Financial inclusion FI financial stability and economic development

Financial inclusion (FI), financial stability and economic development SELAMI XHEPA EUROPEAN UNIVERSITY OF TIRANA SELAMI. XHEPA@UET. EDU. AL

Motivation for this subject: • Financial inclusion is a development priority for many development countries – as tool for economic development; • Current financial crisis is largely attributed to the (unsustainable) levels of financialization; • How we then should move forward in this policy objective?

Content of presentation • (1) FI and financialization: conceptual and measurement issues • (2) importance of financial inclusion for the economic development and impacts on poverty and inequality, • (3) discussion of some controversies with regards to links of FI with the current financial crisis and social changes • Conclusions: towards a new banking and development model?

What is financialization? • Growing role of finance, financial markets and financial institutions in the workings of the economy. • A historical trend of the late 20 th century • Financialization observed at three levels: • Industry – growing share of finance in the value added • Firm - sources of profits from financial markets + shareholders value maximization • Household – higher incomes for employment in finance

FI and Financialization: measurement issues • Financial inclusion is a means to enhance the dimensions of financialization (Interchangeable use) • Measurement: • Quantitative indictors (such as employment in the industry, value added to the economy, etc. , ) • From “activity centered” concept to that of “accumulation centered”: where profits are derived (Kippner, 2005)

FI and Financialization: measurement issues … cont • ascendance of “shareholder value” as a mode of corporate governance; • growing importance of financial markets compared to a bank based finance; • increasing political and economic power of the rentier class; • explosion of financial trading associated with the proliferation of new financial instruments

Financialization measured by organizational change • the growing trend to outsource certain activities, such as financial management; • Negative implication of this change (ascendance of “shareholder value”) is the growing inequality of pay within corporations and economy wide.

Growing role of finance in non-financial firms: post-industrial society Relative share of corporate profits for the US economy, 19502000

Ratio of portfolio income to cash flow of US non-financial corporations, 1950 -2000

Anatomy of financialization – measurement issues

A shift driven by fundamental process • The trend looks basically similar in most developed capitalist societies, despite finance policy regimes that were very different in this period. • in liberal market economies and coordinated market economies. • in economies with strong welfare states and weak welfare states. • in places where neoliberals took power early and places where neoliberals never quite ran the show

Why it is a concern – if there is any? • At macro level: • Tepid economic growth? • Increased financial fragility? • Reservations with regard to sustainability of the process (public, corporate and household debt levels) • Wage stagnation and inequality

Financial depth and growth • Direct relationships • Micro data evidence also suggests that better developed financial systems ease financial constrains facing firms • More access to finance for firms enhances prospects of growth • Indirect relationships • people with no direct access to finance, still have broader opportunities for employment and better pay

Financial inclusion and development- a neo-classical paradigm: • Welfare improving: (Arrow and Debreu, 1954) Financial inclusion Efficient allocation of resources Reduces cost of capital • Better pricing of risk and of economic outcomes – financial speculation is stabilizing (Friedman, 1953)

Financial inclusion and developmentsome theoretical discussions: • Agency problem: relationship of firm and financial markets (Jensen and Meckling, 1976): • Key challenge: how to motivate managers maximize shareholders value • This aligns interests of managers with those of financial market participants (compensation policy with stock options) • The sole purpose: maximize the shareholder value (within the confines of the law) -- from a societal construction --- aggravate the principalagent problem

Financial inclusion and developmentsome theoretical discussions: • “q theory” – (Brainard and Tobin, 1977) • q – market price of capital to its replacement cost • q is a signal that efficiently direct firm in investment and capital accumulation • A q higher than unity – a signal that market price exceeds cost of replacement; • Capital is in short supply • This leads to increased investments

Financial inclusion in developing world • FI – ease of access, availability and usage of formal financial system • Importance of FI – • Efficiency consideration • Therefore: • FI: A desirable political objective – greater social equality • Enhancing opportunities for the excluded groups • Impacts on poverty and inequality

Some policy initiatives • The G 20 made the topic one of its pillars at the 2009 Pittsburgh Summit (G 20 2009) • By fall 2013, more than 50 national-level policy-making and regulatory bodies had publicly committed to financial inclusion strategies for their countries • US Community Reinvestment Act (1997; • Law on Exclusion (1998) in France • The German Bankers Association introduced a voluntary code in 1996 providing for an “everymen” current banking account facilitating banking transactions. • In South Africa a low cost bank account (Mzansi) was lunch for financially excluded people (2004); • Reserve Bank of India has initiated several measures to achieve greater financial inclusion; etc.

“Great moderation” and financial liberalization in developing economies

Financialization in developing countries Saving & Investment, % of GDP

Domestic credit to private sector

Financial flows in developing countries

Structure of financial flows

Relationship between FI and HDI • Building a IFI: • Accessibility: number of bank A/C per 1000 inhabitants • Availability: number of bank branches and ATM/100, 000 inhabitants • Usage: (credit + deposit)/GDP • Final index is calculated as

Relationship between FI and HDI • Correlation coefficient of 0. 74 and is significant • SEE countries – a medium level of FI • But there are exceptions: IFI Country Value HDI Country rank 43 Value 0. 784 Country rank 23 Armenia 0. 041 47 0. 768 27 India 0. 198 29 0. 611 42 Iran 0. 527 9 0. 746 34 Albania 0. 079

. . weak correlation of access to finance and economic development World Bank; Finance for All – 2008

Determinants of financial inclusion • Level of income • Employment • Informality

Determinants of financial inclusion

Financialization, inequality and poverty • Some facts from HDR, 2005: • Income ratios of 20% high income to 20% low income group exceeds 17 in 21 countries; • In 22 countries, more than 1/3 of populations lives below the poverty line • In Albania, about 46% of population lives with less then 5$(PPP)/day

FI and Income: Stagnation of income growth

Financialization and poverty • Conflicting theoretical predictions: • Enhance growth and reduces inequality : reduced credit constrains and enhancing opportunities for the poor • The poor rely on informal market therefore financial markets help the rich – net effect depends on the level of economic development

Finance and changing income distribution

Growth and lowest income share

Finance and poverty alleviation

FI and inequality

Three main findings (Beck et al): • Financial development reduces income inequality • Financial development exerts a positive impacts on the relatively poor: • 40% of the impact is due to reduced inequalities • 60% of the impact through economic growth • Financial development is strongly related to poverty alleviation • Increasingly Robust Evidence of Beneficial Economic Impact of financial inclusion for the poor (WB, 2014)

Conduits to financialization

Working of financial markets: • Financial market deregulation; • Encouragement of foreign financial flows; • Alteration of monetary policy from the control of credit and money supply

Enhancing access to credit: from boring to exciting banking • Glass-Steagal Act (Banking Act of 1933) and relative stability on the banking industry. • Push factors towards deregulation wave of ‘ 80 s: • Crisis of economic growth; • Public finance; • Governance issues and changed profit structure; • + monetary policy regime changes • (pushed by need for reforms or by financial elites? )

Enhancing access to credit: from boring to exciting banking • From credit constrains to democratization of credit market; • A new business model of making money by making people more indebted, pioneered by credit card issuers

Monetary policy • Shift to “inflation targeting’ (IT): a neoliberal market central banking structure (Epstein) – protecting interests of financial elites? (obsession with price stability was fed by the interests of the financial sector (Keynes, 1964) • Fed also uses employment as an indicator for monetary policy • Lower inflation supports credit growth = employment = economic prosperity • Vague relationship between inflation and employment (Philips curve) • Banks (applying IT policy regime) have to some degree accommodated concerns for short-term stabilization objectives, especially with respect to output, exchange rates and, more recently, financial stability.

Prerequisites for a IT regime: • absence of other nominal anchors, such as exchange rates or nominal GDP; • an institutional commitment to price stability; • absence of fiscal dominance; • policy (instrument) independence; • policy transparency and accountability.

Political economy of inflation targeting: • To whom does inflation targeting make the central bank accountable? • Not to government but to financial markets. • BUT: Policy objectives of a central bank are set jointly by government and central bank and they are both accountable to the Parliament

FI and the current crisis • Mostly rightwing: political pressure on banks to force them to grant credit to the poor, marginalized customers encouraged them to live beyond their means; • adding more layers of regulation is helpless and superficial.

FI and the current crisis • Marxist interpretation of the current financial crisis, which looks at the higher profit rates of investment in financial industry as the main driver to financialization (although they also recognize the role of financial inclusion). • re-regulate the industry

A Schumpeterian view of the debate • equilibrium rests on the interaction between a highly dynamic and innovative production sector and very conservative bankers; • recognized the independence of banking not only from politics, but also from business sector, or the entrepreneurial economy

The bottom line: autonomy of financial sector • Financial innovation (and by extension, financial inclusion), played an important role in the making of the current crisis • In all interpretations, the autonomy of financial sector is crucial: • if there is less autonomy, it leads to bank conservatism, • if there is more autonomy it leads to loss of prudence and therefore overinvestment in financial sector.

Towards a new banking and development model • The great divide between the bankers and the public has serious consequences for the credibility of the banking system: • New rules on compensation policies • 2 B 2 Fail and Single European Supervision Mechanism • functioning of guarantee schemes as public institution • Moral hazard • Can this scheme function on private basis?

Towards a new banking and development model • How to make supervisors accountable: • Stress testing and transparency on methodological issues • Trade-offs with publishing information • Stop predatory behavior by banks to exploit borrower’s lack of knowledge

Towards a new banking and development model • Too much discretionary powers to bank supervisors may be misguided; • Empowering/inducing large private market participants to conduct diligence and monitor banks (for example, disclosure of information) may be very powerful

Literature • Gerald Epstein, 2002, Financialization, Rentier Interests, and Central Bank • • • Policy, University of Massachusetts, Amherst World Bank, 2014, Financial Inclusion and Development: Recent Impact Evidence(https: //www. cgap. org/sites/default/files/Focus. Note-Financial. Inclusion-and-Development-April-2014. pdf) Thorsten Beck, Asli Demirgu c -Kunt, Ross Levine, 2007, Finance, Inequality and the Poor (World Bank and NBER) Mandira Sarma, Jesim Pais, 2008, Financial Inclusion and Development: A Cross Country Analysis GERALD F. DAVIS, SUNTAE KIM, 2015, FINANCIALIZATION OF THE ECONOMY; Ross School of Business, Greta R Krippner, 2005, The financialization of the American economy, Oxford University Press