ADB: Financial Inclusion, FinTech, and Banking Stability in Asia and Pacific Economies
SDG 8: Decent Work and Economic Growth | SDG 9: Industry, Innovation and Infrastructure | SDG 10: Reduced Inequalities | SDG 17: Partnerships for the Goals
Ministry of Finance | Reserve Bank of India (RBI)
The ADB working paper titled Financial Inclusion, FinTech, and Banking Stability in Asia and Pacific Economies explores the relationship between financial inclusion, FinTech, and banking stability across 21 Asia-Pacific economies from 2000 to 2021. The study finds that while financial inclusion positively impacts banking stability by diversifying credit portfolios and increasing the customer base, FinTech adoption can negatively affect stability due to regulatory gaps and rapid credit expansion. Notably, FinTech is found to moderate the stabilizing effects of financial inclusion, potentially introducing risks such as over-leveraging and cybersecurity vulnerabilities.
Identifying Critical Channels and Drivers The research identifies two primary channels—operational efficiency and risk management—through which these forces impact the banking sector.
Operational Efficiency: Financial inclusion reduces transaction costs and improves economies of scale, while FinTech may introduce short-term inefficiencies due to integration challenges.
Risk Management: Financial inclusion reduces nonperforming loans (NPLs) by fostering responsible borrowing, whereas FinTech enhances risk assessment but may increase risks through lax screening during credit booms. Other significant factors include foreign bank assets and capitalization, which improve resilience, and higher monetary policy rates, which negatively affect stability by increasing borrowing costs and default rates.
Methodology and Robustness Using an unbalanced panel dataset, the study measures stability via the Z-score. Indices for financial inclusion and FinTech were constructed using Principal Component Analysis (PCA). Robustness checks, including instrumental variable (IV) methods using ICT infrastructure (information and communication technologies) and gender literacy rates, validate that while inclusion enhances stability, unregulated FinTech adoption may undermine it.
What is the “Z-score” in the context of measuring banking stability? The Z-score is a widely used measure of bank stability that represents the inverse of the probability of bank failure. A higher Z-score indicates that a bank has a lower exposure to bankruptcy and is therefore more stable. It is typically calculated based on a bank’s capitalization (equity-to-assets ratio) and profitability (return on assets), providing policymakers with a standardized metric to assess the resilience of the financial sector against potential shocks.
Policy Relevance
As a leading economy in FinTech adoption and financial inclusion, the findings are highly pertinent to India’s Ministry of Finance and the RBI.
Aligning with National Initiatives: The study’s confirmation that financial inclusion enhances stability provides a technical validation for India’s Pradhan Mantri Jan Dhan Yojana (PMJDY), illustrating how universal access reduces funding volatility.
Mitigating Digital Risks: Given India’s lead in mobile payments, the study’s warning regarding “over-leveraging” and “regulatory gaps” highlights a critical need for the RBI to monitor rapid credit expansion in the digital lending sector.
Institutionalizing Innovation: The recommendation for FinTech sandboxes aligns with India’s existing regulatory efforts, suggesting these should be expanded to specifically test for systemic stability before full-scale deployment of new digital financial products.
Enhancing Risk Protocols: India has the potential to improve operational efficiency and risk management by utilizing FinTech’s advanced data analytics for better credit monitoring, provided that short-term integration inefficiencies are managed.
Follow the full paper here: Financial Inclusion, FinTech, and Banking Stability in Asia and Pacific Economies