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

1. Governance, Financial Liberalization, and Financial Development in Sub-Saharan Africa John A Karikari * Assistant Director Center for Economics US Government Accountability Office (GAO) Washington, DC, USA African Finance & Economics Association (AFEA) President-Elect www.afea.info www.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. karikari: govn & findev aec2010

2. Overview • Motivation • Literature Review • Methodology • Model • Data • Results • Discussion & Conclusion karikari: govn & findev aec2010

3. 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 • SSA lag substantially in quality of governance & costs of doing business • What are the roles of financial liberalization & governance in financial development? karikari: govn & findev aec2010

4. Motivation (contd) • Consequences of the low financial development • Limited & inadequate access to capital has varied effects on the economy (AfDB, 2010) • Low productivity in agric in rural areas • Limits contributions of SMEs to private dev • Slows financial dev in oil-exporting countries with a huge capital assets tied to oil prices • Countries successful in attracting private capital inflows have better financial markets, institutional quality, and more integrated globally in financial and trade flows (IMF, 2010) karikari: govn & findev aec2010

5. Literature Review karikari: govn & findev aec2010

6. Methodology • Model: • FDEV: Private credit by deposit banks (Beck et al., 2000) • FLIB: Financial liberalization (Chinn-Itoh index, 2008) • GOVN: World Bank’s World Governance Indicators (WGI) • LGO: Legal origins by World Legal Systems Research Group • Common law (CMN), civil law (CVL), or mixed system (MXD) • X: Other factors • Macroeconomic factors (World Bank’s WDI) • GDP, Inflation rate, Govt expenditure, Aid • BCRISIS in late 1980s/early 1990s (IMF, 2006) • OILEXPORTR: Oil-exporting countries (IMF, 2006) karikari: govn & findev aec2010

7. Methodology (contd) karikari: govn & findev aec2010

8. Methodology (contd) • Financial Development in SSA, 1996-2008 • Data are averages for 1996-2002 and 2003-2008 karikari: govn & findev aec2010

9. Methodology (contd) karikari: govn & findev aec2010

10. Methodology (contd) karikari: govn & findev aec2010

11. Estimation Results karikari: govn & findev aec2010

12. Estimation Results (contd) Table 3, col. 2: • Impact of financial liberalization reduced with high governance, in 1996-2002 and Impact 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 karikari: govn & findev aec2010

13. Estimation Results (contd) karikari: govn & findev aec2010

14. 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: • SSA require higher levels of good governance to fully benefit from financial liberalization • Mixed legal systems, compared to civil laws favored financial development karikari: govn & findev aec2010

15. Estimation Results (contd) Other results (Table 3) • Macroeconomic effects: • Economic growth: Inconclusive • Inflation: Negative • Govt expenditure: Positive • 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) karikari: govn & findev aec2010

16. Estimation Results (contd) karikari: govn & findev aec2010

17. Discussion & Conclusion • Key Results/Policy Implications: • Financial liberalization, by itself, did not improve financial development, contrary to previous studies • The impact of governance, by itself, improved fin dev in 2003-2008 • Governance improved impact of financial liberalization in 2003-2008, but worsened it in 1996-2002 • Civil laws systems are less favorable to financial development, compared to mixed systems with common laws, consistent with previous studies • Political instability is more powerful for financial development than rule of law, contrary to previous studies • Banking crisis in the late 1980s/early 1990s has adverse effects on liquid liabilities • Further Research/Discussion: • What is the appropriate definition of financial liberalization when explaining financial development? karikari: govn & findev aec2010