Financial Intermediary Development Research Articles

DO FOREIGN CURRENCY DEPOSITS PROMOTE OR DETER FINANCIAL INTERMEDIARY DEVELOPMENT IN LOW‐INCOME COUNTRIES? AN EMPIRICAL ANALYSIS OF CROSS‐COUNTRY DATA

Foreign currency deposits (FCD) are prevalent in many low‐income developing countries, but their impact on bank lending has rarely been examined. An examination of cross‐country data indicates that a higher proportion of FCD in total deposits is associated with more private credit only in inflationary circumstances. FCD can lead to a decline in private credit below a certain threshold level of inflation. Given that FCD exhibit persistence, deregulating them in low‐income countries could cause more harm than good to financial intermediary development in the long term.

Financial Intermediary Development and Output Fluctuations: A Dynamic Panel Data Analysis on Asean-5 Plus 3

This paper examines the direct and indirect effects of financial intermediary development on output fluctuations based on the theoretical works by Bacchetta and Caminal (2000) and Beck, Lundberg and Majnoni (2006). According to credit market imperfections, well-developed financial intermediaries dampen the effect of real sector shocks and magnify the effect of monetary shocks on output fluctuations. This paper examines whether financial intermediaries serve as shock absorbers or shock magnifiers that mitigate or amplify the effect of real and monetary shocks on output fluctuations. Using data from 8 countries of ASEAN-5 Plus 3, the empirical results indicate that (1) there is strong and robust evidence for the dampening effect of financial intermediary development on output fluctuations via the propagation of real shocks, (2) there is somewhat weak evidence for the magnifying effect of financial intermediary development via the propagation of monetary shocks and (3) financial intermediary development has strong direct impact on output fluctuations if countries are bankdependent in the cointegration regression.

Finance – Growth Nexus: Evidence from Turkey

This paper examines the causal relationship between financial development and economic growth in Turkey for the period 1986:1-2006:4 using dynamic time series models. The results of the cointegration analysis provide evidence of no long-run relationship between financial development and economic growth. Therefore, the empirical investigation is carried out in a vector autoregression (VAR) framework to analyze the short run effect of the financial intermediary development on economic growth. The results show a one-way causal relationship running from the financial development to the economic growth in Turkey.

Corporate Transparency, Financial Development and the Allocation of Capital: Empirical Evidence

There is controversy regarding the role of financial development in promoting economic growth. Lucas (1988) suggests that the role of financial intermediation in economic growth has been very badly over‐stressed in the popular and professional discussion. Levine et al. (2000), on the other hand, show that in a cross‐country setting the exogenous component of financial intermediary development is positively and robustly linked to economic growth. Although empirical methodologies to investigate the finance‐growth nexus have been refined, there is a lack of understanding about the exact mechanisms through which the financial system could affect economic performance in the real sector. Wurgler (2000) investigates one such mechanism of economic growth: whether capital is allocated efficiently. He then empirically shows that countries with well‐developed financial architecture improve capital allocation. This article extends Wurgler (2000) by investigating the role of an important economic institution, the financial reporting system, on the efficiency of capital allocation. Financial reporting provides the primary source of independently verified information to the capital providers about the performance of managers and facilitates efficient resource allocation decisions. Results show that financial transparency is positively and significantly related to capital allocation efficiency. Further, this result holds after controlling for the impact of stock price synchronicity, state‐owned enterprises and investor protection rights.

The role of the financial sector in economic development: the Malaysian case

In this paper, we empirically examine the finance-economic development relations for the case of Malaysia. Using a battery of time series econometric techniques, we document robust evidence suggesting favorable output effects of financial market development. Likewise, there are consistent results showing the adverse real effects of financial volatility. The results of the development of financial intermediaries, however, are fragile. Moreover, the development of the financial markets hinges crucially on macro-economic performance and financial stability of the country. However, the process of financial market development is likely to be accompanied by financial volatility, leaving Malaysia with the trade-off between financial development and financial volatility. Lastly, we obtain limited evidence indicating the complementarity between financial market and banking sector developments.

Sovereign credit ratings, capital flows and financial sector development in emerging markets

How does the sovereign credit ratings history provided by independent ratings agencies affect domestic financial sector development and international capital inflows to emerging countries? We address this question utilizing a comprehensive dataset of sovereign credit ratings from Standard and Poor's from 1995–2003 for a cross-section of 51 emerging markets. Within a panel data estimation framework, we examine financial sector development and the influence of sovereign credit ratings provision, controlling for various economic and corporate governance factors identified in the financial development literature. We find strong evidence that our sovereign credit rating measures do affect financial intermediary sector developments and capital flows. We find that i) long-term foreign currency sovereign credit ratings are important for encouraging financial intermediary development and for attracting capital flows. ii) Long-term local currency ratings stimulate domestic market growth but discourage international capital flows. iii) Short-term ratings (both foreign and local currency denominated) retard all forms of financial developments and capital flows. There are important implications in this research for policy makers to encourage the provision of longer-term credit ratings to promote financial development in emerging economies.

Financial intermediary development and growth volatility: Do intermediaries dampen or magnify shocks?

We assess the channels through which financial intermediaries affect economic volatility. Building on Bacchetta and Caminal (2000, Do capital market imperfections exacerbate output fluctuations? European Economic Review 44(3), 449–468) our theoretical model predicts that well-developed financial intermediaries dampen the effect of real sector shocks and magnify the effect of monetary shocks. Using a panel of 63 countries over the period 1960–1997 and using the volatility of terms of trade and inflation to proxy for real and monetary volatility, respectively, we find (i) weak evidence that financial intermediaries dampen the effect of terms of trade volatility, and (ii) some evidence that financial intermediaries magnify the impact of inflation volatility in countries where firms have little or no access to external finance through capital markets.

Financing the Alternative: Renewable Energy in Developing and Transition Countries

This paper examines the determinants of credit allocation to renewable energy firms in developing and transition countries. Using a simple en- dogenous growth model, we show that the development of the renewable energy sector, i.e. the diversification of renewable energy resources used in primary energy production, depends on the quality of financial intermedia- tion, debtor information costs to banks, and financing needs of renewable energy firms. Policies should aim at increasing financial sector perfor- mance through better institutional frameworks and improving financing conditions for new energy firms. The empirical analysis confirms the pos- itive effect of financial intermediary development on the renewable energy sector.

The growth in equity market size and trading activity: An international study

This paper presents new evidence on the role of macroeconomic and institutional factors in equity market development and on the sources of equity market growth. Using panel data on 33 countries, I find that development of financial intermediaries and trade openness are positively associated with equity market size, and that development of financial intermediaries is also positively associated with the level of activity in equity markets. Government consumption is negatively associated with equity market activity. I construct a direct estimate of the effect of institutional factors on equity market development that compares a country's actual level of development to a hypothetical “best-practice” country having the same macroeconomic fundamentals as the original country. I show that the level of equity market development of an average country is around 30% below its maximum potential. There are wide differences in institutional characteristics across countries and over time, and Canada, the United States, and Singapore possess the most shareholder-friendly institutional frameworks that foster larger and more active equity markets. It appears that institutional improvements and changes in financial technology have provided the major impetus for the phenomenal expansion of global equity markets.

The influence of financial and legal institutions on firm size

Theory does not predict an unambiguous relationship between a country’s financial and legal institutions and firm size. Using data on the largest industrial firms for 44 countries, we find that firm size is positively related to financial intermediary development, the efficiency of the legal system and property rights protection. We do not find any evidence that firms are larger in order to internalize the functions of the banking system or to compensate for the general inefficiency of the legal system.

The Growth in Equity Market Size and Trading Activity: An International Study

This paper presents new evidence on the role of macroeconomic and institutional factors in equity market development and on the sources of equity market growth. Using panel data on 33 countries, I find that development of financial intermediaries and trade openness are positively associated with equity market size, and that development of financial intermediaries is also positively associated with the level of activity in equity markets. Government consumption is negatively associated with equity market activity. I construct a direct estimate of the effect of institutional factors on equity market development that compares a country's actual level of development to a hypothetical best-practice country having the same macroeconomic fundamentals as the original country. I show that the level of equity market development of an average country is around 30 percent below its maximum potential. There are wide differences in institutional characteristics across countries and over time, and Canada, the United States, and Singapore possess the most shareholder-friendly institutional frameworks that foster larger and more active equity markets. It appears that institutional improvements and changes in financial technology have provided the major impetus for the phenomenal expansion of global equity markets.

Development of financial intermediation and economic growth: The Chinese experience

Abstract Using Chinese provincial data from 1985 to 1999 and applying recent GMM techniques developed for dynamic panels, this paper examines how the development of financial intermediation influences China's economic growth during the post-1978 reform period. Our econometric results show that China's financial intermediation development contributes to its rapid economic growth through two channels: first, the substitution of loans for state budget appropriation and second, the mobilization of household savings. Loan expansion, however, does not contribute to growth since loan distribution by financial intermediaries is inefficient. Deep financial sector reform aimed at correcting this inefficiency is desirable, and is expected to sustain China's economic development in the future.

The Determinants of Stock Market Development in the MENA Region

Since few decades, a wide theoretical debate is concerned with the fundamental relationship between financial development and economic growth. An efficient financial system leads to a sustainable economic growth. In this study, we are interested especially with stock markets as a main component of the financial system according to the increasing role of financial markets in economies. So, their evolution plays an important role in economic growth. We shed some light on the macroeconomic determinants which must have an important influence on stock markets development. It is recognized that real or financial variables such as real income, saving rate, credit to private sector, M3, value traded, turnover, etc. could have a significant impact on market capitalization. The empirical study is conducted using an unbalanced panel data from twelve MENA region countries. Econometric issues are based on estimation of some fixed and random effects specifications. With such specifications in mind, peculiarities of MENA region countries are detected as well as differentiations among them. Thus, differences in market capitalization are explained. The empirical expected results must reinforce the idea which suggest the important role of economic development in promoting stock market development. Explaining power of variables such as real income, saving rate, inflation, financial intermediary development and stock market liquidity is confirmed. Banks and stock markets seem to be complements instead of substitutes.

Financial intermediation and economic growth: evidence from Western Africa

The relationship between finance and economic growth has received considerable attention in economic development literature during recent decades. However, little interest has been devoted to African countries, and specifically, to West African countries. This paper tries to fill that gap, by using causality tests to empirically examine the relationship between finance and economic growth, in the context of West African country members of the Economic Community of West African States (ECOWAS). In all but a few countries, results indicate a weak causal relationship between finance and economic development on one side, and between economic development and finance on the other side. These results imply, ceteris paribus, that leaders of West African countries should focus their economic and monetary policies on the development of financial intermediation, which in turn will favour economic growth.

Financial intermediation and growth: Some robustness results

We examine the relationship between financial intermediary development and economic growth using different instruments. We find a strong positive effect when financial intermediation is measured as private domestic credit or liquid liabilities, supporting earlier findings based on only one instrument.

The role of financial development in economic growth

In our previous progress report (Bloch and Tang, 2001), we review the literature relating to the role of technical change and productivity growth in East Asian economic growth. The topic of economic growth is central to development economics. Growth is one of the (if not the) major engine of improvements in living standards in the developing countries. Much recent work has addressed the potential links between financial development and economic growth. It is this literature which our current report addresses, both in the context of East Asia and more widely. Despite the rapidly growing literature, the debate concerning the role played by the development of financial intermediaries in economic growth is far from settled. The debate focuses on the possible causality running from financial development to economic growth on the one hand and the channels by which financial development contributes to enhancing economic growth on the other. In addition to outlining the main issues in the continuing debate and reviewing the existing literature, this paper also re-examines the data and conducts new tests on the topic. There are two alternative views about the links between financial intermediary development and economic growth. Joseph Schumpeter (1934) in 1911 was among the first to point out that banks facilitate technological innovation in their role of financial intermediaries. By assembling savings, evaluating investment projects, monitoring managers and facilitating transactions, banks are able to acquire detailed information about firms at a lower cost. They thus become the authorized agents of the society to allocate savings to entrepreneurs and to innovating and competitive firms. The Schumpeterian view is that the development of financial intermediaries has a direct impact on the pace of technical change and productivity growth, which feeds through Progress in Development Studies 3,3 (2003) pp. 243–251

Trade Credit, Financial Intermediary Development, and Industry Growth

Recent work suggests that financial development is important for economic growth, since financial markets more effectively allocate capital to firms with high value projects. For firms in poorly developed financial markets, implicit borrowing in the form of trade credit may provide an alternative source of funds. We show that industries with higher dependence on trade credit financing exhibit higher rates of growth in countries with weaker financial institutions. Furthermore, consistent with barriers to trade credit access among young firms, we show that most of the effect that we report comes from growth in the size of preexisting firms.

Dual Financial Systems and Inequalities in Economic Development

This paper analyzes the emergence and the evolution of a modern banking system, in a developing economy where banks coexist with informal credit institutions. Banks have a superior ability in mobilizing savings while informal lenders enjoy a superior information on borrowers. More specifically, banks cannot observe perfectly the behavior of borrowers; therefore the latter need to provide collateral assets in order to obtain bank loans. Physical collateral is not needed to borrow in the informal credit market: informal lenders can rely on social networks to obtain information on borrowers' behavior and invoke social sanctions to enforce repayment. The sustained growth path is associated with the successful development of the banking system that gathers savings on a large scale. However, informal lenders and other traditional credit institutions are necessary in the first stage of development when collateral is scarce. In this economy, the development of modern financial intermediaries is closely associated with the accumulation of collateral assets by entrepreneurs. This implies that the initial level of development as well as the initial distribution of wealth will determine the joint evolution of the real side of the economy and the financial system. Under certain conditions, two long-run steady-state equilibria exist: in the first one the economy stops growing and the banking system never successfully develops; in the second one the economy reaches a sustained growth rate and the informal sector asymptotically vanishes. The impact of the following policies is discussed: financial repression, micro-credit institutions and redistribution of assets.

The Development of Financial Intermediation and Real Effects of Capital Account Liberalization

We consider lending and investment under asymmetric information in an emerging economy. We allow for different forms of Þnancial contracts to arise endogenously in the credit market. We examine the impact of opening the capital account on both aggregate output level and the structure of lending arrangements. Financial intermediaries mitigate the moral hazard problem in investment choice through costly monitoring all projects and liquidating risky, negative NPV projects. Depending on the quality and cost of the monitoring technology, opening the capital account may strengthen or weaken the role of Þnancial intermediaries, leading to an improvement or worsening of the aggregate composition of investment projects. Our results suggest situations where limiting the capital insow or outsow may be necessary to avoid an aggregate risk shift and the collapse of the Þnancial intermediation sector.

Financial intermediation and growth: Causality and causes

This paper evaluates (1) whether the exogenous component of financial intermediary development influences economic growth and (2) whether cross-country differences in legal and accounting systems (e.g., creditor rights, contract enforcement, and accounting standards) explain differences in the level of financial development. Using both traditional cross-section, instrumental variable procedures and recent dynamic panel techniques, we find that the exogenous components of financial intermediary development is positively associated with economic growth. Also, the data show that cross-country differences in legal and accounting systems help account for differences in financial development. Together, these findings suggest that legal and accounting reforms that strengthen creditor rights, contract enforcement, and accounting practices can boost financial development and accelerate economic growth.