Examining The Impact Of Digital Financial Inclusion On Banking Performance: The Moderating Effect Of Institutional Quality In Middle-Income Economies

Abstract

This study examines the impact of digital financial inclusion (DFIII) on banking performance (BP) and the moderating role of institutional quality in middle-income economies. Using balanced panel data from 33 middle-income countries over the period 2011- 2021, the study employs Principal Component Analysis (PCA) to construct composite indices for DFII, BP, and institutional quality. To address endogeneity and dynamic persistence, the two-step System GMM estimator is applied. The findings reveal that DFII significantly and positively influences banking performance, enhancing efficiency, profitability, and stability. Institutional quality, although theoretically important, does not exert a statistically significant direct or moderating effect on the DFII BP relationship within the sampled economies. The results suggest that digital financial expansion serves as a primary driver of banking performance in middle-income countries, while institutional strength may play a supportive but not yet decisive role. The study contributes to the digital finance literature by integrating financial inclusion, governance quality, and banking performance within a dynamic panel framework, offering important implications for policymakers in emerging and transitional economies.