Degree Of Financial Development Research Articles

How does the financial environment affect the stock market valuation of R&D spending?

This paper investigates the role of the financial environment in the stock market valuation of research and development (R&D) spending by firms. We examine the importance of equity financing relative to bank financing and the importance of both relative to the size of the economy on the stock market valuation of R&D expenditures. Empirical analysis of the Compustat Global Vantage firm-level data indicates that, the more market-based a financial system is, the more R&D expenditures are valued by the stock market. The degree of financial development does not appear to be important. Our results remain materially unchanged after controlling for numerous firm and country differences.

Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment

We examine how credit constraints affect the cyclical behavior of productivity-enhancing investment and thereby volatility and growth. We first develop a simple growth model where firms engage in two types of investment: a short-term one and a long-term productivity-enhancing one. Because it takes longer to complete, long-term investment has a relatively less procyclical return but also a higher liquidity risk. Under complete financial markets, long-term investment is countercyclical, thus mitigating volatility. But when firms face tight credit constraints, long-term investment turns procyclical, thus amplifying volatility. Tighter credit therefore leads to both higher aggregate volatility and lower mean growth for a given total investment rate. We next confront the model with a panel of countries over the period 1960-2000 and find that a lower degree of financial development predicts a higher sensitivity of both the composition of investment and mean growth to exogenous shocks, as well as a stronger negative effect of volatility on growth.

Financial market integration and economic growth in the EU

The current diversity in the degree of financial development across the EU can be a great opportunity at a time where this area is poised to become increasingly financially integrated. Integration should accelerate the development of the most backward financial markets, and allow companies from these countries to access more sophisticated credit and security markets. In line with a large recent literature, it is reasonable to expect that financial integration will have a ‘growth dividend’ in Europe. This paper attempts to quantify this growth dividend, using both industry and firm-level data to estimate the empirical relationship between financial market development and growth, and to gauge how it will distribute itself across countries and sectors. — Luigi Guiso, Tullio Jappelli, Mario Padula and Marco Pagano

Financial Sector Development in the Middle East and North Africa

Based on data collected on a wide range of financial sector indicators, new indices of financial development for countries in the Middle East and North Africa (MENA) are constructed, encompassing six themes: development of the monetary sector and monetary policy, banking sector development, nonbank financial development, regulation and supervision, financial openness, and institutional quality. The paper finds that the degree of financial development varies across the region. Some countries have relatively well-developed banking sectors and regulatory and supervisory regimes. However, across the region, more needs to be done to reinforce the institutional environment and promote nonbank financial sector development. Based on a subset of indicators, the MENA region is found to compare favorably with a few other regions, but it ranks far behind the industrialized countries and East Asia.

Understanding reserve volatility in emerging markets: a look at the long-run

In this paper, we examine long-run determinants of cross-country variation in reserve volatility for 30 emerging market economies from 1973 to 2000. Reserve holdings and openness are found to be the most important explanatory variables of reserve volatility. The empirical results are robust for a range of control variables, including monetary variables, the degree of financial development, and the level of indebtedness. We view these results as establishing interesting stylized facts that may be helpful in evaluating reserve volatility as a crisis indicator.

Financial Development and the Sensitivity of Stock Markets to External Influences

The paper investigates how the relative contribution of external factors to stock price movements varies with the degree of financial development. It is found that financial development makes stock markets more susceptible to external influences (both financial and macroeconomic). Interestingly, this effect is present even after having accounted for capital controls and international trade effects.

Can International Capital Standards Strengthen Banks In Emerging Markets?

Who should determine banks' capital standards: authorities or markets? What is the right definition of core capital: equity only or equity plus subordinated debt? Can the assessment of banks' individual credit risks by external rating agencies be of equal or better quality than the assessments derived from banks' own internal rating systems? These are some of the key financial regulatory issues currently being discussed by analysts in industrial countries, especially in the context of the proposed modification to the Basel Capital Adequacy Accord: Basel II is expected to replace the original 1988 Accord. With a few exceptions, these issues are certainly not at the center of the debate in emerging market financial circles. There, the financial issues at hand depend on the country's level of development. For the least developed countries, reform agendas are just advancing in the implementation of accounting standards, disclosure, and other principles of bank supervision; Basel II is certainly not in the medium-term future. If anything, implementation of the original Accord is the issue. The more advanced emerging economies face a different dilemma. Albeit at very different paces, most of these countries embarked on a financial sector reform process in the early 1990s. One of the most important efforts by individual countries, also strongly supported by multilateral organizations, has been the adoption of the recommendations on capital adequacy requirements by the Basel Committee on Banking Supervision. However, in spite of significant advances in implementation, banking crises have abounded in emerging markets during the 1990s and early 2000s. Not surprisingly, some disillusion with a traditional reform agenda has emerged. A key debate, therefore, centers on assessing whether regulatory standards that work in industrial countries are appropriate for emerging markets. Among the most relevant issues are: (a) Can an early warning system of banking crisis particular to emerging markets be constructed? (b) How should capital adequacy ratios be designed in emerging markets? Should they diverge from the recommendations of Basel? And, (c) rather than focusing on banks, shouldn't emerging markets limit the role of banks, and instead, focus on the development of corporate bond markets? This paper deals with the appropriateness for emerging markets of implementing capital requirements as recommended by the Basel Committee on Banking Supervision. The paper is part of a research agenda that I initiated in the late-1990s. In my previous research I concluded that such capital standards have had very little usefulness as a supervisory tool in emerging markets. For fundamental reasons that go beyond the improvements in regulatory procedures, and, instead center on the particular features of financial sectors in many emerging economies, the capital-to-asset ratio has not been a useful early warning indicator of banking problems. While the limitations of capital requirements as a supervisory tool remain severe in most emerging markets, there are some countries where the increasing participation of foreign banks has helped to improve, at least to a certain extent, the usefulness of capital ratios. For these countries the appropriate choice of capital standards is key. In this paper, I advance the following questions: Can the adoption of the Basel recommendations weaken, rather than strengthen, the stability of banks in emerging markets where capital requirements are binding? Would the proposed modification of the Accord (Basel II) weaken even further the franchise value of emerging market banks? Unfortunately, the evidence seems to provide a positive answer to these questions. Therefore, I propose a set of alternative recommendations capable of strengthening banks in emerging markets. The rest of the paper is organized as follows: relying on some of my previous work on the subject, section II first shows and then explains the reasons why capital requirements have not served their intended role as supervisory tools in many emerging markets. Section III demonstrates that adopting capital requirements as advanced by Basel, and especially by the proposed Basel II, may actually deteriorate the strength of banking systems in emerging markets. Section IV presents alternative proposals to strengthen banks according to the degree of financial development in emerging markets. Where capital requirements can be enforced, the paper advances suggestions for an improved capital standard. Section V concludes the paper.

A growth model of inflation, tax evasion, and financial repression

This paper studies the relation between policies of financial repression, inflation rates, and long-term growth. We set up a model which shows that governments might want to express the financial sector because this sector is an ‘easy’ source of resources for the public budget (the inflation tax). To the extent that the financial sector increases the efficiency of the allocation of savings to productive investment, the choice of the degree of financial development will have real effects on the growth rate of the economy. In countries where tax evasion is large the government will optimally choose to repress the financial sector in order to increase seigniorage taxation. This policy will then reduce the efficiency of the financial sector, increase the costs of intermediation, reduce the amount of investment, and reduce the growth rate of the economy. Financial repression will therefore be associated with high tax evasion, low growth, and high inflation.

Financial Development and Economic Growth

This paper examines the empirical relationship between long–run growth and the degree of financial development, proxied by the ratio of bank credit to the private sector as a fraction of GDP. We find that this proxy enters significantly and with a positive sign in growth regressions on a large cross–country sample, but with a negative sign using panel data for Latin America. Our findings suggest that the main channel of transmission from financial development to growth is the efficiency of investment, rather than its volume. We also present a model where the negative correlation between financial intermediation and growth results from financial liberalization in a poor regulatory environment.