Showing papers on "Financial sector development published in 2011"

What is happening to the impact of financial deepening on economic growth

Abstract: I. INTRODUCTION Among the strongest elements of the modern economists' canon is that financial sector development has a significant impact on economic growth. A generation ago, economists like Goldsmith (1969) (1) and McKinnon (1973) began to draw attention to the benefits of financial structure development and financial liberalization. By the early 1990s, McKinnon (1991, 12) could write with confidence that: "Now, however, there is widespread agreement that flows of saving and investment should be voluntary and significantly decentralized in an open capital market at close to equilibrium interest rates." Since the 1990s, a burgeoning empirical literature has illustrated the importance of financial sector development for economic growth. Despite the growing consensus, however, we find that the link between finance and growth in cross-country panel data has weakened considerably over time. At the very time that financial sector liberalization spread around the world, the influence of financial sector development on economic growth has diminished. The seminal empirical work that established the growth-finance link is King and Levine (1993), which extended the cross-country framework introduced in Barro (1991) by adding financial variables such as the ratios of liquid liabilities or claims on the private sector to gross domestic product (GDP) to the standard growth regression. They found a robust, positive, and statistically significant relationship between initial financial conditions and subsequent growth in real per capita incomes for a cross-section of about 80 countries. In the subsequent decade numerous empirical studies expanded upon this, using both cross-country and panel data sets for the post-1960 period. (2) In this paper we reexamine the core cross-country panel result and find that the impact of financial deepening on growth is not as strong with more recent data as it appeared in the original panel studies with data for the period from 1960 to 1989. We consider various explanations for this clear shift. First, we suggest that financial deepening has a positive effect on growth if not done to excess. Rapid and excessive deepening, as manifested in a credit boom, can be problematic even in the most developed markets because it can both weaken the banking system and bring inflationary pressures. We test this hypothesis by looking at the finance-growth nexus among countries that have or have not experienced financial sector crises. We find that once crisis episodes are removed, the finance-growth relationship remains intact. Its weakening over time thus seems to be a result of an increased incidence of crises in later years. Our second and related hypothesis is that the widespread liberalization of financial markets that occurred in the late 1980s and early 1990s made financial deepening less effective. This is reminiscent of Robert Lucas's (1975) critique of econometric policy evaluation advanced three decades ago. Policies that have promoted and/or forced increases in financial depth over the past two decades may have altered the basic structural relationship between finance and growth. This could occur if the observed benefits of financial deepening led many countries to liberalize before the associated legal and regulatory institutions were sufficiently well developed. As a consequence, the impact of financial deepening on growth would become smaller. Our evidence does not indicate that recent liberalizations are responsible for the breakdown of the finance-growth link. However, there may be an indirect link as premature financial development can lead to financial crises that have real effects. Third, we examine the role of global equity markets that have grown in importance and prominence in the years over which the finance-growth relationship disappeared. However, we do not find any evidence to suggest that equity market growth has substituted for the role of credit markets and banks in particular. …

Foreign banks: Trends, Impact and Financial Stability

Abstract: Over the past two decades, foreign banks have become more important in domestic financial intermediation, heightening the need to understand the behavior of foreign banks better. Using a new, comprehensive database on bank ownership for 137 countries over the period 19952009, identifying also the home country of banks, we document substantial increases in foreign bank presence in many countries. We also show large heterogeneity in terms of home and host countries, bilateral patterns, and performance. In terms of impact, we find a negative relation between private credit and foreign bank presence, but only in countries with relatively distant foreign banks. Furthermore, leading up to the crisis, private credit grew faster when foreign bank presence was large, but not in countries with relatively distant foreign banks. In addition, foreign banks reduced credit more compared to domestic banks during the global crisis in countries where they have a small role in financial intermediation, but not so when they were dominant or funded through local deposits. Our results show that accounting for heterogeneity is crucial to better understand the implications of foreign bank ownership.

Financial Access and Exclusion in Kenya and Uganda

Abstract: Policy emphasis has recently shifted to ‘Finance for All’ given evidence that financial sector development contributes to growth but effects on poverty do not arise from pro-poor provision. We argue that, given this policy goal, analyses of barriers to access must be country specific and go beyond the emphasis on transactions costs to incorporate the effects of social institutions since these contribute to discrimination. This paper uses data from Financial Access Surveys carried out in 2006 in Kenya and Uganda to investigate the socio-economic, demographic and geographical factors influencing access to and exclusion from formal, semi-formal and informal financial services.

Financing Africa: Through the Crisis and Beyond

Abstract: Financing Africa: through the crisis and beyond is a call to arms for a new approach to Africa's financial sector development. First, policy makers should focus on increasing competition within and outside the banking sector to foster innovation. This implies a more open regulatory mindset, possibly reversing the usual timeline of legislation-regulation-innovation for new players and products. It also implies expanding traditional infrastructure, such as credit registries and payment systems beyond banks. Second, the focus should be on services rather than existing institutions and markets. Expanding provision of payment, savings and other financial services to the unbanked might mean looking beyond existing institutions, products, and delivery channels, such as banks, traditional checking accounts, and brick-and-mortar branches. All financial sector policy is local. To reap the benefits of globalization, regional integration, and technology, policy makers have to recognize the politics of financial deepening and build constituencies for financial sector reform. While the challenges of expanding access, lengthening contracts, and safeguarding the financial system are similar, the ways of addressing them will depend on the circumstances and context of each country. With its cautiously optimistic tone, this book creates an opportunity for Africa's policy makers, private sector, civil society, and development partners to harness the progress of the past as a way to address the challenges of the future and enable the financial sector to play its rightful role in Africa's transformation.

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.

Determinants of economic growth in Central and Eastern Europe: the global crisis perspective

Abstract: This article presents an empirical analysis of economic growth determinants in the 10 Central and Eastern European (CEE) countries Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. The analysis covers the period 1993–2009. All the calculations are performed on five three-year subperiods and one two-year subperiod: 1993–95, 1996–98, 1999–2001, 2002–04, 2005–07 and 2008–09. The analysis is composed of three steps: data selection, correlation analysis and regression analysis. The correlation analysis is based on the coefficient of partial correlation to exclude the impact of the global crisis. In the regression analysis we build 10 alternative variants of empirical models of economic growth. Our results suggest that the most important economic growth determinants in the CEE countries are investment rate (including FDI), human capital measured by the education level of the labour force, financial sector development, good fiscal stance (low budget deficit an...

Gender and Finance in Sub-Saharan Africa : Are Women Disadvantaged?

Abstract: This paper assesses whether there is a gender gap in the use of financial services by businesses and individuals in Sub-Saharan Africa The authors do not find evidence of gender discrimination or lower inherent demand for financial services by enterprises with female ownership participation or by female individuals when key characteristics of the enterprises or individuals are taken into account In the case of enterprises, they explain this finding with selection bias -- females are less likely to run sole proprietorships than men, and firms with female ownership participation are smaller, but more likely to innovate In the case of individuals, the lower use of formal financial services by women can be explained by gender gaps in other dimensions related to the use of financial services, such as their lower level of income and education, and by their household and employment status

Impact of financial development on economic growth: empirical evidence from Pakistan

Abstract: The present article aims at investigating the effects of financial sector development on economic growth in the case of Pakistan from 1975 to 2008. A composite financial depth indicator is built using principal component analysis (PCA) and is used in the Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration. The results suggest the presence of a positive and significant relationship between financial development and economic growth.

Impact of financial development on economic growth: empirical evidence from Pakistan

Abstract: The present article aims at investigating the effects of financial sector development on economic growth in the case of Pakistan from 1975 to 2008. A composite financial depth indicator is built using principal component analysis (PCA) and is used in the Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration. The results suggest the presence of a positive and significant relationship between financial development and economic growth.

Financial Intermediaries Versus Financial Markets: A South African Experience

Abstract: In this paper, a dynamic causal relationship between stock market development, bank-based financial development and economic growth in South Africa is examined during the period 1980:1-2007:3, using a trivariate Granger causality model. The study attempts to answer two critical questions. Does financial sector development Granger cause economic growth? Which sector leads in the process of financial development in South Africa – bank-based sector or stock market sector? Using a cointegration-based error-correction mechanism, the empirical results reveal that there is a distinct unidirectional causal flow from stock market development to bank development. The results also indicate that there is a bi-directional causal relationship between stock market development and economic growth. Similar results were also found on the causality between bank-based financial development and economic growth. The study, therefore, concludes that whilst both financial development and economic growth Granger cause each other, the development of the financial sector in South Africa is largely driven by the stock market activities.

The Direction of Causality between Financial Development and Economic Growth: Evidence from Turkey

Abstract: In this paper we investigate the causality relationship between financial development and economic growth using available data from 1987:1 to 2006:04 about Turkey. We take total bank credit to private sector and total market capitalization as proxies for financial development and GDP as proxy for economic growth. In this context, Vector Error Correction Model and Impulse Response Functions (IRF) are used to explain possible casual relationships between variables. Empirical findings suggest that there is a bidirectional causality relationship between variables. While the development of the stock market and banking sector has caused economic growth, economic growth has also been brought about by stock market and banking sector developments in Turkey over the same period. Moreover, the contribution of the banking sector to economic growth has been larger than that of the stock market. (ProQuest: ... denotes formulae omitted.) Introduction The different growth rates of countries has preoccupied the minds of economists. The empirical growth literature has found numerous explanations for these differences, such as factor accumulation, resource endowments, the degree of macroeconomic stability, educational attainment, institutional development, legal system effectiveness, international trade, and ethnic and religious diversity. Recently, researchers have focused their attention on financial development to explain the cross-country differences in growth (Khan and Senhadji, 2000). The origin of financial development and economic growth nexus go back to the work of Schumpeter (1934). He took into account financial intermediaries necessary for innovation and development. According to Schumpeter, it is not possible to explain economic change by previous economic conditions alone. The economic state of a people emerges from the preceding total situations. One of the tools economists use to explain the reason of economic changes is the financial systems of countries. Goldsmith (1969) emphasizes that one of the most important problems in the field of finance is the effect of financial structure and development on economic growth. After Goldsmith's seminal work about 40 years ago, the relationship between financial development and economic growth has been studied by economists for a long time. They have searched the relationship from different perspectives. Becsi and Wang (1997) explain the finance-growth nexus with financial intermediaries. They emphasize that financial intermediaries give individuals or firms access to economies of scale that they would not have otherwise. Hence, intermediaries affect saving rates (Andres et al., 2004), facilitate and encourage inflows of foreign capital (DFID, 2004), allocate capital to its most productive use and by this way economic efficiency is enhanced (Becsi and Wang, 1 997; Beck et al., 2000). Also, they play an important role by facilitating the trading, hedging, diversifying, pooling of risk, facilitating the exchange of goods and services (Khan and Senhadji, 2000) and ameliorating asymmetric information (F avara, 2003). How well financial intermediaries carry out their functions may explain different growth rates between countries (Becsi and Wang, 1997). Loayza and Ranciere (2005) searched the relationship between financial development, financial fragility, and growth and used the data of 75 countries. They found that while there is a positive long-run relationship between financial intermediation and output growth, this relationship can be a negative in the short-run. Also, they found that financially fragile countries tend to display significantly negative short -run effects of intermediation on growth. According to modern growth theory, financial sector might affect long-run growth through its impact on capital accumulation and on the rate of technological progress. Financial sector development has a crucial impact on economic growth and poverty reduction especially in developing countries and without it economic development may be constrained, even if other necessary conditions are met (DFID, 2004). …

Development banks : role and mechanisms to increase their efficiency

Abstract: Past performance of development banks, has generally been considered poor and the value of state ownership questioned. There are few institutions that achieve the optimum balance of effectively addressing a policy objective while being financially sustainable. Following the financial crisis, there is a renewed interest in the role development banks can play in weathering the crisis. The purpose of this paper is to highlight the lessons learned following the financial crisis and to present some of the best practices in development banking so that policy makers can be better informed should they be considering how to build strong state financial institutions to address current and future needs in their respective countries.

Igniting Innovation: Rethinking the Role of Government in Emerging Europe and Central Asia

Abstract: This book builds on the lessons from public institutions and programs to support innovation, both successful and failed, from Europe and Central Asia (ECA) as well as China, Finland, Israel, and the United States. Field visits to these countries were hosted by the innovation and scientific agencies of the respective governments, strengthening the international experiences presented here. This book is a culmination of ten years of analytic and operational work led by the private and financial sector development department and the chief economist's office of the ECA region of the World Bank. Several regional reports and country policy notes exploring these issues have been published over the years. The book also reflects the lively discussion in the ongoing series of flagship events to promote knowledge based economies in the region. The most recent knowledge economy forum was held in Berlin in 2010, hosted by the fraunhofer center for Central and Eastern Europe. The book identifies policies that have an adverse affect on innovation. It also identifies policy gaps that, if filled, could have a catalytic effect on private sector innovation.

The Australian Financial System in the 2000s: Dodging the Bullet

Abstract: The global financial crisis (GFC) occupied only a quarter of the decade of the 2000s but, because of its severity and implications for future financial sector development, dominates the decade. The Australian financial system coped relatively well with the GFC, raising the question of whether there was something special about its structure and prior evolution which explains that experience. This paper reviews Australian financial sector performance and development over the decade, then provides a more detailed overview of the Australian GFC experience and its implications, and considers explanations for the Australian financial sector resilience.

Relationship between Financial Sector Development and Sustainable Economic Development: Time Series Analysis from Pakistan

Abstract: The study empirically investigated the contribution of financial sector in sustainable economic development of Pakistan. Annual data were used from the period of 1973 to 2007. The main objectives of the study were to analyze the long run relationship between financial sector development and sustainable economic development along with direction of causality between financial sector indicators and sustainable development. Auto Regressive Distributed Lag (ARDL) bound testing technique for cointegration was applied to estimate the long run relationship. A stable long run relationship was found between financial sector indicators and the sustainable economic development. Error Correction coefficient was statistically significant. It was concluded that financial sector had positive impact on the sustainable economic development in short run as well as in the long run. Causality test revealed that financial sector development was the basis for economic development.

Financial Sector Reforms, Bank Performance and Economic Growth: Evidence from Zambia

Abstract: This paper investigates the effects of market-based financial sector reforms on the competitiveness and efficiency of commercial banks, and economic growth, in Zambia. The results show that reforms adopted in Phase II (strengthening of regulatory and supervisory, payments and settlements, and financial operations frameworks) and Phase III (implementation of a comprehensive financial sector development plan) had significant positive effects on bank cost efficiency. Macroeconomic variables such as per capita GDP and inflation were insignificant. Further, using an endogenous growth model in which industrial production is a proxy for GDP growth, it was found that bank cost efficiency, financial depth, Phase II and III financial sector reforms, the degree of economic openness, and rate of inflation were significant determinants of economic growth. Phase II policies and the inflation rate have negative effects while the rest of the variables have positive effects on economic growth. Some plausible policy lessons are offered.

Financial Integration and Rebalancing in Asia

Abstract: The paper shows that Asia's degree of financial integration, both with the world and within the region remains low by various measures. The paper also provides empirical evidence that greater financial integration can support economic rebalancing in statistically meaningful ways. The implication is that in the debate on managing capital inflows the longer-term benefits of financial openness for broader-based growth should not be forgotten.

Does Financial Structure Matter for Poverty? Evidence from Developing Countries

Abstract: Although there has been research looking at the relationship between the structure of the financial system and economic growth, much less work has dealt with the importance of bank-based versus market-based financial systems for poverty and income distribution. Empirical evidence has indicated that the structure of the financial system has little relevance for economic growth, suggesting that the same could be true for poverty since growth is an important driver in reducing poverty. Some theories, however, claim that, by reducing information and transaction costs, the development of bank-based financial systems could exert a particularly large impact on the poor. This paper looks at a sample of 47 developing economies from 1984 through 2008. The results suggest that when institutions are weak, bank-based financial systems are better at reducing poverty and, as institutions develop, market-based financial systems can turn out to be beneficial for the poor.

Toward universal access : addressing the global challenge of financial inclusion

Abstract: This report highlights key trends, challenges, and opportunities for advancing financial inclusion and presents major high-level policy recommendations for consideration by the Group of 20 (G-20) policy makers to benefit a wider range of developing countries, including many non-G-20 countries. The report serves a broad audience, ranging from policy makers, development finance institutions, and the private sector to experts seeking a synopsis of the key subtopics relevant for financial inclusion and areas of work for advancing progress. The report is organized into four sections. The first recommends broad goals and agenda items to accelerate progress in financial inclusion. The second defines the financial inclusion concept and its importance for economic growth and poverty reduction. The third section provides a snapshot of each of the pillars presented as part of the recommendations, and the fourth section summarizes the way forward. The report also contains an annex that takes a closer look at the microfinance industry as a case in point for reviewing the successes, innovations, and lessons learned, which are critical for the broader discussion on financial inclusion.

Innovation, Trade, and Finance

Abstract: This paper proposes a model where heterogeneous firms choose whether to undertake R&D or not. Innovative firms are more productive, have larger investment opportunities and lower own funds for necessary tangible continuation investments than non-innovating firms. As a result, they are financially constrained while standard firms are not. The efficiency of the financial sector and a country’s institutional quality relating to corporate finance determine the share of R&D intensive firms and their comparative advantage in producing innovative goods. We illustrate how protection, R&D subsidies, and financial sector development improve access to external finance in distinct ways, support the expansion of innovative industries, and boost national welfare. International welfare spillovers depend on the interaction between terms of trade effects and financial frictions and may be positive or negative, depending on foreign countries’ trade position.

Transforming the Philippine Economy: “Walking on Two Legs”

Abstract: With a strong recovery from the global crisis, the Philippines’ policy focus will shift again to a long-term development agenda. Despite favorable initial conditions, the Philippines’ long-term growth performance has been disappointing. Over the decades, the economy has suffered from high unemployment, slow poverty reduction, and stagnant investment. Why could the Philippines not enjoy high growth as its neighbors? What are the main causes of its chronic problems of unemployment, poverty, and underinvestment? This paper argues that the Philippines’ poor growth performance is to be attributed to low productivity growth due to slow industrialization, especially in manufacturing. The chronic problems of high unemployment, slow poverty reduction, and low investment are reflections of slow industrialization. Initial success in electronics had enabled the economy to accumulate capabilities for productive diversification. However, incentives to utilize the accumulated capabilities have been weakened by persistent underprovision of basic infrastructure and weak business and investment climate. The paper also analyzes the growing services sector, in particular the booming business process outsourcing industry, in terms of its impact on job creation. The key conclusion is that, instead of, “leapfrogging,” over industrialization, the Philippines needs to “walk on two legs, to develop both industry and services.

Foreign Banks: Trends, Impact and Financial Stability

Abstract: Using a new, comprehensive database on bank ownership, identifying also the home country of foreign banks, for 137 countries over the period 1995-2009, this paper provides an overview of foreign bank activity and its impact of financial development and stability. We document substantial increases in foreign bank presence, especially in emerging markets and developing countries, but which slowed down dramatically with the onset of the global crisis. Over time, banks from many more home countries have become active as investors, with several emerging countries becoming important exporters. Investment, however, remains mostly regional. In terms of loans, deposits and profits, current market shares of foreign banks average 20 percent in OECD countries and close to 50 percent in developing countries and emerging markets. Foreign banks differ from domestic banks in key balance sheet variables, notably having higher capital and more liquidity, but lower profitability. Cross-country analysis shows that only in developing countries is foreign bank presence negatively correlated with domestic credit creation. Finally, using panel regressions, we show that during the global crisis foreign banks reduced credit more compared to domestic banks, but not when dominant in the host country.

Financial Development in Emerging Markets: The Indian Experience

Abstract: Financial markets that function well are crucial for the long-run economic growth of a country. This paper, in the first instance, looks at how the financial development of an economy can be measured. It then traces the financial development of India through the 1990s to the present, assessing the development of each segment of financial markets. In doing so, it highlights the dualistic development of the financial sector. Finally, the paper makes an attempt to offer an explanation of this dualistic development and proposes a road map for the future development of financial markets in India.

The evolution of the finance growth nexus

Abstract: The fundamentalist view of growth in East Asia seems to have won the debate although the argument regarding the efficacy of interventionist industrial policies remains unsettled. To explore the role of financial institutions, the empirical literature needed an available measure of the extent of financial development. Quickly, and perhaps mistakenly, the role of financial institutions came to be defined by the size of the sector's activity. That is an economy with more intermediary activity was assumed to be doing more to generate efficient allocations. Increases in the quantity of intermediation were assumed to be synonymous with increases in the quality. The size of the financial sector is usually measured by the quantity of intermediation relative to Gross Domestic Product (GDP). To explore the role of financial institutions, the empirical literature needed an available measure of the extent of financial development. Quickly, and perhaps mistakenly, the role of financial institutions came to be defined by the size of the sector's activity. That is an economy with more intermediary activity was assumed to be doing more to generate efficient allocations. Increases in the quantity of intermediation were assumed to be synonymous with increases in the quality. The size of the financial sector is usually measured by the quantity of intermediation relative to GDP.

Do Monetary, Fiscal and Financial Institutions Really Matter for Inflation Targeting in Emerging Market Economies?

Abstract: Most emerging market economies (EMEs) which have implemented inflation targeting (IT) have continued to experience large, frequent and sometimes persistent inflation target misses. At the same time these countries had reformed their institutional structures when implementing IT. In this paper we empirically study the importance of central bank independence, fiscal discipline and financial sector development for the achievement of inflation targets in EMEs using the panel ordered logit model. We find that when we control for variables such as output gap, exchange rate gap and openness, the improvement in central bank independence, fiscal discipline and financial systems reduces the probability of inflation target misses. Importantly, some control variables lead to the missing of inflation target bands. These are, in order of importance; exchange rate gap, output gap, inflation target horizon and level of openness. The combined impact of institutional structures is quite large, indicating their signifi…cant contribution to the infl‡ation performance and credibility of IT.

Contribution of Financial Sector Development in Reducing Unemployment in Pakistan

Abstract: The study empirically investigated the long run relationship between financial sector development and unemployment in Pakistan, along with the direction of causality. Annual data used were from the period of 1973 to 2007. Auto Regressive Distributed Lag (ARDL) bound testing technique for cointegration was applied to estimate the long run relationship. A stable long run relationship was found between financial sector indicators and unemployment. Escalating money circulation in economy proved to have negative impact on employment rate as it increased the unemployment rate by 2.3 percent for aone percent increase in M2 minus currency in circulation/GDP. Increased Financial sector activities showed positive impact on reducing unemployment in short run as well as in the long run. Further, Granger causality test revealed the importance of credit disbursement to private sector in improving job opportunities and increasing employment rate.

Self-Regulation in Securities Markets

Abstract: This paper canvasses the trends in self-regulation and the role of self-regulation in securities markets in different parts of the world. The paper also describes the conditions in which self-regulation might be an effective element of securities markets regulation, particularly in emerging markets. Use of self-regulation and self-regulatory organizations is often recommended in emerging markets as part of a broader strategy aimed at improving the effectiveness of securities regulation and market integrity. According to the International Organization of Securities Commissions, reliance on self-regulation is an optional feature of a regulatory regime. Self-regulatory organizations may support better-regulated and more efficient capital markets, but the value of self-regulation is again being questioned in many countries. Forces such as commercialization of exchanges, development of stronger statutory regulatory authorities, consolidation of financial services industry regulatory bodies, and globalization of capital markets are affecting the scope and effectiveness of self-regulation -- and in particular the traditional role of securities exchanges as self-regulatory organizations.The paper reviews different models of self-regulation, including exchange self-regulatory organizations, member (or independent) self-regulatory organizations, and industry or dealers’ associations. It draws on examples of self-regulatory organizations from many markets to illustrate the degree of reliance on self-regulation, as well as the range of functions for which self-regulatory organizations are responsible, in markets around the world. Issues that are important to the effective operation of self-regulatory organizations are discussed, such as corporate governance, managing conflicts of interest, and regulatory oversight by government authorities.