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Financial Sector Development & Poverty Reduction

There are two ways that the growth of the financial industry might influence efforts to reduce poverty. Through growth, one indirectly contributes. The other operates directly by allowing the underprivileged to have access to financial services.

1. The Indirect Channel through Economic Growth

Economic growth is a key means through which financial sector development aids in reducing poverty. Many people think that increasing the economy lowers absolute poverty. Growth has a variety of potential effects on the eradication of poverty.

· Economic growth could generate jobs for the poor.

· It has been stated that a faster rate of growth may, at a later stage of development, minimize the wage gaps between skilled and unskilled workers, which would be advantageous to the poor.

· High growth may increase tax receipts, allowing the government to spend more money on social programs like health, education, and social protection, which would help the poor; the poor might also increase their investment in human capital.

2. The Direct Channel through Access to Financial Services

Many people feel that by giving or enhancing the poor's access to financial services, financial sector growth may directly help to the alleviation of poverty. According to many economists, the poor will benefit disproportionately from the rise of financial intermediaries.

This is due to the fact that credit limits caused by informational asymmetries disproportionately affect the poor, who lack the means to finance their own initiatives and the collateral necessary to receive bank loans. These loan restrictions prevent the underprivileged from taking advantage of investment possibilities, which slows overall growth by preventing capital from going to its most valuable uses.

Higher-income inequality will result from a dysfunctional financial system that disproportionately prevents money from reaching "wealth-deficient" business owners. Development in the financial industry lowers information and transaction costs and as a result,

· allows more entrepreneurs especially those less well-off to obtain external finance

· improves the allocation of capital

· exerts a particularly large impact on the poor.

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