Low access to formal financial systems is a general facet of the economic environment of many African economies (Evans, 2016). For example, 75% of adults in Sub-Saharan Africa do not have a bank account. Besides, African economies have large informal sectors. The most vulnerable populations (i.e. the poorest, women and youth) have informal jobs. Most informal workers are without a bank account. A large informal sector has a negative impact on monetary policy transmission, as a result of the financial decisions of the huge volume of the financially excluded who are unaffected by the monetary policies of the central bank. Expanding financial inclusion in Africa is therefore not just good for only these poor people, but it’s also good for Africa’s monetary policy effectiveness and, thus, financial stability.
Financial inclusion has been defined as the provision of access to formal financial services at an affordable cost to the large segment of the vulnerable and low-income groups. In other words, financial inclusion means access to formal financial services such as savings, credit and insurance opportunities. Financial inclusion can thus have multiplier effects on the economy in the form of higher disposable income for rural households, more savings and a more robust deposit base for financial service providers. Financial inclusion can ensure different segments of the society are involved in the formal financial sector, thereby, increasing the reach of monetary policy and thus monetary policy effectiveness. How does financial inclusion affect monetary policy? In general, financial inclusion increases access to financial services; access to financial services boosts aggregate demand and investment; aggregate demand and investment become more sensitive to monetary policy via the increased elasticity of the lending rate. Additionally, increase in financial inclusion offers a more robust pool of deposits, affording bigger resilience to banks as regards financial shocks. Succinctly, financial inclusion works with commercial banks’ lending rates to stimulate monetary policy.
Interestingly, only few studies have considered financial inclusion and its relationship with monetary policy effectiveness. One outstanding example is Evans (2016). Evans (2016) used annual data over the period 2005-2014, the Panel VECM approach and panel Granger causality to examine the impact of financial inclusion on monetary policy effectiveness in Africa. The study showed that financial inclusion and monetary policy effectiveness are linked by a set of long-run relationships. The reaction of policy effectiveness to the positive financial inclusion shock is not significant. Policy reaction to the positive money supply shock is statistically significant and positive in the short-run while reactions are not significantly different from zero in the long-run. On the other hand, the positive interest rate has a positive and statistically significant permanent effect on the level of monetary policy effectiveness. The study found that financial inclusion, money supply and interest rate shocks have some role in explaining variations in monetary policy effectiveness, but in the long-run, more than 45 percent of variations in monetary policy effectiveness are explained by interest rate shocks. Moreover, while there exists a one-way causality from monetary policy effectiveness to financial inclusion, there seems to be no causality from financial inclusion to monetary policy effectiveness. This holds for all specifications tried. There is bidirectional causality between money supply and monetary policy effectiveness. As well, there is bidirectional causality between interest rate and monetary policy effectiveness.
Therefore, Evans (2016) has established that financial inclusion is not a significant driver of monetary policy effectiveness in Africa. On the contrary, monetary policy effectiveness is the driver of financial inclusion. For increased financial inclusion in Africa, therefore, heightened effectiveness of monetary policy will be required. Most national governments and international institutions in Africa have been leading major policy initiatives to encourage financial inclusion. The Financial Sector Charter and the Black Economic Empowerment Act in South Africa are examples of initiatives towards universal financial inclusion in Africa. Yet, there is still a yawning gap across the continent. Financial inclusion policies for harder-to-reach rural and remote populations should be the focus of monetary policy in Africa. Other areas are policies for improving digital access to finance, sustaining financial service delivery to remote areas and culturally fitting models for increasing the financial capabilities of populations with cultural/language barriers and poor literacy/numeracy.
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