The role of financial inclusion and institutional factors on banking stability in developing countries

Abstract

Purpose This study aims to examine the role of financial inclusion and institutional factors such as corruption and the rule of law (RL) on the credit risk and stability of banks. Design/methodology/approach The study considers a sample of 61 developing countries and uses very robust estimation techniques that allow controlling for endogeneity, heteroskedasticity and serial correlation, such as instrumental variables method in two-stage least squares (IV-2SLS), instrumental variables generalized method of moments (IV-GMM), as well as system of generalized methods of moments in two stages (Sys-2GMM). Findings The results confirm that financial inclusion and strengthening the RL can significantly contribute to reducing credit risk and improving the financial stability of banks; in contrast, the authors find that weak control of corruption aggravates credit risk. In addition, they found that greater competitiveness in the banking sector increases credit risk. Social implications This study supports the need to promote financial inclusion and strengthen institutional factors to improve the stability of the banking sector, as well as promote general well-being in the economy. Originality/value This study contributes to the scarce literature by simultaneously using institutional factors such as corruption and the RL and macroeconomic variables such as economic growth and inflation in the relationship between financial inclusion and the banking sector, as well as considering competitiveness as an explanatory factor for banks’ credit risk and stability.