We discuss the statistically significant results only for the conditional correlations between overall financial stability and overall financial inclusion (Table 5 under the heading Overall). Countries with higher informality, as measured by the number of years firms operated without formal registration (results for other indicators of informality are not significant), experience a lower trade-off between financial inclusion and stability. A plausible explanation is that previously informal firms that enter the formal sector are relatively greater risk-takers, because informal credit is more expensive and required them to take more risk.<sup>22</sup> Because risk appetites are unlikely to change fast, rapid increases in credit to previously informal firms that enter the formal sector should be monitored for potential threats to financial stability. High financial openness and unobstructed inflow of capital could impose a higher trade-off between inclusion and stability. To manage this trade-off, financial account liberalization may need to be accompanied by adequate prudential supervision to ensure that only responsible financial inclusion takes place.

Limited restrictions on investment appear to increase the trade-off between inclusion and stability, perhaps because such policies allow for greater risk-taking. In contrast, low marginal tax rates and tax burden<sup>23</sup> may mitigate potential trade-offs by lowering the magnitude of the negative correlation between inclusion and stability. Low taxes and smaller social safety nets may stimulate greater precautionary savings by individual and firms that could decrease financial volatility. Also, increases in the strength of the governance structure could significantly reduce the overall negative correlation between inclusion and stability and mitigate the trade-off for policy makers.

When disaggregating financial inclusion to that of firms and that of individuals we can observe some results that are specific to each economic agent. Inclusion of firms can generate smaller trade-offs or even synergies with financial stability in deeper financial system (greater credit to GDP ratio), in countries with higher education attainment, lower percentage of working age population, and greater adoption of mobile phone technology. Highly significant is also the association of stronger public governance with smaller trade-offs and possibly higher synergies between the inclusion of firms and financial stability. Also the inclusion of individuals correlates more positively with stability in countries that show sustained financial deepening (higher through-the-cycle growth of credit), higher education attainment (secondary enrollment rates), and greater informality—similar to the aggregate results. In contrast to the aggregate results and the results for firms, greater share of domestic private ownership in firms significantly mitigates the trade-off between inclusion and stability. However, greater foreign ownership amplifies the trade-off between the inclusion of individuals and stability. In addition to financial openness, fiscal freedom and investment freedom that proved important also on aggregate, financial sector liberalization (financial freedom) increases the trade-off between the inclusion of individuals and stability.

The multivariate conditioning on country characteristics (reported in Table 6) provides results that are broadly consistent with the univariate conditioning but the estimation sample is more representative of developing countries.<sup>24</sup> Financial openness can introduce or increase the trade-off between advancing

> 22 To support our conjecture, Annex 5 provides estimates of the difference between the risk-taking appetite between self-employed in the formal and informal sectors using the Life in Transition Survey II for countries with available data. We thank Hernan Winkler for providing us with the estimates.

> 23 This is the ‘fiscal freedom’ indicator in the Heritage Foundation’s Index of Economic Freedom.

> 24 Note that this exercise is done on a much smaller sample than the univariate conditioning. We see it as delivering complementary inference on the country characteristics influencing the covariance between inclusion and stability, rather than a superior source of inference.  To partially address the influence of the different sample sizes, we run two regressions constraining the sample size to 99 observations (Table 6, Column 1, 3 and 5) and 144 observations (Table

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