Financial innovation and financial inclusion in European countries: How do they interact?

Abstract

The most challenging moments in economic history necessitated adaptability to new realities and foreshadowed innovative reactions from economic agents. The recent global health crisis compelled all the stakeholders to find viable solutions to prevent the economic recovery from stalling. As finance serves as the fuel that keeps the economic engine running, exploring the factors affecting financial innovation is pivotal. Europe's digital transition strategy provides a vibrant approach to bolstering the digital economy and financial landscape. This study evaluates the link between financial inclusion and financial innovation in selected European countries moderated by digital technology. Moreover, subsequent factors related to socio-economic development, like the standard of living, education, urbanization, and globalization, are studied to assess their impact on financial innovation. The study used new-generation panel data techniques to analyze the selected European countries from 2000 to 2020. Durbin Hausman's cointegration test shows a long-run relationship. Our findings from fully modified ordinary least square (FMOLS) and dynamic ordinary least squares (DOLS) tests highlighted an inverse relationship between financial inclusion and financial innovation. Thus, expanding the inclusion of people in the financial ecosystem will not increase the usage of innovative financial tools. However, it will only encourage access to essential financial services and products, considering the high levels of financial inclusion in Europe and the newcomers' financial and digital literacy levels. Additionally, the preference for using cash in European countries, which is still at high levels, also explains our results regarding the indirect connection between financial inclusion and financial innovation diffusion. Moreover, a strong direct correlation is observed between education, standard of living, and urbanization. Konya causality analysis results displayed a causal relationship between independent variables and financial innovation in different countries.