How Do Institutional Frameworks Shape Financial Development in Developing Countries?

Abstract

While the economic effects of financial development have been widely studied,less attention has been paid to the sources of such development, particularly indeveloping countries. Existing studies that have identified institutions as a driverof financial development have not taken into account the different institutionalframeworks, such as democracy, political stability and social policies in Africa,where institutional and financial development is a challenge to trigger the economictake-off of countries. This paper aims to fill this gap by studying the effect of differentinstitutional frameworks on financial development in a sample of North andsub-Saharan African countries using a panel ARDL analysis. In contrast to previousliterature that supports a positive effect between institutions and finance, we findmore nuanced results. While less corruption, expropriation, political instability andautocracy favor the financial sector, a higher level of social policies can undermineits development. These results validate the “hierarchy of institutions”-hypothesisand reveal a “social-financial” dilemma in African countries.