Formal Institutions and Financial Inclusion: Evidence from Cross-Country Analysis

Abstract

This paper investigates the impact of formal institutions on financial inclusion. Our main argument is that the level of financial inclusion is jointly determined by the supply and demand of financial services, both of which are positively influenced by institutional quality. On the supply side, strong institutions strengthen rule of law, investor rights protection and contract enforceability, which incentivize financial institutions to offer more financial services. On the demand side, strong institutions reinforce people’s trust on financial institutions and increases their willingness to make use of financial services. Results from cross-country regressions suggest a positive relationship between formal institutions and financial inclusion. This finding is robust to different measures for institutions and model specifications. Further, we find that the positive impact of formal institutions on financial inclusion is weakened as the degree of existing barriers to finance increases.

Keywords: formal institutions, Financial Inclusion, financial barriers