Heterogeneous Impact of Financial Development on Households: Evidence from Developing Countries

Abstract

The role of financial services is vital for capital allocation and welfare in developing countries. Recent studies have shown that financial development has positively contributed to growth in household incomes. However, to achieve sustainable growth through reduction in inequality, financial development should foster income growth universally across all income groups. This paper examines the relationship between financial development and inequality in terms of shares of incomes of the highest and lowest quintiles of populations in developing countries. We carry out both cross-country and dynamic panel instrumental variables regressions and find that the financial development indicator has a positive impact on the income shares of the highest quintile but a negative impact on the income shares of the lowest quintile. We find that the benefits of finance are disproportionately distributed across these income groups in developing countries.