Does Financial Inclusion Mitigate Banking Risks? A Comparative Study of Nonperforming Loans and Liquidity in MENA Countries

Abstract

Financial inclusion is a global overall policy objective. Still, its overall stabilizing effects on the banking sector are unclear, particularly in the developing and unstable conditions of the Middle East and North Africa (MENA) region. This study analyzes the central question of whether financial inclusion has diminishing or augmenting effects on two central banking risks: credit risk (proxied by nonperforming loans, NPLs) and liquidity risk. Employing a two-stage Generalized Method of Moments (GMM) estimator on a 2005-2022 panel data sample of MENA commercial banks, we construct a multidimensional financial inclusion index and examine its impact. We present evidence supporting a dual nature of financial inclusion. Greater financial inclusion is associated with a substantial decline in nonperforming bank loans, implying greater risk diversification and stability of the deposit base. In contrast, it's a liability-side issue with higher liquidity risk, which could occur owing to the conduct of small, transactional depositors. Estimates are found to be stable to alternative specifications and have a moderate "risk trade-off." According to our findings, although financial inclusion promotes asset quality, it requires advanced systems of liquidity management. Bank supervisors and policymakers should adopt holistic approaches to inclusiveness while simultaneously emphasizing the strengthening of liquidity protection measures to ensure overall financial stability.