Abstract
Led by the seminal papers of McKinnon (1973) and Shaw (1973), a significant number of studies have pointed out that financial liberalization can exert a positive effect on growth rates as interest rate levels rise towards their competitive market equilibrium, while resources are efficiently allocated. Accordingly, eliminating controls on interest rates and allowing them to increase could stimulate a higher level of savings. Moreover, with the assumption of a strong response of savings to the rate of interest, higher interest rates are expected to increase financial intermediation (the level of financial asset channelled by the financial system).1 Strictly under these strong assumptions, it is likely that financial liberalization produces higher savings which ultimately fosters economic development through changes in quality (by allowing efficient allocation of resources) and quantity of investment (Reinhart & Tokatlidis, 2003).
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
We have also defined financial intermediation earlier.
- 2.
However, in other literature this is termed as ceiling on interest rates since deposit rates are also indirectly controlled in the process.
- 3.
- 4.
Financial deepening is defined as the process of accumulating financial assets within the economy at a pace faster than that of accumulating non-financial assets (Shaw, 1973, p. vii).
- 5.
Since interest rates are repressed, banks have a surplus of investors asking for funds. Hence credits have to be directed.
- 6.
An obvious assumption here is that deposit rate is taken as given.
- 7.
They estimate the monthly interest rate in the money lenders segment to be between 47–50% even years after reform.
- 8.
See “Financing the poor through micro-enterprises-lesson from Kenya” in Indian Express, February 8, 2000.
- 9.
In a survey of 44 developing countries, the average informal sector interest rate was estimated to be 95%.
- 10.
The government recognized the need to expand and maintain banking facilities to rural and largely populated districts but there has been no direct and committed policy to achieve this. In his Budget Speech in 1983, the Minister for Finance announced an increment in branch licensing fees for any new openings but recommended to discount such fees by 15% for any rural opening (GoK, 1983). Thus, even though there was a need to encourage rural banking, such bold steps were either not taken or remained rare and inconsistent when taken.
- 11.
A good example of this is India, where to ensure wide distribution and national coverage of commercial banks, the Reserve Bank of India directly restricted branch licensing of banks in highly concentrated urban and metropolitan areas.
- 12.
It has been argued that such restrictive policies largely obviate the need for intermediation, and discourage financial integration (Maje, 1996).
- 13.
Currently banking institutions hold more than 58% of the outstanding treasury bills.
- 14.
This is particularly the case in Kenya as many banks either have bad and doubtful debts or have large NPLs. With NPLs forming 38% of the total loan, this rate is one of the highest in the world (Kinyua & Musau, 2004).
- 15.
Peer group classification is based on the level of total assets. A bank is rated peer group1 if it has an asset accumulation of over Kshs.5 billion.
- 16.
Through interviews with the relevant staff, I have been told that risks of failures and high monitoring cost have led to this.
- 17.
Ndungu and Ngugi (2000) point out that in a liberalized financial environment banks charge a higher risk premium and therefore may lend to risky projects. In a highly unstable economic environment and with little or non-existence of hedging instruments, this may increase the level of NPLs. However, for the banks to maintain their profit margin they may compensate for this by increasing their lending rates.
- 18.
Mostly high liquidity requirement is viewed as an implicit financial tax leading to a high interest rate.
- 19.
Through my interview with staff from the three leading banks in this sector it has been revealed to us that they have been continuously closing a number of countrywide branches rather than expanding to rural areas since 1997.
- 20.
Further discussion on NPLs and changes in NBFIs is given in the next section.
- 21.
See Kabubo-Mariara and Kiriti (2002) for analysis of Kenya's fiscal deficit and its financing.
- 22.
Note that Table 4.16 is given in the Appendix.
- 23.
Death of NBFIs and implicit barriers to entry also explain lack of competition. Discussion on entry barriers is given in Chapter 5 while the transformation of the NBFIs is outlined in the next sub-section.
- 24.
Some indicative evidence on this was given earlier.
- 25.
Indeed, while NBFIs were allowed to undertake mortgage lending and charge higher lending rates, commercial banks were restricted from offering such facilities.
- 26.
See, for example, the recent amendments to the Banking Act where the minimum capital requirement was raised from Kshs.150 million to 250 million during 1998–2000, and further to Kshs.400 million by December 2003 to enhance the quality of the banking sector.
- 27.
This argument is supported by the level of NPLs in NBFIs as we observe an upward trend in general from 1994.
- 28.
Table 4.6 gives suggestive evidence indicating a shift of deposits in favour of bigger commercial banks.
- 29.
See the article “Government should get out of banking” in Daily Nation, Friday, April 23, 1999.
- 30.
Examples of bad government projects that banks had to invest in include a failed Soya bean project (Ksh.850m), Kenya National Trading Company (Ksh.303m) and the Cotton Board of Kenya (Ksh.52m).
- 31.
In fact there have been complaints that a sizeable ratio of non-performing loans was a result of some financial instruments issued to influential individuals on the advice of the Treasury department. See “National Bank needs Sh10b to save it from a shut down” in Daily Nation, Tuesday, July 10, 2001.
- 32.
Further details are given in the article “Obstacles Narc should remove” in Daily Nation, Sunday, January 5, 2003.
- 33.
More precisely, this amounts to financial repression elements which obviate the need for intermediation.
- 34.
Producer prices were still controlled and highly influenced by the Agricultural Development and Marketing Corporation (ADMARC), a body that existed even before reforms.
- 35.
This does not mean that the agricultural sector is now less productive as it contributed 37% of the GDP in 2000 compared to 17% from industry. However, it shows that the non-agricultural sectors are becoming more important and, hence over time, the gap between the two is closing.
- 36.
It has been shown that up until 1989, the National Bank of Malawi (NBM) alone held up to 76% of total deposits and over 60% of assets in the banking sector respectively, while in 1990 NBM and Commercial Bank of Malawi accounted for more than 80% total deposit liabilities of financial institutions (Nissanke & Aryeetey, 1998, pp. 69–70).
- 37.
As opposed to the pre-reforms era, the new amendments gave entry powers to the Central Bank with the Minister for Finance merely acting to endorse their recommendations or giving reasons for denial (Chirwa, 2001).
- 38.
Seemingly, under this structure, there appears to be no stronger platform for the newcomers to launch successful competition to break the existing uncompetitive oligopoly.
- 39.
Chipeta and Mkandawire (2002) provide a detailed coverage of these issues in Malawi.
- 40.
In addition to having budget surpluses as indicated in Table 4.13, external sources such as foreign borrowing and aid were always available alternatives for the government.
- 41.
Arguably this reserve ratio is low. Practically, this could be (i) a government's belief that it has the necessary capital to bail out such institutions in the case of liquidity problems, (ii) a direct policy to encourage lending to the private sector.
- 42.
In support of this Reinke (1997, p. 105) demonstrates that household advances in Botswana have continuously exceeded their share of deposits in the last decade.
- 43.
Notably, De Gregorio (1996) comments that borrowing constraints may reduce the time devoted to formal education and acquiring of human capital. Thus, this enables individuals to have access to resources while in education.
- 44.
Contrastingly, the private savings rate has been increasing. Two reasons may explain this: (i) intertemporal substitution issue where individuals who borrowed in the past save more to honour their payments, (ii) the benefit of economic growth may be reaped more by those with a higher marginal propensity to save than otherwise. Increasing inequality in the country in question may be taken as evidence of this trend.
- 45.
Having a variety of different banks could also enable more product differentiation and specialization.
- 46.
Further, the return of assets of Barclays bank was almost 20% in 1994 compared to over 50% in 1987.
- 47.
On the other hand, statistics indicate that even though the old banks were closing down some of their unprofitable rural branches in response to shrinking market share, more unusually, the new banks were replacing them.
References
Adamolekun, L., & Morgan, P. (1999). Pragmatic institutional design in Botswana: Salient features and an assessment. International Journal of Public Sector Management, 2(7), 584–603.
Athukorala, P. C., & Sen, K. (2002). Saving, investment and growth in India. New Delhi: Oxford University Press.
Atieno, R. (2001). Formal and informal institutions. Lending policies and access to credit by small-scale enterprises in Kenya: An empirical assessment. (AERC Research Paper 111).
Aziakpono, M., & Babatope-Obasa, S. (2003). Financial Liberalization, Currency Substitution and Savings in Nigeria: Evidence from Cointegration and Error Correction Modelling. Paper presented in 8th Annual Conference on Econometric Modelling for Africa of the African Econometric Society. July, 1–4.
BoB. (2000). Recent developments in Botswana economy. Annual Report, Bank of Botswana.
Brock, P. L., & Suarez, L. R. (2000). Understanding the behaviour of bank spreads in Latin America. Journal of Development Economics, 63(1), 113–134.
CBK. (2001). Bank supervision annual report. Central bank of Kenya.
Chan, V. L., & Hu, S. C. (1997). Financial liberalization and aggregate consumption: The evidence from Taiwan. Applied Economics, 29(11), 1525–1535.
Chipeta, C. (1994). The links between the informal and the formal/semi-formal financial sectors in Malawi. African Journal of Economic Policy, 1(1), 159–184.
Chipeta, C., & Mkandawire, M. (2002). Explaining African economic growth performance: Case study of Malawi. AERC collaborative research project on explaining African economic growth performance.
Chirwa, E. W. (2001). Market structure, liberalization and performance in the Malawian banking sector. (ERC Research Paper 108).
Cho, Y. J. (1986). Inefficiencies from financial liberalization in the absence of well-functioning equity market. Journal of Money, Credit and Banking, 18(2), 191–199.
De Gregorio, J. (1996). Borrowing constraint, human capital and growth. Journal of Monetary Economics, 37(1), 49–71.
De Gregorio, J., & Guidotti, P. E. (1995). Financial development and economic growth. World Development, 23(3), 433–448.
Demirguc-Kunt, A., & Huizinga, H. (1997). Determinants of commercial bank interest margins and profitability: Some international evidence. (Policy Research Working Paper No.1900). The World Bank.
Fry, M. J. (1995). Money, interest, and banking in economic development. Baltimore: The Johns Hopkins University Press.
Fry, M. J. (1997). In favour of financial liberalization. Economic Journal, 107(1), 754–770.
Gibson, H. D., & Tsakalotos, E. (1994). The scope and limits of financial liberalisation in developing countries: A critical survey. The Journal of Development Studies, 30(3), 578–628.
GoK. (1983). Budget speech 1983/1984. Ministry of Finance, Government of Kenya.
GoK. (2000). Survey of the financial service sector. Ministry of Labour and Human Resource Development, Government of Kenya.
Harvey, C. (1996). Banking policy in Botswana: Orthodox but untypical. (IDS Discussion Paper no.39). Institute of Development. Sussex.
Harvey, C., & Lewis, S. R. (1990). Policy choice and development performance in Botswana. Bristol: Macmillian and OECD Development Centre.
IEA. (2000). Moderating the interest rate spread. “The point”. Bulletin of the Institute of Economic Affairs, 42. Nairobi.
Ikhide, S. I. (1996). Commercial bank offices and the mobilization of private savings in selected sub-Saharan African countries. Journal of Development Studies, 33(1), 117–132.
Jefferis, K. (1995). Botswana stock market and its role in financial and economic development. World Development, 23(4), 663–678.
Kabubo-Mariara, J., & Kariti, T. W. (2002). Structural adjustment, poverty and economic growth: An analysis for Kenya. (AERC Research Paper 124). African Economic Research Consortium.
Kahauti, A., & Wright, M. (1997). The real cost of inflation in Botswana. In J. S. Salkin, et al (Eds.), Aspects of the Botswana economy: Selected paper. Gaborone: Lentswe la Lesedi; Oxford: James Curry Ltd.
Kinyua, W., & Musau, B. (2004). Reforms for enhanced performance of Kenya's financial sector. Nairobi: Kenya Bankers Association Report.
Kitchen, R. L. (1986). Finance for the developing countries. New York: Wiley.
Levine, R. (1997). Financial development and economic growth: Views and agenda. Journal of Economic Literature, 35(2), 688–726.
Maipose, G. S., & Matsheka, T. C. (2002). Explaining African growth performance: The Botswana case study. AERC Collaborative Project Papers on Explaining African Economic Performance.
Maje, E. H. (1996). Financial sector reforms in Tanzania: Nature and prospects. African Journal of Economic Policy, 3(2), 49–62.
Malawi, X. (2000). Exchange and interest rate determination in Malawi: Past and present. (Research Paper). Lilongwe: Reserve Bank of Malawi.
Manda, D. K. (2002). Globalization and the labour market in Kenya. (Discussion Paper 6). KIPPRA.
Mandlebe, W. (1997). Trends in real wages and labour productivity in Botswana. In J. S. Salkin, et al (Eds.), Aspects of the Botswana economy: Selected paper. Gaborone: Lentswe la Lesedi, Oxford: James Curry Ltd.
Masalila, K. (2001). Financial liberalization and monetary policy effectiveness: A comparison of Botswana, Malawi and Zimbabwe. The Research Bulletin, Bank of Botswana, 19(1), 9–26.
Mauro, P. (1997). The effect of corruption on growth, investment, and government expenditure: A cross-country analysis. In K. Elliott (Eds.), Corruption and the global economy. Washington, DC: Institute for International Economics.
McKinnon, R. I. (1973). Money and capital in economic development. Washington, DC: The Brookings Institution.
Mlachila, M., & Chirwa, E. W. (2002). Financial reforms and interest rate spread in the commercial banking system in Malawi. (IMF Working Paper WP/02/6). International Monetary Fund.
Motsomi, A. (1997). Policy options for savings mobilization in Botswana. In J. S. Salkin, et al (Eds.), Aspects of the Botswana economy: Selected papers. Gaborone: Lentswe la Lesedi, Oxford: James Curry Ltd.
Mwega, F. M., & Ndungu, N. S. (2002). Explaining African economic growth performance: The case of Kenya. AERC Collaborative Project on Explaining African Economic Performance.
Ndungu, N. S., & Ngugi, R. W. (2000). Banking sector interest rate spread in Kenya. (Discussion Paper Series DP 05/2000). KIPPRA.
Ngugi, R. W., & Kabubo, J. W. (1998). Financial sector reforms and interest rate liberalization: The Kenyan experience. (AERC Research Paper No.72). African Economic Research Consortium.
Nissanke, M., & Aryeetey, E. (1998). Financial integration and development in Sub-Saharan Africa. London: Routledge.
NSE. (2001). Reforming Kenya's financial sector for economic recovery. Nairobi Stock Exchange (NSE): Financial Institution Committee.
Olomola, A. S. (1994). Financial liberalization and economic growth under structural adjustment in Nigeria. African Journal of Economic Policy, 1(1), 141–157.
Reinhart, C. M., & Tokatlidis, I. (2003). Financial liberalization: The African experience. Journal of African Economies, 12(3), 53–88.
Reinke, J. (1997). Savings mobilization in the household sector: The case of Botswana. In Salkin, J. S., et al, (Eds.), Aspects of the Botswana economy: Selected papers. Gaborone: Lentswe la Lesedi; Oxford: James Curry Ltd.
Shaw, E. S. (1973). Financial deepening in economic development. New York: Oxford University Press.
Sikorski, T. M. (1996). Financial liberalization in developing countries. Cheltenham: Edward Elgar.
UNDP. (1999). Malawi globalization, liberalization and sustainable human development. Country Assessment Report, UNDP/UNCTAD, December.
World Bank. (1984). Agricultural credit sector policy paper. The World Bank: Second.
Author information
Authors and Affiliations
Corresponding author
Appendix
Appendix
Rights and permissions
Copyright information
© 2010 Springer-Verlag Berlin Heidelberg
About this chapter
Cite this chapter
Ahmed, A.D., Islam, S.M.N. (2010). The Theory of Financial Liberalization and its Economic Impact: An Assessment. In: Financial Liberalization in Developing Countries. Contributions to Economics. Physica, Heidelberg. https://doi.org/10.1007/978-3-7908-2168-0_4
Download citation
DOI: https://doi.org/10.1007/978-3-7908-2168-0_4
Published:
Publisher Name: Physica, Heidelberg
Print ISBN: 978-3-7908-2167-3
Online ISBN: 978-3-7908-2168-0
eBook Packages: Business and EconomicsEconomics and Finance (R0)