Financial inclusion is an important objective for the financial system for a variety of reasons including: better alignment of financial sector signals and real sector with respect to allocation of resources, allowing people to smooth consumption across time and enable diversification of risks for households. However it needs to be achieved in a manner that it does not impair the systemic stability of the financial system and its ability to offer a high degree of depositor protection.
The objective function may therefore be defined as: maximise (financial inclusion) subject to a high degree of depositor protection and systemic stability. The two constraints are in turn a function respectively of solvency of financial institutions and liquidity in the financial system and alternate designs for financial inclusion would need to be evaluated using these two dimensions.
Adverse selection (AS) and moral hazard (MH) are real challenges for lenders in an environment where collateral does not exist or loss given default is very high on account of enforcement challenges. Information assets like credit information sharing / credit bureau could significantly mitigate AS and MH. However, this will take time to acquire significance because a lot of the current household borrowing is informal and if the threat of credit denial / rationing upon default has to be credible, there has to be more integration with the formal financial system. And countries where these information assets have typically proved to be useful have been those where financial inclusion is already at a high level and therefore maintaining a high credit score is seen to be valuable because otherwise credit lines could simply dry up. Also in those countries typically the levels of poverty and income uncertainty are such that it is possible for an individual to maintain a good credit record and not have their entire savings swamped by the impact of health or other income shocks.
