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Financial Systems and EconomicFinancial Systems and Economic

Development:Critical Issues andDevelopment:Critical Issues and

Policy Implications for AfricanPolicy Implications for African

CountriesCountries

Presented byPresented by

Charles Amo YarteyCharles Amo YarteyFaculty of Economics and PoliticsFaculty of Economics and Politics

University of CambridgeUniversity of Cambridge

UKUK


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Presentation OutlinePresentation Outline

1. Introduction

2. Financial development and economic growth3. Financial systems and economic growth

4. Financial development in Africa

5. Financial liberalisation in Africa6. Policy implications for African countries.


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1. Introduction1. Introduction

1. The services provided by the banking system arecritical for economic growth (Schumpeter)

VersusWhere enterprise leads finance follow (Robinson)

2. Stock market development is a natural progression inthe growth process. (The World Bank)

Versus

When the capital development of a country becomes theby product of the activities of a casino the job islikely to be ill done. (Keynes)


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Contribution of the paperContribution of the paperWe provide two main contributions to the

literature:

1. A non technical survey and synthesisof the finance and growth literature.

2. We analyse important policy

implication of the literature for

Africa.


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2. Financial development and2. Financial development and

economic growtheconomic growtha. Mechanisms through which finance works

The traditional growth theories saw no role for finance in the

growth process According to the new growth theory finance can influence

growth in three ways;

Increasing the efficiency of the intermediation process

Increase the productivity of capital

Increasing the savings rate.

Promoting entrepreneurship (Rajan and Zingales 1998)

Encourage new entry of firms which breeds competition


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b. Financial development versusb. Financial development versus

Financial structureFinancial structureFinancial structure can be defined as the institutions,

financial technology, and the rules of the game thatdefine how financial activities are organised at a

particular time period.

Financial development refers to the development of

well functioning financial markets and intermediaries.

Financial development depends on the financialstructure of the economy.

Indicators of financial development include M2/GDP;

stock market capitalisation/GDP; bank asset/GDP


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3. Financial systems and3. Financial systems and

economic growtheconomic growth

3a. The stock market and economic growth

The stock market can promote economic growththrough:

Raising the savings rate.

Increasing the level of investment. Ensuring that past investments are

efficiently used (the takeover mechanism).


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3c. Bank3c. Bank--based systems andbased systems and

economic growtheconomic growthPromoting effective corporate governance

Providing stable and efficient long term finance

Permitting a higher investment than would be possible

under stock market based system.

Promoting long term perspective by preventing a free

market for corporate control.Encouraging more rapid sectoral mobility.


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3d.The other side of bank3d.The other side of bank

based systemsbased systems

Banks may hinder the ability of new innovative

firms to obtain external financing.

The market power of the banks reduces the

incentive of firms to undertake profitable

investments.

Banks might also continue to finance unprofitablecompanies.

Banks may collude with managers against creditors

and minority shareholders.


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3e. Convergence3e. Convergence

The availability and quality of financial services are

important, not so much who provides them (the

financial services view).It is not financial structure but overall financial

development that promotes growth

It is the overall quality of the financial system as

determined by the efficiency of the legal system thatpromotes growth (the legal based view).


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4. Financial development in Africa4. Financial development in Africa

Indicators of financial development have stagnated or

witnessed slow growth in SSA since 1980.M2/GDP and credit/GDP were lower in the 1990s than

1980s.

Credit to the private sector/GDP in 2002 was 131.7 in

South Africa, 11.8 in Benin , and 4.1 in Chad.

The low credit to GDP is a source of concern.

Empirical evidence in Africa show a positive effect of

financial development on growth.


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Stock Market Development in Selected African Countries

02040

60

80

100120

140160

180200

Bots

wana

Egypt,A

rabRep

.Gh

ana

Kenya

Mauri

tius

Morocco

Namibia

Nigeria

South

Africa

Tunisia

Zamb

ia

Zimb

abwe

Country

Market

Capitalization/GDP(%

)

1995 2001

Small size: Average capitalisation ratio is 27 percent excluding South Africa and

Zimbabwe.

South Africa has about 90 percent of the combined market capitalisation.

Low liquidity: turnover ratio is about 2.7 in Ghana and 37.4 in South Africa


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Reasons for the Underdevelopment ofReasons for the Underdevelopment of

the financial system in Africathe financial system in Africa

Historical financial repression Most African government adopted financial

repression policies after independence

Public sectors demand for low cost finance led to

pressures to hold down interest rates.

Income distributional goals led to directed credits. The effect of financial repression is bank insolvency,

low savings, and inefficient allocation of resources.


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5. Financial liberalisation in5. Financial liberalisation in

AfricaAfrica

A typical programme of financial liberalisation has three

main aspects:Removal of interest rate ceiling

Reducing quantitative controls

Removal of capital controls

Other aspects of financial liberalisation include:

Improving supervision and regulation

Increasing competition

Removal of entry barriers.


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Why financial liberalisation has notWhy financial liberalisation has not

achieved the expected resultsachieved the expected resultsFinancial liberalisation led to the expected positive real

interest rates.

The expected results of increased investments and savingshave not been plentiful.

The thesis assumes that savings determine investment and

that resources are fully used.

Financial liberalisation may lead to financial fragility.Financial liberalisation should be accompanied by good

prudential regulation.


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Policy ImplicationsPolicy Implications

How do we promote financial development?Countries with well developed legal and regulatory

infrastructure tend have well developed financial

markets.

For external finance to develop investors need to be

protected by laws and regulation.

Resolution of political risk can be important in stock

market development.Macroeconomic stability is necessary .

Encourage savings and investment by appropriate

policies.


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Bank based or market basedBank based or market based

financial system?financial system?Stock market often lead to short termism which may

adversely affect competitiveness and growth.

Evidence show that over the long run bank based systemsoutperformed market based systems in terms of savings

investment and growth.

The economic development of Italy and Japan occurred

without any help from the stock market


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Bank based systems areBank based systems are

better.better.Because they are better able to deal with problems of

informational asymmetries.

There is no necessary progression from bank based system

to a stock market economy.African countries should contend with the development of

the banking system through appropriate prudential

regulation.

If the banking system is weak and unreliable a stockmarket is likely to add to the fragility.

Regulation and supervision are key for financial stability


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THANK YOUTHANK YOU

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