Inclusive Finance, Shadow Banking and the Need for Financial Citizenship

banks-229440_1280Why are poor people offered financial inclusion products? One answer to this question is that the poor have unique financial needs and require financial institutions and instruments tailored for their particular conditions. This explanation sees poverty as the driver of demand for inclusive finance, but engages only superficially with the question of why mainstream financial institutions are unable to accommodate the poor.

The alternative explanation, which I examine in my research, is that the demand for inclusive finance is driven by practices known as ‘financial infrastructure withdrawal’: this is the very same process behind the rise of predatory lending in the Anglosphere (Leyshon and Thrift, 1995) and reveals that financial systems have inbuilt tendencies to be exclusionary (Dymski and Veitch, 1992).  Given these tendencies, scholars of financial exclusion in advanced capitalist countries, have argued for a concept of financial citizenship which notes that like countries, financial systems have an inside and an outside (Leyshon and Thrift, 1995).  Those who can access finance only in the form of, for instance, high-cost loans and not through mainstream banking institutions are relegated to the outside and are hence not financial citizens. The processes that underlie this relegation include the tendency of mainstream banks to cross-sell products within groups, privileging ‘blue-chip’ clients by offering them subsidies in exchange for brand-loyalty. Less wealthy clients, as a result, inevitably pay more for the same products and services than their more affluent counterparts.

How Is Shadow Banking Linked to Financial Inclusion?

These practices may be attributed to shifting models of banking, as practices of disintermediation mean that lending and borrowing activities are no longer closely linked. Whereas in the past the dominant model was one in which banks relied on depositors to provide funds that could be loaned to borrowers, newer approaches to banking focus more on the ‘slicing and dicing’ of loans (Chick and Dow, 1988). These have pushed a departure from the branch-oriented approach to banking and allowed banks to overcome geographical constraints. In poor countries disintermediation has occurred in the inclusive finance segment, mostly because of the ready availability of finance from private sources and the ‘philanthropy-finance-development complex’ (Gabor and Brooks, 2017).  This arrangement is not only a manifestation of shadow banking in the Global South but also an extension of shadow banking in the Global North.

Shadow banking refers to credit intermediation activities carried out by entities outside of the regular banking system. Commonly associated with the global financial crisis of the last decade, the institutions and practices of shadow banking wield immense influence over the shape of inclusive finance in the Global South. The two key mechanisms that drive shadow banking in rich countries are the same as those in poor countries. One of these arises from regulatory avoidance and arbitrage, and the other arises from the demand for yield from institutional investors (Nesvetailova, 2017; Pozsar, 2011).

The issue of regulatory arbitrage and avoidance was among the earliest explanations suggested for the rise of the shadow banking industry: commentaries from Pozsar (2008) and Adrian and Shin (2009) note the role of regulatory burdens in creating gaps in traditional banking that are filled by shadow banks. This view of shadow banking is sometimes described as the supply side explanation in which the focal point is the behaviour of financial institutions in response to regulatory and legal constraints. In many countries of the Global South, financial institutions face an even more expansive set of constraints which create the space in which inclusive finance operates formally.  For instance, the capital adequacy and leverage limitations imposed by institutions such as Basel, and the know-your-customer (KYC) requirements of the Financial Action Task Force (FATF) to counter money laundering and terrorist funding (de Koker, 2014). As a result of these constraints it is difficult for both enterprises and individuals lacking extensive documentation to obtain credit and at times, even a traditional bank account.

The second explanation for the growth of shadow banking is described as the demand side view, in which the focus is on the decision of institutional investors to place their cash in wholesale funding instead of deposits. Thus, a key role of shadow banks in the global financial crises was to create ‘safe, short-term, liquid instruments to cater to the safety preferences of institutional cash investors and a deficit of US Treasury bills in general’ (Pozsar, 2011). These practices have carried over to the Global South and are a component of the inclusive finance industry for instance in form of microfinance investment funds and the involvement of global banks in impact investing and social ventures. This form of shadow banking is also being described as ‘market-based finance’ and many scholars of international development have expressed deep concern over the increasingly commercial and privatised nature of developmental strategies (Gabor, 2018). While funds from global investors may be seen as useful for meeting the borrowing needs of the poor, the practices of specific lending institutions for the poor reproduce inequalities because they are a corollary of the exclusionary practices of the mainstream banks. As a result the poor always pay more, not only for their loans but also for other services such as remittances and payments.

In this light, I argue for a concept of shadow financial citizenship, which builds on the work of Leyshon and Thrift (1995) to describe the grey area between financial exclusion and full financial citizenship. When inclusive finance is presented as a remedy to financial exclusion or to the circumstance of being ‘unbanked’ or even ‘underserved’, shadow financial citizenship emerges because of exclusionary practices. This is so because these exclusionary practices that obstruct financial citizenship are embedded in the financial landscapes of poor countries. These practices arise from the shadow banking and inclusive finance nexus that is a focal point of my research.


Adrian, T., & Shin, H. S. (2009). Money, liquidity, and monetary policyAmerican Economic Review, 99(2), 600-605

de Koker, L. (2014). The FATF’s customer identification framework: fit for purpose?. Journal of Money Laundering Control, 17(3), 281-295.

Chick, V., and Dow, S.C. (1988). A Post Keynesian Perspective on the Relation Between Banking and Regional Development. In P. Arestis (ed.), Post Keynesian Monetary Economics. Aldershot, UK: Edward Elgar, 219–250

Dymski, G., & Veitch, J. M. (1992). Race and the financial dynamics of urban growth: LA as Fay Wray. Department of Economics, University of California, Riverside.

Gabor, D. (2018) Goodbye (Chinese) shadow banking, hello market-based finance. Development and Change, 49 (2). pp. 394-419. 

Gabor, D., & Brooks, S. (2017). The digital revolution in financial inclusion: international development in the fintech eraNew Political Economy, 22(4), 423-436.

Leyshon, A., & Thrift, N. (1995). Geographies of financial exclusion: financial abandonment in Britain and the United States. Transactions of the Institute of British Geographers, 312-341.

Nesvetailova, A. (Ed.). (2017). Shadow Banking: Scope, Origins and Theories. Routledge.

Pozsar, Z. (2011). Can shadow banking be addressed without the balance sheet of the sovereign?. IMF Working paper.

Pozsar, Z. (2008). The rise and fall of the shadow banking system. Regional Financial Review, 44, 1-13. 

Juvaria Jafri is a PhD Student in the Department of International Politics at City University, London.

This blog post is a part of the blog series Inclusive or Exclusive Global Development? Scrutinizing Financial Inclusionin which a new perspective on financial inclusion is published every #FinanceFriday of February, March and April 2019.   


2 thoughts on “Inclusive Finance, Shadow Banking and the Need for Financial Citizenship

  1. I am concerned about this statement, “Whereas in the past the dominant model was one in which banks relied on depositors to provide funds that could be loaned to borrowers….” ‘In the past’ when, exactly? Savings-and-loans may apply to credit unions but it doesn’t apply to high street or commercial bank lending which create loans on demand with no ‘fractional reserve’ element.


    • Thank you for this comment which draws attention to an important issue. While I do not disagree that banks create deposits by creating loans, my research focus is on poor/ developing countries where banks are constrained in their ability to produce money because of (1) the evolutionary stage which their national banking system is currently in and (2) the peripheral/ semi-peripheral position of their economy in the financial system. For all countries (rich and poor) the departure from fractional reserve banking is captured in Victoria Chick and Sheila Dow’s exposition of the stages of banking: based on this view the UK, for instance, is at an advanced stage whereas poor countries where financial access is a policy goal are in an early stage.

      If possible I will add Chick and Dow (1988) to the bibliography here to make this point clearer.


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