information systems. In addition, greater trade-offs between the inclusion of individuals and stability are associated with greater investment freedom—including less regulated domestic and foreign capital flows and labor markets—and deeper financial systems as measured by credit to GDP. It appears that the tradeoffs in the country context of greater financial openness, investment freedom, and financial depth, can be mitigated or even reversed when financial policy to advance financial inclusion of individuals is accompanied by deepening of credit information systems. While fiscal freedom and population density have to be treated exogenous to financial policy, coordination with fiscal and urbanization policies could help as well.

# **6 Conclusion**

Understanding the interrelationship between financial inclusion and stability is paramount for policy makers. This paper confirms that there is indeed much to gain from coordinated policies that take into account synergies and trade-offs between financial inclusion and financial stability. On average, there appears to be a trade-off between financial inclusion and stability that should be considered by policy makers. However, both trade-offs and synergies are found in cross-country experience depending on the indicator of stability and inclusion one is examining. This implies that while trade-offs can dominate the relationship between inclusion and stability, synergies can occur with almost equally high probability. Excluding periods of crisis, we find that greater financial inclusion is associated with greater stability and may mitigate expected losses of the financial sector. But greater financial inclusion, particularly associated with extensive borrowing by individuals, may also increase the risk of extreme events, unexpected losses of the financial system, and ultimately more frequent banking crises.

The relationship between inclusion and stability is systematically influenced by country characteristics, such as financial openness, tax rates, education, and the depth of credit information systems. While financial openness increases trade-offs between inclusion and stability, low tax rates, education, and credit information depth help generate synergies between the two goals. Greater financial openness and movement of capital is particularly challenging in middle and low income countries that tend to have a limited capacity to manage capital flows and ensure prudent and efficient allocation of the funding to creditworthy firms and individuals. Low tax rates may generate synergies by stimulating precautionary savings due to smaller social safety nets and greater probability of unexpected increases in taxes. Education can generate a positive relationship between inclusion and stability by improving financial literary and responsible financial inclusion that helps the financial system reap the benefits of economic scale and risk diversification. The depth of credit information systems generates synergies by improving screening of creditworthy customers, including new users of credit, and aids stability by, for example, improving the accuracy of estimations of expected losses. Finally, greater information depth also promotes competition in oligopolistic markets, decreases the cost of finance, and encourages more firms and people to start using a financial service or use more than one financial service. Particularly if financial policy focuses on advancing the financial inclusion of individuals, complementary policies to deepen credit information systems could help mitigate the estimated trade-offs with financial stability.

Our findings have important policy implications. Because trade-offs and synergies between financial inclusion and financial stability are significant, they need to be addressed in policy making. Because 17