Financial inclusion transitions in Peru: does labor informality play a role?

Summary

Focus

In recent years, financial inclusion (FI) has become a prominent policy goal in emerging market and developing economies (EMDEs). FI is generally understood as affordable access to financial services provided by formal financial intermediaries, including payments, savings, credit and insurance. FI may depend on another key feature of EMDEs, namely labor informality (LI). Workers with informal jobs typically operate in cash-based ecosystems and may view opening a bank account as a burden.

Contribution

Using Peruvian survey data from 2015–18, we explore the dynamic relationship between FI and LI. In particular, we examine how LI and movements between formal and informal jobs may affect the probability of entering and exiting the formal financial system (ie opening and closing a bank account). As far as we know, ours is the first paper to consider the relationship between the two in a dynamic setting, and thus to consider both FI and LI as dynamic processes (comparable with movements into and out of employment or poverty).

Findings

We find that becoming informally employed reduces the probability of entering the formal financial system by 8 percentage points (pp). It increases the likelihood of exiting from it by 9.3 pp. Relative to persistently informal workers, those who stay in formal jobs have a 9 pp higher probability of gaining access to bank accounts and a 12 pp lower probability of losing access. Workers who move into formal jobs are more likely to enter the formal financial system by 9.7 pp and less likely to exit from it by 7.1 pp.

Abstract

Low financial inclusion and high labor informality are two major challenges in developing countries. Using Peruvian survey data from 2015-18, we explore the dynamic relationship between these two variables by examining how labor informality and movements between formal and informal jobs may affect the transition probabilities of financial inclusion. First, we find that becoming informally employed reduces the probability of entering the formal financial system by 8 percentage points (pp) and increases the likelihood of exiting from it by 9.3 pp. Relative to persistently informal workers, those who stay in formal jobs have a 9 pp higher probability of gaining access to bank accounts, and 12 pp lower probability of losing access. Workers who move into formal jobs are more likely to enter the formal financial system by 9.7 pp and less likely to exit from it by 7.1 pp. These results underscore the complementarity of formalizing the informal sector and expanding access to financial services.

JEL Classification: C23, D14, E26, I31, O17 

Keywords: financial inclusion, labor informality, transition probabilities, dynamic random-effect panel probit