Has financial inclusion made the financial sector riskier?
| DOI | https://doi.org/10.1108/JFRC-08-2020-0074 |
| Published date | 18 January 2021 |
| Date | 18 January 2021 |
| Pages | 237-255 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Peterson Kitakogelu Ozili |
Has financial inclusion made the
financial sector riskier?
Peterson Kitakogelu Ozili
Governors Department, Central Bank of Nigeria, Abuja, Nigeria
Abstract
Purpose –This paper aims to examinewhether high levels of financial inclusion is associatedwith greater
financialrisk.
Design/methodology/approach –The study uses regression methodology to estimate the effect of
financialinclusion on financial risk.
Findings –The findings reveal that higher account ownership is associated with greater financial risk
through high non-performing loans and high-costinefficiency in the financial sector of developed countries,
advanced countries and transition economies. Increased use of debit cards, credit cards and digital finance
products reduced risk in the financial sector of advanced countries and developed countries but not for
transition economies and developing countries. The findings also show that the combined use of digital
finance products withincreased formal account ownership improves financialsector efficiency in developing
countries whilethe combined use of credit cards with increased formalaccount ownership reduces insolvency
risk and improvesfinancial sector efficiency in developing countries.
Research limitations/implications –The paper offers several implications for policy and financial
regulation. It suggests policies that would reduce the financial risk that financial inclusion poses to the
financialsector.
Originality/value –The recent interest in financial inclusionand the unintended consequences of policy-
driven financialinclusion in some parts of the world is raising concern about the risks that financial inclusion
may introduce to the formal financialsector. Little is known about the risks that financial inclusion may pose
to the financial sector.
Keywords Financial inclusion, Digital finance, Fintech, Financial technology,
Non-performing loans, Efficiency, Financial innovation, Insolvency risk, Credit card, Debit card,
Formal accounts, Account ownership, Black swan
Paper type Research paper
1. Introduction
This paper investigates whether financial inclusion increases financial risk in the formal
financial sector.
Recently, the government of many countries have introduced several supply side
initiatives and policies to promote financial inclusion (Demirguc-Kunt et al., 2017;Ozili,
2020a; Prastyo et al., 2018; Markose et al., 2020), but these efforts are being forestalled by
weak demand for such services,particularly a declining demand for basic financial services
after a few years, which gives rise to a typical “excess supply –low demand”economic
problem, and the risk of loss to providers of financial services (Markose et al.,2020).
Financial inclusion is a subject of growing interest among policymakers, scholars and
development economists. Financial inclusion is defined as access to, and the use of, formal
financial services (Allen et al.,2016). Financial risk is the potential for loss that arises from
JEL classification –G0, G1, G2, G3, G21, G28, O16
Financial
inclusion
237
Received15 August 2020
Revised15 November 2020
27November 2020
Accepted4 December 2020
Journalof Financial Regulation
andCompliance
Vol.29 No. 3, 2021
pp. 237-255
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-08-2020-0074
The current issue and full text archive of this journal is available on Emerald Insight at:
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the acquisition, utilization and management of funds in firms. Examples of financial risk
include credit risk,liquidity risk, operational risk, rising cost, etc.
A growing literature shows that financial inclusion has significant benefits for poor
individuals and households.The benefits include access to savings instruments(Ouma et al.,
2017), spending on education and health-care (Dupas and Robinson, 2009), greater
consumption (Turvey and Xiong,2017), easy access to credit (Hendricks and Chidiac, 2011),
encouraging individuals to set up their own businesses (Ozili, 2018b), low-cost financial
services through digital finance apps (Ozili, 2018b) and empowering women to become
financially independent (Demirgüç-Kunt, 2014). There is also evidence that the financial
policies, instruments and structures created to improve access to finance have had positive
effects for financial inclusion (Donovan, 2012;Beck et al.,2014;Ozili, 2018b). The
expectation is that financial inclusion will give poor people the tools the rich have used to
acquire their great wealth. When poor individuals and households have access to credit,
they will feel empowered to starttheir own businesses and to meet their personal expenses.
Financial inclusion alsohas other benefits to the economy such as greater financial stability,
a reduction in the level of unemployment and greater economic growth (Morgan and
Pontines, 2014; Neaimeand Gaysset, 2018; Ozili,2018b, 2020a).
Financial inclusion (i.e. opening a bank account) may translate to higher financial risk
(e.g. non-performing loans (NPLs)) especially for account owners who take loans from
lending institutions. Arguably, not all individuals open a formal bank account for the
purpose of borrowing. Some individuals may open an account for transaction purposes not
necessarily for borrowing. Even with transaction accounts, financial institutions expect to
earn fee income from transaction costs for services rendered to accountholders and fee
income from account maintenance fees charged to account owners. However, it is very
plausible that financial institutions can lose fee income when account ownersperform fewer
transactions than usual.The decline in the volume of transactions will reducethe fee income
to financial institutions, and the loss of fee income is also a source of financial risk, which
can lead to a high cost-to-income ratio (i.e. low-efficiency ratio due to low income and high
cost) when the income component declines. High financial inclusion can also give rise to
other risks such as the inactive user problem (Ozili, 2020a), and the misuse of credit, which
can make poor people worse-off than they were without credit (Smith et al., 2015). These
observations in the literature suggest that some relationship exists between financial
inclusion and financialrisk but this relationship has not been tested in the literature.
Using cross country data, the findings reveal that higher financial inclusion (through
higher account ownership)is associated with greater financial risks (through high NPLs and
cost inefficiency) in the financial sector of developed countries, advanced countries and in
transition economies,but the combined use of digital finance products with increased formal
account ownership improves financial sector efficiency in developing countries. The
implication of the findings is that the policiesdesigned to promote financial inclusion lead to
higher NPLs although it improves cost efficiency whenaccount ownership is used together
with digital financeproducts.
This paper contributes to the literaturein the following way. First, this study contributes
to the theoretical literature on financial risk. The literature argues that high financial risk
negatively affects the performance of financial institutions (Duffie and Singleton, 2012;
Bülbül et al., 2019;Psillaki et al., 2010), and financial institutions may respond to financial
risk by cutting down credit supply and operating cost and such actions can affect the
customers they serve (Hull,2012;Rampini et al.,2020). Second, this study also contributesto
the financial inclusion literature. This literature focuses mostly on the determinants and
benefits of financial inclusion(Donovan, 2012;Demirguc-Kunt et al.,2017). In contrast to this
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