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American Journal of  Applied 
Statistics and Economics (AJASE)

The Impact of  Financial Inclusion on Banking Stability- An Analytical Study in the Iraqi 
Banking Sector

Mohammed Hammad Safi1*, Hichem Khlif1

Volume 2 Issue 1, Year 2023
ISSN: 2992-927X (Online)

DOI: https://doi.org/10.54536/ajase.v2i1.2106
https://journals.e-palli.com/home/index.php/ajase

Article Information ABSTRACT

Received: October 18, 2023

Accepted: November 16, 2023

Published: November 20, 2023

This research examines the impact of  financial inclusion, as indicated by its indicators, on 
banking stability. The Iraqi banking sector has been tested, and the main research problem 
revolves around finding appropriate ways to achieve financial inclusion that align with 
the Iraqi Central Bank’s policies, tailored to the Iraqi environment to achieve stability in 
the banking sector. The research was applied to the banking sector as a whole through 
quantitative and statistical data analysis from 2010 to 2021. The main hypotheses were tested 
to determine the impact relationships between research variables, to answer the research 
questions and achieve the set objectives. To analyze the data and information, various 
statistical methods were used using the statistical software (STATA13) and EXCEL, in 
addition to using the least squares method with the regression model for the hypotheses. The 
research yielded a set of  results, indicating a significant partial effect of  financial inclusion 
indicators on banking stability in this study. The results of  the financial inclusion indicators 
in banking stability varied, and the sub-hypotheses were partially accepted, emphasizing a 
greater contribution of  financial inclusion to it.

Keywords

Financial Inclusion, Banking 
Stability, Iraqi Banking Sector

1 Baghdad University, Iraq
* Corresponding author’s e-mail: mohammad87alsafi@gmail.com

INTRODUCTION
One of  the main lessons learned from financial crises, 
including the global financial crisis of  2007-2009, and 
culminating with the COVID-19 crisis, is the importance 
of  containing systemic financial risks and maintaining 
financial stability in general, and banking stability in 
particular. At the same time, countries’ economies 
strive to enhance financial inclusion, increasing access 
to financial services for low-income households and 
small businesses. This is part of  their comprehensive 
economic and financial development strategies, facilitated 
through modern electronic systems that help extend 
banking services to a wider range of  financial consumers. 
Electronic systems have played a significant role in the 
overall economic and financial sector, particularly in the 
banking sector, which has seen significant developments 
in banking services. The banking needs and demands 
of  the population have changed significantly over the 
years, with the expectation of  accessing these services at 
anytime and anywhere, with minimal cost and effort. 
In alignment with these developments in the nature of  
electronic banking services, the current research idea 
has crystallized to address important and critical factors 
in banking, namely financial inclusion and banking 
stability. The results of  many practical or applied studies 
have demonstrated the significance of  these variables in 
the success and leadership of  many banks in different 
environments, increasing their market share. Given the 
need of  Iraqi banks for such studies and research, this 
research aims to test these variables in the Iraqi banking 
sector. Accordingly, the main objective of  the research 
is to diagnose the levels of  financial inclusion and 
banking stability in the Iraqi banking sector. To achieve 
this objective, the research includes, according to its 

methodology, an overview of  financial inclusion, while 
the second part addresses banking stability and presents 
the research framework.

LITERATURE REVIEW 
Financial Inclusion
The authors and researchers have approached the concept 
of  financial inclusion from different perspectives. (Lenka 
& Sharma, 2017) defines it as “the process of  ensuring that 
vulnerable groups, such as low-income sectors and low-
income groups, have access to suitable financial products 
and services at reasonable cost equitably and transparently 
by efficient mainstream institutions.” On the other 
hand, (Guérineau & Jacolin, 2014) sees it as “permanent 
access of  the population to a variety of  suitable financial 
products and services at reasonable costs and their 
effective and efficient use.” From this definition, three 
areas can be identified to define financial inclusion: access 
(supply), usage (demand), and affordability (financial 
conditions/product quality). Additionally, (Barajas et al., 
2020) aims to generalize banking and financial products 
and services to all members of  society with different 
segments through innovative, high-quality, and reasonably 
priced financial services using formal methods, including 
financial awareness and education. Therefore, measures 
of  usage likely reflect the availability of  access, cost, and 
quality, and vice versa. With more detailed data available 
on specific aspects of  financial inclusion, either within 
or across countries, the concept can be expanded to 
include access, quality, and cost dimensions as well. (Lozi, 
2021) introduces integrates financially marginalized or 
low-income categories that do not allow engagement in 
banking operations by dealing with the banking system 
through the digital work system, meaning completing all 



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financial transactions electronically. Financial inclusion 
focuses on providing financial services through easy, 
simple, and cost-effective methods, such as mobile phone 
payments.
The importance of  financial inclusion lies in empowering 
low-income individuals to access high-quality and 
affordable financial services. It also gives them the 
appropriate importance and priority within the framework 
of  economic policies, legislative development, and 
regulatory frameworks that help improve the spread of  
financial and banking services and encourage innovation 
in this field. Therefore, expanding the reach of  financial 
services benefits society as a whole, enhances individual 
financial stability (Akhtar & Pearce, 2010), and supports 
the banking sector and savings. The significance of  
financial inclusion also stems from its role in supporting 
entrepreneurs and startups by providing support and 
funding, enabling these startups to grow into small and 
medium-sized enterprises. These enterprises generate 
business opportunities and employment (Blancher et al., 
2019). It’s worth noting that the widespread availability 
of  financial services and broadening participation in the 
formal financial system are essential factors in achieving 
sustainable development goals, improving living 
standards, empowering women financially, financing 
small and medium-sized projects, reducing poverty and 
inequality, creating jobs, promoting economic growth, 
and integrating the informal economy into the formal 
economy.
There is a set of  objectives that the central bank seeks 
to achieve by directing banks to hold annual conferences 
and compete among themselves to achieve financial 
inclusion because it cannot be achieved without a culture. 
The informed customer is more aware of  the risks and 
gains associated with financial products and more aware 
of  their rights and responsibilities. Among these goals 
mentioned by researchers such as (Al-Hasnawi & Mahdi, 
2020; Gabor & Brooks, 2017; Helms, 2006; Ishioro, 2022; 
Kumar, 2011) are; promoting access for all segments of  
society to financial services, informing individuals about 
the importance of  these services, how to obtain them, 
and how to benefit from them; improving the living 
conditions of  individuals, especially the poor classes, 
and working to reduce poverty and achieve prosperity 
by promoting entrepreneurship, providing economic 
development opportunities, and improving their social 
and economic conditions; speeding up access to sources 
of  financing and providing support to small companies 
to expand their operations to achieve the required 
investment; establishing freelance projects to promote 
the country’s economic growth; encouraging individuals 
to save in banks and invest money using optimal methods, 
such as creating programs and promoting a culture of  
competition.
The Group of  Twenty (G20) issued, along with the Global 
Partnership for Financial Inclusion (GPFI), in June at 
the Los Cabos Summit, the indicators for measuring 
financial inclusion. These indicators were developed 

during the 2016 China Summit for the purpose of  
financial inclusion. These indicators address three main 
dimensions, as adopted by many authors and researchers 
in their books and studies, including (Al-Chahadah et al., 
2020; Eldomiaty et al., 2020; Maher, 2022) : (1) Access to 
financial services. (2) Usage of  financial services. And (3) 
The quality of  financial services, including the quality of  
products and service delivery.

Banking Stability
The authors and researchers have addressed the concept 
of  banking stability from various perspectives. (Shubbar 
& Vladimirovich, 2019) defined banking stability as 
the optimal way of  analyzing the financial situation to 
avoid financial crises and ensure the banking system’s 
stability. This involves awareness of  the need to use an 
organized approach to achieve and maintain stability in 
the long term, both at the national and regional levels.  
(Alsomaidaee et al., 2023; Bhattarai, 2020) emphasized 
that banking stability plays a vital role in the economic 
growth of  a country, as it is a commercial institution 
that must generate profits from its operations to survive 
and fulfill its responsibilities. The main activities of  
commercial banks include resource mobilization, which 
involves costs, and profitable resource deployment. 
Generating income exceeding expenses is the primary 
source of  a bank’s profit. In cases where the bank fails 
to achieve sufficient returns on the allocated resources, 
it depletes both the company’s and the state’s resources. 
Assets are the most important factor in determining the 
strength of  any financial institution. The key factors to 
consider are the quality of  the loan portfolio, the risk asset 
mix, and the credit management system. A high level of  
non-performing loans is a major concern for any bank. 
(My, 2020) defines the concept of  banking stability as the 
effective execution of  important economic functions such 
as resource allocation and risk management, the ability 
to fully absorb shocks faced by the system, evaluating 
changes in financial risks, and the efficient allocation of  
resources. This, in turn, demonstrates the resilience of  all 
financial activities and sectors to reduce losses occurring 
during banking crises. Both (Anh et al., 2021), and 
(Sifrain, 2021) define banking stability as a state in which 
a bank can operate smoothly and efficiently, allowing it 
to perform its functions well, such as resource allocation, 
risk distribution, income distribution, payments, and 
credit. Additionally, the bank must be able to withstand 
external shocks, which aligns with.
The importance of  financial stability becomes evident 
through the repercussions of  recurring financial crises 
in general, and banking crises in particular, which affect 
economies periodically, starting from the financial crisis 
of  2008 and extending to the COVID-19 crisis. This 
prompts central banks to focus on achieving financial 
and banking stability in their countries. Both (Uhde & 
Heimeshoff, 2009) and (Alwan & Kadhim, 2020) agree 
that the importance of  banking stability lies in the 
measures and policies adopted by banks, with the most 



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important ones being the accuracy of  public budget 
calculations in the operation of  financial institutions 
increases investor confidence and transparency in credit 
flow, as well as an increase in the percentage of  credit 
allocation to medium and small projects with feasibility. 
This helps improve market discipline, increase bank 
disclosure, and address cases where banks refrain from 
financing profitable projects due to significant deviations 
in asset prices from their true value or failure to settle 
payments on time.

Banking Stability Measures
The global financial crisis highlighted the significant 
impact that struggling banks can have on the global 
economies. The successful development of  an economy, 
as noted by (Ginevičius & Podviezko, 2013), depends on 
banks’ efficient and stable performance. This leads to the 
necessity of  having sound indicators for banks, as risks 
must be identified by integrating both internal (banking) 
and external (market) factors that are easily accessible and 
can be easily designed by banks (J. Powell & H. Vo, 2020). 
Banking crises and banking regulation are recurring 
topics in economic and financial policy discussions. Since 
the early 1970s, banking crises have repeatedly affected 
emerging and transitional economies more than others. 
However, there is a lack of  understanding of  the factors 
that generate banking crises. Regulators tend to assist 
troubled institutions more than resolving them. Prudential 
regulatory controls aim to reduce excessive banking risks 
and capital shortfalls in an attempt to protect society 
(Kane, 2016). Unfortunately, these controls often come 
too late, after the crisis has already spread. Therefore, 
a better understanding of  risk factors can be useful in 
reducing risks, especially when regulatory authorities 
can address distress situations before they spread to the 
broader financial system (Martínez-Malvar & Baselga-
Pascual, 2020).
The increase in capital adequacy has become a more 
important strategy for enhancing banking stability in 
the aftermath of  the global financial crisis of  2007-
2009. During this period, most central banks proposed 
an increase in capital adequacy as a requirement for 
building stability in the banking industry (Sulemana 
et al., 2018). To the best of  the researcher’s knowledge 
and information, several authors and researchers have 
concurred, including (Chouhan et al., 2014; Mutarindwa 
et al., 2020; Oyetade et al., 2022; Yunita, 2022). They used 
the Z-SCORE indicator to measure banking stability. The 
Banking Financial Stability Indicator (Z-SCORE) plays 
a vital role in enhancing the reputation and security of  
the banking system and increasing international trade 
in light of  the significant economic growth in countries 
that impact banking services. This indicator suggests 
the ability to predict financial crises (Alshubiri, 2017) 
and can be counted as an early warning system for the 
banking system (Faruqinata & Wibowo, 2020). The post-
global financial crisis period of  2007-2009 witnessed 
numerous experimental efforts to assess the effectiveness 

of  discriminative analysis. Most of  these studies focused 
on cases of  bank failures during the financial crisis, 
increasing interest in the Z-SCORE indicator from 
earlier times (Mugo, 2021). (Syed et al., 2022) emphasized 
that the Z-SCORE indicator is important in achieving 
banking stability, a point reiterated by (Oyetade et al., 
2022). Z-Score is a measure used to predict bank failure 
or financial distress and is a common measure of  banking 
resilience, assessing the extent to which a bank’s capital 
can cover losses resulting from variations in returns 
without going bankrupt.

METHODOLOGY
The research sample represents the Iraqi banking system 
in its entirety. This is because there were changes in the 
structure of  the banking system during 2021, due to the 
entry of  some local banks and the exit of  some foreign 
banks from the banking sector, particularly Lebanese 
banks that were invested in Iraq. This resulted from the 
economic crisis in Lebanon, which led Lebanese banks 
to withdraw from some countries, including Iraq. The 
total number of  operating banks, with the Central Bank 
of  Iraq at the forefront, became 74 banks, including 7 
government banks and 3 specialized banks, 3 commercial 
banks, and one Islamic bank. Meanwhile, the number 
of  private banks reached 67 banks, including 25 local 
commercial banks and 28 local Islamic banks, as well as 
14 foreign banks, consisting of  2 Islamic banks and 12 
commercial banks. 
The Z-Score measure has been proposed as an indicator 
of  risk and the likelihood of  bank insolvency or failure. 
This measure has been widely used in numerous studies 
and has become common for assessing banks’ distress, 
failure, and stability. It was initially developed by Roy in 
1952 and subsequently refined by (Sifrain, 2021). Its value 
indicates the number of  standard deviations that need to 
occur in the return on assets (ROA) ratio, which is the 
number of  times the return decreases from its value in 
order to deplete equity and render the bank insolvent. The 
value of  the indicator increases with higher profitability 
and equity levels (Lepetit & Strobel, 2015). Conversely, 
it decreases when returns are more volatile and decline, 
as reflected in an increase in the standard deviation of  
the return on assets. In other words, as the indicator 
value rises, the bank’s stability increases, and conversely, 
when the indicator value significantly declines, the level 
of  stability and the ability of  banks to withstand shocks 
decrease (Li et al., 2017). As the value approaches one or 
approaches zero or becomes negative, the bank enters 
a state of  financial distress and instability, leading to a 
banking crisis. The stability of  the banking sector can be 
expressed mathematically, as in the following formula.
Z-score=  (ROA+(Equity/Assets))/(σ(ROA))
The financial stability in Iraq can also be measured using 
the aggregate index. Different countries vary in their 
use of  indicators and measures of  banking stability, 
depending on the monetary policy adopted by the 
central bank. This variation is attributed to the strength 



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of  banking systems and the systems in place, whether 
they are advanced with full electronic automation or they 
follow traditional systems. The Central Bank of  Iraq has 
defined the banking stability indicators in Iraq, including 
capital adequacy, asset quality, profitability, and liquidity 
(Central Bank of  Iraq Report, 2021).

RESULTS AND DISCUSSION
To test research hypotheses and analyze them, the impact 
of  financial inclusion with its indicators on banking 
stability was tested based on time series data. Through 
this model, the relationship between research variables 

will be identified. Before starting the hypothesis testing 
procedures, it is necessary to ensure the suitability of  the 
data for the regression model of  least squares used in this 
research by examining the data and determining whether 
it possesses the characteristic of  normal distribution, 
i.e., whether the data of  the variables follow a normal 
distribution.
The table 1. displays the results of  normal distribution 
tests using the Shapiro-Wilk W test for this type of  
test. It ensures that all variable indicators possess the 
characteristic of  a normal distribution.

Table 1: Results of  normal distribution tests
Shapiro Wilk W test for normal data
Variable Obs W V Z Prob>z Sig.
Banking Density 12 0.85399 2.440 1.738 0.4113 not significant
banking spread 12 0.96338 0.612 -0.957 0.83082 not significant
ATMratio 12 0.86575 2.243 1.574 0.05775 not significant
SUB/1000km 12 0.86103 2.322 1.641 0.05036 not significant
ATM/1000km 12 0.86422 2.269 1.596 0.05523 not significant
Depth of  Banking Loans Index 12 0.94051 0.994 -0.012 0.50471 not significant
Depth banking index 12 0.89952 1.679 1.009 0.15637 not significant
B. St. Index 12 0.81225 3.137 2.228 0.1296 not significant

Hypothesis Testing
The primary hypothesis of  the research was to test the 
direct impact of  financial inclusion, as indicated by its 
independent indicators, on banking stability. Table (2) 
presents the results of  testing the first hypothesis of  the 
study, which showed significant effects. The BD index 
had a significant impact on stability (β=-0.0089, P < 
0.05), as did the BS index (β=0.1228, P < 0.05), ATM 
(1000) (β=-0.053, P < 0.05), and DOBLI (β=-0.0333, 
P < 0.05), while the R ATM (β=0.0318, P > 0.05) 
and SUB (1000) (β=0.00769, P > 0.05) did not have a 
significant impact on banking stability. The coefficient 
of  determination or R-squared (R2) for each test model 
was significant (R2=(0.281, 0.255, 0.221, 0.488, 0.426), 
with a statistical significance of  P = 0.000. This indicates 
that the variation in banking stability was explained by 
the significant financial inclusion indicators, while the 
remaining determination coefficients were explained by 
other variables not considered in this test model.

Based on these results, the impact of  financial inclusion 
during the study period was not total but partial, due to the 
significant impact of  some indicators in the test model. The 
reason for the significance of  the impact on banking stability 
may be that the financial inclusion indicators represent an 
investment that aims to achieve planned stability. However, 
this stability appears to be inversely related to the beta 
values, meaning that as there is an expansion in financial 
inclusion, it is accompanied by a decrease in stability. 
This could be attributed to the growth rates of  financial 
inclusion indicators leading to an increase in deposits and 
loans provided by banks to customers. Additionally, the 
banking spread index in all its forms negatively affects the 
nature of  stability due to an increase in the supervision 
scope and a loss of  control over branches. This, in turn, 
leads to an increase in non-performing loans compared to 
the decrease in deposits, which are considered the primary 
drivers of  banking activity. Table (2) summarizes the results 
of  testing the hypothesis.

Table 2: Results of  the first hypothesis testing
Path α Coef. Std. Err. T P>|t| R2 Prob
BD  <--- B. St. Index .6301 -.0089 .0041 -2.17 0.030 0.281 .000
BS  <---  B. St. Index -.0313 .1223 .0603 2.03 0.043 0.255 .000
R ATM  <---  B. St. Index .3935 .0318 .0174 -1.82 0.069 0.216 .000
SUB/1000 <---  B. St. Index .1165 .0769 .0953 0.81 0.420 0.051 .478
ATM /1000  <---  B. St. Index .3797 -.0530 .0286 -2.05 0.044 0.221 .000
DOBLI  <---  B. St. Index .5544 -.0333 .0098 -3.38 0.001 0.488 .000
DBI  <---  B. St. Index .5635 -.0245 .0082 -2.99 0.003 0.426 .000



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CONCLUSIONS 
The current paper aimed to test the impact of  financial 
inclusion on the stability of  the Iraqi banking sector. The 
results confirmed a significant decrease in the number of  
bank branches during the research sample period relative 
to the population in Iraq, according to international 
standards. The results indicated the inadequacy of  the 
number of  ATMs, despite a noticeable increase in their 
numbers. However, this increase is not proportional to 
the growing demand for them, leading to a significant 
gap between the two. Regarding banking distribution, 
there has been a noticeable relative increase in recent 
years during the time frame of  the research sample. 
However, it has not reached the required level according 
to global standards. This can be attributed to the focus 
of  the research sample’s banks on major cities, which 
are characterized by high population density. Also, the 
stability of  the Iraqi banking system witnessed significant 
fluctuations during the research sample period. In the first 
five years of  the research period, there was clear stability, 
followed by a significant decrease in the composite index 
level, as endorsed by the Central Bank of  Iraq, as a 
natural consequence. The reasons for this can certainly 
be attributed to the security and political conditions that 
Iraq went through during that period, and undoubtedly 
followed by the COVID-19 pandemic. 
In light of  the conclusions reached regarding the Iraqi 
banking sector in the research sample, it becomes evident 
that there is a need for banking management to increase 
access to financial services by increasing the number of  
branches and ATMs in all Iraqi provinces, taking into 
account the country’s size, and not restricting them 
to specific provinces only. Furthermore, it is essential 
for banking management to consistently focus on 
the indicators adopted by international central banks, 
including the Central Bank of  Iraq. 

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