In the factors behind the financial development and

In the literature, both definition of financial
inclusion and index formation to define financial inclusion have been
extensively discussed. Studies of causes of financial inclusion either focused
on particular regions or covered all countries. First, index formation will be
discussed then literature looking at financial inclusion’s impact on growth,
stability and income equality will be presented.

 

Definition of
Financial Inclusion and Index Formation

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Existing literature on financial inclusion has
different definitions of the concept and the notion of financial inclusion attracted
a mounting interest from the academia. Numerous studies define the concept in
terms of financial exclusion instead which is linked to a broader context of
social inclusion. Sinclair
(2001) indicated that the notion of financial exclusion was the
incapability to access essential financial services while Leyshon and Thrift (1995)
defined it as the processes which serve to preclude some social groups and/or
individuals from accessing the formal financial system. Similarly, Carbo et al. (2005)
defined financial exclusion as the incapacity of some groups in accessing the
financial system.

 

On the other hand, Government of India’s definition of
financial inclusion lies on the basis of creating a system that
guarantees/ensures access by exposed groups (including low income ones) to
financial services with (i) acceptable credit conditions and (ii) with an affordable
cost, in a timely manner. Rajan
(2014) signifies that financial inclusion encompasses the deepening of
financial services for those people with limited access as well as extension of
financial services to those who do not have any access. Furthermore, Amidži?,
Massara, and Mialou (2014) and Sarma (2008) directly define financial
inclusion. The former describe financial inclusion as an economic state where persons
and firms have access to basic financial services.

 

Other studies have results that certainly could have significant
policy implications with regards to increasing the level of financial inclusion.
For instance, Burgess and
Panda (2005) found that the expansion of bank branches in rural India
had a significant impact on alleviating poverty. Meanwhile, Allen et al. (2013) explored
the factors behind the financial development and inclusion amongst African
countries. Particularly, Brune
et al. (2011) conducted experiments in rural Malawi examining how access
to formal financial services improves the lives of the poor, pertaining to
saving products.

 

Although it appears that there is a consensus on how financial inclusion is defined, there certainly is no standard way of
measuring it. Hence, existing studies offer differing measuring techniques of financial inclusion. For example, Honohan
(2007 and 2008) constructed an indicator
measuring financial access by taking into account the overall adult
population in an economy
with access to formal financial
intermediaries.  For countries with existing data on
financial access, the composite indicator
is formulated by
utilizing household survey data.
For those without household
survey, the indicator is formed using the information on bank account numbers in
combination with GDP per capita.
The data is constructed as a
cross-section series using the most
recent data as the reference year varying across economies. 
However, Honohan’s (2007 and 2008) calculations only deliver a snapshot of
financial inclusion across various countries and is not appropriate for comprehending the relative trends and
changes across countries over time.

 

In order to overcome the aforementioned deficiencies,
Sarma (2008, 2010, and 2012) and Chakravarty and Pal (2010) suggested construction
of composite indices of financial inclusion that combine various banking sector
parameters in order to gauge accessibility, availability and usage of banking
services. These indices assign equal weights to all parameters and dimensions, with
the assumption that all parameters and dimensions have the same impact on
financial inclusion.