metadata: authors: 0: author: Singh,Raju
1: author: Huang,Yifei
count: Africa
docna: 0: docna: Financial channels, property rights, and
            poverty : a Sub-Saharan African perspective
docty: Policy Research Working Paper
subtopic: Social Policy,Legal Products,Judicial System Reform,Common Property Resource Development,International Trade and Trade Rules,Inflation,Legal Reform,Legislation,Regulatory Regimes,Inequality,Financial Sector Policy
teratopic: Poverty Reduction,Finance and Financial Sector Development
abstracts: cdata!: Studies on the link between financial
            development and poverty have been inconclusive. Some claim
            that deeper financial sectors should improve the allocation
            of capital by allowing entrepreneurs greater access to
            finance, which should particularly favor the poor. Others
            argue that improvements in the financial system primarily
            benefit the rich and politically connected. The literature
            has also been ambiguous about the channels through which
            finance may be associated with lower poverty (deposits
            versus credit). Looking at a sample of 37 countries in
            Sub-Saharan Africa from 1992 through 2006, the paper
            suggests that financial deepening is associated with lower
            poverty through different channels depending on the strength
            of property rights. In the absence of well-defined and
            enforced property rights, wider access to saving and
            risk-sharing instruments is accompanied by a reduction in
            poverty. Only once property rights grow stronger is credit
            associated with lower poverty.
repnme: repnme: Financial channels, property rights, and
            poverty : a Sub-Saharan African perspective
display_title: Financial channels, property rights,
            and poverty : a Sub-Saharan African perspective
listing_relative_url: /research/2016/02/25884473/financial-channels-property-rights-poverty-sub-saharan-african-perspective
topicv3: Personal Property Rights m1326571 1907,Poverty m1326687 695,Inflation m1326709 0870F4727ACED1CF8525815C00471347,Trade m1326924 698,Financial Sector Development m1327681 1920
publishtoextweb_dt: 2016-02-08T00:00:00Z
historic_topic: Poverty Reduction,Finance and Financial Sector Development
no_of_pages: 28
author_keys: 0: author_key: 1074835
model_extractions: WPS7559 Policy Research Working Paper 7559 Financial Channels, Property Rights, and Poverty _Raju Jan Singh Yifei Huang_ Latin America and the Caribbean Region Haiti Country Management Unit February 2016
Policy Research Working Paper 7559

# **Abstract**

Studies on the link between financial development and poverty have been inconclusive. Some claim that deeper financial sectors should improve the allocation of capital by allowing entrepreneurs greater access to finance, which should particularly favor the poor. Others argue that improvements in the financial system primarily benefit the rich and politically connected. The literature has also been ambiguous about the channels through which finance may be associated with lower poverty (deposits versus credit).

Looking at a sample of 37 countries in Sub-Saharan Africa from 1992 through 2006, the paper suggests that financial deepening is associated with lower poverty through different channels depending on the strength of property rights. In the absence of well-defined and enforced property rights, wider access to saving and risk-sharing instruments is accompanied by a reduction in poverty. Only once property rights grow stronger is credit associated with lower poverty.

This paper is a product of the Haiti Country Management Unit, Latin America and the Caribbean Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at rsingh9@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
**Financial Channels, Property Rights, and Poverty: A Sub-Saharan African Perspective**<sup>**1**</sup>

**Raju Jan Singh The World Bank**

# **Yifei Huang GMO**

JEL Classification Numbers: G00, I30, O11, O16, Keywords: financial development, credit, property rights, poverty, Africa Author’s E-Mail Address: <u>rsingh9@worldbank.org; phoebyhuang@gmail.com</u>

> 1 This work was initiated when Raju Jan Singh was a Senior Economist and Yifei Huang a summer intern at the African Department of the International Monetary Fund. We thank Kassia Antoine for her research assistance and for their useful comments on previous drafts Andrew Berg, Punam Chuhan-Pole, Jiro Honda, Roland Kpodar, Mauro Mecagni, Brett Rayner, and Gonzalo Salinas, as well as two anonymous referees The opinions expressed in this paper are those of the authors and do not necessarily reflect those of the International Monetary Fund, the World Bank, or Grantham, Mayo, Van Otterloo & Co., LLC.
# **I.   INTRODUCTION**

While a large body of literature has examined the link between financial development and economic growth, far less attention has been paid to the relationship between finance and poverty. Theory provides conflicting predictions in this regard and empirical evidence has been equally mixed, being ambiguous even about the channels through which finance could effect poverty or inequality. Yet, lack of access to finance has been argued to be one of the main factors behind persistent poverty.<sup>2</sup> Furthermore, research focused on Africa has been limited so far, despite the importance of poverty in this region. According to the latest measure of global poverty, Sub-Saharan Africa is the region with by far the highest headcount ratio of extreme poverty (with about 43 percent of its population falling below the poverty threshold of USD 1.90 a day in 2011 PPP terms). At the same time, the region has the shallowest financial sector in the world, with credit to the private sector amounting to less than 28 percent of GDP (compared to a ratio higher than 75 percent of GDP in East Asia and the Pacific). Cross-country studies have tended to favor broader samples and cover developing countries at best. Using a larger sample increases the degrees of freedom, but it may also introduce unwanted heterogeneity if factors explaining income distribution or poverty differ between country groups.

<!-- Start of picture text --> Poverty Headcount Ratio, 2012* Domestic credit to private sector, 2014*<br>(in percent of population) (in percent of GDP)<br>45 80<br>40 70<br>35 60<br>30 50<br>25 40<br>20<br>30<br>15<br>20<br>10<br>5 10<br>0 0<br>Europe and Middle East Latin America East Asia and South Asia Sub‐Saharan East Asia and Europe and Latin America Middle East South Asia Sub‐Saharan<br>Central Asia and North and Caribbean Pacific Africa Pacific Central Asia and Caribbean and North Africa<br>Africa Africa<br>Source: World Bank Source: World Bank<br>*2008 for Middle East and North Africa * or latest<br><!-- End of picture text --> Deepening the financial sector is also a complex process involving a number of intermediaries and instruments. In this regard, recent theoretical and empirical work has underscored the importance of institutions such as property rights. Yet these dimensions are not directly captured by the most common measure for financial development: private credit.

This paper aims to bring a contribution to the literature in several ways. First, it focuses on Sub-Saharan Africa (SSA), reducing sample heterogeneity and reaching more conclusive results than studies with global coverage on the role of finance in the region. Second, it

> 2 There has also been a considerable literature on the impact of growth and poverty and on how best to reduce income inequality. This paper does not try to argue that financial deepening is the most effective and direct way to reduce poverty, but only discusses a possible association between these two variables.

2
discusses various channels through which financial development could affect poverty (credit versus deposits). Third, it tries to capture explicitly the role of institutions and examines in particular the role of property rights.

Its results suggest that financial deepening is associated with lower poverty through different channels depending on the strength of property rights. When property rights are still illdefined and enforced, wider access to saving and risk-sharing instruments is accompanied by a decline in poverty. Increased credit at this stage benefits mainly the richest segment of the population. It is only when property rights grow stronger that the credit channel is associated with lower poverty.

In what follows, Section II reviews the literature; Section III discusses the data, describes the methodology, and presents the results; and Section IV draws some conclusions.

# **II.   THEORETICAL BACKGROUND AND REVIEW OF THE LITERATURE**

# **A.   Finance and Poverty**

Financial development could help the poor through several channels.<sup>3</sup> First, it has been argued that the poor cannot borrow against future earnings to invest because of the high unit costs of small-scale lending and other imperfections, and hence lack of access to finance is one of the main factors behind persistent poverty (Levine, 2008). Second, the provision of improved financial services could also make it easier for entrepreneurs and households to manage risks and, thereby, expand their economic opportunities (Stiglitz, 1974; Newberry, 1977; Atkinson and Stiglitz, 1980; Townsend, 1982; and Bardhan et al., 2000). A drop in the fixed cost of managing risk would disproportionately benefit poorer households. Along similar lines, even if the financial sector does not provide credit to the poor, it can be nevertheless useful by offering safe and profitable saving opportunities (the “conduit effect”, McKinnon, 1973).

Empirically, many studies looking at micro data find evidence of a positive correlation between lack of access to finance and poverty. Lack of access to credit has been found to perpetuate poverty in Peru, for instance, because poor households cannot afford to provide their children with appropriate education (Jacoby, 1994). Evidence has also shown that households from Indian villages without access to credit markets tend to reduce their children’s schooling when transitory shocks reduce their income (Jacoby and Skoufias, 1997). Rosenzweig and Wolpin (1993) and Rosenzweig and Binswanger (1993) find evidence to support the risk diversification view. Their results suggest that low-wealth

> 3 See Demirguc–Kunt and Levine (2009) for a detailed discussion on the various channels through which finance could affect poverty.

3
households without access to services that would help to manage their risks choose lowerreturn, lower-risk activities compared to households without these constraints.

Work using macro data are, however, less conclusive on a possible association between poverty and financial development. The empirical literature has typically used a banking indicator to measure the credit channel. Some researchers have looked at the ratio of bank assets to GDP, although it also covers credit to the government and state-owned enterprises. Jalilian and Kirkpatrick (2002) find a positive association between financial intermediation and the income of the poor, looking at a sample of advanced and developing economies. Others have considered the ratio of commercial bank assets to total bank assets, although central banks or governments could influence the flow of credit through moral suasion to favor some sectors of the economy. Using this measure, Dollar and Kraay (2002) find that financial development does not affect the poor, examining the average income of the poorest quintile in a sample of advanced and developing economies.

In an environment characterized by rationing and involuntary savings or inappropriately developed institutions to support credit (such as property rights), looking at the credit to the private sector directly may be more appropriate. Beck et al. (2007), Honohan (2004), and Boukhatem and Bochra (2012) have turned to the amount of credit to the private sector in terms of GDP, looking only at developing countries. These authors find that the degree of financial intermediation has a strong positive impact on the income of the poor. Inoue and Hamori (2012) find similar results considering credit in a panel of 28 Indian states. By contrast, Guillaumont-Jeanneney and Kpodar (2011) and Fowowe and Abidoye (2012) conclude that the association between private credit and poverty turns out to be statistically insignificant.

These ambiguous results on the association of private credit and poverty could stem from the omission of institutional factors such a property rights. Examining the role of property rights in SSA countries, Singh and Huang (2015) reach more nuanced conclusions on the association of private credit and poverty. Their results suggest that financial deepening could narrow income inequality and reduce poverty, but only if it is accompanied by stronger property rights. If not, greater access to credit would have the opposite effect.

Finally, studies trying to assess the liquidity channel have used the ratio of broad money to GDP. This measure captures the deposit-gathering risk-management activities of the financial system. It includes the liabilities of central banks, as well as those of commercial banks and other financial intermediaries. Guillaumont-Jeanneney and Kpodar (2011) suggest that the poor benefit primarily from the ability of the banking system to facilitate transactions and provide savings opportunities rather than reaping the benefit of greater access to credit.

4
Looking at a sample of developing countries, these authors find a positive relationship between financial development and poverty if financial development is measured by the ratio of M3 to GDP. Inoue and Hamori (2012) find similar results considering deposits in a panel of 28 Indian states. Kraay (2004), by contrast, studying the association between the change in absolute poverty and the ratio of M2 to GDP in a sample of developing countries, finds that financial development is not associated with a faster decline in poverty.

# **B.   Finance and Property Rights**

Financial institutions operate in settings where information is often asymmetric. On the one hand, entrepreneurs seeking financing normally have more information about their projects than their banks do. On the other, projects that may have different probabilities of success are indistinguishable from the viewpoint of a financial institution. This information asymmetry requires banks to screen applications so as to grant loans only to the most promising projects (Singh, 1992).

Stiglitz and Weiss (1981) have shown, however, that lenders cannot rely simply on increasing the interest rate. Raising the interest rate charged on loans may adversely affect the composition of the pool of borrowers. Lenders would like to be able to identify borrowers who are more likely to repay, since the expected return to lenders depends on the probability of repayment. Those who are willing to borrow at high interest rates, however, are willing to do so because if their project succeeds it will yield a high enough return to cover the high financing costs, but also because they perceive their probability of repaying the loan to be low (and hence are riskier). Under these conditions, for a given expected return, an increase in interest rates will induce low-risk projects to drop out first, leaving only the riskier ones in the pool.

More efficient exchange of information could reduce the cost of screening borrowers. Bank branches bring banks closer to their potential clients and by hiring local staff they can tap into local knowledge to discriminate between high- and low-risk borrowers. GuillaumontJeanneney and Kpodar (2011) show that extending bank coverage may change their initial observation that the poor may not benefit from increased credit. Their results show a positive and significant coefficient for the interaction term between the credit ratio and the number of bank branches per km<sup>2</sup> . In advanced countries, databases centralizing information on borrowers are often established by the private sector or maintained by central banks. These registries collect information on the standing of borrowers in the financial system and make it available to lenders. The system improves transparency, rewarding good borrowers and increasing the cost of default.

As an alternative, lenders could also impose a cost if the entrepreneur defaults by requiring collateral. As higher risk projects entail a greater probability of failure, the same amount of 5
collateral will reduce the expected profit of these projects by more than that of less risky ones. Bester (1985) argued that lenders could design attractive contracts adapted to the various characteristics of borrowers, leading to perfect sorting. In this setting, the poor, who have no formal collateral, would find it difficult to come up with the needed collateral to signal themselves as low-risk endeavors and reap the benefits of a larger financial sector. The rich would thus benefit from a deeper financial sector if reforms to deal with information problems are not carried out at the same time (Banerjee and Newman, 1993; Galor and Zeira, 1993; Piketty, 1997).

In this regard, the importance of legal institutions (especially those protecting private property rights) has been stressed by the law and finance literature in explaining international differences in financial development. Where legal systems enforce private property rights, support private contracts, and protect the legal rights of investors, lenders tend to be more willing to finance firms: in other words, stronger creditor rights tend to promote financial development (see Cottarelli et al., 2003; Acemoglu and Johnson, 2005; Dehesa et al., 2007; McDonald and Schumacher, 2007; Tressel and Detragiache, 2008; and Singh et al., 2010).

But how would clearer property rights help the poor? De Soto (2003) argues that the developing world has accumulated a great deal of wealth. Much of it is “dead capital”, however, that cannot be sold or collateralized to back loans without legal institutions that establish and defend ownership and property rights. The lack of such institutions makes it particularly difficult for the poor to leverage their informal ownership into capital.

# **III.   EMPIRICAL ANALYSIS**

# **A.   Data**

Poverty is usually defined as having insufficient resources or income. In its extreme form, it is a lack of basic human needs, such as adequate food, clothing, housing, clean water, or health services. Poverty is also a lack of education or opportunity, and may be associated with insecurity and fears for the future, lack of representation and freedom. Poverty is therefore a complex reality and may have many faces, often changing from place to place and across time.

Consistent with the existing literature, the paper focuses on the economic aspect of poverty, mainly captured through three indicators of poverty: the headcount index, the poverty gap, and the income of the poorest quintile. The econometric analysis uses panel data for 37 SSA countries averaged over five-year periods from 1992 through 2006.<sup>4</sup>

> 4 The choice of period (1992-2006) is dictated by the availability of data on the institutional and poverty variables.

6
The _headcount index_ measures the percentage of the population living with per capita consumption or income below the poverty line, defined as US$1 a day. This is the most popular measure of poverty because, though arbitrary, it provides a quantifiable metric of people living in what a society at one point in time considers unacceptable conditions.

The _poverty gap_ takes into account the distance of the poor from the poverty line. This measure characterizes how far below the poverty line lies the average income of the poor and provides some sense of distribution. Unlike the headcount index, this indicator captures a decrease or increase in the income of the poor even when it does not cross the poverty line.

The _income of the poorest quintile_ is defined as the average per capita income of the poorest 20 percent of the population, and measures relative poverty. Indeed, indicators based on the poverty line tend to describe poverty in absolute terms. Yet studies suggest that an individual’s welfare depends not only on absolute income, but also on how his or her income compares with that of the rest of the population. Whereas the Gini coefficient measures inequality over the entire distribution of income, the income of the poorest quintile only focuses on the bottom of the distribution. This is an important feature since changes in the Gini coefficient may be associated, for instance, with income redistributed from the top to the middle class without affecting the bottom quintile (Deininger and Squire, 1996).

This paper will consider two indicators of financial development in an attempt to highlight the channels through which finance could be associated with poverty. The ratio of private credit to GDP, which excludes credit to the government or state-owned enterprises, captures the actual amount of credit channeled from savers to private firms through financial intermediaries. The ratio of broad money to GDP (M3/GDP) captures the deposit-gathering activity of the financial system and its ability to offer an instrument to save and diversify risk. One would expect money and credit to be closely linked, representing the two sides of the same balance sheet. Deposits enable banks to lend and bank credit ends up in deposits. In an environment characterized by rationing or inappropriately developed institutions to support credit, however, these two indicators may diverge.

The research reviewed above suggests that financial development is associated with progress in strengthening property rights. Following this literature, this paper examines the role of the interaction of property rights and financial development in poverty reduction. The strength of property rights is captured by an index measuring the ability of individuals to accumulate private property, secured by clear laws that the state fully enforces. The indicator also assesses the likelihood that private property may be expropriated and the ability of individuals and businesses to enforce contracts. The index ranges between 0 and 100 (strongest), and is compiled annually by the Heritage Foundation.

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The more certain the legal protection of property, the higher a country’s score. A score of 100 would describe a country where private property is guaranteed by the government. The court system enforces contracts efficiently and quickly, and there is no corruption or expropriation. Hong Kong SAR, China, and Singapore, for instance, rank at the top with a score of 90. In the opposite direction, a score of 0 would describe a country where private property would be outlawed, and all property belong to the state. Corruption would be endemic and people would have no access to the courts. The Democratic People’s Republic of Korea has a score of 5.

Finally, in line with Dollar and Kraay (2002), we include a set of control variables that are commonly used as factors determining poverty: overall income per capita, to capture the contribution of economic development ( _GDP per capita_ ); growth of the consumer price index, to control for the macroeconomic environment ( _inflation_ ); and the degree of international openness ( _trade openness_ ) measured by the sum of exports and imports as a share of GDP. The inclusion of the latter two variables has been used as a robustness test. Incorporating GDP per capita in the estimation also controls for any indirect effect our variables could have on poverty through a faster growth rate.

Tables 1 and 2 present descriptive statistics and correlations for the sample period. Table 1 shows that there are wide cross-country differences in the prevalence of poverty. Similarly, the countries in the sample demonstrate important variations in financial sector development as measured by the private credit-to-GDP ratio or by the broad money-to-GDP ratio.

Table 1. Descriptive Statistics, 1992-2006

|Variables|Observations|Mean|Standard<br>deviation|Minimum|Maximum|
|---|---|---|---|---|---|
|Headcount index (log)|69|3.63|0.65|0.59|4.39|
|Income of the poorest quintile (log)|67|2.49|0.51|0.89|3.69|
|Poverty gap (log)|69|2.58|0.90|-1.11|3.93|
|Private credit over GDP (log)|69|2.08|1.37|-4.74|4.17|
|M3/GDP (log)|69|3.13|0.39|1.87|3.98|
|GDP per capita (log)|69|5.78|0.79|4.48|8.28|
|Property rights (log)|65|3.68|0.41|2.30|4.25|
|Inflation (log(1+inflation rate))|69|0.12|0.16|0.01|1.12|
|Trade openness (log)|69|4.09|0.47|2.98|5.17|

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Table 2. Correlation Matrix

|Variables|1|2|3|4|5|6|7|8|9|
|---|---|---|---|---|---|---|---|---|---|
|Headcount index (log)|1<br>1.00|||||||||
|Income of the poorest|2<br>-0.8311*|1.00||||||||
|quintile (log)|(0.00)|||||||||
|Poverty gap (log)|3<br>0.9832*<br>(0.00)|-0.8946*<br>(0.00)|1.00|||||||
|Private credit over<br>GDP (log)|4<br>-0.3454*<br>(0.00)|0.3413*<br>(0.00)|-0.3603*<br>(0.00)|1.00||||||
|M3/GDP (log)|5<br>-0.2538*|0.2173*|-0.2720*|0.2893*|1.00|||||
||(0.04)|(0.08)|(0.02)|(0.02)||||||
|GDP per capita (log)|6<br>-0.5809*|0.3454*|-0.5147*|0.2820*|0.2212*|1.00||||
||(0.00)|(0.00)|(0.00)|(0.02)|(0.07)|||||
|Property rights (log)|7<br>-0.0811|-0.0604|-0.0485|0.2545*|0.1922|0.2933*|1.00|||
||(0.52)|(0.64)|(0.70)|(0.04)|(0.13)|(0.02)||||
|Inflation|8<br>0.1563|-0.2683*|0.2159*|-0.1466|-0.0969|0.016|0.0949|1.00||
|(log(1+inflation rate))|(0.20)|(0.03)|(0.07)|(0.23)|(0.43)|(0.90)|(0.45)|||
|Trade openness (log)|9<br>-0.2144*|0.0425|-0.1253|0.0011|0.1405|0.4506*|0.1481|0.2393*|1.00|
||(0.08)|(0.73)|(0.30)|(0.99)|(0.25)|(0.00)|(0.24)|(0.05)||

Notes: p value in brackets; * indicates a correlation coefficient significant at 10 percent confidence level or less.

As could be expected, the private credit and M3/GDP ratios appear positively correlated. As suggested in previous research, private credit to GDP and M3 to GDP are correlated positively with GDP per capita. They are also negatively correlated with the headcount index and the poverty gap, and positively with the income of the poorest quintile. In addition, richer countries as measured by GDP per capita tend to have lower poverty levels; so are countries with sound macroeconomic policies measured by the inflation rate.

# **B.   Methodology and Main Results**

To examine the association of financial development with poverty, the paper will first consider different measures of poverty and credit to the private sector. It will then consider broad money as an alternative indicator of financial development. In both cases, the model will allow for a nonlinear relationship between financial development and poverty by investigating whether property rights help alleviate poverty through a more efficient financial system. We expect to see financial development to be negatively associated with poverty, and stronger property rights not only to be linked with lower poverty, but also to enhance the negative relationship between financial deepening and poverty.

For this purpose, a standard model along the lines of Dollar and Kraay (2002) and Clarke et al. (2006) will be used, where poverty depends on financial development, and a set of economic and institutional conditions. We also introduce an index on property rights (PR) 9
and an interaction term with our financial development variable. The model specification is as follows: log( _Pi_ , _t_ )   0  log( _FDi_ , _t_ )   2  log( _PRi_ , _t_ )   3  log( _FDi_ , _t_ )  log( _PRi_ , _t_ )   4  _X i_ , _t_  _u i_  _vt_   _i_ , _t_ where<sup>_P_</sup> _i_ , _t_<sup>is one of the poverty indicators in country</sup><sup>_i_at time</sup><sup>_t_.</sup> _FDi_ , _t_ represents private credit over GDP or M3 over GDP, _PRi_ , _t_ is the property right indicator, _X i_ , _t_ stands for a set of control variables,<sup>_u_</sup> _i_<sup>is an unobserved country-specific effect;</sup><sup>_v_</sup> _t_<sup>is a time dummy, and</sup>  _i_ , _t_ is the error term.

The relationship between finance and our measures of poverty could face an endogeneity problem, stemming from measurement errors, omitted variables or potential reverse causality. One could argue, for instance, that as poverty drops, a larger share of the population becomes bankable, increasing the demand for financial services and thereby developing the financial sector. To try to deal with these issues, we used the Feasible Generalized Least Squares (FGLS) method, including country and time random effects. This approach is also more appropriate for our panel data than fixed effect models because the time span is short: for each country, data are available from at most three periods. Furthermore, a Hausman test failed to reject the null hypothesis that the right-hand-side variables are not correlated with the error term, favoring the random-effects specification.

To further test our results, we also ran the model using a two-stage least squares estimator for panel-data models. To instrument financial development, we relied on a range of instruments used previously in the literature: the legal origin (Beck, Demirguc-Kunt, and Levine, 2003), the initial values of financial development and creditor rights (Kim and Lin, 2011), and an indicator of overall strength of the legal environment (the rule of law index). Regarding income per capita, we followed Barrios et al. (2010), and Brückner and Lederman (2012) and used rainfall as an instrument.<sup>5</sup> The results are presented in Tables 3-10. Turning first to the control variables, we find a significant association between GDP per capita and poverty: negative when measured by the headcount index or the poverty gap, positive for the income of the poorest quintile. The coefficients are significantly lower than unity, however, suggesting that in our sample growth benefits less than proportionally the poorest segments of the population. Inflation is consistently detrimental for the poor. Trade openness does not seem to have a significant

> 5 The Hansen test statistics do not reject the validity of the instruments.

10
impact on poverty measured as the headcount index or the poverty gap, but seems to be negatively associated with the income of the poorest.<sup>6</sup> The results on the general relationship between private credit and poverty are reported in Tables 3-5, columns 1-2. One observes that for all three indicators of poverty, there seems to be a negative and significant association: the greater the credit to the private sector, the lower the headcount poverty and the poverty gap, the higher the income of the poorest quintile. This observation holds whether only the level of economic development is controlled for (Tables 3-5, column 1) or additional control variables are included, namely inflation and trade openness (Tables 3-5, column 2). A 1 percent increase in the private credit-to-GDP ratio would be associated, for instance, with about a 0.1 percent increase in the income of the poorest. These results are for the average quality of property rights observed in our sample. Controlling for the quality of property rights reveals, however, a more subtle and interesting relationship.

When assessing the role of property rights (Tables 3-5, columns 3-4), the results indicate that the coefficients on both the property rights variable and its interaction term with the financial development indicator are generally significant: negative when the dependent variable is the headcount index or the poverty gap, and positive when the response variable is the income of the poorest. Controlling for the quality of property rights reveals that in some instances financial development may be detrimental to the poor. Consistent with Singh and Huang (2015) and similar to the observation on bank coverage in Guillaumont-Jeanneney and Kpodar (2011), the results suggest that, when property rights are ill defined and enforced, greater credit to the private sector could be detrimental to the poor. Only as property rights strengthen does this negative relationship reverse. The inclusion of additional control variables does not change these results. The threshold is relatively low, however. Using specification 4 of Table 5, the level of the property rights index below which the marginal impact of the private credit ratio on poverty becomes positive is estimated at 2.85. Figure 1 shows that all countries in the sample are above that threshold, with the exception of three: Guinea-Bissau, Rwanda, and Sierra Leone. The use of instrumental variables does not alter these results (Table 9).

We consider next broad money as an alternative measure and channel for financial development (Tables 6-8). The previous results hold with one interesting exception: deposit

> 6 The lack of clear correlation between trade openness and poverty might arise from the fact that all the poor are not equally affected by trade reforms. Some poor may be in sectors loosing from higher trade openness (importsubstitution sectors), while others are in the sectors benefiting from trade reforms (export-oriented sectors). In addition, Winters et al. (2004) and more recently Le Goff and Singh (2014) argue that the impact of trade liberalization on poverty depends on country context and accompanying policies, which may be not appropriately captured in cross-country or panel regressions.

11
gathering seems to be associated with lower levels of poverty even in an environment with weak property rights. The coefficients of the interaction terms suggest that this positive relationship fades as property rights grow stronger, but it remains beneficial to the poor. Indeed, Figure 2 suggests that for all countries in the sample, the marginal impact of M3/GDP on poverty remains negative in the headcount poverty and poverty gap models, and positive when poverty is measured by the income of the poorest. Consistent with Guillaumont-Jeanneney and Kpodar (2011), this result would suggest that at early stages the poor may benefit primarily from the ability of the financial system to provide saving and risk-sharing instruments rather than from wider access to credit. As enforcement of property rights strengthens, the benefits from access to credit for the poor become greater. Here again, the inclusion of additional control variables or the use of instrumental variables does not alter the results (Table 10).

# **IV.   SUMMARY AND CONCLUSIONS**

While financial development and its effects on economic growth have attracted considerable attention in the literature, far less work has been done on the relationship between financial deepening and poverty. Theory provides conflicting predictions in this regard and empirical evidence has been equally mixed, being ambiguous even about the channels through which finance could effect poverty. Does increased finance open opportunities for all or does it benefit mosly the richest segment of the population? Is credit the vector for higher income or is it deposits by providing a safe instrument to manage risk? What is the role of institutions and in particular property rights? This paper aimed at contributing to this debate by focusing on SSA countries, introducing institutional variables such as property rights, and examining various channels. By doing so, we hoped to reach more conclusive results.

Our estimations suggest that financial deepening is associated with less poverty in SSA countries but its channels depend on the strength of property rights. In the absence of well defined and enforced property rights, financial development seems to reduce poverty by offering saving and risk-sharing instruments, along the lines of the “conduit effect” put forward by McKinnon. At that stage, greater access to credit mostly benefits the richest segments of the population. Only once property rights grow stronger does credit contribute to lower poverty.

The main policy implications are that improving access to credit for the private sector is not enough to reduce poverty and income inequalities. If financial development is to be pro-poor, it needs to be accompanied by efforts to firm up property rights. This is, however, an equally complex process. It would depend, for instance, on efficient property registration and land surveying in both urban and rural areas. Land rights are, however, very often defined by customary law in rural areas. While moving towards more formal property registration, care should be taken not to undermine customary rights and transfer unintentionally property to 12
richer segments of the population. It would also be important to reform courts to improve enforcement.

In addition, financial development is a complex process involving a number of intermediaries and instruments. Capturing this multi-dimensional concept through credit or deposits even when taking into account institutional variables such as property rights may still be incomplete. Examining financial stability, efficiency and access would also be important dimensions to assess the true role of the financial sector in reducing poverty.

Further work to refine the analysis provided in this paper could thus include case studies of countries where improvements in defining and enforcing property rights have been successfully achieved and possible lessons could be drawn. Further empirical studies using multi-dimensional poverty indicators could be carried out to confirm the results presented in this paper, as well as examining the role of financial stability, efficiency and access more directly as indicators capturing these dimensions become more widely available.

While strengthening of property rights would make the poor more creditworthy, there could be nevertheless other constraints on the supply side that could continue preventing them from accessing credit. For instance, low competition in the banking system, lack of innovation and reluctance to engage in “risky” activities could constrain credit to the poor even if property rights are well defined and enforced in the courts.

One could argue that lower competition would lead to higher market power, and the ability to charge higher interest rates on loans and less pressure to enter into under-served segments of the market. One could also argue the opposite, however: with monopoly power, even locally, a bank could have an incentive to foot the cost of screening under-serviced customers since once identified there will be no competitor to attract them away. It would also be easier for the bank to monitor its customers and make sure they repay their loans on time, since they would not be able to shop around. All this could lead to better access to credit. Testing these hypotheses under various institutional settings would be another path calling for further investigation.

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Table 3. Financial Development (Credit/PIB), Property Rights and Poverty (Headcount poverty)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|Private Credit/GDP (log)|-0.084|-0.078|0.371|0.436|
||(4.04)***|(4.16)***|(2.00)**|(2.29)**|
|GDP per capita ($US, log)|-0.454|-0.454|-0.452|-0.505|
||(8.89)***|(8.01)***|(7.55)***|(8.47)***|
|Property Rights (log)|||-0.299|-0.339|
||||(1.87)*|(2.04)**|
|Private Credit/GDP (log) * Property Rights (log)|||-0.138<br>(2.60)***|-0.153<br>(2.77)***|
|Inflation (log)||0.377||0.331|
|||(3.93)***||(3.21)***|
|Trade Openness (log)||-0.013||0.068|
|||(0.15)||(0.84)|
|Constant|5.857|5.906|6.870|7.059|
||(18.48)***|(15.79)***|(12.27)***|(12.26)***|
|Observations|69|69|65|65|
|Number of countries|34|34|33|33|
|Chi square (Wald test)|192.79|207.64|210.12|320.39|
|Pseudo R2|0.43|0.44|0.44|0.45|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

Table 4. Financial Development (Credit/PIB), Property Rights and Poverty (Income of the poor)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|Private Credit/GDP (log)|0.103|0.086|-0.218|-0.312|
||(4.45)***|(5.15)***|(1.18)|(1.77)*|
|GDP per capita ($US, log)|0.212|0.239|0.202|0.223|
||(5.88)***|(8.66)***|(4.87)***|(4.90)***|
|Property Rights (log)|||0.012|0.108|
||||(0.06)|(0.61)|
|Private Credit/GDP (log) * Property Rights (log)|||0.096<br>(1.80)*|0.117<br>(2.29)**|
|Inflation (log)||-0.371||-0.419|
|||(3.52)***||(4.56)***|
|Trade Openness (log)||-0.214||-0.203|
|||(3.28)***||(3.12)***|
|Constant|1.716|2.429|1.746|2.107|
||(6.95)***|(7.36)***|(2.98)***|(3.27)***|
|Observations|67|67|63|63|
|Number of countries|34|34|33|33|
|Chi square (Wald test)|104.16|519.75|206.72|378.54|
|Pseudo R2|0.39|0.33|0.34|0.32|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

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Table 5. Financial Development (Credit/PIB), Property Rights and Poverty (Poverty gap)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|Private Credit/GDP (log)|-0.115|-0.105|0.463|0.660|
||(3.15)***|(3.40)***|(1.66)*|(2.26)**|
|GDP per capita ($US, log)|-0.576|-0.595|-0.539|-0.640|
||(7.83)***|(7.22)***|(6.46)***|(8.00)***|
|Property Rights (log)|||-0.292|-0.469|
||||(1.16)|(1.83)*|
|Private Credit/GDP (log) * Property Rights (log)|||-0.181<br>(2.23)**|-0.228<br>(2.69)***|
|Inflation (log)||0.732||0.739|
|||(4.71)***||(3.89)***|
|Trade Openness (log)||0.090||0.171|
|||(0.67)||(1.38)|
|Constant|5.351|5.070|6.089|6.687|
||(11.53)***|(8.36)***|(7.22)***|(7.10)***|
|Observations|69|69|65|65|
|Number of countries|34|34|33|33|
|Chi square (Wald test)|134.01|265.23|132.64|172.40|
|Pseudo R2|0.44|0.44|0.44|0.44|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

Table 6. Financial Development (M3/PIB), Property Rights and Poverty (Headcount poverty)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|M3/GDP (log)|-0.145|-0.166|-1.355|-1.239|
||(1.76)*|(1.82)*|(5.56)***|(5.54)***|
|GDP per capita ($US, log)|-0.450|-0.479|-0.546|-0.571|
||(8.20)***|(7.61)***|(12.65)***|(11.83)***|
|Property Rights (log)|||-0.877|-0.695|
||||(4.01)***|(3.33)***|
|M3/GDP (log) * Property Rights (log)|||0.299|0.248|
||||(4.48)***|(3.75)***|
|Inflation (log)||0.504||0.594|
|||(5.13)***||(7.28)***|
|Trade Openness (log)||-0.053||-0.026|
|||(0.61)||(0.46)|
|Constant|6.572|6.977|10.670|10.427|
||(25.82)***|(21.03)***|(13.77)***|(14.34)***|
|Observations|70|67|66|64|
|Number of countries|36|34|34|33|
|Chi square (Wald test)|166.04|165.53|272.75|423.44|
|Pseudo R2|0.39|0.46|0.44|0.48|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

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Table 7. Financial Development (M3/PIB), Property Rights and Poverty (Income of the poor)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|M3/GDP (log)|0.077|0.128|1.051|1.125|
||(1.12)|(2.00)**|(2.97)***|(2.97)***|
|GDP per capita ($US, log)|0.236|0.275|0.322|0.239|
||(5.11)***|(5.76)***|(7.58)***|(4.79)***|
|Property Rights (log)|||0.677|0.559|
||||(1.97)**|(1.55)|
|M3/GDP (log) * Property Rights (log)|||-0.247|-0.205|
||||(2.51)**|(1.99)**|
|Inflation (log)||-0.599||-0.406|
|||(6.17)***||(3.35)***|
|Trade Openness (log)||-0.072||-0.142|
|||(1.05)||(1.78)*|
|Constant|1.051|0.993|-2.140|-1.350|
||(5.05)***|(3.00)***|(1.64)|(1.02)|
|Observations|68|65|64|59|
|Number of countries|36|34|34|32|
|Chi square (Wald test)|55.58|164.49|166.67|217.41|
|Pseudo R2|0.38|0.43|0.40|0.38|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

Table 8. Financial Development (M3/PIB), Property Rights and Poverty (Poverty gap)

||(1)|(2)|(3)|(4)|
|---|---|---|---|---|
|M3/GDP (log)|-0.306|-0.352|-1.791|-1.526|
||(2.84)***|(3.19)***|(4.43)***|(3.44)***|
|GDP per capita ($US, log)|-0.583|-0.616|-0.661|-0.713|
||(8.32)***|(7.28)***|(9.12)***|(8.28)***|
|Property Rights (log)|||-1.089|-0.763|
||||(2.92)***|(1.84)*|
|M3/GDP (log) * Property Rights (log)|||0.383|0.295|
||||(3.25)***|(2.27)**|
|Inflation (log)||0.905<br>(5.91)***||1.074<br>(5.65)***|
|Trade Openness (log)||0.037||-0.011|
|||(0.33)||(0.09)|
|Constant|6.661|6.764|11.372|10.667|
||(22.69)***|(12.85)***|(8.56)***|(7.09)***|
|Observations|70|67|66|64|
|Number of countries|36|34|34|33|
|Chi square (Wald test)|254.52|180.44|336.40|160.53|
|Pseudo R2|0.39|0.45|0.43|0.48|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

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Table 9. Financial Development (Credit/PIB), Property Rights and Poverty: Instrumental Variable

||Headcount<br>poverty|Income of<br>thepoor|Poverty<br>gap|
|---|---|---|---|
|Private Credit/GDP (log)|1.111|-1.297|1.659|
||(2.04)**|(2.47)**|(1.95)*|
|GDP per capita ($US, log)|-0.853|0.683|-1.204|
||(3.88)***|(3.50)***|(3.60)***|
|Property Rights (log)|-0.995|1.061|-1.491|
||(2.27)**|(2.54)**|(2.17)**|
|Private Credit/GDP (log) * Property Rights (log)|-0.354|0.405|-0.527|
||(2.24)**|(2.65)**|(2.12)**|
|Inflation (log)|0.759|-0.963|1.396|
||(2.00)*|(2.75)***|(2.39)**|
|Trade Openness (log)|0.104|-0.170|0.227|
||(0.47)|(0.84)|(0.67)|
|Constant|11.190|-3.931|13.160|
||(6.06)***|(2.30)**|(4.62)***|
|Observations|45|45|45|
|Number of countries|26|26|26|
|R2|0.48|0.43|0.43|
|Hansen test|0.89|0.62|0.84|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

Table 10. Financial Development (M3/PIB), Property Rights and Poverty: Instrumental Variable

||Headcount<br>poverty|Income of<br>thepoor|Poverty<br>gap|
|---|---|---|---|
|M3/GDP (log)|-1.579|1.757|-3.005|
||(2.07)**|(1.81)*|(2.30)**|
|GDP per capita ($US, log)|-0.411|0.398|-0.517|
||(2.43)**|(1.87)*|(2.07)**|
|Property Rights (log)|-1.079|1.274|-2.030|
||(1.75)*|(1.68)*|(1.94)*|
|M3/GDP (log) * Property Rights (log)|0.351|-0.420|0.658|
||(1.76)*|(1.68)*|(1.92)*|
|Inflation (log)|0.410|-0.688|0.975|
||(1.11)|(1.73)*|(1.79)*|
|Trade Openness (log)|0.040|-0.192|0.148|
||(0.22)|(0.92)|(0.54)|
|Constant|10.608|-4.136|14.039|
||(4.44)***|(1.40)|(3.46)***|
|Observations|50|49|50|
|Number of countries|29|29|29|
|R2|0.51|0.37|0.52|
|Hansen test|0.30|0.19|0.33|

Notes: Data are averaged over five years. Absolute value of t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

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Figure 1. Marginal Impact of Financial Development (Private credit/GDP) on Poverty Depending on Country’s Strength in Property Rights <!-- Start of picture text --> Headcount poverty model Income of the poorest<br>RWASLEGNB B S EN WZ A<br>UGAUGAGMB<br>SEN<br>M ETH ZAFKEN TZACIV LSOG NGS MB A HDG LI WIA<br>TZBFETH A<br>CAF M CMRDGLIMLIGMBUGA<br>COG MRTBEN A TGOCIV CD FADI GAMR OZ N R<br>COG<br>BFA ETH MRT A TNGC CDG DIERIV MR OZ N O A<br>CAF M CMRDGLIMLIGMBUGA<br>ETHTZBF A<br>MZAFKEN TZAETHNGCIV GH S LSOMB A DG LI WIA<br>SEN<br>UGAUGAGMB<br>RWAGNBSLE<br>B S EN WZ A<br>2.5 3 3.5 4 4.5 2.5 3 3.5 4 4.5<br>Property right index (log) Property right index (log)<br>Povert gap model<br>RWASLEGNB<br>COG<br>BDITMRT ETHA NGCIV GCD FAER MR OZ N O A<br>CAF M CMRDGLIMLIUGAGMB<br>BFTZETH A<br>TZA ZMBKEN ETH MWILSO SCIVNG GHAF ALI DGA<br>SEN<br>UGAGMBUGA<br>B SW ENA Z<br>2.5 3 3.5 4 4.5<br>Property right index (log)<br>.1 .2<br>.15<br>0<br>.1<br>.05<br>-.1<br>0<br>Marginal impact of Private credit/GDP Marginal impact of Private credit/GDP<br>-.2<br>-.05<br>.1<br>0<br>-.1<br>-.2<br>Marginal impact of Private credit/GDP<br>-.3<br><!-- End of picture text --> 18
Figure 2. Marginal Impact of Financial Development (M3/GDP) on Poverty Depending on Country’s Strength in Property Rights <!-- Start of picture text --> Headcount poverty model Income of the poorest<br>B SW ENAZ<br>UGAGMBUGA RWASLEGNB<br>SEN<br>ZAFM TZA KEN ETH GHALSO CIVNGS MB A DG LI WI<br>BFETHTZ A<br>CAF M CMRLIDGMLIUGAGMB<br>AETH MRTNERBDITGOCIV CD FA MRGA OZ N<br>COG<br>COG<br>MBFAT A CNG GCD DIE MR IV RT OZ N RO A<br>CAF M CMRLIDGMLIGMBUGA<br>BFTZETH A<br>ETH ZMB TZA K CIV GHAMDG S LSO NG AFENWI LI<br>SEN<br>UGAGMBUGA<br>B SW ENAZ<br>RWAGNBSLE<br>2.5 3 3.5 4 4.5 2.5 3 3.5 4 4.5<br>Property right index (log) Property right index (log)<br>Poverty gap model<br>B S EN W AZ<br>UGAUGAGMB<br>SEN<br>ZMB ETH K TZA MDGGHA SCIV LSO NG AFEN A WI LI<br>TZETHBF A<br>CAF M CMRLIDGMLIGMBUGA<br>BDINERT ETHA CIVMOZ GCD FA MR GRT N O A<br>COG<br>RWAGNBSLE<br>2.5 3 3.5 4 4.5<br>Property right index (log)<br>-.2 .7<br>-.3 .6<br>-.4 .5<br>-.5 .4<br>Marginal impact of M3/GDP -.6 Marginal impact of M3/GDP .3<br>-.7 .2<br>-.2<br>-.4<br>-.6<br>Marginal impact of M3/GDP<br>-.8<br><!-- End of picture text --> 19
# Appendix I—Sample

Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Congo Rep., Congo Dem. Rep., Côte d'Ivoire, Ethiopia, Gabon, Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Madagascar, Malawi, Mali, Mauritania, Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, Sierra Leone, South Africa, Swaziland, Tanzania, Togo, Uganda, and Zambia.

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Appendix 2: Variable Definitions and Data Sources

|Variable|Definition|Source|
|---|---|---|
|Headcount index|Headcount index is the percentage of population<br>living in households with consumption or income per<br>person below the poverty line ($1 per day). It is also<br>called poverty incidence.|PovcalNet|
|Poverty gap|Poverty gap is a ratio of the distance of mean<br>shortfall from the poverty line ($1 a day or less) and<br>the poverty line. It characterizes how far below the<br>’|PovcalNet|
||poverty line the average poors income lies.||
|Income of the poorest<br>quintile|Defined as the share of income earned by the poorest<br>quintile times average income divided by 0.2;<br>however, when the first quintile share is not|Dollar and Kraay<br>(2002),<br>WIDER database|
||available, it is assumed that the distribution of<br>income is lognormal, and the share of income<br>accruing to the poorest quintile is obtained as the 20<sup>th</sup><br>percentile of this distribution, using Gini coefficient.|PovcalNet|
|GDP per capita|Nominal gross domestic product divided by the size<br>of the population|IMF database|
|Private credit over GDP|Private credit by deposit money banks to GDP.|Financial Structure<br>Database (2007), and<br>International<br>Financial Statistics<br>(2007)|
|M3/GDP|Liquid liabilities of the financial system as a percent<br>of GDP.|WDI database|
|Property rights|An index measuring the ability of individuals to<br>accumulate private property, secured by clear laws<br>that are fully enforced by the state.|Heritage Foundation<br>database (2007)|
|Inflation|Annual change in consumer price index (CPI)|WDI database|
|Trade openness|Sum of imports plus exports as share of GDP (in<br>percentage)|WDI database|
|Legal origin|A dummy variable taking 1 when a country’s law is<br>based on English common law; and 0 otherwise.|La Porta and others<br>(1998)|
|Rainfall|Average annual rainfall.|Ciccone (2011) and<br>WDI database|
|Creditor rights|The index measures the legal rights of creditors<br>against defaulting debtors in different jurisdictions,<br>and ranges from 1 to 4, with a higher value indicating<br>stronger creditor rights.|Djankov, McLeish,<br>and Shleifer (2005)|
|Rule of law|<br>A score measuring the extent to which agents have<br>confidence in and abide by the rules of society, and in<br>particular the quality of contract enforcement, the<br>police, and the courts, as well as the likelihood of<br>crime and violence|Governance Matters<br>(World Bank)|

21