheets and income statements for banks in the Asian region from ( ) is an index that is calculated using four sub-indices, including the number of ATMs per 100,000 adults; the number of bank branches per 100,000 adults; the number of credit cards per 1,000 adults; and the number of debit cards per 1,000 adults.

Finally, the error term represents exogenous factors that might have an effect on a bank's z-score.

The relationship between financial market stability and economic development are not compellingly clarified so far. Many researchers also cast doubt on the linkage between financial inclusion and economic development. They refer to this inconclusive relationship between the two as distributional concerns, which state that financial inclusion cannot be deeply enhanced without sacrificing economic development. In order to obtain comprehensive insights into this relationship, previous empirical papers use the z score as a proxy for bank stability. The z score has been widely discussed and considered not only as a gauge of bank operational risk but also profitability and thus as an absolute gauge of financial stability. Banks with the same z score value might engage in activities that optimize the compensation structure and still ensure functional consistency, whereas other banks carry out many risky projects to maximize returns. On the basis of previous studies, including Han and Melecky (2013) , Ahamed and Mallick (2019) , and Vo et al. (2018) , in this study, we construct the z score as follows:

where denotes the return on assets, is defined as the ratio between total bank equity and total bank assets. Technically, the z score is commonly interpreted as the extent to which returns would have decreased before the bank equity was depleted. In other words, for every standard deviation of bank profitability, the z score represents the specified bank's ability to withstand risk.

The financial inclusion index for Asian countries in the sample for the period 2008 to 2017 is constructed using data from the IMF along two different dimensions, each of which represents one aspect of comprehensive financial integration. In this paper, four indicators are used, and they are divided into two groups: the first group proxies for financial supply For the second dimension (usage), we use the number of credit cards and of debit cards per 1,000 adults as proxies. Because these four indices tend to move together, we consider it reasonable to assign an equal weight to each of them. As such, in this paper, we use a technique to address their correlation. Ahamed and Mallick (2019) concluded that unbiased results were obtained when the impact of financial inclusion on bank stability was examined. They found that the financial inclusion index, calculated using PCA, is significantly correlated with the macroeconomic data. In order to use PCA, the input data has to be normalized by stipulating the range for every value such that they are in the range [0, 1]. Table 1 presents the PCA results. The first component, whose eigenvalue is higher than one, explains up to 71 percent of the variations in the sample. Because the other three eigenvectors are lower than 1, their proportional probabilities can be used as the weights for calculation of our financial index. Notes:

The z score and financial inclusion index are measured as discussed in the text. The bank characteristics include: bank size, measured as the logarithm of total bank assets; K index, which represents capital adequacy; operational revenue, which is the current year's operational revenue; loan provision, which represents the provisions as of the end of the year; ROA, which is the return on assets in the current year; and market power, which is reflected using the Lerner index. GDP per capita and GDP growth are the control variables for macroeconomic conditions. Infrastructure, the economic freedom index, and financial market development are the instrumental variables used in the GMM models. All three variables are measured on a ten-point scale in which 1 is the lowest level of development.

We begin our analysis with the baseline model, which employs the standard OLS regression technique. Our regression model is as follows:

The subscripts i, j, and t correspond to bank , country *, and year . Financial inclusion is estimated using four sub-indicators that represent the dimensions financial usage and financial penetration. Bank characteristics are included in our baseline regression, including loan provision, bank size, operational revenue, K index, ROA, and market power.

We conduct tests to confirm the presence of autocorrelation and heteroskedasticity using Wooldridge test, modified Wald test, and Breusch-Pagan test. The results in Table 4 indicate that both autocorrelation and heteroskedasticity exist in our model. Therefore, we use robust standard errors to address this with the variance-covariance matrix estimator. In addition, GDP per capita and the GDP growth rate are both used in our model, as in Ahamed and Mallick (2019) . The inclusion of these two variables might introduce a multicollinearity problem. We consider these two variables complementary, in particular in the sample of countries with high income per capita and countries with high economic growth rates. Australia, Japan, Singapore, and the UAE have higher income per capita than the other countries in the sample. However, their economic growth rates are lower than those of other countries, such as Vietnam and Thailand. Table 5 presents the correlation matrix and the variance inflation factor (VIF). A VIF of below 10 indicates multicollinearity is not a problem in the model. 

Endogeneity is generally considered inevitable in studies that use panel data set containing general macroeconomic variables. For example, several possible factors could simultaneously change the level of national income and the banking system. These omitted factors could unintentionally compromise the estimated results. In addition, the causality effect between financial inclusion and financial stability warrants attention.

Our analyses indicate that the model used in this study suffers from heteroskedasticity and autocorrelation, so we use GMM to overcome these problems, which is consistent with previous empirical studies Haris et al., 2019; Tran and Vo, 2018; Sardo and Serrasqueiro, 2017) . Roodman (2009) and Chan and Hameed (2006) also stated that a GMM estimation can be used to address with the problems of serial correlation and unobservable heterogeneity. The Sargan, Hansen, and Arellano-Bond statistics confirm the validity of our instrumental variables in the GMM estimation.

Our estimated results are in Table 6 , including empirical results from the OLS regression which shows a positive relationship between financial inclusion and bank stability.

However, our focus is on the findings from the GMM estimations. The findings from our preferred model, Model 1, which includes both GDP growth and GDP per capita, indicate the significant and positive contribution to stability of financial inclusion. Notes: *, **, *** significant at 10 percent, 5 percent, and 1 percent level, respectively.

In addition, to enhance the robustness of the findings, 2 we consider various scenarios in Models 2, 3, and 4. First, we construct Model 2 by excluding GDP growth because of the concern over potential multicollinearity with GDP per capita. Second, we construct Model 3 by excluding GDP per capita because of concern over potential multicollinearity with GDP growth. Third, we construct Model 4 to incorporate the effect of the 2008 financial crisis using a dummy variable.

Our results confirm that financial inclusion positively and statistically contributes to stability in the Asian region, as shown in Models 1, 2, and 3, using dynamic GMM. In contrast, when the effects of the crisis are taken into account, financial inclusion negatively and statistically contributes to stability in the banking sector in the Asian region. However, based on Hansen's test, the findings from Model 4 are not robust. Therefore, we conclude that our overall findings using various scenarios indicate that financial inclusion contributes positively and significantly to macroeconomic stability in the Asian region over the period 2008-2017. In addition, our analyses as presented in Models 1 and 2 show that ROA, GDP per capita, and financial market development also contribute positively and significantly to stability in the banking sector in the Asian region.

The outbreak and spread of the COVID-19 virus have caused two global crises, a health crisis and an economic crisis, which have attracted particular attention to the stability of the financial sector in countries everywhere. Stability of the financial sector is critical in providing countries a robust financial buffer in response to these crises. In addition, the concept of steadily inclusive growth based on financial inclusion has drawn considerable attention from policymakers, practitioners, and economists. Many developing countries and international financial institutions have made various attempts to ensure financial stability and an inclusive financial system to enhance economic growth and development. Despite increasing growth in the banking sector and advancement in all areas of it, great concern remains that banks should not provide banking products and services to underserved segments of the population, such as the poor, small businesses, and people living in remote areas to ensure stability of the banking sector and the economy.

Using a GMM regression, this study is conducted with a sample of 3,071 banks in Asian countries for the period 2008 to 2017. We examine various scenarios to ensure the robustness of our findings, which confirm a positive and significant contribution of financial inclusion to macroeconomic stability in Asian countries. Our results suggest that financial inclusion acts as a lubricant for the entire economic system through expanding savings and investment. Furthermore, an inclusive financial system is a conduit for pro-poor policies by governments, which help households to eliminate poverty. Our results indicate that banks could take advantage of more substantial savings and more extensive deposits by rural households to help finance their lending activity. Financial inclusion ensures the stability of the retail basis of deposits. In addition to relying on costly sources of funding in the capital market, banks could increase and stabilize their operational revenue by targeting the underserved segments of the population. We find that financial inclusion facilitates stability in the financial sector by providing households and SMEs with timely and appropriate financial solutions and products.

Bank profitability is increased by employing a comprehensive strategy and less costly sources of demand deposits. Additionally, designing a lending mechanism that is tailor-made for borrowers based on specific purposes can reduce the moral hazard issues in banks' daily operations. For this reason, financial inclusion is a significant step in achieving a more stable financial system. In addition, financial inclusion plays a vital role in maintaining a resilient financial system. Financial inclusion and a stable financial system should be considered complementary in policy formation and implementation and should not be considered in isolation from each other.

Many essential policy implications have emerged from our analysis. Extending financial inclusion appears to be appropriate for enhancing stability in the banking sector in the Asian region. As it is one of the most dynamic economic regions in the world, underserved segments of the population, such as the poor, people living in remote areas, and small businesses, should be targeted to ensure that sufficient financial products and services are available. By expanding financial products for those who are underserved, banks will obtain a great opportunity to avail themselves of steady sources of funds for lending activities. Doing so will achieve dual objectives for the banking sector: enhancing the stability of operations in the entire sector and increasing profits.

Laos and Vietnam have the lowest degree of financial inclusion in the Asian region. As such, increasing the degree of financial inclusion in the future would enable them to reach a significant milestone. In particular, in Vietnam, one of the most successful countries in the Asian region and the world in the past two decades in terms of economic growth and development, expanding financial inclusion is necessary and urgent for supporting continuation of economic growth and development. For example, Vietnam, which has approximately 3.5 bank branches for 100,000 adults and a financial inclusion index of 0.045, is far from achieving financial integration and an inclusive financial system in comparison to other Asian countries. Therefore, policies on financial inclusion in Vietnam, and other emerging markets, should be enhanced to encourage an extension of banking services and products to underserved segments of the population, mainly SMEs and households in remote areas.

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