Abstract
This research explores the role and importance of institutional quality in promoting financial development in emerging market countries. The panel dataset was conducted on 26 emerging countries for the period covering 1999-2019. The dataset was collected from major sources including World Governance Indicators (WGI) from World Bank, International Financial Statistics office (IFS), and World Development Indicators (WDI). We used GMM and 2SLS methods to analyze the behavior of the components of institutional quality including political stability, regulatory quality, rule of law, control over corruption, government effectiveness, and voice and accountability in influencing financial development. According to the results obtained, well-functioning institutions have the capability to promote financial development. Countries that have improved their institutional quality and governance systems have scored high rates of financial development. A unit increase in the components of institutional quality has a positive and significant influence on financial development. This indicates that poor institutions lead to poor financial growth. Keywords: Institutional Quality, Emerging Market Economies, Financial Development, Institutions, Regulatory Framework. DOI: 10.7176/RJFA/12-10-01 Publication date: May 31 st 2021
Highlights
The idea whether institutional quality can cause real effect on the process of financial development has been greatly navigated in recent years
Methodology and Data Description The dataset puts together 20 years of annual data between 1999 and 2019 for 26 emerging countries. It draws on a number of data sources: The World Bank FinStats (Feyen, Kibuuka, and Sourrouille, 2014), International Monetary Fund (IMF)’s Financial Access Survey, World Governance Indicators, and Bank for International Settlement (BIS) debt securities database. 1A vast body of literature estimates the impact of financial development on economic growth, inequality, and stability
FD is the financial development for private sector credit bank, proxies for financial development as a share of GDP, PS is the political stability, RQ represents the regulatory quality, RL is the rule of law, COC shows the control of corruption, GE is used to indicate the government effectiveness, VA represents the voice and accountability, POP is the population, GS is the saving, Cap-For is the capital formation used for private investment, while TO represents the trade openness which distress financial development, explained by Svaleryd and Vlachos (2002) and by Rajan and Zingales (2003), Chinn and Ito (2006), Braun and Raddatz (2008), Law and Azman-Saini (2008) as well by Baltagi, Demetriades, and Law (2009)
Summary
The idea whether institutional quality can cause real effect on the process of financial development has been greatly navigated in recent years. We can observe that all the theories developed states that the institutional quality and legal system has the ability to influence the efficiency and effectiveness of the financial system, financial development, and long-term economic growth and stability of an economy. Empirical evidences found that most of the emerging and developing countries experience lower degree of financial development and economic growth mainly due to lack of well-stablished legal system and a good quality institution which are fundamental foundations to promote and foster financial system progress and development. The study observed, that the pace of financial development matters to certain degrees This is to say when deepening of financial institutions goes fast, it can potentially lead to financial and economic instabilities through encouraging high risk-taking actions and excessive leverages, which makes it very clear the premium of creating a good quality institution is vital in avoiding or minimizing those adverse effects of a positive outcome of financial deepening.
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