Bank Lending and Income Inequality: Evidence from Indonesia

Abstract

This paper investigates the relationship between financial development and income inequality by using a broad range of loan categories as proxies for financial development. Our unique data set allows us to identify loans to micro, small and medium-sized enterprises (MSMEs). It also allows us to distinguish business loans and consumer loans. Using panel data for 33 provinces in Indonesia during the 2007-2013 period, we find that lending to MSMEs reduces income inequality while businesses loans, either for working capital or investment purposes, but also consumer loans increase income inequality. Our results indicate that boosting loans to micro, small, and medium-sized enterprises could significantly contribute to reduce income inequality.