In recent times, the emphasis of economic policy has been on financial inclusion. Not only is financial inclusion good for welfare, but it also has the capacity to promote financial development, particularly financial stability. Financial inclusion enables the poor and low-income earners, who have more stable savings and borrowing appetite, to participate in the formal financial system. In times of crises, deposits from retail clients serve as a more stable funding source for banks in contrast to wholesale funding sources, which cease during crises periods (Neaime & Gaysset, 2018).

Furthermore, financial inclusion enables banks and other financial institutions to discover new business areas by reaching out to a vast majority of the unbanked and underbanked in developing countries. In this regard, financial inclusion enables banks to diversify across locations, financial products and services, and income groups. This enhances the resilience of financial markets and institutions. Again, financial inclusion increases the efficiency of monetary policy by increasing the number of participants in the formal financial system, thereby increasing the scope for monetary policy. A more financially included economic environment ensures that monetary policy signals are effectively transmitted to the real sector. This is contrasted with financial development, where few people are in the formal financial system impeding the flow of monetary signals to the real sector. Also, by bringing a lot of previously unbanked and underbanked customers closer to the formal financial system, financial inclusion ameliorates information asymmetry, allowing banks to roll out cost-effective financial models (Aha- med & Mallick, 2017). This reduction in information asymmetry mitigates financial vulnerability by improving loan recovery while reducing a bank's bad loan portfolios.

The empirical literature supports the financial sector's stabilising role of financial inclusion. Ahamed and Mallick (2017) studied the impact of financial inclusion in 2,600 banks across 86 economies over the period 2004-2012. They found that financial inclusion promotes financial stability, especially in banks that have significant customer deposit profiles and those with smaller marginal costs of delivering financial services and in banks operating in countries with better institutional quality. In a sample of the Middle East and North Africa (MENA) region over the period 2002-2015, Neaime and Gaysset (2018) found financial inclusion to boost banking sector resilience by stabilising the deposit-funding base in the region. Using a panel of 97 countries over the period 2004-2012, Rasheed, Law, Chin, and

Habibullah (2016) similarly found financial inclusion to positively influence two indicators of financial development: credit to private sector and stock market turnover ratio. Thus, the empirical evidence largely dispels one of the notions that banks have, which prevents them from extending finance to the poor: financial inclusion will disrupt the soundness of the financial system. Notwithstanding the evidence in support of the ability of financial inclusion to foster financial development, there is still a section of the literature that argues that financial inclusion can increase the vulnerability of the financial system by bringing into the banking system those individuals and businesses that are high-risk borrowers (see Box 10.1 for more on this argument).

BOX 10.1 The dark side of financial inclusion

'So far, we have focused on the 'bright side' of financial inclusion. Unfortunately, there can be a 'dark side' too. Partly in response to the global financial crisis - and also inspired by Raghu Rajan's, 2005 Jackson Hole paper - a growing body of research questions whether finance is always good for growth, suggesting that 'too much' or 'too fast' finance can plant the seeds of future financial crises (Arcand, Berkes, & Panizza, 2015; Gourinchas & Obstfeld, 2012; Mian & Sufi, 2014; Schularick & Taylor, 2012). This vulnerability is not an exclusive feature of financial markets in advanced economies. During the microcredit crisis in India in 2010, the state government of Andhra Pradesh, worried about widespread overborrowing and alleged abuses by microfinance collection agents, issued an emergency ordinance, bringing microfinance activities in the state to a complete halt. This large contraction in microcredit supply translated into large negative effects on the labour market and on consumption (Breza & Kinnan, 2018). More recently, the assessment of the JDY programme in India presented by Agarwal et al. (2018) also shows evidence of an increase in loan defaults in areas more exposed to the programme, pointing to a trade-off between inclusion and stability'.

Beck, Peria, Obstfeld, and Presbitero (2018)


We first look at the financial inclusion-economic growth transmission channels and then discuss the empirical literature on the financial inclusion and inclusive growth and development nexus.

The financial inclusion-economic growth transmission channels

Theoretically, financial inclusion can promote economic growth and development through the following channels: capital accumulation, innovation and entrepreneurship, income and employment, opportunities for diversification, productivity, and financial security.

Financial inclusion promotes the accumulation of savings in the banking system and in other financial intermediaries. These savings serve as capital for investment in productive ventures. Again, these savings deposits are transformed into loans and other financial products to support the investment plans of deficit spending units. The savings triggered by financial inclusion are broad based and ensure the mobilisation of resources from economic units (rural and poor households) that were otherwise considered unable to save.

The quality of human capital is an indisputable precursor to economic growth. Meanwhile, the quality of human capital determines the degree of innovation and entrepreneurship in an economy. Financial resources are critical to the training and capacity development of human capital. Households and small and medium-size enterprises (SMEs) that are financially included are more able to find the financial resources to fund their education and training needs than their counterparts who are excluded from the formal financial system. Even in situations where individuals cannot pay education fees out of pocket, an inclusive financial system will enhance access to affordable credit and other avenues of support, be they private or governmental. Financial inclusion provides new, affordable, and convenient means of paying school fees. A well-trained workforce is able to generate inventions and bring innovative solutions to societal problems. Such new inventions and innovations bring about drastic increases in output and economic growth. Financial inclusion spurs entrepreneurship by providing access to capital, stimulating financial literacy, and imparting business management skills to individuals who otherwise would have been deprived of opportunities to live their dreams, because of financial exclusion.

Financial inclusion provides business and employment opportunities for individuals, households, financial institutions, and governments. Financial inclusion provides both direct and indirect employment. The indirect jobs provided by financial inclusion are more difficult to estimate but are likely to be greater in number than the direct jobs. Financial inclusion affords banks and other financial intermediaries opportunities to reach out to the untapped unbanked population through the development of innovative financial services and delivery mechanisms for the poor. In doing so, these financial institutions create new job openings, enhance their profitability, and strengthen their position in the financial system. Entrepreneurship is facilitated in these new locations, leading to improvements in the performance of SMEs. In a nutshell, financial inclusion engenders job creation both directly and indirectly and yields income to beneficiaries therefrom.

By making funds available to a wide range of investors, financial inclusion increases the range of economic choices available to individuals, households, and businesses, leading to economic diversification. By helping poor people and SMEs to save and borrow, build assets, insure against the unforeseen, and make and receive payments with ease, financial inclusion enables the production of diverse goods and services, access to various markets (locally and internationally), and the diversification of income sources. This increases the economic resilience of beneficiary individuals, households, and businesses and subsequently cascades into a more resilient and stable macroeconomy. Through diversification, financial inclusion serves as a risk management mechanism, reducing borrowers' reliance on vulnerable sources of output, markets, and income.

Many economic agents are not as productive as they should be, because of financial exclusion, which makes them unable to provide the needed inputs at the required quantities at the right time to support production or take advantage of promising opportunities. With access to finance, rational economic agents can employ the right quantities of labour, capital, technology, and other factors in order to boost productivity. By spurring innovation and entrepreneurship, financial inclusion extends the frontier of production, helping economic agents attain new productivity heights.

Financial inclusion opens up the range of financial choices available to the poor, enables the poor to accumulate capital over the long run, facilitates long-range investment and consumption planning, and enhances the capacity of households to absorb economic and financial shocks. From a theoretical perspective, financial inclusion promotes economic growth and inclusive development by enabling capital accumulation, stimulating entrepreneurship and innovation, generating direct and indirect job opportunities, promoting economic diversification, boosting productivity, and ensuring financial security.

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