Financial inclusion and financial stability nexus: are they synergies or trade-offs

The recent financial crisis has shown that financial innovation can have devastating systemic impacts on financial stability, an example of the sub-prime crisis in the United States. International financial standards and national regulators’ response have been a global concerted effort to overhaul and tighten financial regulations. However, at a time of designing stricter regulations, it is crucial to avoid a backlash against expanding the financial access frontier with a compromise on the effectiveness of lending standards. In this study, it is argued that greater financial inclusion presents opportunities to enhance financial stability. The arguments are based on the following insights: • Financial inclusion poses risks at the institutional level, but these are hardly systemic in nature. Evidence suggests that low-income savers and borrowers tend to maintain solid financial behaviour throughout financial crises, keeping deposits in a safe place and paying back their loans. • Institutional risk profiles at the bottom end of the financial market are characterized by large numbers of vulnerable clients who own limited balances and transact small volumes. Although this may raise some concerns regarding reputational risks for regulators and consumer protection agencies, in terms of financial instability, the risk posed by inclusive policies is negligible. • In addition, greater financial inclusion could also contribute to better transmission of n=monetary policy as data become more representative thus contributing to greater financial stability • However, with poor financial regulation and weak outsourcing of key functions such as credit risk management with the objective of expanding the financial access frontier, can have a devastating effect on financial stability. In this study, we evaluate the current state of financial inclusion globally across the developing world, explore trends in financial inclusion and examine the most effective policies boosting financial stability. The paper arges that innovations aimed at countering financial exclusion may help strengthen and broaden financial systems. However, analysis of synergies and trade-offs between financial inclusion and financial stability remain an extensive debate in the financial literature. However, this study found out that provision of skills training, safety nets, financial education, income generating activities, financial linkages, adopting innovation and technology in financial delivery, among others can to a large extent inspire positivity of financial inclusion on financial stability, thus building synergies of achieving double objectives.