Financial Inclusion and Bank Stability: Heterogeneous Effects of Bank Size and Capital: Evidence from an Emerging Economy
Purpose: This study examines the effect of financial inclusion on bank stability in Pakistan, with particular attention to the moderating roles of bank size and capital adequacy. Design/Methodology/Approach: The study employs a dynamic system Generalized Method of Moments (GMM) estimator using an unbalanced panel of commercial banks in Pakistan covering the period 2011–2025. Two-stage least squares (2SLS) estimation is employed as a robustness check. Bank stability is measured using the Z-score, while financial inclusion is captured through a multidimensional index incorporating both traditional and digital access indicators. Findings: The results indicate that financial inclusion has, on average, a positive effect on bank stability. This effect is significantly stronger among smaller banks, for which the stability gains associated with an expanded and diversified deposit base outweigh the relatively modest marginal benefits observed among larger banks. In addition, well-capitalized banks are substantially better positioned to translate inclusion-driven growth into improvements in solvency and overall stability. These findings highlight significant heterogeneity in the relationship between financial inclusion and bank stability according to banks' institutional characteristics. Practical implications: The study contributes to the literature by demonstrating that the stability effects of financial inclusion are conditional on bank size and capital strength. The findings suggest that financial inclusion policies in Pakistan should account for differences in banks' institutional characteristics rather than being applied uniformly across the banking sector. Originality/Value: The study also provides a basis for comparative research on financial inclusion and bank stability in other emerging banking systems.