Journal of Economics and Business xxx (xxxx) xxx

Contents lists available at ScienceDirect

Journal of Economics and Business

journal homepage: www.elsevier.com/locate/jeb

What do we know about the relationship between banks and

income inequality? Empirical evidence for emerging and
low-income countries
Claudio Oliveira de Moraes a, *, Guilherme Cruz b
a
Central Bank of Brazil, and Coppead–Graduate Business School, Rio de Janeiro, RJ, Brazil
b
Coppead–Graduate Business School, Rio de Janeiro, RJ, Brazil

A R T I C L E I N F O A B S T R A C T

Keywords: The objective of this article is to examine whether the banking sector contributes to reducing
Income inequality income inequality and poverty. We assess the effect of banks on income inequality considering
Poverty various banking qualities with a dynamic panel data analysis of 46 emerging markets (EMs) and
Banking sector
66 low-income countries (LICs) using updated data for the 2000–2018 period. The simultaneous
Financial development
Financial inclusion
and non-linear effects of banking qualities were also evaluated. The results indicate that banking
Non-linearity activities (i.e., availability, relevance, and financial efficiency) reduce income inequality and
Emerging markets (EMs), low-income countries poverty for EMs and LICs. However, there is an optimal degree of each quality mentioned for
(LICs) banks’ impact on inequality beyond which it increases rather than decreases income inequality.

1. Introduction

The important role that the financial system plays in determining income inequality has recently been changing mainstream
macroeconomic thought. The idea that central banks are strictly responsible for controlling inflation is no longer hegemonic, as stated
in Shambasugh & Strain (2021). The Federal Reserve (The Fed), The Reserve Banks of New Zealand, Japan, and England, and, most
recently, the European Central Bank are actively emphasizing central banks’ role in maximizing employment. As pointed out in the
Global Financial Stability Report published by the International Monetary Fund (IMF, 2021), policymakers worldwide are loosening
regulatory policies to ensure economic growth and expand banks’ lending capability to avoid harmful impacts on income inequality.
This study explores the relationship between specific banking qualities (i.e., availability, relevance, and financial efficiency) and
income inequality. Since the problem of income inequality is more severe in developing and low-income countries (LICs), our work
contributes to the literature by analyzing distinct samples from this set of countries unlike studies that connect financial inclusion and
inequality. Zhang & Ben Naceur (2019) analyzed the effect of financial development measures on income inequality from a joint
sample of developed and developing countries, and Jauch and Watzka (2016) assessed the impact of the credit-to-gross domestic
product (GDP) ratio on income inequality for a similar sample of developed and developing countries. Our work innovates by focusing
on the influence that bank actions have on inequality, which differs from previous literature that investigated only the impact of
financial development.
Greenwood and Jovanovic (1990) first associated financial intermediation activities with income inequality. After that, the

* Corresponding author.
E-mail addresses: claudio.moraes@bcb.gov.br (C.O. de Moraes), gscruz112@gmail.com (G. Cruz).

https://doi.org/10.1016/j.jeconbus.2022.106086

Available online 15 September 2022

0148-6195/© 2022 Elsevier Inc. All rights reserved.

Please cite this article as: Claudio Oliveira de Moraes, Guilherme Cruz, Journal of Economics and Business,
https://doi.org/10.1016/j.jeconbus.2022.106086
C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

literature related to the financial system and poverty reduction provided divergent predictions regarding banks’ impact on the
financial system. Some authors suggested that improving the availability of financial services may benefit the poor. Specifically,
availability, as measured by transaction ease, use of credit, and access to financial services such as savings products, marginally in­
creases income and improves the ability of the poor to make profitable investments in health, human capital, and entrepreneurial
activities, especially at the early stages of a country’s development, as stated by Turégano & Herrero (2018). Conversely, banks may
indirectly harm income inequality, for example, by increasing the wealth of financial market professionals and providing a higher
return on capital for the most privileged. In regards to the indirect effect, economic growth usually comes with some negative mac­
roeconomic impacts such as inflation according to Jeanneney and Kpodar (2011).
According to Levine (2005), Rajan & Zingales (2003), and Aghion and Bolton (1997), the collateral effects of a financial system’s
growth mitigate its inequality-diminishing effects. As stated by Dhrifi (2015), banks exclude the poor from their acceptable loan
clientele due to commercial restrictions because they represent the lowest-income quintile of society and do not have the necessary
guarantees. Therefore, the poor are excluded from the financial system, and only the rich with adequate resources can benefit from
credit access and the improvements derived from financial intermediation activities, which intensify the distance between the income
distribution of the rich and the poor. Furthermore, as pointed by Holden and Prokopenko (2001), growth is a necessary condition to
diminishing poverty, but while finance tends to increase with the former, due to improvements on capital allocation efficiency and the
easing of borrowing constraints, it also increases income distribution inequality.
It is important to highlight the fact that the financial development literature shows a positive link between banking and poverty
reduction, as seen in Seven and Coskun (2016), Ho and Odhiambo (2011), Azra et al. (2012), and Uddin et al. (2012). However, studies
about the impact of banks’ activities on inequality are still rare. According to Turégano & Herrero (2018), access to credit can help
reduce income inequality, especially at the early stages of economic development. Furthermore, the greater the size/liquidity of a
financial system, the greater the equality among society, as stated in Brei et al. (2018). It is almost a consensus that developing
intermediation services has an effect on income distribution, as pointed out by Beck et al. (2010), Omar and Inaba (2020), Jauch and
Watzka (2016), and Seven and Coskun (2016).
This study addresses the following research questions: Do bank qualities reduce poverty and inequality in emerging markets (EMs)
and LICs? Do various bank qualities have different impacts on inequality? Finally, are there limits to the impact that banks have on
income inequality and poverty? To investigate these questions, we constructed a cross-country panel combining information collated
from the World Bank, the IMF, and the Standardized World Income Inequality Database (SWIID) for 2000–2018 from a database
developed by Solt (2014). The evidence presented in this study suggests that the banking sector impacts income inequality for both
EMs and LICs. The results indicate that financial efficiency has the most significant impact on income inequality for EMs. Availability
has a more significant potential to impact the poor in LICs. Our findings reveal that the banking sector’s impact on inequality follows a
U-shaped curve, reducing income distribution until an optimal level is reached, but then its impact once again begins increasing it.
The remainder of this paper is structured as follows. Section 2 presents the methodology and data used with a focus on inequality
and banking sector variables. Section 3 is reserved for empirical analysis and robustness checks. Finally, Section 4 summarizes the
main conclusions and offers policy recommendations.

2. Data and methodology

To analyze the impact of banking qualities on income inequality in EMs and LICs, a database was built using data gathered from the
IMF, the World Bank, and the SWIID database that overcomes the World Bank’s insufficient amount of inequality data by using a
missing-data algorithm developed by Solt (2014). The annual dataset is a panel containing 46 EMs and 66 LICs from 2000 to 2018. The
country subgroups are defined according to income per capita, nominal GDP, population, exports of diversified goods and services,
global trade and financial system integration, sustained growth, and stability, as stated by Duttagupta & Pazarbasioglu (2021). For
further details, see Tables A1, A2, and A3 (on supplementary material). In particular, three dimensions of banking quality are used:
Availability, a composition of commercial bank branches and automatic teller machines per 100,000 adults, extracted from the IMF’s
Financial Development database, usually treated in the literature as financial inclusion as seen in Inoue (2019); domestic credit to the
private sector by banks (as a percentage of GDP) to represent bank Relevance, gathered from the World Development Indicators (WDI)
extracted from the World Bank’s database; and Financial Efficiency, a compound of bank financial indicators such as net interest
margin, lending–deposit spread, return on assets, and return on equity extracted from the IMF’s Financial Development database.
The Gini coefficient from the WDI database accounts for the extent to which the distribution of income among individuals or
households within an economy deviates from a perfectly equal distribution. The index varies from 0 to 100, with the former meaning a
perfect income distribution and the latter signifying the most extreme income inequality. Although the Gini coefficient is the variable
used most often to represent income distribution, as can be seen in Beck et al. (2010) and Zhang & Ben Naceur (2019), we cannot
conclude a country’s welfare level solely from its results as the poverty level can increase even with a decrease in the former, as pointed
out in Seven and Coskun (2016). Therefore, we introduced a second dependent variable, the income share held by the lowest 20%,
gathered from the WDI database, to have an alternative view of the influence of banks on poverty and serve as a robustness test, as seen
in Dollar and Kraay (2004).
To determine the strength of the links between the banking sector, inequality, and poverty, this study also considers macroeco­
nomic variables as controls for other potential determinants of inequality and poverty as follows. Unemployment is the portion of the
labor force that is without work but is available for and seeking employment based on the total labor force. It is expected that an
increase in unemployment leads to an increase in inequality and poverty because most non-rich people have only their wage as income.
Beck et al. (2010) and Liang (2006) found that this variable is significant in determining inequality. Inflation is the annual percentage

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C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

change in costs for the average consumer. There are mixed signals in the literature regarding its impact on inequality and poverty, with
it having both alleviating effects, as found by Inoue (2019), and inequality-increasing effects, as seen in Seven and Coskun (2016).
Other studies, such as Easterly and Fischer (2001) and Dollar and Kraay (2004), confirm the relevance of this variable. Trade openness
as a ratio of GDP (Trade) is the sum of exports and imports of goods and services measured as a percentage of GDP. There is not a
consensus in the literature regarding the impact of this variable on inequality, but it is often present, as seen in Altunbaş and Thornton
(2019), Zhang & Ben Naceur (2019), and Ayyagari et al. (2020). Lastly, the government consumption-to-GDP ratio (Gov_C), which
includes all current government expenditures for purchases of goods and services as its share in GDP, may have a decreasing effect on
inequality if government expenditures can be held by the poor. There is no consensus in the literature with regards to Gov_C, as pointed
out in Beck et al. (2000) and Seven and Coskun (2016).
The baseline model considers the variables stated in the literature as important for determining inequality. The first explanatory
variable is the lagged value of the dependent variable, which turns the equation into a dynamic model and enables us to measure
persistence in income inequality and poverty measurements. Pires Tiberto at al. (2020) pointed out that the advantage of using a
dynamic panel is that in a parsimonious model, the lagged variable plays a large part in the explanation. In addition, lagged inequality
in the equation allows us to identify the dynamics of its adjustment over time, as explained by Baltagi (2005). So, to test the effects
described above, the following equation was estimated:
Yi,t = β0 + β1 Yi,t− 1 + β2 Banki,t + β3 Zi,t + µi,t (1)

where µi,t = ηi + ωi,t , ηi is the unobserved time-invariant country-specific fixed effects, and ωi,t is an independent and identically
distributed random term with E(ωi,t ) = 0 and Var(ωi,t ) = σ2.
i denotes country identifiers and t represents the time period distributed annually. Yi,t− 1 is the lagged value of the Gini coefficient.
Banki,t represents the level of bank qualities in period t. Finally, Zi,t represents a set of macroeconomic control variables such as
unemployment, inflation, trade openness, and the government consumption-to-GDP ratio. Table 1 provides the definition of the
variables. Summary statistics can be found in Tables A4 and A5 in the Appendix (on supplementary material).
This study uses dynamic panel estimation by applying the Blundell–Bond System of Generalized Method of Moments (S-GMM)
approach, an improved version of GMM developed by Arellano and Bover (1995) and fully employed by Blundell and Bond (1998).
Arellano and Bond (1991) presented the first-difference GMM panel data method and uses lagged values of the endogenous variables as
instruments. Blundell and Bond (1998) found that first-difference GMM is biased for large and small samples and has a low level of
accuracy. Thus, the proposed use of lagged values of the endogenous variables in levels as a solution can actually produce weak in­
struments, as stated by Arellano and Bover (1995) and Staiger and Stock (1997).
As pointed out by Roodman (2009), if the S-GMM estimation framework is applied to a small sample and if there are too many
instruments, over-fitting of the instruments will probably occur, causing bias in the results. Although this is not the case with our
sample, which has 112 countries and 19 years, to avoid the aforementioned over-fitting of instruments in the regressions, we use less
than one instruments/cross-sectional ratios in each regression.
Considering that the S-GMM framework requires the use of instruments, overidentification analysis has a relevant role in validating
the instrumental variables to improve the efficiency of the estimators, as stated in Cragg (1983). Therefore, we performed a standard
J-test to test this property for the validity of the overidentifying restrictions, according to Hansen (1982). The instruments chosen were
dated to the period t− 1 or earlier to help predict contemporaneous variables unavailable at time t. This procedure of using lagged
explanatory variables as instruments follows Johnston (1984). We use external instruments based on the theoretical and empirical
developments of finance in the inequality/poverty literature such as levels of financial institutions and financial markets, corruption
control, poverty index at United States dollars (US$) 5.50, government effectiveness and voice, and regulatory quality. A description of
the instruments used in the models estimated with the S-GMM framework is presented in the Appendix (see Tables A6 and A7).
First-order AR(1) and second-order AR(2) tests along with tests for serial autocorrelation are also performed. The null hypothesis of the
Arellano–Bond test determines that there is no autocorrelation.
Despite the GMM estimators being reliable even in the presence of omitted variables and avoiding unobserved effects on the re­
gressions as stated by Arellano and Bond (1991), we also undertake a series of robustness checks to validate our baseline results using
the feasible generalized least squares (FGLS) method. However, it is important to highlight that, like De Mendonça & Brito (2021), we
estimate dynamic models and short-panel data (T < N). Therefore, due to Nickell’s bias (Nickell, 1981), fixed-effects models do not
perform well.1 Since the FGLS regressions do not control endogeneity and simultaneity bias, we will still present them for purposes of
comparison. However, our main analysis will be based on the coefficients presented for the S-GMM estimations.

3. Empirical results

As a preliminary analysis of the relationship between banks and poverty and to ensure that our model does not suffer from a high
level of collinearity among the control variables, we present the correlation matrix of these variables for EMs (Table A8(a)) and LICs
(Table A8(b)) used in this study from 2000 to 2018. Table A8(a) shows Availability and Financial Efficiency as having a negative impact
on the Gini coefficient, so society becomes more equal, while Relevance has the opposite influence. Table A8(b) shows that each of the

1
The fixed-effects model in a dynamic panel, particularly when T is small and N is large, creates a correlation between the regression and the error
term (i.e., Nickell’s bias).

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C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

Table 1
Description of the data sample and sources.
Name Code Goal Description Employed in (Selected) Source

Dependent variable
Gini coefficient Gini Verify the impact of Gini index measures the extent to which the Beck et al. (2010), Zhang & WDI,
banking sector on the distribution of income among individuals or Ben Naceur (2019) SWIID,
poor households within an economy deviates from a PovStats
perfectly equal distribution.
Income share held Inc20 Percentage share of income or consumption is the Seven and Coskun (2016) WDI,
by lowest 20% share that accrues to subgroups of population PovStats
indicated by deciles or quintiles.
Banking sector
variables
Availability Measure bank Commercial bank branches and ATMs (per Inoue (2019), IMF
development 100,000 adults) Omar and Inaba (2020)
Relevance Domestic credit to private sector by banks (% of Park and Shin (2017), Rajan WDI,
GDP) & Zingales (2003) PovStats
Financial Net interest margin, lending-deposits spread, non- Brei et al. (2018), Zhang & IMF
Efficiency interest income to total income, overhead costs to Ben Naceur (2019)
total assets, return on asset, return on equity
Control Variables
Trade openness Trade Control other potential Trade is the sum of exports and imports of goods Altunbaş and Thornton WDI,
determinants of and services measured as a share of gross domestic (2019), Zhang & Ben Naceur PovStats
inequality and poverty product. (2019),Ayyagari et al. (2020)
Inflation rate Inflation Inflation measures the annual percentage change Inoue (2019),Seven and WDI,
in the cost for the average consumer of acquiring a Coskun (2016),Easterly and PovStats
basket of goods and services. Fischer (2001),Dollar and
Kraay (2004)
Government Gov_C Government consumption includes all Beck et al. (2000), WDI,
consumption government current expenditures for purchases of Seven and Coskun (2016) PovStats
goods and services as a share of GDP.
Unemployment Unemployment refers to the share of the labor Beck et al. (2010), WDI,
force that is without work but available for and Liang (2006) PovStats
seeking employment.

three banking proxies has a negative impact on inequality.

Table 2 presents the results for the effect of banking qualities on income inequality in EMs for both the FGLS and S-GMM methods.
All S-GMM regressions accept the null hypothesis in the Sargan tests (J-statistic), which means that the overidentifying restrictions are
valid. Moreover, both serial autocorrelation tests (AR(1) and AR(2)) do not indicate the presence of serial autocorrelation. The high R2
statistics on the FGLS estimations suggest that the variables are in the models are sound.
The first column of Table 2 considers bank Availability as the main variable. This variable shows negative and statistical significance
at 1% and 5% for the S-GMM estimations and at 10% for the FGLS estimations. One possible reason for this is that increased Availability
reduces inequality by creating more opportunities for a new mass of people with bank accounts, which facilitates consumption and
engagement in economically productive activities. For those with limited bank access due to long distances, increasing Availability can
diminish the transaction costs, thus marginally increasing the income of disadvantaged segments of the population. Omar and Inaba
(2020) support our results when they stated that access can reduce income inequality on its own. Therefore, including more people in
banking intermediation activities might reduce inequality in EMs.
The second column of each model estimates the impact of banking sector Relevance on inequality for EMs. The S-GMM estimation
presents a negative signal and statistical significance. Relevance is interpreted as financial deepening, which indicates the amount of
credit provided by banks in a society, as pointed out by Park and Shin (2017) and Rajan & Zingales (2003). Economically, this can
mean that it facilitates a new firm or an entrepreneur obtaining financing as stated in Kim and Lin (2011). The alleviating effect of
deepening inequality can also be seen in Beck, Demirgüç-Kunt, and Levine (2007) and Zhang & Ben Naceur (2019).
The third column of the model estimates the impact of Financial Efficiency on inequality for EMs. This variable has a negative signal
and statistical significance for the S-GMM equations. Efficiency is directly related to how banks can provide services and products at a
low cost, maintaining revenue at a sustainable level. This result identifies the potential of bank efficiency alleviating the effect on
inequality or how much of this efficiency gain benefits the poor, reducing the costs of their banking services relationship. This result is
in line with what was found by Zhang & Ben Naceur (2019). Efficiency is also related to banking’s potential to reduce credit constraints
and improve capital allocation, resulting in better credit opportunities for the poor to implement productive investments, as pointed
out by Brei et al. (2018).
The right-hand lagged Gini coefficient variable enters positively with a 1% statistical significance for all equations, suggesting the
existence of a persistence effect. Regarding Unemployment, the coefficient is positive in all equations, presenting statistical relevance in
most. One possible outcome of this result is that the level of unemployment has an increasing effect on inequality, so the level of the
workforce deprived of job opportunities impacts the poor with higher intensity, which is the same conclusion determined by Sheng
(2012).
Inflation is statistically significant with a negative coefficient for all S-GMM estimations. The literature has mixed opinions about

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 C.O. de Moraes and G. Cruz
Table 2
Estimates of bank development on inequality (Emerging markets).
Dependent variable: Gini coefficient (t)

Sample Emerging Markets Emerging Markets

Model 1 (FGLS) Model 2 (FGLS) Model 3 (S− GMM) Model 4 (S− GMM)
Regressors Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency
Gini(− 1) 0.767 * ** 0.796 * ** 0.788 * ** 0.788 * ** 0.798 * ** 0.799 * ** 0.909 * ** 0.841 * ** 0.834 * ** 0.870 * ** 0.807 * ** 0.904 * **
(0.057) (0.055) (0.047) (0.058) (0.059) (0.053) (0.020) (0.016) (0.015) (0.031) (0.057) (0.030)
Banks − 0.020 * − 0.008164 − 0.018 − 0.015 − 0.006308 − 0.01 − 0.010 * ** − 0.018 * ** − 0.031 * ** − 0.013 * ** − 0.035 * ** − 0.022 * **
(0.011) (0.009) (0.013) (0.010) (0.008) (0.015) (0.004) (0.007) (0.011) (0.004) (0.012) (0.007)
Unemployment 0.091 * * 0.113 * ** 0.098 * ** 0.044 * * 0.091 * ** 0.012
(0.040) (0.043) (0.036) (0.019) (0.032) (0.015)
Inflation rate 0.003 0.005 0.002 − 0.007 * − 0.033 * ** − 0.013 * **
(0.004) (0.004) (0.007) (0.004) (0.012) (0.004)
Trade 0.002 0.002 (0.007) 0.013 * ** 0.023 * * 0.017 * **
(0.008) (0.008) (0.008) (0.005) (0.009) (0.004)
Gov_C − 0.023 − 0.065465 − 0.066579 0.063 * * 0.045 0.064 * *
(0.059) (0.066) (0.061) (0.031) (0.043) (0.027)
Observations 436 434 436 406 404 406 371 395 398 357 328 357
R− squared 0.97 0.97 0.97 0.98 0.98 0.98
5

F− Statistic 393.98 384.57 388.63 415.16 409.16 410.83

N. Inst./N. Cross Sec. 0.59 0.64 0.64 0.75 0.69 0.75
J. Statistic 15.87 16.73 17.08 16.23 14.46 18.00
p − value 0.60 0.61 0.58 0.58 0.56 0.46
AR(1) p − value 0.00 0.00 0.00 0.00 0.00 0.00
AR(2) p − value 0.86 0.53 0.55 0.13 0.47 0.16

Arellano and Bover (1995) without time period effects. Tests for AR (1) and AR (2) check for the presence of first order and second− order serial correlation in the first− difference residuals. All AR(1)
coefficients are negative. The sample is an unbalanced panel of 46 countries from 2000 to 2018.

Journal of Economics and Business xxx (xxxx) xxx

 C.O. de Moraes and G. Cruz
Table 3
Estimates of bank development on inequality (Low-income countries).
Dependent variable: Gini coefficient (t)

Sample Low-income countries Low-income countries

Model 5 (FGLS) Model 6 (FGLS) Model 7 (S− GMM) Model 8 (S− GMM)
Regressors Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency
Gini(− 1) 0.954 * ** 0.971 * ** 0.974 * ** 0.933 * ** 0.966 * ** 0.979 * ** 0.888 * ** 0.910 * ** 0.901 * ** 0.938 * ** 0.978 * ** 1.023 * **
(0.016) (0.020) (0.020) (0.027) (0.021) (0.029) (0.003) (0.004) (0.003) (0.026) (0.032) (0.025)
Banks − 0.016 * ** − 0.003 * * − 0.001 − 0.023 * * − 0.007 * * − 0.003 − 0.021 * ** − 0.004 * ** − 0.008 * ** − 0.028 * ** − 0.007 * ** − 0.013 * **
(0.006) (0.002) (0.001) (0.009) (0.003) (0.002) (0.001) (0.001) (0.001) (0.004) (0.002) (0.003)
Unemployment − 0.003 − 0.001 0.003 0.025 * ** 0.015 * * 0.030 * **
(0.006) (0.005) (0.004) (0.008) (0.006) (0.011)
Inflation rate 0.001 0.002 0.003 − 0.030 * ** − 0.039 * ** − 0.031 * **
(0.003) (0.002) (0.003) (0.009) (0.007) (0.007)
Trade 0.002 0.004 * * 0.001 0.005 * * 0.009 * ** 0.003 *
(0.002) (0.002) (0.002) (0.002) (0.002) (0.002)
Gov_C − 0.003129 − 0.004 − 0.001 − 0.02627 − 0.009 * ** − 0.004
(0.006) (0.007) (0.007) (0.019) (0.002) (0.003)
Observations 679 679 679 185 185 185 664 664 660 137 135 134
R− squared 0.99 0.99 0.99 0.99 0.99 0.99
6

F− Statistic 27672.68 24469.81 23346.49 4331.16 3513.52 3035.61

N. Inst./N. Cross Sec. 0.76 0.76 0.76 0.61 0.77 0.73
J. Statistic 40.20 36.19 36.71 14.99 18.30 15.21
p − value 0.33 0.51 0.48 0.31 0.37 0.51
AR(1) p − value 0.00 0.00 0.00 0.04 0.08 0.06
AR(2) p − value 0.69 0.59 0.41 0.52 0.53 0.31

Arellano and Bover (1995) without time period effects. Tests for AR (1) and AR (2) check for the presence of first order and second− order serial correlation in the first− difference residuals. All AR(1)
coefficients are negative. The sample is an unbalanced panel of 66 countries from 2000 to 2018.

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C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

inflation’s impact on inequality, suggesting that even if the rich can hedge against inflation due to their easier access to financial
markets, the unexpected impact of inflation will benefit debtors once it reduces the real debt burden due to the nominal contract’s
property, as stated by Jauch and Watzka (2016). Our findings are also in line with Omar and Inaba (2020), who suggested that inflation
depreciates the value of higher-income people’s cash holdings, imposing that they spend their money on real capital expenditures that
employ the low-income unemployed people and therefore reduce poverty rates.
Trade is positive for all estimations and has statistical significance in S-GMM estimations, suggesting an increase in inequality due
to an increase in the government’s trade balance share in the GDP. This result is supported by Altunbaş and Thornton (2019), although
there is no consensus in the literature as seen in Zhang & Ben Naceur (2019). There is also no consensus in the literature regarding the
impact of Government consumption-to-GDP ratio, but some arguments support our findings: its possible contribution to wealth con­
centration can be explained by the small elite’s advantage in capturing the gross of public investments or because part of the spending
on transfers is destined to the middle class, as concluded by Abed and Davoodi (2000) and Milanovic and Bank (1994).
Table 3 presents the results for both the FGLS and S-GMM estimations for the LICs sample. It is interesting to observe that the results
for LICs are quite similar to those found for the EMs, even though the behavior of each set of countries differs. To illustrate this, in 2018
the LIC average income per capita was US$ 1105, while it was US$ 6249 for the EM sample. This analysis considers the same pro­
cedures to avoid heteroskedasticity and serial autocorrelation with regard to the Sargan test (J-statistic), AR(1), AR(2), and the high R2
on FGLS.
To our knowledge, the economic literature related to inequality and banking on LICs is scarce given the insufficient amount of data
available to provide robustness to the results.2 Therefore, the analysis for LICs contributes soundness to the previous results for EMs, as
it is innovative to the literature.
The first column of the model in Table 3 considers Availability as its principal right-hand variable. Bank Availability is statistically
significant and negative for all models with a solid 1% significance on S-GMM equations. Availability’s high coefficient value and
statistically relevant results suggests that people mostly benefit from the improvement in bank size and financial efficiency if they are
in touch with intermediation services. It is well-known that the bank registration process—people’s lack of documentation, lack of
affordability to create and maintain an account, and lack of appropriate products and services, as mentioned by Beck et al. (2007)—
creates barriers to accessibility for a wide range of people, especially for those living in poor conditions.
The second column of each model refers to Relevance as an indicator of a bank quality. This variable presents statistical significance
for all estimations, including both FGLS and S-GMM methods. Therefore, from the results, we might say that an increase in Relevance
may have a reducing effect on inequality for LICs. At a macro level, the reduction in inequality makes sense, as more credit in the hands
of private banks creates space for a broader range of services and products offered, so that the final client may absorb some.
benefit from the ease in obtaining financing. It can also represent the entrance of new players into the market that will operate in
the gaps left by the incumbent banks.
The third column of each model tests the impact of Financial Efficiency on inequality for the LIC sample. The results are once again
robust, presenting negative coefficients for both methods and a 1% statistical significance for all S-GMM estimations. Thus, we might
suggest that one of the possible outcomes from the increase in Efficiency, as expected from its behavior of improving costs, has a
reducing impact on inequality for the LIC sample since some of these gains are destined for the poor.
Regarding the control variables, Unemployment is positive and statistically relevant for all S-GMM estimations, as expected and
described for the EM sample. Inflation has a negative coefficient and a 1% statistical significance on all S-GMM equations; Trade shows
a positive signal on all estimations for both methods, presenting statistical relevance for most of them. Gov_C does not show a solid
statistical significance, and since it has mixed interpretations in the literature, we will not suggest any conclusion.
Based on these results, we can say that the studied banking sub-indexes help reduce inequality in EMs and LICs. Moreover, these
results have a clear economic intuition. When carrying out financial intermediation, the banks mitigate one of the most classic market
failures, the meeting between those demanding financial resources and those providing them. Acting as an intermediary, the banks
provide this intersection in an impersonal way. Furthermore, the deeper, more accessible, and more efficient the financial interme­
diation, the better it will be for society as more opportunities open up for businesses, purchasing goods, and other endeavors.
Therefore, the results of this study identify the characteristics of financial intermediation that have the most impact on reducing
income inequality.
Models 9 and 10 are presented in Table 4 to determine which banking quality is the most relevant for EMs and LICs. For this
purpose, we apply the Wald test to verify whether the differences observed between the estimated coefficients for the different samples
are significant. The results of the Wald test reveal the joint impact of banks on the Gini coefficient for both EMs and LICs by testing if
the sum of the coefficients is statistically significant and different than zero (see Table A9 in the Appendix). Both the EM and LIC
samples reject the null hypothesis of the Wald test, suggesting that the variables are jointly negative.
Thus, the results of Table 4 provide additional evidence of the impact that banks have on income inequality. In Model 9, Financial
Efficiency is estimated as the principal banking variable for EM. For LICs, Model 10 shows Availability to have the greatest impact on
inequality. This result suggests that in less sophisticated economies, Availability is the most important banking variable, as seen in the
results for LICs (Model 10), which present very low coefficients for Relevance and Financial Efficiency. This indicates that the deepening
of bank products and services along with the cost reduction does not have an expressive impact on income distribution if there is not
sufficient access to financial activities. Once a mature economic level is achieved, as seen in Model 9 for EMs, Financial Efficiency,

2
Altunbaş and Thornton (2019) found similar results to ours with regards to the EM sample’s income inequality analysis but could not conclude
the same for LICs due to an absence of statistical significance.

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C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

Table 4
Estimates of bank development on inequality.
Dependent variable: Gini coefficient (t)

Model 9 (Emerging Markets) Model 10 (Low-income countries)

Method S− GMM S− GMM
Gini(− 1) 0.663 * ** 0.924 * **
(0.026) (0.011)
Availability − 0.011 * * − 0.023 * **
(0.005) (0.003)
Relevance − 0.012 * − 0.003 *
(0.006) (0.001)
Fin. Efficiency − 0.020 * − 0.004 *
(0.012) (0.002)
Unemployment 0.161 * ** 0.020 * **
(0.039) (0.007)
Inflation rate − 0.106 * ** − 0.030 * **
(0.024) (0.004)
Trade 0.029 * ** 0.008 * **
(0.008) (0.001)
Gov_C − 0.210 * ** − 0.008 *
(0.049) (0.004)
Observations 265 120
N. Inst./N. Cross Sec. 0.93 0.89
J. Statistic 16.01 17.34
p − value 0.66 0.43
AR(1) p − value 0.00 0.04
AR(2) p − value 0.54 0.95

Arellano and Bover (1995) without time period effects. Tests for AR (1) and AR (2) check for the presence of first order and second− order serial
correlation in the first− difference residuals. All AR(1) coefficients are negative. The sample is an unbalanced panel of 46 countries for EM and 66 for
LIC, from 2000 to 2018.

Table 5
Estimates of nonlinearity effect of bank development on inequality.
Dependent variable: Gini coefficient (t)

Sample Emerging Markets Low-income countries

Model 11 (S− GMM) Model 12 (S− GMM)
Regressors Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency
Gini(− 1) 0.619 * ** 0.840 * ** 0.707 * ** 0.866 * ** 0.935 * ** 1.058 * **
(0.092) (0.040) (0.071) (0.018) (0.019) (0.030)
Banks − 0.217 * ** − 0.109 * ** − 0.467 * ** − 0.057 * ** − 0.024 * ** − 0.041 * *
(0.060) (0.038) (0.142) (0.011) (0.005) (0.018)
Banks^2 0.002 * ** 0.001 * * 0.004 * ** 0.001 * * 0.001 * ** 0.001 * *
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
Unemployment 0.265 * ** 0.074 * * 0.175 * * 0.010 0.011 * 0.020 *
(0.064) (0.034) (0.075) (0.007) (0.006) (0.011)
Inflation rate − 0.050 * * − 0.013 * * − 0.073 * ** − 0.029 * ** − 0.038 * ** − 0.023 * **
(0.024) (0.006) (0.014) (0.009) (0.007) (0.006)
Trade 0.001 0.005 0.026 * * 0.012 * ** 0.012 * ** 0.005
(0.016) (0.007) (0.012) (0.001) (0.002) (0.002)
Gov_C 0.129 * 0.092 * − 0.150379 − 0.016 * ** − 0.010 * * 0.005
(0.074) (0.051) (0.102) (0.004) (0.005) (0.006)
d(Banks)= 0 53.79 45.49 64.15 81.85 117.66 58.20
% above limit 37.0% 54.3% 63.0% 0.0% 3.0% 53.0%
Observations 366 335 320 135 134 129
N. Inst./N. Cross Sec. 0.75 0.84 0.69 0.76 0.76 0.76
J. Statistic 12.20 19.56 9.33 20.45 17.43 14.44
p − value 0.79 0.49 0.86 0.16 0.29 0.49
AR(1) p − value 0.00 0.00 0.00 0.04 0.04 0.09
AR(2) p − value 0.25 0.95 0.31 0.79 0.66 0.73

Arellano and Bover (1995) without time period effects. Tests for AR (1) and AR (2) check for the presence of first order and second− order serial
correlation in the first− difference residuals. All AR(1) coefficients are negative. The sample is an unbalanced panel of 46 countries for EM and 66 for
LIC, from 2000 to 2018.

8
 C.O. de Moraes and G. Cruz
Table 6
Estimates of bank development on poverty.
Dependent variable: Income share of the 20% lowest (t)

Sample Emerging Markets & Low− income countries Emerging Markets & Low− income countries
Model 13 (FGLS) Model 14 (FGLS) Model 15 (S− GMM) Model 16 (S− GMM)
Regressors Availability Relevance Fin. Availability Relevance Fin. Efficiency Availability Relevance Fin. Efficiency Availability Relevance Fin.
Efficiency Efficiency
Inc20(− 1) 0.461 * ** 0.504 * ** 0.512 * ** 0.441 * ** 0.464 * ** 0.476 * ** 0.843 * ** 0.834 * ** 0.918 * ** 0.810 * ** 0.826 * ** 0.742 * **
(0.142) (0.132) (0.128) (0.150) (0.142) (0.136) (0.053) (0.012) (0.009) (0.043) (0.041) (0.037)
Banks 1.153 * * 0.008 * ** 0.428 1.013 * 0.008 * ** 0.308 0.343 * ** 0.003 * ** 0.379 * ** 0.218 * * 0.002 * 0.443 * **
(0.586) (0.003) (0.413) (0.548) (0.003) (0.499) (0.130) (0.001) (0.083) (0.010) (0.001) (0.128)
Unemployment − 0.035 * * − 0.048 * * − 0.043 * * − 0.076 * ** − 0.071 * ** − 0.058 * **
(0.017) (0.022) (0.022) (0.008) (0.006) (0.010)
Inflation rate − 0.002 − 0.002 − 0.002 0.014 * ** 0.011 * ** − 0.008 * **
(0.002) (0.002) (0.002) (0.003) (0.002) (0.003)
Trade − 0.005 − 0.005 − 0.005 − 0.006 * * − 0.005 * * − 0.000921
9

(0.004) (0.004) (0.004) (0.003) (0.002) (0.001)

Gov_C − 0.007 0.008 0.021 0.056 * ** 0.057 * ** 0.039 * *
(0.027) (0.031) (0.033) (0.017) (0.018) (0.017)
Observations 482 480 482 456 454 456 445 442 380 421 418 360
R− squared 0.96 0.96 0.96 0.96 0.96 0.96
F− Statistic 286.34 270.83 265.32 278.57 270.02 262.98
N. Inst./N. Cross 0.53 0.53 0.45 0.55 0.55 0.45
Sec.
J. Statistic 16.71 30.82 28.01 30.81 30.89 25.11
p − value 0.47 0.53 0.62 0.28 0.28 0.57
AR(1) p − value 0.00 0.00 0.00 0.00 0.00 0.00

Journal of Economics and Business xxx (xxxx) xxx

AR(2) p − value 0.12 0.12 0.43 0.69 0.83 0.21

Arellano and Bover (1995) without time period effects. Tests for AR (1) and AR (2) check for the presence of first order and second− order serial correlation in the first− difference residuals. All AR(1)
coefficients are negative. The sample is an unbalanced panel of 33 countries for EM and 7 for LIC, from 2000 to 2018.
C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

which represents banks’ ability to provide services and products at a lower cost, potentially has the greatest impact on income dis­
tribution followed by Relevance, which represents the deepening of banks, and Availability, a proxy for financial access.

3.1. Nonlinearity and thresholds

The results presented in the previous section indicate that the banking qualities for both EMs and LICs may reduce income
inequality. However, some studies raise the following questions: is the trend linear or is there a limit on their impact on inequality? In
other words, does the impact of the main variable reach a threshold and then go in the opposite direction? This section aims to clarify
the impact of banks on inequality and explore these thresholds, as seen in Kim and Lin (2011). For this purpose, we considered only the
S-GMM method, which also treats possible cases of endogeneity (see Wooldridge, 2002).
Therefore, to verify the optimal degree of the banking sector’s influence on inequality, we estimated Eq. (2) including the quadratic
term of Banks. The control variables remain as previously presented. Once again, we considered all of the procedures to ensure that
there were no overidentification (see J-statistic) and autocorrelation issues in all of the models (see AR(1) and AR(2) p-values). Our
general specification to determine the non-linearity effect and threshold levels for EMs and LICs is as follows:

Yi,t = β0 + β1 Yi,t− 1 + β2 Banki,t + β3 Bank2i,t + β4 Zi,t + µi,t (2)

In Table 5, all bank qualities (Availability, Relevance, and Financial Efficiency) present negative coefficients and statistical signifi­
cance. The quadratic term presented is positive and is also significant for all models in both the EM and LIC samples. This finding
suggests a U-shaped curve for the impact of the banking qualities on income inequality. Moreover, we built the optimal degree of each
equation, represented as d(Banks) = 0, by applying the first differential and setting it equal to zero, as seen in Arcand, Berkes, and
Panizza (2015).
Analyzing the EM sample, presented on the left-hand side of Table 5, the optimal degree for Availability is established at 53.79 (a
variable ranging between 0 and 100). Considering the country’s developmental level in 2018, we found that 37% of the sample had
already surpassed that limit. Therefore, these countries did not benefit from an increase in this variable or its development resulted in
more inequality. However, for the remaining 63% of the EMs, an increase in access still produced some reduction in income inequality.
The results for Relevance showed that 54.3% of the sample selected had surpassed the inequality-alleviating impact threshold, indi­
cating that most of the EMs selected would face higher inequality levels from this intensification of the banking proxy. Financial Ef­
ficiency had the highest maturity level among the variables studied with 63% of the sample being above the optimal degree, which
indicates that an increase in this variable might harm income inequality.
The analysis of the LICs, presented on the right-hand side of Table 5, confirms the expectation that they would have more banking
opportunities than the EMs. Availability has 0% of the sample above its 81.85 threshold level. Therefore, considering data from 2018,
all of the countries selected would benefit from the intensification of banking access with a reduction in income inequality. When
analyzing the Relevance index, only 3% of the sample achieved the limit at which income inequality was harmed by the growth of the
former, so many of the LICs would benefit from an increase in banking service deepening. Financial Efficiency once again shows relevant
progress compared to the other variables: 53% of the countries would not obtain an inequality-diminishing effect due to its increase.

3.2. Robustness analysis

The robustness analysis considers the use of an alternative proxy for poverty, the income share held by the lowest 20%. To check the
robustness of the previous results, we used the same framework with a different dependent variable considering a unique sample of 33
EMs and 7 LICs. The countries were chosen according to their data availability (see Table A10). The main variables’ coefficient signals
ensured that our findings were not sensitive to the choice of econometric model or method, as stated by Chen et al. (2017), Davydov
et al. (2018), Mamatzakis and Bermpei (2016), Perera and Wickramanayake (2016), Uddin et al. (2020), and Dang and Dang (2020).
In Table 6, the first column of each model represents Availability and is positive and statistically significant in all equations, which
suggests that an improvement in access increases the average income of the poorest 20% in the countries selected. The second column
of each model relates to Relevance with positive and statistically significant coefficients for all models, indicating that the income of the
poor benefits from an improvement in banks’ deepening, which is in line with the previous decrease in the Gini coefficient. The third
column relates to Financial Efficiency with positive and statistically significant coefficients for the S-GMM method, which is in line with
the results from the previous section; the cost reductions and operational improvements potentially benefit the poor considering the
increase in the income of the lowest 20%. In conclusion, we suggest that these results bring robustness to the present paper.
Regarding to the control variables, Unemployment confirms the previous results and suggests a negative effect for the poorest,
indicating that an increase in its level reduces their income. Inflation rate gives mixed signals. Trade-to-GDP exhibits negative signals,
suggesting a harmful impact on the income of the poorest 20% in the sample. Government consumption-to-GDP is positive and statis­
tically relevant, suggesting that government expenditures are absorbed by the poorest quintile.

4. Conclusion

This study analyzed the impact of the banking sector on inequality and poverty using a panel data analysis for 46 EMs and 66 LICs
over a period of 19 years (i.e., 2000–2018). Based on the idea that improving financial intermediation activities may reduce inequality
in society, two variables were used to represent inequality/poverty: the Gini coefficient and the income share held by the lowest

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C.O. de Moraes and G. Cruz Journal of Economics and Business xxx (xxxx) xxx

quintile. The main finding of this study investigates the importance of three banking sub-indices—namely, Availability, Relevance, and
Financial Efficiency—to decrease the income distribution level and benefit the poor.
The results indicate that improvements in the banking sector might reduce income inequality for emerging countries and LICs. The
improvement of Financial Efficiency has a more significant impact on inequality in emerging economies, while for LICs, an increase in
Availability brings more benefit to the poor. The results also suggest that the banking sector’s impact on inequality follows a U-shaped
curve, which reduces inequality at first. However, after surpassing an optimal degree, its improvement has an inequality-increasing
impact.
The policy recommendations emerging from this study reveal the importance of considering the banking system’s maturity level.
when analyzing its potential stimulus on reducing inequality through banking development. It is important for policymakers to
analyze the optimal degree and intensity of the banking sub-index impact for their respective countries and deepen the analysis for a
single country to verify the precise threshold that it should respect. Regardless of whether or not bank qualities reduce inequality, their
improvement has limits and can harm the poor after a certain threshold. As an example, for emerging economies, although Financial
Efficiency represents the greatest reducing impact on inequality as implied by the Wald test’s analysis in Table 4, it also has the highest
number of countries above the threshold. This does not indicate that all Efficiency opportunities should be avoided at the expense of
Relevance and Availability initiatives that are less mature, but actions regarding Efficiency should be taken cautiously due to the higher
probability that it may augment inequality.
To improve the discussion on poverty, especially for LICs, further research should consider the impact of digital finance on the
accessibility, relevance, and efficiency of financial intermediation activities. The present analysis provides evidence for both EMs and
LICs as to the efficacy of financial intermediation in reducing inequality and poverty.

Appendix A. Supporting information

Supplementary data associated with this article can be found in the online version at doi:10.1016/j.jeconbus.2022.106086.

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