Financial Liberalization and Credit-Asset Booms and Busts in East Asia

This paper presents econometric evidence that sheds new light on the role played by financial liberalization in the Korean and Thai financial crises. Drawing on previous empirical studies, it argues that while the banking systems of both Korea and Thailand supported their remarkable long-run growth performance, they were ill prepared to face the risks emanating from financial liberalization. New evidence is then presented which shows that financial liberalization set in motion a classic credit-asset boom and bust cycle in Thailand and created other weaknesses in the Korean financial system, which made both economies vulnerable to the sentiments of foreign investors and lenders. When capital flows were reversed, the ensuing liquidity crisis triggered a bust that was further magnified by currency depreciations and interest rate hikes. In the light of this analysis, the paper argues that besides strengthening prudential regulation and accounting standards, there is a need for upgrading management systems and expertise to deal with financial risks and an important need for a more widespread appreciation of the risks associated with financial liberalization. Furthermore, there remain gaps in the international financial architecture that need to be addressed, such as the absence of an effective international lender of last resort. Given that these weaknesses may require a long time to address, it is argued that in the interim period financial restraints can act as a relatively cheap, effective and transparent safety device in safeguarding financial stability.

Sources and Effectiveness of Financial Development: What We Know and What We Need to Know

financial development, growth, institutions, banking

Excess Credit and the South Korean Crisis

over-borrowing, South Korea, financial crisis

Financial Restraints in the South Korean Miracle

We provide novel empirical evidence on the effects of financial restraints on South Korean financial development. The evidence is linked to a simple model of the Korean banking system that encapsulates its cartelised nature, which predicts a positive association between financial development and (i) the degree of state control over the banking system, (ii) mild repression of lending rates. The model also predicts that in the presence of lending rate controls, increases in the level of the administered deposit rate are unlikely to influence financial deepening. We test the model empirically by constructing individual and summary measures of financial restraints. Our empirical findings are consistent with our theoretical predictions but contrast sharply with the predictions of earlier literature that postulates that interest rate ceilings and other financial restraints constitute sources of ‘financial repression’.Financial deepening; financial restraints

Loan Defaults in Africa

African financial deepening is beset by a high rate of loan defaults, which encourages banks to hold liquid assets instead of lending. We put forward a novel theoretical model that captures the salient features of African credit markets which shows that equilibrium with high loan defaults and low lending can arise when contract enforcement institutions are weak, investment opportunities are relatively scarce and information imperfections abound. We provide evidence using a panel of 110 banks from 29 African countries which corroborates our theoretical predictions.Financial development; Africa

The End of Financial Repression? A Cross-Country Analysis of Investment

We estimate a model of investment under financial restrains due to Demetriades and Devereux (2000), using total and private aggregate investment data from 38 high income and low income countries during 1972-2002. Our main findings for the overall sample are that (i) the US real interest rate is a robust determinant of total investment, suggesting that US monetary policy may have unintended global consequences; (ii) a term proxying domestic financial restraints is found to have an insignificant impact both on total and private investment. These findings are, however, somewhat less conclusive when we examine low income countries on their own, where financial restraints are found to have a negative and marginally significant effect on total investment.Financial restraints; investment; dynamic panel data

Sources and Legitimacy of Financial Liberalization

This article seeks to clarify how we understand domestic and international sources of globalization and specifically how we explain financial liberalization across countries. The article also develops our understanding of the underlying legitimacy of financial liberalization. We debate e.g. Abiad and Mody (2005) and others who have found political factors to have little impact on financial openness. Using the same data undergirding such conclusions we argue, in contrast, that even a slight broadening of the political variables employed in the model and much closer attention to “input” and “output” aspects of the political legitimacy of financial liberalization over time reveal a more central role for politics in shaping liberalization. Input legitimacy involves the representation of stakeholders in initial and ongoing decisions to liberalize, while “output” legitimacy concerns liberalization’s distributional consequences and management thereof over time. Several empirical measures of domestic-national and international political factors plausibly influence such aspects of legitimacy and are found to play a significant role in shaping liberalization, suggesting legitimation politics to be more important to financial openness than existing studies have typically acknowledged.financial openness; liberalization dynamics; financial regulation; political legitimacy; political variables; financial reform

Financial Development, Openness and Institutions: Evidence from Panel Data

Utilising four annual panel datasets and dynamic panel data estimation procedures we find that trade and financial openness, as well as economic institutions are statistically important determinants of the variation in financial development across countries and over time since the 1980s. However, we find mixed support for the hypothesis that the simultaneous opening of both trade and capital accounts is necessary to promote financial development in a contemporary setting.Financial development, Trade Openness, Financial Openness, Economic Institutions, Financial Liberalization, Dynamic Panel Data Analysis

Does the Chinese Banking System Promote the Growth of Firms?

Using a large panel dataset of Chinese manufacturing enterprises during 1999-2005, which accounts for over 90% of China’s industrial output, and robust econometric procedures we show that the Chinese banking system has helped to support the growth of both firm value added and TFP. We find that access to bank loans is positively correlated with future value added and TFP growth. We also find that firms with access to bank loans tend to grow faster in regions with greater banking sector development. While the effects of bank loans on firm growth are more pronounced in the case of purely private-owned and foreign firms, they are positive and statistically significant even in the case of state-owned and collectively-owned firms. We show that excluding loss-making firms from the sample does not change the qualitative nature of our results.Chinese banking system development; value added and TFP growth; panel dataset

The Impact of Financial Liberalisation Policies on Financial Development Evidence from Developing Economies

We collect data on a number of financial restraints, including restrictions on deposit and lending interest rates and reserve and liquidity requirements, from central banks of six developing countries. We estimate the effects of these policies on financial development, controlling for the effect of economic development and using standard econometric techniques. We find that the effects of financial policies vary considerably across our sample of countries. Our findings demonstrate that financial liberalisation is a much more complex process than has been assumed by earlier literature and its effects on financial development are ambiguous.Financial Development; Financial Liberalisation; Cointegration Analysis