In a time of crisis when financial policy makers are focused on protecting the stability of the financial system, it is important not to lose sight of financial inclusion goals. In fact, evidence has continued to mount that the stability of a financial system depends, to some extent, on how inclusive it is.
For many years, financial policy makers around the world focused on the stability of the global financial system and considered financial inclusion to be more of a niche issue for development folks. Over the past decade, however, global standard setters and others have elevated financial inclusion as a fundamental policy goal, alongside financial stability, integrity and protection.
This sea change came about with research showing that far from being a niche issue, financial inclusion has an impact on stability. Back in 2012, CGAP helped frame the nexus between financial stability and financial inclusion in “Financial Inclusion and Stability: What Does Research Show?” Recently, we decided to revisit the topic and explore roughly 40 publications that contribute to a better understanding of this paradigm.
What we find today is that there is now even stronger evidence of the financial inclusion – financial stability nexus. There are many synergies, and where there are trade-offs, they can be mitigated.
The synergies between stability and inclusion differ by financial service, but there are clear links. For instance, research shows that better access to payments and savings has a positive effect on stability. Savings products enable a stable, resilient and broad deposit base, which fosters the stability of financial institutions. Notably, women’s propensity to save fosters their financial inclusion (and their participation in the real economy) and contributes to the stability of the financial institutions that serve them.
As a 2015 IMF Staff Discussion Note concludes, “Closing the gender gap in account usage, promoting bank accounts among the low-income households, and encouraging greater diversity in bank deposits would all improve growth without impairing banking sector stability.”
Yet there also are trade-offs that can and should be mitigated. Expanding access to credit without strong supervision poses risks for both financial services providers and customers. Certain policies associated with financial inclusion efforts, such as credit quotas and interest rate caps, also can have destabilizing effects in some contexts. This can happen when policies distort incentives for lenders and borrowers, thereby reducing asset quality or disincentivizing new banks to enter the market. Greater competition can be a powerful way to address the goals of financial inclusion and stability at the same time without the same risk of market distortions.
Innovations that advance financial inclusion also can pose new risks. Especially in the fintech space, innovations are leading to efficiency and diversity and offer product diversification that reduces risk, while at the same time introducing outsourcing risks, concentration risks, cyber risks, macrofinancial risks and the risk of weakening lending standards, market conduct risks and data privacy risks.
Current research on fintech by the Basel Committee on Banking Supervision (BIS) and others frames fintech as offering opportunities for both financial inclusion and financial stability, while recognizing the risks. In their 2019 paper “Fintech: The Experience So Far,” the IMF and World Bank note that “…countries are broadly embracing the opportunities of fintech to boost economic growth and inclusion, while balancing risks to stability and integrity.”
The research clearly shows that to promote synergies while mitigating risks between financial inclusion and stability, a strong regulatory and supervisory environment is paramount. Mitigants include a strong but proportionate regulatory framework, robust risk management, a risk-based supervisory approach and the monitoring of market information.
With the COVID-19 pandemic posing greatly heightened risk for the financial sector and for market participants, it’s understandable why policy makers are focused on the stability of global as well as national financial systems right now.
Yet this is not the time to back off on mainstreaming financial inclusion. The challenges of maintaining the stability of the financial system and protecting access to financial services are tied to one another now just as much as they were before the crisis.
As BIS General Manager Agustín Carstens has said, there is an urgent need for central banks to find ways to reach the last mile with COVID-19 interventions.
The measures called for in the face of COVID-19 can be complementary. Emergency measures to ensure stability can reinforce financial inclusion by increasing the survival of financial institutions that serve low-income customers. Women, rural households, informal workers and other vulnerable segments that are disproportionately affected by global events like COVID-19 will face greater challenges if they also lose access to the financial services they rely on.
Measures designed to safeguard financial inclusion include liquidity support for financial institutions that target unserved and underserved customers, credit facilities to support lending to small and medium-sized enterprises, continued expansion of digital financial services and their delivery, a risk-based approach to customer due diligence, rapid opening of accounts for social assistance payments, enhancement of cross-border remittances and payments and customer-centric financial consumer protection. These measures also promote financial stability by contributing to the prudent functioning and diversification of financial institutions. On the other hand, if fewer people or enterprises are able to access, use or trust financial services, there could be even greater economic repercussions that would, in turn, exacerbate stability risks.
Specifically, policy makers and regulators can do several things to reinforce synergies between stability and inclusion and mitigate risks in the current context:
- Apply policy and regulatory enablers of digital financial inclusion.
- Loosen constraints to financial inclusion with stability factors in mind.
- Apply a risk-based approach to regulation and supervision.
- Identify and assess the inclusion-stability synergies and trade-offs when adjusting crisis-related regulatory measures.
- Push forward on the digital front while keeping an eye on the opportunities and risks of fintech.
- Use stretched supervisory capacity to focus on the essentials.
The stakes are high. Financial inclusion needs to remain high on the policy agenda. Policy makers and international bodies should consider the state of financial inclusion and the characteristics of the financial sector in each country and adapt emergency measures accordingly. Last but not least, financial inclusion needs to be a component of a more inclusive economic recovery.