Financial intermediation and poverty nexus: evidence from selected developing countries

Abstract

The study examined the relationship between financial intermediation and poverty in selected developing countries. In particular the study sought to examine the deterministic relationship, cointegration and the causality between financial intermediation and poverty. Panel data spanning the period 2004-2016 for 35 developing countries was employed. Substantial empirical research proposed that financial development expands economic prospects and reduces poverty and inequality. Hitherto, there is a dearth of empirical studies on the potential effects of formal financial dimensions of financial access, financial efficiency and financial stability in reducing poverty. There is also a lack of empirical work on the joint effect of the other financial dimensions in a financial intermediation setting in poverty reduction. The present study contributed to literature by including these financial dimensions in examining cointegration and causality between financial dimensions and poverty. The study employed a number of econometric methodologies to address the objectives of the research such as the GMM, panel ARDL and panel ECM. The GMM was employed to examine the determinants of poverty that were selected for this study. To examine the long run, short run and the causal relationship, the panel ARDL and the error correction model were used. In addition the study deployed PCA to develop the composite index for institutional quality. Panel heterogenous estimation methods such as the pooled mean group to infer the cointegration and causal effect between the financial dimensions and poverty were employed. The Hausman test was used to determine the most appropriate estimator and the PMG estimator was selected as the most appropriate since the p-value of the Hausman test was insignificant. The results from panel ARDL, cointegration test showed the existence of a long run relationship between financial intermediation, financial access, financial efficiency, financial access and poverty. Furthermore, the study noted that the relationship between financial intermediation and poverty differ depending on how poverty is measured. Therefore, the distortions in understanding and definition of poverty may consequently lead to distorted policies that yield little or no results for the effectiveness of the financial sector in poverty reduction.The study found strong causality in the long run for all the poverty proxies and the selected financial variables. Additionally the results from the panel causality tests indicate the bidirectional causality of the variables in the long run. We fail to observe the causality among most iii of the variables in the short run. There is strong joint causality among the variables in the panel as the results of the error correction term is negative and significant indicating that there is dynamic stability between the financial variables and poverty. The study further included the domestic public debt and remittances as determinants of poverty in a financial intermediation setting. Since domestic public debt can crowd out private credit, this study included domestic public debt for the panel of the developing countries and the study found that domestic public debt has a poverty reducing effect. Additionally the study found that remittances reduce the share of population living in poverty whilst increasing inequality as indicated in the findings of the study.