Abstract

This study aims to assess what determines/improves the overall multidimensional nature of the financial development index and its sub-indices. For this purpose, we use data over the period 1998 to 2017 for 9 countries from the Asia-Pacific region. The hypothesis of no long run relationship between variables is tested via the three-panel co-integration test i.e. Kao test, the Pedroni test, and the Johansen test. We also examine the impact of these variables on each index through long-run dynamic estimation. We utilize FMOLS and DOLS for this purpose. All the three-panel co-integration tests suggest a long-run relationship among variables. Findings from long-run dynamic estimation indicate that efficient regulation of financial services and control over prices by the government significantly influences the financial depth, financial efficiency, and financial access indices. The financial freedom index measured by regulation of financial services negatively influences the indices, suggest that too much government regulation could distort the market. Also, an increasing probability of default of the country's banking system adversely affects the sub-indices of financial development. These findings suggest that too much government regulation of financial services and control over prices along with default of country banking system could worsen the country's financial development situation and vice versa. The promulgation of prudent regulatory policies by financial regulatory institutions is the need of the time to ensure full access to financial services, soundness, and stability of the financial sector.

Highlights

  • The role of financial liberalization/freedom and the government effort to control price stability through intervention in financial markets in determining financial development/stability are not fully explored

  • We find that the impact of government regulation of financial services proxies by financial freedom and monetary freedom and bank-specific variables varies when we change the dependent variable of the model

  • A plethora of work can be found to investigate the impact of financial development on economic growth, income inequality, and other macroeconomic variables, the literature is very scant to examine the relationship between financial regulation/liberalization, monetary freedom, and financial development

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Summary

Introduction

The role of financial liberalization/freedom and the government effort to control price stability through intervention in financial markets in determining financial development/stability are not fully explored. On the other hand financial liberalization as well as the excessive and unnecessary intervention of the government to make sure price stability in the economy is considered as one of the reasons behind crises in the banking sector and fragility of the financial system. The recent debate on the relationship between bank competition and financial stability suggests that financial freedom through bank competition negatively influences financial stability. The ’competition stability view’ maintains that the increased bank competition following financial liberalization could increase financial stability because the more the competition is the less is the incentives for banks to peruse riskier projects (Boyd & De Nicolo, 2005)

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