# **1. Introduction**

Academic and policy interest in financial development has risen in step with the accumulation of evidence supporting the view that a sound financial system is not just correlated with a healthy economy, but actually causes economic growth.<sup>1</sup> By and large, the empirical work behind this evidence has used financial sector depth, typically expressed as the ratio of financial assets to GDP, as the “independent variable,” thereby implicitly assuming that depth is a good proxy for financial development.<sup>2</sup> This may be a justifiable assumption when it comes to empirical work, given the arguably strong correlation between financial depth and financial development, and considering data constraints. But it is clear that the intricate web of institutional and market interactions that are at the heart of financial development can hardly be reduced to a single dimension. It is financial development in all of its dimensions—and not just financial depth—which lubricates and boosts the process of growth. It is not surprising, therefore, that the discussion of finance and growth has naturally widened to consider other dimensions of finance that appear crucial to economic and social development. These include stability, diversity, and—the focus of this study—access to finance. Of these dimensions, access to finance is, so to speak, the “new kid in the block.”<sup>3</sup> Although a relatively new field, the study of financial development from the perspective of the breadth of access to financial services has mushroomed.<sup>4</sup> There are a number of factors that have contributed to this. First, there is some empirical evidence, albeit still limited, that the expansion of access may reduce poverty. Burgess and Pande (2005), for instance, find that a 1 percent increase in the number of rural banked locations in India reduces rural poverty by 0.34 percent (see also Department for International Development, 2004, and references therein).<sup>5</sup> 1 The literature on the finance-growth nexus is vast. Reviews of such literature can be found in a variety of forms that can suit all sorts of different tastes. A comprehensive review is found in Levine (2005). Rajan and Zingales (2001; 2003a), by contrast, provide shorter reviews in less technical language. Caprio and Honohan (2001) offer an excellent rendition that emphasizes the World Bank contributions to the empirical literature.

2 A notable exception is Beck, Demirguc-Kunt, and Martinez Peria (2005), who collect several indicators of banking sector outreach and find that outreach is associated with lower firm-level financial constraints, even after controlling for financial sector depth.

3 The study of financial stability is arguably a more mature endeavor that includes such well-researched topics as regulation and supervision, early warning systems, crisis prevention, crisis management and resolution, and monetary and financial sector linkages. The study of financial system diversity is arguably also a relatively more mature subject, inasmuch as financial sub-sectors (e.g., banking, capital markets, insurance, and pensions) are the object of specialized disciplines.

4 A large number of recent studies have focused on quantifying the lack of access of households and firms and trying to determine its causes. In the case of developing countries, these studies include: Kumar (2005) for Brazil; World Bank (2003a) for Colombia; Srivastava and Basu (2004) for India; Atieno (1999) for Kenya; Aliou and Zeller (2001) for Malawi; Caskey et al. (2004) and World Bank (2003b) for Mexico; Beegle, Dehejia, and Gatti (2003) and Satta (2002) for Tanzania. Halac and Schmukler (2004) present data for various Latin American countries. In addition, Beck, Demirguc-Kunt, and Maksimovic (2002), Francisco and Kumar (2004), IADB (2002), Tejerina (2004), and Schulhofer-Wohl (2004) analyze measures of access to finance for small firms.

5 A broader group of studies has shown a link between financial market depth and poverty reduction, but does not identify whether this is caused by a simultaneous expansion in the breadth of access, or simply by 1