The impact of formal financial inclusion on informal financial intermediation and cash preference: evidence from Africa

ABSTRACT

This paper examines the effect of formal financial intermediation (inclusion) on informal financial intermediation and the use of cash for economic activities. Using data from the Global Findex 2014, we examine whether the use of formal financial intermediaries reduces cash preference and the use of informal financial intermediaries. Our empirical results show that informal financial intermediation is positively associated with formal financial inclusion. This indicates that the relationship between informal and formal financial intermediation is complementary rather than a trade-off, which demonstrates the importance of informal finance plays in the financial system of Africa. Moreover, the use of formal financial intermediaries significantly reduces the preference for holding cash, implying that a robust financial system infrastructure has the potential of mobilizing excess liquidity in the informal economy of Africa for growth and development.

KEYWORDS:

• Financial intermediation
• informal
• formal
• cash preference
• ROSCAs
• Tontines

JEL CLASSIFICATION:

• D14
• G23
• O17

Data availability

Data analyzed in the study are collected from public sources

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The data provides proxies on formal financial intermediation, income quintiles, types of informal financial intermediation, and preference for use of cash for domestic remittances and payments. See Demirgüç-Kunt et al. (2015a).

² Informal financial intermediation denotes four separate variables describing how individuals engage in resource mobilization. These include informal savings clubs (ROSCAs), family and friends, moneylenders and store credit. These and the other variables used can be obtained from Demirgüç-Kunt et al. (2015a).

³ In Table 4, the informal borrowing variable has three categories (family and friends, store credit and moneylenders) which are all forms of informal borrowings. In Table 7 however, we put them together as one variable of informal borrowing. This is because we are interested in the overall impact of formal financial inclusion on informal financial intermediation (informal borrowing).

⁴ Tables 5 and 6 have several variables of cash preference with their corresponding formal financial institutions accounts ownerships that help us to define which activity involves the use of cash or banks. However, in Table 7 column 3, we chose a generic title to represent all the cash preference variables for simplicity, but regress each form of cash preference against their corresponding bank accounts ownership forms as reported in column 3 of Table 7.