European Microfinance Week 2015

PRESENTATIONS

Piotr KORYNSKI of the Microfinance Centre set the objectives for the session: to clarify the importance of financial inclusion, explore the relationship between financial inclusion and stability, and discuss implications for policy makers and practitioners. Korynski defined financial inclusion as access to, and use of formal financial services by households and firms. Financial stability he defined as the extent to which the financial system – intermediaries, markets and market infrastructure – can withstand shocks without major disruption in financial intermediation and effective allocation of savings to productive investment. He stressed that financial inclusion and stability can have trade-offs and synergies, which would be further explored during this session.

Timothy LYMAN of CGAP presented his research on Financial Inclusion, Stability, Integrity and Consumer Protection (I-SIP), which was launched under the auspices of the G20 Global Partnership for Financial Inclusion (GPFI). In the past, stability was the main focus of financial sector policymakers, but since the last financial crisis, financial integrity and consumer protection became increasingly important. Financial inclusion is the newest entrant to the policy objectives of many standard-setting bodies and policy makers. The linkages between all four are little studied. CGAP just concluded a research exercise in the Philippines, which followed similar research in South Africa, Pakistan and Russia, showing that at the level of outcomes, financial inclusion reinforces the other three objectives, but is also reinforced by them in the long term. However, in the short term, and at the level of individual policy interventions, the linkages between I-SIP objectives are not well understood and therefore not systematically considered in policy making.

Lyman then introduced CGAP’s approach to defining pairwise linkage zones between any two of the I-SIP linkages, using the pairwise linkages between inclusion and stability as an example. The matrix used defines trade-off zones and synergy zones – as well as a neutral zone in the middle, for ineffective interventions that do not affect either of the objectives in question. Policy makers want to optimize the linkages, maximizing synergies and minimizing trade-offs. In order to optimize linkages among inclusion, stability, integrity and protection in designing a particular intervention policy makers should have: 1) clear definitions for each of the I-SIP objectives; 2) a structured approach to identify material linkages; 3) inter- and intra-agency collaboration; 4) regularly collected and analysed data; 5) periodic structured consultation with providers; and 6) management of I-SIP linkages by adapting policy and regulation over time. Lyman concluded by mentioning that the potential of the I-SIP methodology is not only to analyse past interventions, but also to guide policy makers beforehand.

Adalbert WINKLER of the Frankfurt School of Finance & Management introduced preliminary findings of a study conducted jointly with Tania Lopez, a PhD student at the Frankfurt School on the linkages between financial inclusion and stability. The study was motivated by the fact that on the one hand there was financial crisis of 2008 and on the other hand, policy makers responded to the crisis by a call to achieve universal access to finance by 2020. He wondered if this should not be considered as a paradox. Winkler started out by reviewing the theory on financial inclusion and stability. Theory suggests that financial inclusion might contribute positively to financial stability due to: 

1) diversification effects on the asset side and 2) the expansion of cheap and reliable retail deposits on the liability side, limiting risk taking on the asset side. However, theory also indicates that financial inclusion might have a negative impact on financial stability because it involves deterioration in lending standards. The limited empirical evidence available mainly points towards financial inclusion positively contributing to financial stability. At the same time, the available studies use different indicators for financial inclusion and stability. 

Winkler then presented a cross-country analysis based on the IMF Financial Access Database. Financial inclusion was measured by the number of borrowers served by the banking sector, namely the growth rate in the period 2004-2007, depicting the pre-crisis rise in financial inclusion, and the percentage of borrowers in the working age population in 2007, depicting the level of financial inclusion. Financial stability was measured by the drop in credit growth in the period 2007-2009. The study showed that: 1) financial inclusion seems to follow a pro-cyclical pattern; 2) stronger growth in financial inclusion does not contribute to making financial systems more stable; 3) having a high(er) level of financial inclusion has a moderating impact on financial instability; 4) caution is warranted in making strong statements that financial inclusion might foster financial stability; and 5) the case for financial inclusion has to be based on other arguments than financial stability benefits.

Olivier JÉRUSALMY of EFIN presented cases where extension of credit delivery increased financial exclusion, and therefore influenced financial stability. According to EFIN, financial exclusion is a process whereby people encounter difficulties accessing financial services which are appropriate to their needs and enable them to lead a normal life. This definition stresses the need for fairness and social justice in access to finance. However, markets do not allocate value to the principles of fairness or social justice. According to Jérusalmy, free market providers will provide anything if the price is high enough and they can expect to make a return – regardless of higher level of arrears and defaults. 

He substantiated his view with two cases. One related to the sub-prime lending market in the UK where there is effectively no limit on the amount lenders can charge borrowers. The other example related to foreign currency denominated mortgages in Romania, which increase the risk of default when the exchange rate changes. Jérusalmy promoted the quality of the credit portfolio as an indicator to assess credit practices, to identify toxic credit as well as to assess the responsible practices by policy makers on credit market regulation. 

DISCUSSION

The audience asked the panel if they looked at the level of the individual or households in their researches, and to what extent SMEs were considered. Lyman answered that CGAP only looks at those SMEs which operate informally at the household level. These enterprises are not bankable by the formal sector. Winkler supported Lyman’s response. Thomas Rahn illustrated the case of the Arab region, where donors continue to pour credit into markets. He asked Winkler if this approach will eventually work for the region. Winkler responded that liquidity and credit are not directly linked to financial inclusion. He stressed that we should be careful in claiming that credit is a panacea for everything. It can also be very destabilizing if the right measures are not in place. The causality between growth and financial inclusion is still unclear. The only thing we know so far is that the two do not go without each other.

Another contribution from the audience asked how the conclusions of the presented research can help practitioners. Winkler responded that although financial inclusion and stability are not perfect partners, they are promoted together. Winkler stressed to be cautious with this claim as there are not enough studies which robustly show that boosting financial inclusion will increase financial instability. Lyman agreed, and called for caution when interpreting the data.

Lyman then answered a question on how climate change has a place in this debate. He mentioned that the Financial Stability Board (FSB) recently added climate finance as a topic of concern (while also putting on its agenda explicitly for the first time the topic of stability and financial exclusion risk), though it remains unclear where they will go with either topic.