Does financial liberalization lead to financial development? Evidence from emerging economies

ABSTRACT

In the last few decades, most of the emerging market economies (EMEs) have adopted financial liberalization. Evidence shows that the financial sectors/institutions in emerging economies were either underdeveloped or functioning with a lot of inefficiencies under inadequate regulation. The paper examines whether liberalization in the financial sector has led to financial development for a bunch of EMEs including BRICS. The paper differs from the existing literature in its approach of dealing with the measurements of financial development and considering financial liberalization as a gradual process. Panel regressions are estimated for 9 countries based on 22 years’ data for four aspects of financial development, viz. depth, efficiency, stability and competition. Results indicate that financial liberalization in terms of freedom in capital markets has a positive effect on financial depth and competition, whereas liberalization from government interference in the banks and other financial institutions has a positive impact on the stability of the financial sector. Trade openness has a role in enhancing the efficiency of the financial sector. Also, evidence suggests that capital account openness leads to increased depth and does not destabilize the financial sector. GDP, political stability, regulatory quality and government effectiveness are also important factors in influencing more than one aspect of financial development in a country.

KEYWORDS:

• Financial development
• financial liberalization
• BRICS
• emerging economies
• Asian economies

JEL Classifications:

• F21
• F38
• F62
• G20
• G28

Acknowledgements

We are grateful to the participants of Finance and Economics Conference 2019 of International Management Institute Kolkata for their helpful suggestions.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 This refers to increased provision of financial services in terms of better access to such services by all sections of populations as well as wider availability of financial services.

2 The details of the existing literature in this context are elaborated in the next section.

3 The process of liberalisation of these economies is explained in detail in Williamson and Mahar (1998), Chen (2018), and Feyzioğlo, Porter, and Takáts (2009).

4 IMF also provides data on financial development index but other than efficiency and stability it considers the aspect of financial development in terms of access only.

5 They constructed their index from various data sources – FinStats (2015) and Financial Access Survey (2014), corporate debt database of Dealogic and Bank for International Settlement (BIS) debt securities database.

6 https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/financial-depth (World Bank 2016). Often a proxy variable that has received much attention in the empirical literature in this regard is private credit relative to gross domestic product (GDP). 

7 This is based on the principal component analysis.

8 See Bumann, Hermes, and Lensink (2013) for different methods of measuring financial liberalization.

9 Regarding measure of financial Openness see Chinn and Ito (2008).

10 The WGI provides data for alternate years from 1996 to 2002 and for consecutive years from 2002. The WGI variables are normalized to get values from 0 to 5.

11 Levin, Lin, and Chu (2002) test could not be performed owing to insufficient number of time periods.

12 KAOPEN could not be tested for panel unit roots. However, the country-wise time series plots in Figure 9 suggest no trend and hence the time series seem to be stationary. For majority of countries, this remained more or less the same, except some fluctuations in Russia, Indonesia and Philippines.

13 See also Leszczensky and Wolbring (2019) and Shepherd (2010).

14 In this study, though, there is a positive correlation between RQ and FF, but it is not very high.

15 Standard errors for IF and FF are not high.

16 It should be noted from regression 3 that when IF and FF interaction term is included, it seems that there is a problem of multicollinearity and it is not considered. And that is why regression with such interaction terms is not considered for other regressions as well, with depth, stability or competition.

17 This empirical relation may be a specific case for emerging economies and may not hold in developed and advanced economies.