When toxic sub-prime housing loans in the United States were identified as the major cause of the Global Financial Crisis in 2008, financial instability was hastily linked to financial inclusion. As a network of financial sector regulators and policymakers, AFI members are drivers of both stability and inclusion and faced an immediate need to react to this supposed incompatibility.

Research by the US Federal Reserve has since demonstrated that policies to help extend loans to low-income communities (through the Community Reinvestment Act) had little impact on the sub-prime crisis, which helped delineate the difference between focused programs for the poor versus widespread risky lending. Yet, given the magnitude of the crisis and its significance for the regulatory discourse, the issues and interplay between financial inclusion and financial stability have persisted on the agenda of the AFI network and the discussion remains active.

Synergies between financial inclusion and financial stability A recent ADB Institute Working Paper “Financial Inclusion and Financial Stability: Current Policy Issues” authored by AFI Executive Director Alfred Hannig and Stefan Jansen looks deeper into some of the historical evidence that identifies financial inclusion and financial stability as mutually reinforcing. The authors argue that greater financial inclusion presents opportunities to enhance financial stability using the following insights:

Financial inclusion poses risks at the institutional level, but these are not typically systemic in nature. Evidence suggests that low-income savers and borrowers tend to maintain solid financial behavior throughout financial crises, keeping deposits in a safe place and paying back their loans.

• • Institutional risk profiles at the bottom end of the financial market are characterized by large numbers of vulnerable clients who own limited balances and transact small volumes. Although this profile may raise some concerns regarding reputational risks for the central bank and consumer protection, in terms of financial instability, the risk posed by inclusive policies is negligible.

• • Risks prevalent at the institutional level are manageable with known prudential tools and more effective customer protection.

• The potential costs of financial inclusion are compensated for by important dynamic benefits that enhance financial stability over time through a deeper and more diversified financial system.

The experiences of AFI member regulators and policymakers are adding weight to the arguments put forth in the working paper as they pursue the goals of financial stability and inclusion simultaneously with the repercussions and responses to the crisis still playing out.

Recognition has also grown for adding a potential third pillar to the stability and inclusion dynamic: financial integrity. Ongoing discussions between regulators participating in the AFI Financial Integrity Working Group and with the standard setting bodies indicate that financial inclusion measures provide strong support for financial integrity. With a growing realization of the intimate relationship between financial stability, integrity, and inclusion, the G-20’s Global Partnership for Financial Inclusion will study triangular complementarities in more detail in the course of 2011.