Address given at World Savings Day seminar arranged by National Savings Centre on October 31, 2017
Financial inclusion has become a very popular topic in international development circles in the last two decades. The concept refers to the degree of participation of certain groups in the formal financial system of a country. These groups typically include low-income households, women, and small entrepreneurs. In some countries, the groups of interest may include certain minorities. Usually, the metric defining inclusion is the proportion of the target group that has a bank account through which to access savings, payments and credit services.
Financial inclusion in Pakistan
In the case of Pakistan, financial inclusion has the following main aspects:
Fewer than 13% of adults, 11% of adults from the poorest 40% of the population and 5% of women have a formal bank account. The comparative figures for these groups among South Asian countries taken as a whole are 46%, 38% and 37%. This clearly suggests that some local factors are holding back financial inclusion in Pakistan. Why do only 5% of women have bank accounts here while 37% of women have such accounts on average among South Asian neighbors?
Micro, small and medium enterprises receive only 7% of the total bank credit provided to the private sector. There are 3.2 million small and medium enterprises in Pakistan but bank records show only 188000 loans outstanding to this category.
Financial inclusion and economic development
Why does it matter whether such groups are included in the formal financial system or not? Does their inclusion promote growth and development in a country? Does it reduce poverty and inequality?
The relevant literature has addressed these questions at three levels: macro, local and micro. The macro level research consists of cross-country comparisons. The local level research focusses on the experiences of different regions and provinces within a given country. The micro level work relates to outcomes for low-income households and small firms.
Macro level research generally shows that countries with more financial inclusion tend to grow faster. However, there is an important qualification. The positive correlation between financial inclusion and growth does not appear in countries that have weak governance and high inflation. The quality of governance and macroeconomic management appears to dominate in some contexts, so much so that having broad-based access among the public to bank accounts does not seem to correlate significantly with economic growth. Cross-country comparisons also show a positive correlation between measures of financial inclusion and measures of poverty and income distribution.
Local level research is typically available only for large countries where there is significant variation in economic conditions and outcomes among provinces or districts within each country. Such research has led to mixed results. One study for Mexico found that the spread of banking among districts via the branches of a retail chain led to positive outcomes. Districts with more branches of the retail chain tended to have better growth outcomes than those with fewer branches. On the other hand, a study in India found that, while there was a positive correlation between the density of government bank branches and district growth performance, this effect was temporary and disappeared when the bank branches experienced high levels of nonperforming loans and subsequent defaults. The lesson appears to be that when the private sector expands economic and financial activity geographically within a country, this has positive and sustainable effects. However, financial inclusion via public sector institutions tends to be unrelated to underlying economic realities and may not be sustained.
Micro level research is the most common form of research on financial inclusion. It typically looks at different categories of financial inclusion, such as credit, savings and insurance, and the impact of financial inclusion in these categories.
There is by now a huge literature on microfinance or the provision of small loans to low income households for business or consumption purposes. The results are generally positive for loans taken out for business purposes and are reflected in such outcomes as more startups, expansion of business size, diversification of inventory of livestock and durable assets, higher revenues, and better coping with risks and shocks.
For consumption loans, however the results are mixed. While some studies show positive impacts, one rigorous study of microfinance in Hyderabad, India showed no long-term positive effect on education, health, female empowerment or consumption. In some cases where positive impacts occur, they are linked to group loans and not to individual loans. This suggests that the better monitoring that occurs in group loans tends to enforce a discipline on borrowers leading to better outcomes.
One area of growing importance is the use of "mobile money" by low-income households. This refers to the use of accounts linked to mobile phones. The best-known mobile money scheme is the M-Pesa scheme that started in Kenya and has now spread to many countries. The Kenya scheme has over 17 million customers, mostly low income. Preliminary research shows positive outcomes. Compared to non-users of such schemes, users send more and larger remittances. They are also better able to cope with income fluctuations due to shocks such as job loss, livestock death, crop failure, poor health and so on. Users have higher consumption during the shock episode than non-users.
I would draw several broad conclusions for Pakistan from the international literature. First, financial inclusion is an objective worth pursuing. It does have positive outcomes for growth and poverty reduction. Second, the outcomes depend on the involvement of the private sector. Where private financial institutions have taken the lead in providing greater access to under-served groups, outcomes have been better and more sustained. Third, microfinance has had more sustained success in the case of business loans than for consumption loans. Fourth, in the long term, the issue of financial inclusion may well be solved more by technology than by policy. As the ownership of mobile phones becomes more widespread and mobile money savings and payment systems become cheaper to organize, private firms will enroll greater numbers of low-income households in the natural course of seeking profits through expanding their business.