Financial inclusion and institutional quality: Catalysts for economic growth in Asia-Pacific countries

Abstract

With 24% of unbanked people living in developing countries, policymakers nowadays pay attention to enhancing financial inclusion in poor segments of those countries. Advancing financial inclusion is a crucial challenge but holds prominence, given the minimal use of formal finance in Asia–Pacific countries. Moreover, institutions are pivotal in driving both financial and economic development. However, the effect of institutional quality on the financial sector has recently become a debatable topic with inconsistent empirical evidence. This paper examines the impact of financial inclusion on economic growth and how institutional quality affects the nexus between financial inclusion and economic growth in 37 Asia–Pacific countries from 2004 to 2021. The financial inclusion index and the institutional quality index are constructed using principal component analysis. Fixed-effect regression is used to find the effect of financial inclusion on economic growth and the impact of institutional quality on the nexus between financial inclusion and economic growth. The paper further examines the robustness of baseline results by adding more control variables, employing the system generalised method of moment, two-stage least square method, and panel quantile regression. The study findings show that the Asia–Pacific countries with inclusive finance promote economic growth, which is more pronounced with strong institutional quality contributing to the Theory of Finance and Growth and Institutional Theory. This study contributes to the new empirical evidence that financial inclusion improves economic growth in the Asia–Pacific countries while it is stronger with the presence of institutional quality.