Using a Multidimensional Index to Deepen the Discourse on Financial Inclusion
Over the last decade and more, significant effort has gone into harmonizing definitions and methodologies used to measure and track financial inclusion. In 2013 the Global Partnership for Financial Inclusion (GPFI) released its Basic Set of financial inclusion indicators, simultaneously giving a clear message that over time, new indicators will be added to account for an evolving financial services industry and to comprehensively cover all financial services, along with measures of quality and the ubiquity of digital channels enabling access and usage like never before.
More recently, global standard setting entities, national financial sector regulators, and financial inclusion stakeholders, such as the Bank for International Settlements, the Alliance for Financial Inclusion (AFI) and some central banks have explored and released financial inclusion indexes, essentially multi-dimensional composite measures. Arguments put forth in favor of a multi-dimensional index include the benefits of capturing the complex nature of financial inclusion in one measure creating a powerful tool for policy makers, taking into account both supply and demand side data; collapsing the many facets of financial inclusion into a holistic measure that can be used to study the link between financial inclusion and other macroeconomic variables (GDP growth, inflation, literacy, etc.); and third, organizing information by sub-index category provides a useful tool for problem solving and diagnosis, enforcing a standard of not getting lost down the rabbit hole of a single indicator at the expense of several contributing factors. An example is the logistics performance index (LPI) of the World Bank which is built off six sub-indices focusing on multiple aspects of a country’s logistics industry—customs, infrastructure, international shipments, logistics competence, tracking and tracing and timeliness.
Arguably, one of the most widely known multidimensional indices is the Human Development Index (HDI), developed in 1990 by a Pakistani economist Dr. Mahbub ul Haq, with the explicit objective to “shift the focus of development economics from national income accounting to people-centered policies”. Since then, the HDI has provided a powerful alternative to a previously income focused approach to national development. More than 30 years later, the HDI continues to be the centerpiece of the annual Human Development Report published annually by the UNDP, with the 2020 report ranking 189 countries. Over the years, the HDI has been augmented by the Inequality-adjusted HDI, the Gender Development Index, the Gender Inequality Index and the Multidimensional Poverty Index. Despite subsequent embellishments, the core HDI continues to wield influence among policy makers and leaders, not least due to its uncomplex structure (equally weighted for three dimensions—income, education and health) and its ability to leverage off available data banks. Thus, while the HDI is not touted as, or meant to encompass the totality of human development in a country (no single measure can do that), it has served as a powerful device to shape public and political debate, encouraging a reorienting of objectives and action by leaders, policy makers and organizations.
Similarly, to enrich the conversation around financial inclusion beyond the measurement of standalone supply-side or demand-side indicators, the Bank for International Settlements released a publication in 2017 showcasing a multidimensional index measuring financial inclusion. The index was constructed using data from 138 countries, utilizing 20 indicators, both supply and demand side, and including banked and unbanked populations. The index was developed using a parametric method i.e., weights for categories of sub-indicators were assigned using Principal Component Analysis (PCA) i.e., weights for sub-indices were assigned endogenously. The exercise also ranked Pakistan for each sub-category—usage (132), access (50), and barriers (102).
In the same year, three International Monetary Fund (IMF) personnel also released a paper in the Journal of Banking and Financial Economics presenting their methodology for a composite financial inclusion index aimed at cross country comparison. The authors designed new indicators of banking sector outreach for three types of banking services—deposits, loans, and payments—across three dimensions—physical access, affordability, and eligibility. The index leveraged data from the IMF’s Financial Access Survey dataset and also included Pakistan.
In addition to indices developed explicitly for cross-country comparisons, some central banks have also devised financial inclusion indices for use within the country itself. In 2021 the Reserve Bank of India (RBI) released such a composite index painstaking constructed using 97 indicators. The index incorporates details on banking, investments, insurance, and also postal and pension services and is comprised of three weighted parameters—Access (35%), Usage (45%), and Quality (20%). The quality parameter is captured using data on financial literacy, consumer protection, and inequalities and deficiencies in services. With plans to publish the index annually, financial inclusion for India was estimated at 53.9 for the period ending March 2021 as against 43.4 for the period ending March 2017. While the resulting estimate is meant for cross-country comparison, it provides a tailored, intuitive measure to inform policy makers and will also serve an important purpose of sustaining policy attention on improving performance on financial inclusion.
Country-specific indices can also be constructed to assess variations in intra-country financial inclusion, shining a light on geographies with low performance. One example is an index proposed for Mexico in 2013 to assess regional variations in financial inclusion within the country i.e., for all its municipalities. The index was calculated using PCA on variables related to the measurement of the levels of access and usage of financial services, financial education, consumer protection and social development.
While the particulars of developing a financial inclusion index will depend on the primary and secondary purpose identified and the use the index is to serve (country comparison versus regional comparison, banking sector versus banking plus, formally included versus formal and informal inclusion, financial inclusion of individuals only versus individuals and firms, voluntary exclusion versus involuntary exclusion); the availability and robustness of data; and the level of effort and financing required for frequent estimations, constructing a multidimensional index for financial inclusion and measuring it annually, or at longer but specified intervals, has unambiguous advantages as it democratizes and deepens the conversation around financial inclusion while providing a powerful tracking device. Given that Pakistan has a comparatively robust financial inclusion database at its disposal, a multidimensional index will be very useful in ensuring that we maintain a holistic approach to its continued promotion.