# Introduction

Well‐functioning financial systems serve a vital purpose by offering savings, payment, credit, and risk management services and contribute to economic development. Inclusive financial systems are those with a high share of individuals that use financial services (World Bank, 2014; Demirgüç‐Kunt, Klapper, and Singer 2017). Such systems provide individuals with greater access to resources to meet their financial needs, such as saving for retirement, investing in education, capitalizing on business opportunities, and confronting shocks. Inability to use these financial services can contribute to persistent income inequality and slow economic growth.

However, financial systems around the world are far from inclusive. Many poor people around the world lack the financial services that can serve these functions, such as bank accounts and digital payments. They rely on cash, which can be unsafe and difficult to manage. Without access to financial services that enable formal savings and borrowing, these “unbanked” people are also less likely to be able to come up with emergency funds to meet unexpected expenditure needs. This paper focuses on financial inclusion of individuals, provides an overview of how Europe and Central Asian countries fare in the global context, and identifies opportunities and challenges in promoting financial inclusion.

# Why Does Financial Inclusion Matter?

Development theory provides important clues about the impact of financial inclusion on economic development. Available models illustrate how financial exclusion and, in particular, lack of access to finance can lead to poverty traps and inequality (Aghion and Bolton, 1997; Banerjee and Newman, 1993; Galor and Zeira 1993). For example, in the model of Galor and Zeira (1993), it is because of financial market frictions that poor people cannot invest in their education, despite their high marginal productivity of investment. In Banerjee and Newman’s model (1993), the occupational choices of individuals (between becoming entrepreneurs or remaining wage earners) are limited by the initial endowments. These occupational choices determine how much individuals can save and what risks they can bear, with long‐run implications for growth and income distribution. These models show that lack of access to finance can be critical for generating persistent income inequality or poverty traps, as well as lower growth.

There is also a growing body of empirical literature that documents the potential development benefits of financial inclusion, especially from the use of digital financial services, including mobile money services, payment cards, and other financial technology applications. Recent research shows financial inclusion yields a wide range of benefits. Mobile money services, which allow users to store and transfer funds through a mobile phone, can improve people’s income‐earning potential and reduce poverty. A study in Kenya finds that among households headed by women, access to mobile money services increased their savings by more than 20 percent and helped reduce extreme poverty by 22 percent (Suri and Jack 2016).

Digital financial services can also help people manage financial risks and smooth consumption. When times are tough, mobile money services can make it easier for families to receive money from friends and relatives living far away. Digital payment systems can lower the cost of remittances and save time 2