Assessing the direct effect of financial development on poverty reduction in a panel of low- and middle-income countries

• We investigate the influence of financial development on reducing poverty in low- and middle-income countries.
• Financial development is beneficial for the poor by increasing its access to various sources of funding and improving its well-being.
• The study supports both the McKinnon's conduit effect and the argument of Beck et al. (2007a).
• Financial instability significantly affects the poor and bears the risk to annihilate the benefit of financial development.
• A more pro-poor public expenditure policy is recommended in low- and middle-income countries.

This paper empirically assesses the directly contribution of financial development to poverty reduction in 67 low- and middle-income countries over the period 1986–2012. The main goal of the paper is to identify and quantify the channels through which financial development affects poverty. The results obtained suggest the important contribution of financial development to the reduction of poverty, and this, independently of the econometric techniques used. On the other hand, instability related to the financial development would penalize the poor population and would annihilate the positive effects of financial development. The final battery of tests is motivated by the issues of overidentification and weak instruments in system-GMM estimator. The results show the validity of the exclusion restrictions and the absence of instrument proliferation. Also, they may call into question the pro-poor public investment policy in low- and middle-income countries.

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