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Editorial Simplified

Financial inclusion is good for banks too [Editorial Simplified]

There is a strong association between greater financial inclusion and bank stability. The higher the degree of financial inclusion, the better the bank performance in terms of reducing risks and influences bank soundness.
By IASToppers' Editorial Board
November 04, 2017

Contents

  • Introduction
  • Significance of the financial inclusion to the banks
  • Challenges
  • Conclusion

Financial inclusion is good for banks too [Editorial Simplified]

For IASToppers’ Editorial Simplified Archive, click here

GS (M) Paper-3: “Inclusive growth and issues arising from it.”

 

Introduction:

  • Financial inclusion is about having the access to formal financial services and use such services effectively.
  • It has become an important public policy priority following the recent global financial crisis but still very little is known about its impacts and the soundness of the providers of financial services-the banks.

Significance of the financial inclusion to the banks:

bank_queue Financial inclusion iastoppers

  • There is a strong association between greater financial inclusion and bank stability.
  • The higher the degree of financial inclusion, the better the bank performance in terms of reducing risks and influences bank soundness.
  • Banks that have higher customer deposit funding share, lower marginal costs of producing financial services, and which operate in countries with stronger institutional quality, are more stable.
  • It contributes to the greater pricing power of banks and makes them more stable.
  • By broadening banking services to unbanked and/or underbanked people, bank can take early advantage of exploiting the untapped potential of customers and create a ‘lock-in’ effect.
  • Banks can also aid an inclusive development agenda while allocating resources into more productive areas.
  • The greater access to finance increases savings, reduces income inequality and poverty, increases employment, and improves overall well-being.
  • Banks are responsible for providing the bulk of financial services to households/firms in any economy. It has immense managerial and economic importance for inclusive financial development and growth.
  • By exploiting innovative technology, banks can provide financial services to a large number of customers, potentially at a reduced cost, and mobilise large non-wholesale long-term funding.
  • It helps banks garner ample risk-free, cheap retail deposits, reducing their reliance on volatile, costly money market funding.
  • The relationship is particularly pronounced for those banks that have higher customer deposit funding share and lower marginal costs of providing banking services; and also with those that operate in countries with stronger institutional quality.
  • Therefore, in an inclusive financial sector, banks have opportunities to garner a large amount of deposit funding from a vast customer base.
  • Increased banking sector outreach helps reduce distance, enabling financial institutions to build a good relationship.
  • With the competitive advantage of better information, banks can make judicious lending decisions and set prices accordingly.
  • It enables the banks with lower marginal costs & reduced funding costs to reduce excessive risk-taking and become more stable.

Challenges:

  • While dealing with poor households or small firms, there could be loss of banking stability due to informational asymmetries.
  • It may also occur due to lack of managerial and technical expertise, and agency problems related to complex organisational and product structure required to serve a wide-ranging customer base.

Conclusion:

  • A higher level of financial inclusion contributes to greater bank stability.
  • Greater financial inclusion promotes stable socio-political environments as banks get to operate efficiently in those settings and in turn become more stable.
  • Banks with stronger institutional quality could experience greater operating efficiency in financial intermediation, and hence make themselves sound.
[Ref: Business Line]

 

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