Showing papers on "Financial sector development published in 2010"

Financial institutions and markets across countries and over time : the updated financial development and structure database

Abstract: This article introduces the updated and expanded version of the financial development and structure database. The database includes indicators on the size, efficiency, and stability of banks, nonbank financial institutions, and equity and bond markets over 1960-2007. It also contains indicators of financial globalization.

Finance for renewable energy: an empirical analysis of developing and transition economies

Abstract: This paper examines the role of the financial sector in renewable energy (RE) development. Although RE can bring socio-economic and environmental benefits, its implementation faces a number of obstacles, especially in non-OECD countries. One of these obstacles is financing: underdeveloped financial sectors are unable to efficiently channel loans to RE producers. The influence of financial sector development on the use of renewable energy resources is confirmed in panel data estimations on up to 119 non-OECD countries for 1980–2006. Financial intermediation, in particular commercial banking, has a significant positive effect on the amount of RE produced, and the impact is especially large when we consider non-hydropower RE such as wind, solar, geothermal and biomass. There is also evidence that the development of the RE sector has picked up significantly in the period since the adoption of the Kyoto Protocol.

Finance-investment-growth nexus in South Africa: an ARDL-bounds testing procedure

Abstract: In this paper we examine the dynamic causal relationship between financial development, investment and economic growth in South Africa—using the newly developed ARDL-Bounds testing procedure. Unlike the majority of the previous studies, we incorporate investment in the bivariate model between financial development and economic growth—thereby creating a simple trivariate causality model. In addition, we use three proxies of financial development, namely M2/GDP, the ratio of private sector credit to GDP and the ratio of liquid liabilities to GDP in order to test the robustness of the results. Our results show that, on the whole, economic growth has a formidable influence on the financial sector development. The study also finds that there is a distinct unidirectional causal flow from economic growth to investment. Moreover, the study also finds that investment, which results from growth, Granger-causes financial development. The study, therefore, recommends that South Africa should intensify its pro-growth policies in order to bolster investment and financial development.

Why Do Firms Evade Taxes? The Role of Information Sharing and Financial Sector Outreach

Abstract: Informality is a wide-spread phenomenon across the globe. We show that firms in countries with better information sharing systems and greater financial sector outreach evade taxes to a lesser degree, an effect that is stronger for smaller firms, firms in smaller cities and towns, and firms in industries relying more on external financing, with higher liquidity needs and with greater growth potential. However, it is variation in firm size that dominates firm variation in location and industry variation in explaining cross-firm and cross-country variation in tax evasion. This effect is robust to controlling for an array of other measures of the financial and institutional environment firms face. The effect is also robust to controlling for fixed firm effects in a smaller panel dataset of Central and Eastern European countries many of which introduced credit registries or upgraded them in the early 2000s.

Financial globalization and economic policies

Abstract: We review the large literature on various economic policies that could help developing economies effectively manage the process of financial globalization. Our central findings indicate that policies promoting financial sector development, institutional quality, and trade openness appear to help developing countries derive the benefits of globalization. Similarly, sound macroeconomic policies are an important prerequisite for ensuring that financial integration is beneficial. However, our analysis also suggests that the relationship between financial integration and economic policies is a complex one and that there are unavoidable inherent tensions in evaluating the risks and benefits associated with financial globalization. In the light of these tensions, structural and macroeconomic policies often need to be tailored to take into account country-specific circumstances to improve the risk-benefit tradeoffs of financial integration. Ultimately, it is essential to see financial integration not just as an isolated policy goal but also as part of a broader package of reforms and supportive macroeconomic policies.

A Closer Look at Financial Development and Income Distribution

Abstract: This paper analyzes the under-investigated relationship uniting financial development and income distribution. We use a novel approach taking into account for the first time the specific channels linking banks, capital markets and income inequality, the time-varying nature of the relationship, and reciprocal causality. We construct a set of annual indicators of banking and capital market size, robustness, efficiency and international integration. We then estimate the determinants of income distribution using a panel Bayesian structural vector autoregressive (SVAR) model, for a set of 49 countries over the 1994-2002 period. We uncover a significant causality running from financial sector development to income distribution. In addition, the banking sector seems to exert a stronger impact on inequality. Finally, the relationship appears to depend on characteristics of the financial sector, rather than on its size.

Foreign bank participation in developing countries : what do we know about the drivers and consequences of this phenomenon?

Abstract: Foreign bank participation has increased steadily across developing countries since the mid-1990s. This paper documents this trend and surveys the existing literature to explore the drivers and consequences of this phenomenon, paying particular attention to the differences observed across regions both in the degree of foreign bank participation and in the impact of this process. Local profit opportunities, the absence of barriers to entry, and the presence of mechanisms to mitigate information problems have been the main factors driving foreign bank entry across developing countries. In general, foreign bank participation has been shown to exert a positive influence on banking sector efficiency and competition. The weight of the evidence suggests that foreign bank presence does not endanger, but rather enhances banking sector stability. And although some case studies suggest that foreign bank entry limits access to finance, many cross-country studies offer evidence to the contrary.

Financial Development and Economic Growth in Developing Asia

Abstract: Economic theory suggests that sound and efficient financial systems - banks, equity markets, and bond markets - which channel capital to its most productive uses are beneficial for economic growth. Sound and efficient financial systems are especially important for sustaining growth in developing Asia because efficiency of investment will overshadow quantity of investment as the driver of growth in the region. The data indicate that the region’s financial systems have become deeper and more diversified since the early 1990s. A more formal econometric analysis on a panel data of 125 countries confirms that financial development has a significant positive effect on growth, especially in developing countries. The results also indicate that the impact of financial development on the region’s growth is not noticeably different than elsewhere, and the impact has weakened since the Asian financial crisis. Overall, our evidence supports the notion that further development of the financial sector matters for sustaining developing Asia’s growth in the postcrisis period. However, the primary role of financial sector development in growth is likely to shift away from mobilizing savings, thus augmenting the quantity of investment toward improving the efficiency of investment, and thereby contributing to higher economywide productivity.

Foreign capital inflows-growth nexus and role of domestic financial sector: an ARDL cointegration approach for Pakistan

Abstract: This study explores the roles of foreign capital inflows and domestic financial sector development on economic growth in the case of Pakistan. Using annual data series of World Bank and Economic Survey of Pakistan over the period of 1971-2008, ARDL bounds testing approach to cointegration and Error Correction Model (ECM) are employed for long run and short run relationships, respectively. Empirical evidence reveals that foreign capital inflows have positive effect on economic growth. Financial sector’s development and public investment stimulate economic growth. Human capital stock and inflation also contribute to economic growth positively. The present study suggests that Pakistan government should undertake financial reforms to improve the efficiency of the domestic financial sector which will ultimately increase the rate of economic growth in the country.

Financial development and income inequality: evidence from African countries

Abstract: This paper present empirical evidence on how financial development is related to income distribution in a panel data set covering 22 African countries for the period between 1990 to 2004. A dynamic panel estimation technique (GMM) is employ and the findings indicate that income inequality decrease as economies develop their financial sector, which is consistent with the bulk of theoretical and empirical research. The result also confirm that educational attainment play a significant role in making income distribution more equal. We also find no evidence supporting the Greenwood-Jovanovic hypothesis of an inverted-U- shaped relationship between financial sector development and inequality.

Market structure, capital regulation and bank risk taking

Abstract: This paper discusses the effect of capital regulation on the risk taking behavior of commercial banks. We first theoretically show that capital regulation works differently in different market structures of banking sectors. In lowly concentrated markets, capital regulation is effective in mitigating risk taking behavior because banks’ franchise values are low and banks have incentives to pursue risky strategies in order to increase their franchise values. If franchise values are high, on the other hand, the effect of capital regulation on bank risk taking is ambiguous. We then test the model predictions on a cross-country sample including 421 commercial banks from 61 countries. We find that capital regulation is effective in mitigating risk taking only in markets with a low degree of concentration. The results remain robust after accounting for financial sector development, legal system efficiency, and for other country and bank-specific characteristics.

Remittances and the Brain Drain: Skilled Migrants Do Remit Less!

Abstract: It has been argued that the adverse impact of skilled versus unskilled labor migration can be mitigated or even offset by the fact that skilled migrants remit more than unskilled ones. This paper contributes to the much debated and so far unresolved related issue, namely whether remittances actually increase with migrants' level of education. The determinants of remittances considered include migration levels and rates, migrants' education level, and source countries' income, financial sector development and expected growth rate. The estimation accounts for potential endogeneity, an issue not considered in the few existing studies on this topic. Our main finding is that remittances decrease with the share of migrants with tertiary education. This provides an additional reason for which source countries would prefer unskilled to skilled labor migration. Moreover, as predicted by our model, remittances increase with source countries' level and rate of migration, financial sector development and population, and decrease with their per capita income and expected growth rate.

Financial Sector Development and Economic Growth: Empirical Evidence from Nigeria

Abstract: The paper examines the relationship between financial sector development and economic growth in Nigeria. It tests the competing finance-growth nexus hypothesis using Granger causality tests in a VAR framework over the period 1960-2009. Four variables, namely; ratios of broad money stock to GDP, growth in net domestic credit to GDP, growth in private sector credit to GDP and growth in banks deposit liability to GDP were used to proxy financial sector development. The empirical results suggest bidirectional causality between some of the proxies of financial development and economic growth variable. Specifically, we find that the various measures of financial development grangercause output even at 1per cent level of significance with the exception of ratio of broad money to GDP. Additionally, we find that net domestic credit is equally driven by growth in output, thus indicating bidirectional causality. The variance decomposition shows that the share of deposit liability in the total variations of net domestic credit is negligible, indicating that shock to deposit does not significantly affect net domestic credit. The findings from the paper indicate that the current reforms in the Nigerian banking sector should not be emphasized unilaterally. Rather, attention should be given to the complimentary and coordinated development of financial reforms and changes in the real sector of the economy.

Banking on politics : when former high-ranking politicians become bank directors

Abstract: New data are presented for a large number of countries on how frequently former high-ranking politicians become bank directors. Politician-banker connections at this level are relatively rare, but their frequency is robustly correlated with many important characteristics of banks and institutions. At the micro level, banks that are politically connected are larger and more profitable than other banks, despite being less leveraged and having less risk. At the country level, this connectedness is strongly negatively related to economic development. Controlling for this, the analysis finds that the phenomenon is more prevalent where institutions are weaker and governments more powerful but less accountable. Bank regulation tends to be more pro-banker and the banking system less developed where connectedness is higher. A benign, public interest view is hard to reconcile with these patterns. Banking sector development, institutions, political economy.

The Binding Constraint on Firms’ Growth in Developing Countries

Abstract: Firms in developing countries face numerous and serious constraints on their growth, ranging from corruption to lack of infrastructure to inability to access finance. Countries lack the resources to remove all the constraints at once and so would be better off removing the most binding one first. This paper uses data from World Bank Enterprise Surveys in 2006-10 to identify the most binding constraints on firm operations in developing countries. While each country faces a different set of constraints, these constraints also vary by firm characteristics, especially firm size. Across all countries, access to finance is among the most binding constraints; other obstacles appear to matter much less. This result is robust for all regions. Smaller firms must rely more on their own funds to invest and would grow significantly faster if they had greater access to external funds. As a result, a low level of financial development skews the firm size distribution by increasing the relative share of small firms. The results suggest that financing constraints play a significant part in explaining the missing middle -- the failure of small firms in developing countries to grow into medium-size or large firms.

Consumer protection and financial literacy : lessons from nine country studies

Abstract: The 2008 global financial crisis has emphasized the need for adequate consumer protection and financial literacy for long-term stability of the financial sector. This Working Paper aims to summarize key lessons from reviews of consumer protection and financial literacy in the nine middle-income countries of Europe and Central Asia: Azerbaijan, Bulgaria, Croatia, the Czech Republic, Latvia, Lithuania, Romania, the Russian Federation and Slovakia. All the country assessments used a systematic common approach, based on a set of Good Practices for Consumer Protection and Financial Literacy developed by the World Bank's Europe and Central Asia Region. A financial consumer protection regime should meet three objectives. First, consumers should receive accurate, simple, comparable information of a financial service or product, before and after buying it. Second, consumers should have access to expedient, inexpensive and efficient mechanisms for dispute resolution with financial institutions. Third, consumers should be able to receive financial education when and how they want it. A common challenge among the nine countries is the need of an adequate institutional structure for financial consumer protection. Regardless of the specific institutional structures, financial consumers should have one single agency where to submit complaints and inquiries. Financial institutions should be required to apply fair, non-coercive and reasonable practices when selling and advertising financial products and services to consumers. Personal data should also be carefully protected.

The Impact of FDI and Financial Sector Development on Economic Growth: Empirical Evidence from Asia and Oceania

Abstract: This paper empirically examines if financial sector development is an important precondition for foreign direct investment (FDI) to enhance economic growth in the Asia-Oceania region. The study will also examine whether the impact is dependent on the stages of development of the countries. Panel data methods (fixed effects-estimator and random effects-estimator) were used to analyse the relationship between FDI, financial sector development and economic growth on a sample of 44 Asia and Oceania countries for the period 1996-2005. The empirical analysis showed that financial sector development enhances the contribution of FDI on economic growth in the region. It also showed that the complementary role of FDI and financial sector development on economic growth is most important for least developed economies in the region. Key strategies to enhance the role of FDI and financial development on economic growth in developing and least developed Asia and Oceania countries are also discussed in the paper.

Consumer protection regulation in low-access environments : opportunities to promote responsible finance

Abstract: This focus note describes current practices and assesses options for design and implementation of basic consumer protection rules, focusing on low-access environments. It includes the following: 1) a package of basic consumer protection rules that address problems faced by poorer consumers with little experience using formal finance and that are appropriate in low-access environments-i.e., those with low levels of access to formal financial services, especially among low-income people, and limited regulatory capacity; 2) a package of 'next generation' measures that could be implemented later, as markets develop, competition increases, products become more numerous and diverse, and regulatory capacity and experience deepens; 3) analysis of regulatory options to promote the three core consumer protection principles-transparency, fair treatment, and effective recourse in low-access environments; 4) observations on implementation, monitoring, and enforcement of the basic and next generation packages; and 5) discussion of how the two other pillars of responsible finance-industry standards and improvement of consumer financial capability-can complement and reinforce regulation.

Regulatory Reforms for Improving the Business Environment in Selected Asian Economies— How Monitoring and Comparative Benchmarking Can Provide Incentive for Reform

Abstract: The determinants of a business friendly environment that underpin rapid and sustained economic growth include the macroeconomic and financial market environments, infrastructure, labor market skills and efficiency, and governance and institutions. Obtaining licenses and credit to start a business, finding and managing labor, ensuring investor protection, enforcing contracts, paying taxes, trading across borders, and identifying the requirements for closing a business are all important factors in assessing the operating climate for doing business. By comparative benchmarking, this paper examines these determinants in six developing Asian economies — the People’s Republic of China, Indonesia, Malaysia, the Philippines, Thailand, and Viet Nam — and compares them with similar indicators for five benchmark economies — the newly industrialized economies (NIEs) of Hong Kong, China; the Republic of Korea; and Singapore; and the developed economies of Japan and the United States. This paper also identifies areas where reform has taken place and where further efforts are needed, such as addressing policy uncertainties, the quality of governance and legal and institutional frameworks, and inadequate regulatory capacity. Attending to these shortcomings will require policymakers to implement structural reforms that improve efficiency and competitiveness by minimizing unnecessary regulatory barriers in business activities, encouraging private incentives and market discipline, creating a level playing field across all sectors, and fostering competition to upgrade institutional capacity. This paper argues that the regular monitoring of relevant indicators and comparative benchmarking can provide important incentive structures that encourage the sharing and implementation of good practices through peer pressure mechanisms and serve as a starting point for dialogue between governments and the private sector on reform priorities that can improve the business environment.

Banking Sector Stability, Efficiency, and Outreach in Kenya

Abstract: Although Kenya's financial system is by far the largest and most developed in East Africa and its stability has improved significantly over the past years, many challenges remain. This paper assesses the stability, efficiency, and outreach of Kenya's banking system, using aggregate, bank-level, and survey data. Banks' asset quality and liquidity positions have improved, making the system more resistant to shocks, and interest rate spreads have declined, in part due to reduction in the overhead costs of foreign banks. Outreach remains limited, but has improved in recent years, driven by mobile payments services in the domestic remittance market. Fostering a level regulatory playing field for all deposit-taking institutions is a key remaining challenge. Specifically, an effective but not overly burdensome framework for regulation and supervision of microfinance institutions and cooperatives is a priority. Maintaining an openness to new, and non-bank, providers of financial services, which has enabled the success of mobile payments, could also further outreach.

Growth and Capital Flows with Risky Entrepreneurship

Abstract: This paper shows that the behavior of entrepreneurs facing incomplete financial markets and risky investment can explain why growth accelerations in developing countries tend to be associated with current account improvements. The uninsurable risk of losing invested capital forces entrepreneurs to rely on self-financing, so that when business opportunities open up entrepreneurs increase saving to finance the investment that produces growth. The key insight is that saving has to rise more than investment to allow also for the accumulation of precautionary assets. Plausibly calibrated simulations show that this net saving increase can sustain large and persistent net capital outflows.

Reforming China's Monetary Policy Framework to Meet Domestic Objectives

Abstract: As a result of reforms and financial sector development, the People’s Bank of China (PBoC) now exerts significant control over money market interest rates. With money market conditions increasingly influencing effective commercial lending rates, the PBoC is also able to affect the cost of credit without recourse to its benchmark commercial bank rates. Furthermore, interest rates are an important determinant of investment spending in China, via the user cost of capital, and aggregate economic activity influences inflation. Hence, greater use of interest rates in implementing monetary policy would enhance macroeconomic stabilisation while avoiding a number of drawbacks of the current quantity-based approach. In addition, increased flexibility in the exchange rate would enhance its role in offsetting macroeconomic shocks and allow the PBoC more scope to tailor monetary policy to domestic macroeconomic conditions. Concurrently, changes in the PBoC’s policy stance should be predicated on informed judgments based on the monitoring of a set of indicators in conjunction with a flexible inflation objective as the nominal anchor. This paper relates to the 2010 OECD Economic Review of China (www.oecd.org/eco/surveys/china).

Financial Development and Income Inequality: Evidence from African Countries

Abstract: This paper present empirical evidence on how financial development is related to income distribution in a panel data set covering 22 African countries for the period between 1990 to 2004. A dynamic panel estimation technique (GMM) is employ and the findings indicate that income inequality decrease as economies develop their financial sector, which is consistent with the bulk of theoretical and empirical research. The result also confirm that educational attainment play a significant role in making income distribution more equal. We also find no evidence supporting the Greenwood-Jovanovic hypothesis of an inverted-U- shaped relationship between financial sector development and inequality.

Determinants of China's Private Consumption: An International Perspective

Abstract: This paper gauges the key determinants of China's private consumption in relation to GDP using data on the Chinese economy and evidence from other countries' experiences. The results suggest there is nothing "special" about consumption in China. Rather, the challenge is to explain why the conditioning variables-notably a low level of service sector employment, the level of financial sector development, and low real interest rates-are so different in China relative to other countries' historical experience. The results suggest, in particular, that efforts to further raise household income and the share of employment in the services sector, as well as to develop capital markets, including liberalizing interest rates and creating alternative savings instruments are likely to have the biggest impact on consumption. Other mechanisms to raise household income and mitigate household-specific risk (such as by improving the healthcare and pension systems) also have a role to play.

The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma

Abstract: This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the “crisis economies” could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization.

Financial Sector Development and Income Inequality: Is There a Financial Kuznets Curve?

Abstract: The existing empirical knowledge in the area of financial sector development and income inequality finds evidence for the theoretical work of Banerjee and Newman (1993) and Galor and Zeira (1993) who posit a simple, linear relationship between the two variables. In this paper, we subject the extant empirical knowledge to close scrutiny and point out to a potential dynamic and endogenous relationship between financial sector development and inequality. By using dynamic multivariate panel data analysis on a carefully selected dataset of income inequality data for developed and developing countries spanning the period 1962-2006, we find robust empirical evidence for the existence of an inverted U-curve relationship between financial sector development and income inequality. The results are robust to inclusion of different control variables and different lag structure in the estimation method. In that token, we confirm the theoretical stipulations of Greenwood and Jovanovic (1990) for an inverted U-curve relationship between the financial sector and income inequality.

Responding to the Global Financial and Economic Crisis: Meeting the Challenges in Asia

Abstract: The global financial and economic crisis marks an important turning point for finance and the Asian growth model. Regional consensus is now supporting economic rebalancing away from the dominant focus on exports to developed markets and towards more a more balanced economic structure supported by domestic and regional financial development. In relation to finance, the crisis highlights the necessity of addressing a range of issues across the region. First, Asian approaches to financial liberalization, prudential regulation, and financial innovation are likely to be closely considered around the world. At the same time, while the region has not been at the center of the global crisis - in contrast to the Asian financial crisis of 1997/98 - it nonetheless provides an important opportunity to strengthen domestic and regional financial regulation. Second, beyond the post-crisis issues, and the prevention of systemic risk in particular, finance must continue to play a central role in supporting economic development and poverty reduction across the region. While the global crisis has highlighted once again the risks of finance, a central objective across Asia must be financial sector development to support economic growth and development. Third, in addition to domestic reform, the crisis provides an opportunity to enhance the international financial architecture, not only to improve its efficacy, but also to enhance the role of empowered Asian economies in global fora and institutions. At the same time, weaknesses in the international financial architecture suggest the need for Asian regional alternatives to address liquidity, liberalization, regulation, and exchange rate volatility.

Determinants of China's Private Consumption : An International Perspective

Abstract: This paper gauges the key determinants of China's private consumption in relation to GDP using data on the Chinese economy and evidence from other countries' experiences. The results suggest there is nothing "special" about consumption in China. Rather, the challenge is to explain why the conditioning variables-notably a low level of service sector employment, the level of financial sector development, and low real interest rates-are so different in China relative to other countries' historical experience. The results suggest, in particular, that efforts to further raise household income and the share of employment in the services sector, as well as to develop capital markets, including liberalizing interest rates and creating alternative savings instruments are likely to have the biggest impact on consumption. Other mechanisms to raise household income and mitigate household-specific risk (such as by improving the healthcare and pension systems) also have a role to play.

Macroeconomic Variables, Financial Sector Development and Capital Structure of Indian Private Corporate Sector during the Period 1981-2007

Abstract: Assuming that firms operate in a perfect and frictionless capital market, Modigliani and Miller (1958) argue that the value of a firm is independent of its capital structure. But other researchers argue that financial leverage depends on firm, industry and country-specific factors. As an economy transforms itself from an agro-based one to an industry and services-based one, the orientation of its financial system may also change. The orientation of the financial system and macroeconomic variables are expected to affect the sources of finance and the costs and benefits associated with different forms of financing. This paper examines the effect of the financial system and macroeconomic variables on the financial leverage of the Indian non-financial private corporate sector during the period 1981-2007. It is found that financial leverage is negatively related to stock market development and positively related to banking sector development, rate of inflation and effective rate of corporate tax.