Financial Stability and Financial Inclusion

This paper contributes to the existing literature on the subject of the relationship between financial inclusion and financial stability. It estimates the effects of various measures of financial inclusion on some measures of financial stability, including bank non-performing loans and bank Z-scores. The paper covers the following sections in detail:

• Definition of financial stability and financial inclusion with a description of the possible channels for interaction between the two;
• Description of the available data on financial stability and financial inclusion with a focus on the limitations imposed due to the relative scarcity of the latter;
• Stylized facts of the relationship between financial stability and financial inclusion;
• Literature review of previous publications on this subject;
• Description of the model used for the study and the results from econometric analysis.

Based on the results of the analysis, the paper suggests that an increase in the share of lending to small and medium-sized enterprises (SMEs) aids financial stability, mainly by reducing non-performing loans (NPLs) and the probability of default by financial institutions. It also suggests that policy measures to increase financial inclusion, at least by SMEs, will have the side-benefit of contributing to financial stability.