Financial inclusion and bank stability: evidence from capital buffer and capital adequacy ratio
| Date | 08 January 2025 |
| Pages | 109-129 |
| DOI | https://doi.org/10.1108/JCEFTS-05-2024-0035 |
| Published date | 08 January 2025 |
| Author | Peterson K. Ozili |
Financial inclusion and bank
stability: evidence from capital buffer
and capital adequacy ratio
Peterson K. Ozili
Advisory Services Group, Central Bank of Nigeria, Abuja, Nigeria
Abstract
Purpose –This study aims to examine the effectof financial inclusion on bank stability, and the effectofbank
stabilityon financial inclusion from 2011 to 2020.
Design/methodology/approach –This study analyses33 countries which are divided into Asian countries,
African countries, European countries and countries in the region of the Americas and using the panel
regressionmethod.
Findings –The analysis for the impact of financial inclusion on bank stability shows that high levels of
financial inclusionhave a significant positive impact on bank stability.The regional results show that financial
inclusion improves bank stability in African countries and in countries in the region of the Americas while
financial inclusion impairsbank stability in European countries. The analysis for the impact of bank stability
on financial inclusion shows that bank stability has a significant effect on financial inclusion. The regional
analysis shows that greater bank stability decreases financial inclusion in European and African countries
while greater bank stability increases financial inclusionin countries in the Americas region. The results
suggest that the effect of financial inclusion on bank stability, and the effect of bank stability on financial
inclusion,depends on how financial inclusion and bank stability are measuredand the region examined.
Originality/value –Existing studies have not examined the effect of financial inclusion on capital-based
measures of bank stabilityand have not examined the effect of capital-based measuresof bank stability on the
level of financialinclusion.
Keywords Financial inclusion, Bank stability, Capital adequacy ratio, Capital buffer,
Financial inclusion index, Automated teller machines, Bank deposits, Commercial banks
Paper type Research paper
1. Introduction
We investigate theimpact of financial inclusion on bank stability and the impact of bank
stability on financial inclusion.In terms of definition, financial inclusion refers to access and
usage of affordable formal financial services (Demirgüç-Kunt and Klapper, 2012), while
bank stability refers to a condition in which individual banks can carry out their bank
intermediation function efficiently and without assistance from external institutions
including the government (Nier, 2005;Köhler, 2015;Goetz, 2018). Banks are generally
considered to be stableif they have adequate capital adequacy ratio, a good regulatorycapital
buffer, low insolvency risk (or high Z-score), high liquidity ratio and low single-digit
nonperforming loans(Thakor, 2014).
In this paper, we focus on capital-basedmeasures of bank stability because bank capital or
the capital buffer is usually the first line of defense to absorb unexpected losses in banks
(Farag et al.,2013). Without bank capital, a bank cannot survive. A bank whose capital
JEL classification –G21, G28
Journal of
Chinese
Economic and
Foreign Trade
Studies
109
Journalof Chinese Economicand
ForeignTrade Studies
Vol.18 No. 1, 2025
pp. 109-129
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-05-2024-0035
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1754-4408.htm
adequacy ratio is negative or below the minimum regulatory capital adequacy ratio is in
distress or failing (Farag et al.,2013).Therefore, having sufficient capital adequacy ratio and
a good regulatory capital bufferare good signals of the stability of a bank(Thakor, 2014).
Despite the importance of bank capital for bank stability,existing studies have not examined
the effect of financial inclusion on capital-based measures of bank stability and have not
examined the effect of capital-based measures of bank stability on the level of financial
inclusion.
An emerging literature has examined the effect of financial inclusion on bank stability.
Majority of these studies showed that financial inclusion affects bank stability through the
credit channel and the deposit-liquidity channel (see, for example, Dienillah et al., 2018;
Barik and Pradhan, 2021). The credit channel occurs when financial inclusion is achieved
through greater access to credit (Barik and Pradhan, 2021). Under the credit channel, it is
commonly argued that rapid credit growth could lead to the lowering of loan screening
standards and credit monitoring standards which can increase credit risk, lead to rising
nonperforming loans and increase bank fragility or bank instability (Barik and Pradhan,
2021), thereby implyinga negative impact of financial inclusion on bank stability. A counter
argument is that, if regulatorscan compel banks to tighten their loan screening standards and
credit monitoring standards when extending loans to individuals, small and medium scale
enterprises (SMEs) and large corporations, the resulting improvement in credit risk
management will ensure thatfinancial inclusion through greater access to credit will improve
bank stability (Siddik and Kabiraj, 2018), thereby implying a positive impact of financial
inclusion on bank stability. The deposit-liquidity channel occurs when financial inclusion is
achieved through many depositors who keep their money in banks. Under the deposit-
liquidity channel, it is commonly argued that the increase in the number of depositors (or
bank accounts) will increasethe deposit base of banks and lead to a more diversified deposit
base which can serve as cheap liquidity which banks can use to shore up their liquidity
position to make them more stable and resilient to shocks (Han and Melecky, 2013;Hakimi
et al., 2022), thereby implying a positive impact of financial inclusionon bank stability. A
counter argument is thatif depositors and savers are not rewarded with high deposit rates that
would motivate them to keep their deposits in banks for a long time, depositors and savers
will only keep their funds in banks for a short time. Such deposits will be unstable and may
not be readily available forbanks to use as cheap liquidity to shore up their liquidity position.
This would make banks become potentially unstable, vulnerable to shocks and become
fragile (Wang and Luo, 2022), thereby implying a negative impact of financial inclusion on
bank stability. While the credit and deposit-liquidity transmission channels are the most
common channels through which financial inclusion affects bank stability in the literature
(Han and Melecky, 2013;Siddikand Kabiraj, 2018;Hakimi et al., 2022), little attention has
been paid to a third channel, whichis the financial access point channel, particularly financial
inclusion throughautomated teller machines (ATM)penetration and bank branch expansion.
In this paper, we revisitthe impact of financial inclusion on bank stability and focus onthe
financial access pointchannel. Firstly, we arguethat there is a pass-through between financial
inclusion (via ATM penetration) and bank stability because the increasing patronage of
existing ATMs by banked adults can increase the demand for debit cards among banked
adults, generate fee income for banks,increase bank profitability and some of the generated
profits will be retained and used to boost bank capital and to improve bank stability. Wealso
argue that financial inclusion (via bank branch expansion) can improve bank stability,
because bank branch expansionto new locations may lead to inflow of new deposits to banks
and generate a more diversified deposit base for banks. The diversified deposits could serve
as cheap liquidity which bankscan rely on to shore up their liquidity position and make them
JCEFTS
18,1
110
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