Reports on the financial stability of emerging countries indicate that non-traditional institutions advancing financial inclusion are increasingly important. The contemporary financial services landscape in many markets includes new financial inclusion instruments such as electronic and mobile phone-based banking. For these newer entrants and many credit-offering institutions, the governing regulatory frameworks are either non-existent or much looser than those for formally-constituted banking institutions.
Does this lack of oversight affect market stability?
In reviewing the recent studies on the possible links between financial stability and inclusion, although additional research and analysis is required, it is shown that greater access to and use of formal financial intermediaries might reduce financial instability. As for why, the studies point to six reasons:
- More diversified funding base of financial institutions
- More extensive and efficient savings intermediation
- Improved capacity of households to manage vulnerabilities and shocks
- A more stable base of retail deposits
- Restricting the presence of a large informal sector
- Facilitating the reduction of income inequality, thereby allowing for greater political and social stability
The principal definitions of financial stability support this notion. Institutions that carry out financial inclusion activities help develop effective intermediation of resources and diversify risk, which are essential elements in supporting sustainable markets.
If greater access to and use of formal financial markets promote financial stability, it is essential that we understand what limits participation in formal financial markets. What does the research say?
The lack of access has traditionally been determined by information and transaction costs. Information frictions include barriers such as requirements for collateral or documentation, or high fees that a large part of the population cannot afford. High transaction costs (especially in remote rural areas) make opening a bank branch or financial services point unprofitable. If there are financial intermediaries that can operate in these environments and with these clients, it would help to reduce these frictions and increase access and, with it, stability.
Generally, for people who have access, low usage occurs for reasons such as lack of financial knowledge or education; lack of savings, employment, or income; mistrust of financial institutions; fear of getting into debt; or as a result of the psychological impact of systematic discrimination in the past. These problems may give rise to self-exclusion by prospective customers. It is therefore crucial for policy makers and financial service providers to better understand these demand-side frictions.
However, less than responsible expansion of services and use can endanger financial stability. The so-called quality dimension of financial inclusion is a key element in combating this. Although universally-recognized indicators for quality do not exist, it is commonly accepted that quality takes into account adequate regulation and supervision of new financial inclusion instruments and institutions, effective financial consumer protection policies, and programs of financial education.
One might think that these three stability-enhancing measures are similar to those outlined after the global financial crisis for mainstream finance in the most sophisticated financial sectors. Nevertheless, the risks and frictions associated with financial inclusion are different (and less pronounced) than those associated with financial development in its most advanced stages, as are the measures to be applied. As is highlighted in some studies, the risk implied by financial inclusion institutions seems to be well understood, as is its prudential regulation.
Regulatory and supervisory measures, as well as financial consumer protection policies and financial education programs, are fundamental in achieving effective financial services spread and uptake. To this end, it is important to specify what type of state intervention or regulation is necessary specifically for financial inclusion, rather than automatically applying measures derived from the financial crisis.
The application of standards and other measures that promote financial stability might set back the inclusion processes. In light of this, designing regulation and supervision for financial inclusion instruments involves balancing risks and benefits in the face of the costs. An example of this is delegated supervision, which seems to be the most advisable alternative, as in the case of federations for the supervision of cooperatives.
It seems fitting to conclude by highlighting the need to continue studying and testing the potential links between financial stability and inclusion. One area of focus for further study is additional frictions of financial markets. In addition, there are enormous gaps in the information on financial inclusion institutions, given that a large part of them are outside the regulatory perimeter. It is also necessary to develop databases that contain information on the nature of financial inclusion institutions and instruments, as well as regulatory and supervisory structures.