Financial Sector Policy and Development in the Wake of the Global Crisis: the role of national development banks

Abstract

Financial sector liberalisation has led to market failure on a massive scale. In industrial countries market failure led to the Great Financial Crisis that erupted in 2007 and continues into its fifth year. In developing countries liberalised financial markets have failed to provide access to financial services for the vast majority of households and firms. Small and medium-sized enterprises (smes), which are critical for employment, income creation and economic development, are particularly excluded by liberalised private financial markets. Market failure necessitates government intervention. To enhance smes' financial access requires an activist role by governments—not only by ensuring an enabling policy framework and financial infrastructure for smes, but also by supporting direct provision of financial services through national development banks and directed credit programmes. More broadly the crisis also provides an opening for a neo-structuralist development paradigm to replace the failed Washington Consensus. In this context activist financial sector policies should be integrated with industrial sector strategies.

Notes

Research for this article was undertaken while I was Fulbright-Canada Visiting Research Chair at the Woodrow Wilson International Center for Scholars in Washington, DC between January and May 2011. Iam grateful for the support of the Fulbright Visiting Scholar Program and the Woodrow Wilson Center. I am also indebted to a number of individuals for comments on an earlier draft. The usual disclaimers apply.

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 2 ‘Financial repression’ is a concept attributable to R McKinnon, Money and Capital in Economic Development, Washington, DC: Brookings Institution, 1973; and E Shaw, Financial Deepening in Economic Development, New York: Oxford University Press, 1973.

 3 See K von Mettenheim, Federal Banking in Brazil: Policies and Competitive Advantages, London: Pickering & Chatto, 2010; and B Stallings with R Studart, Finance for Development: Latin America in Comparative Perspective, Washington, DC: Brookings Institution, 2006.

 4 Stallings & Studart, Finance for Development, ch 2.

 5 N Hermes & R Lensink, ‘Does financial liberalization influence saving, investment and economic growth? Evidence from 25 emerging market economies, 1973–96’, in B Guha-Kasnobis & G Mavrotas (eds), Financial Development, Institutions, Growth and Poverty Reduction, New York: UN-wider/Palgrave Macmillan, 2008, ch 8.

 6 CM Reinhart & KS Rogoff, This Time is Different: Eight Centuries of Financial Folly, Princeton, NJ: Princeton University Press, 2009, pp 155–158.

 7 World Bank, Finance for All? Policies and Pitfalls in Expanding Access, Washington, DC: World Bank, 2008, pp 79–84.

 8 mfis typically go beyond the provision of credit by providing depositary (savings) facilities and sometimes insurance.

 9 P Honahan, Financial Sector Policy and the Poor: Selected Findings and Issues, World Bank Working Paper No 43, Washington, DC: World Bank, 2004.

10 C McKay & M Pickens, Branchless Banking 2010: Who's Served? At What Price? What's Next?, Washington, DC: cgap, September 2010.

11 ‘Sacrificing microcredit for megaprofits’, New York Times, 14 January 2011.

12 Access through Innovation Sub-Group of the G-20 Financial Inclusion Experts Group, Innovative Financial Inclusion: Principles and Report on Innovative Financial Inclusion, Washington, DC: cgap, 2010.

13 Micro-enterprises are typically based in the household; the abbreviation msmes thus includes these smallest of enterprises.

14 P Stein, T Goland & R Schiff, Two Trillion and Counting, Washington, DC: ifc/McKinsey & Company, October 2010.

15 United Nations, Building Inclusive Financial Sectors for Development, New York: United Nations, 2006.

16 World Bank, Finance for All.

17 For an exposition of how poor households suffer from lack of access to reliable banks, see D Collins, J Morduch, S Rutherford & O Ruthven, Portfolios of the Poor: How the World's Poor live on $2 a Day, Princeton, NJ: Princeton University Press, 2009.

18 CP Chandrasekhar, cited in JK Sundaram, Reforming the International Financial System for Development: Lessons from the Current and Recent Crises in Developing Countries, Washington, DC:G24, 2010. Chandrasekhar makes this case forcefully, linking it to the inexorable tendency incapitalist economies to deregulate and liberalise the financial sector. In so doing he also recapitulates arguments in favour of public banking, in industrialising countries, previously made by Gerschenkron. A Gerschenkron, Economic Backwardness in Historical Perspective, New York: Praeger, 1962.

19 See J Stiglitz, Freefall: America, Free Markets, and the Sinking of the World Economy, New York: WW Norton, 2010, pp 318–320.

20 DS Landes, The Wealth and Poverty of Nations, New York: WW Norton, 1999.

21 Gerschenkron, Economic Backwardness in Historical Perspective.

22 For example, see A Amsden, The Rise of the Rest: Challenges to the West from Late-Industrializing Economies, New York: Oxford University Press, 2001. Note that in Amsden's parlance, ‘the rest’ includes 12 countries, comprising not only South Korea and Taiwan, the original ‘newly industrialised economies’, but also China, India, Indonesia, South Korea, Malaysia, Thailand, Argentina, Brazil, Chile, Mexico and Turkey.

23 N Takafusa, Lectures on Modern Japanese Economic History 1926–1994, Tokyo: LTCB International Library Foundation, 1994.

24 R Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization, Princeton, NJ: Princeton University Press, 2004.

25 Ibid, pp 160–161, 324–325.

26 Amsden, The Rise of the Rest, pp 125-132.

27 See, for example, RG Rajan & L Zingales, Saving Capitalism from the Capitalists, Princeton, NJ: Princeton University Press, 2004.

28 The following is based on World Bank, Finance for All.

29 E Levy-Yeyati, A Micco & U Panizza, ‘State-owned banks: do they promote or depress financial development and economic growth?’, Social Science Research Network, 2004, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=629384

30 For a recent analytical and empirical treatment of a neo-structuralist approach to growth and development, see JA Ocampo & L Taylor, Growth and Policy in Developing Countries, New York: Columbia University Press, 2009.

31 D Rodrik, ‘Growth after the crisis’, background paper prepared for the Commission on Growth and Development, 2009. Rodrik's basic argument is that ‘poor countries become rich by producing what rich countries produce’.

32 JY Lin, New Structural Economics: A Framework for Rethinking Development, Policy Research Working Paper 5197, Washington, DC: World Bank, February 2010.

33 Ibid.

34 JY Lin, X Sun & Y Jiang, Toward a Theory of Optimal Financial Structure, Policy Research Working Paper 5038, Washington, DC: World Bank, September 2009.

35 Note that four of the 13 ‘high-growth countries’ identified by the Commission on Growth and Development in 2008 are not in East Asia: Botswana, Brazil, Malta and Oman.

36 The Economist, 13 May 2010.

37 Von Mettenheim, Federal Banking in Brazil, avers that ‘Without government banks, financial markets would not be where they are today’.

38 Stallings & Studart, Finance for Development.

39 Conference Board of Canada, ‘Lessons from the recession and financial crisis: lesson 2—public sector financial institutions prove their worth’, Executive Action, Ottawa, January 2010.

40 See H Rudolph, State Financial Institutions: Mandates, Governance and Beyond, Policy Research Working Paper 5141, Washington, DC: World Bank, November 2009, who identifies bdc as an exemplary state-owned financial institution. He also examines Banco Estado (Chile), the Development Bank of Southern Africa, and Finnvera plc (Finland) as state-owned financial institutions ‘that operate successfully within their predetermined set of targets, exist in a sound functioning regulatory framework, and can be regarded as benchmarks for other state financial institutions’ (p 3).

41 S Claessens, P Honohan & L Rojas-Suarez, ‘Principle 8', Report of the CGD Task Force on Access to Financial Services, Center for Global Development: Washington DC, 2009, p 25, http://www.cgdev. org/files/1422882_file_Financial_Access_Task_Force_Report_FINAL.pdf.