Does financial inclusion enhance or weaken financial stability? Exploring their relationship in Latin American countries

Abstract

This study investigates the effect of financial inclusion on financial stability in Latin American countries during the period 2004-2021, since governments in this region have intensified their efforts to promote financial inclusion policies after the global financial crisis. By using a random effects model, a positive significant effect of the financial inclusion index on financial stability, measured by the Z-Score, is observed for 11 Latin American countries during this sample period. This result is robust with the NPL ratio as a dependent variable, which reflects the degree of financial instability. Furthermore, similar findings are obtained when replacing the financial inclusion index with the usage and penetration dimension of financial inclusion. The results, which are consistent with the findings of previous studies, can be mainly explained by three key benefits that financial inclusion brings to financial stability. These include the diversification of bank’s loan portfolio, a stable retail base of deposits, as well as the lower costs of funding associated with the growth of retail deposits.