In the literature, both definition of financialinclusion and index formation to define financial inclusion have beenextensively discussed.
Studies of causes of financial inclusion either focusedon particular regions or covered all countries. First, index formation will bediscussed then literature looking at financial inclusion’s impact on growth,stability and income equality will be presented. Definition ofFinancial Inclusion and Index Formation Existing literature on financial inclusion hasdifferent definitions of the concept and the notion of financial inclusion attracteda mounting interest from the academia. Numerous studies define the concept interms of financial exclusion instead which is linked to a broader context ofsocial inclusion. Sinclair(2001) indicated that the notion of financial exclusion was theincapability to access essential financial services while Leyshon and Thrift (1995)defined it as the processes which serve to preclude some social groups and/or personsfrom accessing the formal financial system. Similarly, Carbo et al.
(2005) defined financialexclusion as the incapacity of some groups in accessing the financial system. On the other hand, Government of India’s definition offinancial inclusion lies on the basis of creating a system thatguarantees/ensures access by exposed groups (including low income ones) tofinancial services with (i) acceptable credit conditions and (ii) with an affordablecost, in a timely manner. Rajan(2014) signifies that financial inclusion encompasses the deepening offinancial services for those people with limited access as well as extension offinancial services to those who do not have any access. Furthermore, Amidži?,Massara, and Mialou (2014) and Sarma (2008) directly define financialinclusion.
The former describe financial inclusion as an economic state where personsand firms have access to basic financial services. ( Other studies have results that certainly could have significantpolicy implications with regards to increasing the level of financial inclusion.For instance, Burgess andPanda (2005) found that the expansion of bank branches in rural Indiahad a significant impact on alleviating poverty. Meanwhile, Allen et al.
(2013) exploredthe factors behind the financial development and inclusion amongst Africancountries. Particularly, Bruneet al. (2011) conducted experiments in rural Malawi examining how accessto formal financial services improves the lives of the poor, pertaining tosaving products. Although it appears that there is a consensus on how financial inclusion is defined, there certainly is no standard way ofmeasuring it.
Hence, existing studies offer differing measuring techniques of financial inclusion. For example, Honohan(2007 and 2008) constructed an indicatormeasuring financial access by taking into account the overall adultpopulation in an economywith access to formal financialintermediaries. For countries with existing data onfinancial access, the composite indicatoris formulated byutilizing household survey data.For those without householdsurvey, the indicator is formed using the information on bank account numbers incombination with GDP per capita.The data is constructed as across-section series using the mostrecent data as the reference year varying across economies. However, Honohan’s (2007 and 2008) calculations only deliver a snapshot offinancial inclusion across various countries and is not appropriate for comprehending the relative trends andchanges across countries over time.
In order to overcome the aforementioned deficiencies,Sarma (2008, 2010, and 2012) and Chakravarty and Pal (2010) suggested constructionof composite indices of financial inclusion that combine various banking sectorparameters. Importantly, these indices assign equal weights to all parametersand dimensions, with the assumption that these dimensions have equal effect onfinancial inclusion. These indices are created in order to gauge the availabilityand accessibility; as well as the usage of banking services. Sarma (2008) described financial inclusion as thelevel of ease for any individual or a group to access, to reach availabilityand to make use of the formal financial system.
The study followed a multidimensionalapproach with an index of financial inclusion (IFI). The multi-dimensionalindex captured information on various dimensions of financial inclusion underone single digit between 0 and 1. On theone extreme, 0 displayed complete financial exclusion; while on the other sideof the spectrum 1 reflected complete financial inclusion in an economy at agiven point in time.
The easy to calculate index contains information onvarious dimensions of an inclusive financial system. The calculated index inthis paper could be utilized to compare different levels of financial inclusionacross economies at a specific time point. It could also be utilized for observingthe advancement of policy initiatives for financial inclusion over a timeperiod.
These two attributes were the biggest advantage of this study. In otherwords, this paper filled the gap of a comprehensive measure that can beutilized to measure the extent of financial inclusion across economies. The construction methodology for this index was relativelysimilar to UNDP’s computation of well-known development indices of the HDI, theHPI, the GDI. Similar to these indices, the study proposed a dimension indexfor each dimension of the financial inclusion. The dimension is then calculatedby subtracting the minimum value from the actual value and dividing it by thedifference between the maximum and minimum value. Then the index was calculatedby the normalized inverse Euclidian distance of the ideal point. The IFI indextook into account three fundamental dimensions including (i) bankingpenetration (measured by number of bank accounts divided by the totalpopulation), (ii) availability of the banking services (the number of bankbranches per 1000 inhabitants) and (iii) banking system usage (the volume ofcredit and deposit divided by the GDP of the country).
The main reason for theselection of these dimensions was as a result of mainly the data availability forlarge number of countries as well as the recent trends in literature.