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Governance, Financial Liberalization, and Financial Development in Sub-Saharan Africa

John A Karikari *Assistant Director

Center for EconomicsUS Government Accountability Office (GAO)

Washington, DC, USA

African Finance & Economics Association (AFEA)President-Electwww.afea.infowww.afea.net

*The opinions expressed herein are those of the author and do not necessarily reflect those of the GAO or the US federal government.

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Overview

MotivationLiterature ReviewMethodology

• Model• Data

Results Discussion & Conclusion

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Motivation SSA has shallow financial markets & face the

challenge of deepening & strengthening them Attempts have been made to liberalize

financial markets But, low quality of institutions & governance

could be limiting the impact of financial liberalization

o SSA lag substantially in quality of governance & costs of doing business

What are the roles of financial liberalization & governance in financial development?

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Motivation (contd)

Consequences of the low financial development

o Limited & inadequate access to capital has varied effects on the economy (AfDB, 2010)Low productivity in agric in rural areasLimits contributions of SMEs to private devSlows financial dev in oil-exporting countries

with a huge capital assets tied to oil priceso Countries successful in attracting private capital

inflows have better financial markets, institutional quality, and more integrated globally in financial and trade flows (IMF, 2010)

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Literature Review

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Methodology Model:

o FDEV: Private credit by deposit banks (Beck et al., 2000)o FLIB: Financial liberalization (Chinn-Itoh index, 2008)o GOVN: World Bank’s World Governance Indicators (WGI)o LGO: Legal origins by World Legal Systems Research Group

o Common law (CMN), civil law (CVL), or mixed system (MXD)

o X: Other factorso Macroeconomic factors (World Bank’s WDI)

GDP, Inflation rate, Govt expenditure, Aid

o BCRISIS in late 1980s/early 1990s (IMF, 2006)o OILEXPORTR: Oil-exporting countries (IMF, 2006)

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Methodology (contd)

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Methodology (contd) Financial Development in SSA, 1996-2008

Data are averages for 1996-2002 and 2003-2008

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Methodology (contd)

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Methodology (contd)

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Estimation Results

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Estimation Results (contd)

Table 3, col. 2:

Impact of financial liberalization reduced with high governance, in 1996-2002andImpact of financial liberalization enhanced with high governance, in 2003-2008

Why?• A certain threshold of governance required for liberalization

to be effective• Government forbearance of weak, mostly state-owned

banks in earlier period

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Estimation Results (contd)

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Estimation Results (contd)

Table 4:

Financial liberalization, by itself, was associated with lower financial development, particularly, in 1996-2002, contrary to McDonald & Schumacher (2007)

Governance has negative impact in 1996-2002 that was offset by a positive impact in 2003-2008

Implication: o SSA require higher levels of good governance to fully benefit

from financial liberalization Mixed legal systems, compared to civil laws favored

financial development

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Estimation Results (contd)Other results (Table 3) Macroeconomic effects:

o Economic growth: Inconclusiveo Inflation: Negativeo Govt expenditure: Positiveo Aid: Positive

Banking crisis: Negative Oil exporter: Negative

Robustness checks Excluded South Africa (Table 3, col 3) Endogeneity of financial liberalization Dependent variable: Liquid liabilities (Table 3, col 4) Individual dimensions of governance (Table 5)

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Estimation Results (contd)

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Discussion & Conclusion Key Results/Policy Implications:

o Financial liberalization, by itself, did not improve financial development, contrary to previous studies

o The impact of governance, by itself, improved fin dev in 2003-2008o Governance improved impact of financial liberalization in 2003-

2008, but worsened it in 1996-2002o Civil laws systems are less favorable to financial development,

compared to mixed systems with common laws, consistent with previous studies

o Political instability is more powerful for financial development than rule of law, contrary to previous studies

o Banking crisis in the late 1980s/early 1990s has adverse effects on liquid liabilities

Further Research/Discussion:o What is the appropriate definition of financial liberalization when

explaining financial development?