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This chapter focuses on the literature review of the role of finance in economic
empowering conditions for growth. In this regard, a summary of the views of various
economists and the details of various earlier studies conducted, are highlighted in section
2.2. The research gap that has been explored on the literature review is stated in section
2.3 along with an account of the literature review in the table format, and a summary of it
in the form of a literature map. Section 2.4 explains the definitions and process of
financial inclusion, which plays a crucial role in measuring the access and impact of
banking services. The outline of the conceptual framework, based on the literature
review, linking financial inclusion, impact of access to finance and inclusive growth is
given in section 2.5. The constructs of the study through which the conceptual framework
is articulated are stated in the subsection 2.6. An account of the variables identified and
the operational definitions which form the basis of measuring nature, extent and the
impact of availing formal financial services are given in sections 2.7 and 2.8 respectively.
The various hypotheses put forward for the empirical verification are enumerated in
divergent view regarding the importance of the access to finance for economic growth
among the economists. As early as eighteenth century, Adam Smith (1776) had expressed
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Review of Literature
the view about the significant and crucial contribution of high density of banks in
Scotland for the stimulating development of the Scottish economy. Walter Bagehot
(1873) and John Hicks (1969) argued that, access to finance played a determining role in
had the view that, well functioning banking network leads to technological innovation by
financing bankable entrepreneurs. In the year 1952, Joan Robinson opined that,
and the financial system responds in turn to this change. Later, this decisive focus on the
financial sector in economic development has been reinforced, with the historical
inequality. Simon Kuznets (1955, 1963) and Kaldor (1966) reasoned that, rapid growth
would need wealth concentration at the initial stages, leading to a trade-off between
growth and social justice, until the benefits of growth spread throughout the economy.
This is due to the high marginal propensity to save of the rich people than that of the
poor, and the necessity to finance large investment projects in the process of growth,
leading to wealth concentration and trade-off between growth and social justice.
Empirical evidence in this regard reveals that, enhanced access to finance is also pro-
poor, results in the reduction of poverty and income inequality, leading to inclusive
growth.
Further in literature (World Bank 2005), the modern development theory states that, the
progression of financial access, growth, and income dynamics of different generations are
closely related. Access to finance influences not only the quality of resource allocation in
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Review of Literature
the economy but also improves the comparative economic opportunities of individuals of
poor households.
In the literature it is also argued by the social scientists that, given the capital market
productivity will have little money to invest in their education and their occupational
options are limited because low initial endowments (Aghion & Bolton, 1997; Aghion,
Caroli & Garcia-Penalosa, 1999; Banerjee &Newman, 1993; Galor & Zeria1993; Rajan
Banking access is an important incentive for technological innovation (King & Levine,
1993). Research in the last decade strengthens the belief that, a well developed financial
system paves the way to faster and equitable growth (Honohan, 2004). Patrick Honohan
also developed an index to measure access to finance in 160 countries and it is revealed
that, those economies with higher indices were developed/advanced economies. He had
also proved that, societies with deeper financial system had low level of absolute poverty.
There is also other indirect evidence of the link between growth and poverty alleviation.
Financial depth has been shown to be an important factor in reducing inequality among
the population belonging to the vulnerable sections (Li et al, 1997). The correlation
between child labour and poverty has been found to be influenced by the financial depth
In a study of Grameen Bank and MFI in Bangladesh, Pitt and Khandker (1998) proved a
significant and positive effect of the use of credit on household expenditures; assets,
labour supply, and the possibility of children attending schools. Coleman (1999), in his
study on micro credit borrowers in northeast Thailand proved that, there was no
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education etc.
Gine and Townsend (2004), in their study by drawing on data from Thai households
between 1976 and 1996 showed that, flexibility in financial access and the consequent
increase in access to credit services explains the quick growth in per capita GDP in the
Burgess and Pande (2005), in one of the experiment involving the policy of the Indian
government on bank branch expansion , between 1977 and 1990 found that, as a result of
branching regulations and the new bank branches opened, there was a fast growth in
non-agricultural output and decline in poverty, compared with before and after this period
of regulation.
A study across the countries on the relationship between financial access and income
inequality by Li, Squire and Zou (1998) and Li, Xu, and Zou (2000) found a negative
correlation between access to finance and the income inequality using Gini coefficient.
A comparison between the Index of Financial Inclusion (IFI) and the ranks of UNDP
human Development Index (HDI) indicates that, there is a positive correlation between
them. In the literature it has been highlighted that, countries with high income inequality
have less formal financial access (Kempson, 2006). A study by Karlan and Zinman
(2006), in South Africa, between the groups of borrowers with the control group of
rejected applicants found that, after loan application, borrowers were more likely to retain
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Demirguc Kunt and Levine (2007) argued that, reducing financial market frictions create
opportunities, eradicate income inequality and poverty which is beneficial for the poor
World Bank research report on access to finance (2008), states that, financial access can
have direct and indirect benefits on small firms and poor households, makes them more
capable to take advantage of investment opportunities and insures them against risks.
Studies by using cross-sectional data on households in Peru revealed that, after availing
income prospects, and the number of children attending school. Studies for Guatemala,
India, and Tanzania also point out this. They also show a positive effect of the use of
credit on upward class movement, allowing them to start new business ventures.
Therefore, without an inclusive financial system, poor individuals and small enterprises
have to rely on their own limited savings and earnings to invest in their economic and
educational activities and to take the advantage of growth opportunities. Michael Thiel
(2001) opined that, while there is a firm consensus that, a well-functioning financial
sector is a precondition for the efficient allocation of resources and the exploitation of an
economy's growth potential, the economic literature is less consensual on how and to
what extent finance affects economic growth. This study is an attempt in this direction.
By reviewing the literature, it can be reasoned that, access to formal finance and availing
formal financial services could play a significant role in the efforts of poverty
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Review of Literature
eradication. Poor households belonging to the vulnerable sections can benefit from
credit, savings, payment and insurance services and money transfer facilities. The large
amount of empirical proof available in the literature indicates a significant and strong
relationship between financial access and growth through which financial development
influences economic growth. Based on this, the research gap that has been explored can
be summarized as follows:
(i) Even though there is a empirical proof to strengthen the fact that, a well-functioning
financial sector plays a crucial role in the efficient allocation of resources and the
consensual on the fact that to what extent finance affects economic growth. This
(ii) Even after initiatives towards financial inclusion in Indian economy, macro level
empirical proof reveals that, a vast segment of households belonging to the marginal
sections do not have access to any formal banking services and there is wide
disparity throughout the economy across the regions and social groups in financial
inclusion. There may be studies to look into this at the macro level in India, but there
may be disparities across the revenue divisions within states, among the households
Based on the summary of arguments, views and dimensions (Table 2.1) earlier studies
and their outcomes (Table 2.2) on access to finance and economic development, research
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Walter Bagehot (1873) and John Hicks Access to finance ushering industrialization by mobilization of
(1969) capital.
Robinson (1952) Economic development creates demand for financial services and
financial system responds in turn.
Simon Kuznets (1955, 1963) Rapid growth leads to wealth concentration in early stages, later
Kaldor(1966) improved access to finance results in pro-poor growth reducing
income inequality and poverty.
Banerjee and Newman (1993) Poor people with high marginal productivity of investment
cannot invest in education or occupational choices due to less
Aghion and Bolton (1997)
initial endowments given the capital market imperfection or low
Aghion, Caroli and Garcia-Penalosa access to finance.
(1999), Rajan and Zingales (2003).
Galor and Zeria (1993) It is because of financial market frictions that poor people cannot
invest in their education, despite their high marginal productivity
of investment.
King and Levine ( 1993) Access to finance is an incentive for new technologies and ideas.
Michael Thiel (2001) There is a firm consensus that, a well-functioning financial sector
is a precondition for the efficient allocation of resources and the
exploitation of an economy's growth potential and the economic
literature is less consensual on how and to what extent finance
affects economic growth.
Honohan ( 2004) Research in the last decade leads us to believe that a well
functioning financial system is linked to faster and equitable
growth.
Beck, Demirguc Kunt and Levine Reducing financial market imperfections to expand individual
(2007) opportunities creates positive incentive effects.
World Bank ( 2008) The extensive empirical evidence suggests a significant and
robust relationship between financial depth and growth.
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Adam Smith (1776) Walter Bagehot (1873) Schumpeter (1912) Robinson (1952)
Simon Kuznets (1955) 1963) Kaldor (1966) John Hicks (1969) Banerjee & Newman
(1993)
Galor, & Zeria (1993) King, Levine (1993) Aghion &, Bolton (1997) Aghion, Caroli & Garcia
Penalosa, (1999)
Michael Thiel (2001) Rajan &, Zingales (2003) Beck, Demirguc Kunt
Honohan, (2004)
(2007)
Li et al (1997) Pitt and Khandker Coleman (1999) Li, Squire & Zou
(1998) (1998)
Honohan (2004) Gine &Townsend (2004) Li, Xu, and Zou (2000)
Dehijia & Gatti, (2002)
Honohan, (2004) Burgess & Pande Clarke Xu (2006) Kemp son (2006)
(2005)
& Pande
Karlan & Zinman (2006) Cotler & Woodruff (2007) Fernando (2008)
Research Gap
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identify the underlying factors of financial exclusion. This will play a deciding role in
conditioning the empirical evidence which measures access to financial services and its
impact that links to development outcomes. In the economic literature it is suggested that,
Due to this, there is less ground reality known about financial inclusion around the world.
Along with this, the literature on financial inclusion lacks a comprehensive measure
which can be used to measure the nature and extent of financial inclusion. Though
indicators of the extent of access to banking system, capital markets, and insurance sector
are widely available, less information is known about the degree of financial inclusion. In
sector, the type of financial institutions or services effective in supporting access by poor
households and the practical and policy barriers which may be hindering the financial
accessibility.
Broadly, financial inclusion means providing formal financial services with improved
range, quality and availability of financial services to the vulnerable sections which are
financially excluded. This process covers variety of formal financial institutions. On the
one hand, there are banks or formal financial institutions, which provide variety of
financial services to their customers, like, deposits, loans, payment services, remittance
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facility and insurance products to the poor and low-income households and their small
business entities.
timely delivery of financial services, like, credit, savings, insurance and remittance
facilities at an affordable cost to the vast sections of the disadvantaged and low-income
groups. This is an attempt to lift the poor from the vicious circle of poverty. This can be
achieved through state driven intervention or through voluntary effort by the banking
community to bring within its fold the large section of the society which is bankable.
Demirg-Kunt, Beck, and Honohan (2008) define financial inclusion as the use of
financial services by individuals and firms. Financial inclusion allows individuals and
firms to take advantage of business opportunities, invest in education, save for retirement,
and insure against risks. In the Indian context, financial inclusion, according to the
Finance Ministers 2006-07 budget speech is defined as the process of ensuring access to
timely and adequate credit and financial services by vulnerable groups at an affordable
cost.
Raghuram Rajan Committee, GOI (2007), defines Financial Inclusion as the universal
access to a wide range of financial services at a reasonable cost. This includes not only
banking products, but also other financial services, such as, insurance and equity
products.
In a similar vein, the Rangarajan Committee, GOI (2008), defines financial inclusion as
the process of ensuring access to financial services and timely, adequate credit where
needed, to vulnerable groups such as weaker sections and low income groups, at an
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Review of Literature
affordable cost. This can also be stated in the form of a schematic representation (Figure
2.2).
Savings
Financial Inclusion
Payments
Financial Advice Remittance
Affordable Credit
there is no single inclusive measure to estimate the extent of financial inclusion across
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World Bank (2008) Broad access to financial services implies an Access to financial services such as
absence of price and non-price barriers in the deposit, credit, payments, insurance.
use of financial services; it is difficult to define
and measure because access has many
dimensions.
Source: Report of Currency and Finance RBI, GOI.
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financial inclusion formal banking products and services are provided to the excluded
population through the institutional banking structure for ensuring financial access, which
Insurance Loan/Credit
Accounts
Payment and
Small value loans/credit Remittance
Services
MFCs/NGOs
Post Offices
Figure 2.3: Financial Products and Services and the Institutional Structure
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Based on the literature review and in consistence with the previous research on inclusive
growth, financial inclusion and economic development, the study proposes a conceptual
framework linking financial inclusion, impact of availing financial services and inclusive
Impact of Availing
Demand for Households Financial Services on INCLUSIVE
Financial Services Socio-Economic Status GROWTH
Formal
Financial Informal
Financial
Network
Network Relationship not investigated in research
Financial Inclusion
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Accordingly, the nature of financial inclusion has been studied by looking at the type and
number of formal financial institutions accessed and services availed by the households.
The extent of financial inclusion has been examined by looking at the outreach of
financial services on the various income and asset levels and the number of years of
The impact of availing formal financial services has been quantified by exploring the
pathways in which the members of the household experienced change after availing
formal financial services. The pathways through which the impact of financial inclusion
has been explored are material changes, cognitive changes, perceptional and relational
changes which have been taken place in the household after availing formal financial
services.
households has been studied by analyzing the changes in the pattern of household
The social impact of financial inclusion on households has been analyzed by assessing
the changes in human and social capital of the households viz., changes in literacy level,
the number of children attending school and availing of higher education facility,
and the society, changes in self esteem, self confidence and the mobility of the members,
enhanced role of women, bargaining power of the members of the household etc.,
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To articulate the conceptual framework by capturing the data on the nature, extent and
impact of financial inclusion, in the present study, three constructs were designed.
Construct 1:
inclusion.
Construct 2:
Construct 3:
In the study, while measuring the components of financial inclusion and its impact on the
socio-economic status of the BPL households, the primary components of the constructs
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component. With this background, the identified variables are summarized in Table 2.4.
Following are the operational definitions of the study in relation to the various concepts,
in order to come to a logical conclusion to the research problem which has been
identified.
(i) Inclusive Growth: Growth or the positive changes taken place in the socio-
economic status of the rural and urban households after availing formal financial
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relational and material changes that have been taken place in the households after
households.
(iv) Nature of Financial Inclusion: The component, which measures the type and
(v) Extent of Financial Inclusion: The component of the outreach of the formal
financial services at different income levels, asset levels, and the years of availing
income of the household, approximate asset value of the household, and the number
(vi) Material Changes: The component, which gives the measure of the changes in
services.
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(vii) Cognitive Changes: The component, which gives the measure of the changes in
the literacy level, number of children attending primary and higher education,
(viii) Perceptional Changes: The component, which gives the measure of the changes
(ix) Relational Changes: The component, which gives the measure of the changes in
the mobility, bargaining power and decision making of the members of the
(x) Household: A group of persons living together and take their meals from a
common kitchen, unless the exigencies of work prevent them doing so. Members
are not related live in a house, without taking their meals from the common
kitchen, then, they are not the constituents of a household. The link in finding out
(xi) Revenue Division: The administrative divisions in Karnataka state, which are
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based on legal infrastructure, which provides recourse to the lenders and protection
to the depositors.
changes taken place among the members of the households after availing formal
financial services.
Based on the conceptual framework, review of the literature, pilot study and the valuable
Null Hypothesis H10: There is no disparity in financial inclusion among the rural and
urban households belonging to the vulnerable sections across the revenue divisions.
Alternative Hypothesis H11: There is disparity in financial inclusion among the rural
and urban households belonging to the vulnerable section across the revenue divisions.
Null Hypothesis H20: Financial inclusion and the social status of the households
Alternative Hypothesis H21: Financial inclusion and the social status of the households
Null Hypothesis H30: Financial inclusion and the economic status of the households
Alternative Hypothesis H31: Financial inclusion and the economic status of the
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Null Hypothesis H40: The impact of availing formal financial services on the socio-
heterogeneous.
Alternative Hypothesis H41: The impact of availing formal financial services on the
heterogeneous.
Access to finance plays crucial role in the process of inclusive growth. Literature and
empirical evidence support this. In this direction, this chapter is an attempt to provide a
theoretical background of the study. Based on this, a conceptual framework has been
designed and constructs of the study have been arrived at to articulate the conceptual
framework. The logic of the quantification of the identified variables rests on this. This
has provided the grounding to put forward hypotheses, which were tested to arrive at a
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