The Impact of financial Inclusion on financial Stability: review of Theories and international Evidence

Abstract

International policymakers prioritize financial stability and inclusion, but often view them as separate goals, overlooking potential overlap and trade-offs. If synergies and trade-offs between the two concepts are not recognized and understood, policy design may yield less-than-ideal results. This paper provides a systematic review of the theoretical literature on financial inclusion and financial stability as well as empirical research initiatives examining the relationship between the two concepts. We found that current studies do not always present a unified theoretical approach or conceptual framework to explain the channels of the relationship between financial inclusion and stability. Empirical studies to date offer divergent views on the financial inclusion and stability nexus. While some studies are inconclusive, some also suggest that financial inclusion has a positive and significant impact on financial stability, as explained by the institutional theory. While other studies, supported by the aggressive credit expansion theory, reveal that financial inclusion can have a negative influence on financial stability. Through this comprehensive review, we intend to improve awareness and cohesion among scholars and policy makers of financial inclusion and financial stability while also facilitating the development of solid foundations to address future research and policy making challenges.