nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2020‒06‒15
twenty-one papers chosen by
Georg Man

  1. Household Credit and Growth: International Evidence By Florian Léon
  2. Financial Frictions, Borrowing Costs, and Firm Size Across Sectors By Bento, Pedro; Ranasinghe, Ashantha
  3. Financial Markets, Industry Dynamics and Growth By Maurizio Iacopetta; Raoul Minetti; Pietro Peretto
  4. Recurrent Bubbles and Economic Growth By Pablo A. Guerron-Quintana; Tomohiro Hirano; Ryo Jinnai
  5. How Do Financial Globalization, Institutions and Economic Growth Impact Financial Sector Development in European Countries? By Nasreen, Samia; Mahalik, Mantu Kumar; Shahbaz, Muhammad; Abbas, Qaisar
  6. Mobilizing domestic resources for economic development in Nigeria: The role of the capital market By Fidelis 0. Ogwumike; Davidson A. Omole
  7. Financial sector reforms and interest rate liberalization: The Kenya experience By R.W. Ngugi; J.W. Kabubo
  8. The Impact of Uncertainty Shocks in South Africa: The Role of Financial Regimes By Mehmet Balcilar; Rangan Gupta; Theshne Kisten
  9. Financial Access, Governance and the Persistence of Inequality in Africa: Mechanisms and Policy instruments By Vanessa S. Tchamyou
  10. Governance and the Capital Flight Trap in Africa By Simplice A. Asongu; Joseph Nnanna
  11. African Economic and Monetary Union (WAEMU) By Sandrine Kablan
  12. Capital Market Integration with Multiple Convergence Clubs: The Case of Prewar Japan By Tetsuji OKAZAKI; Koji SAKAI
  13. The global effects of global risk and uncertainty By Bonciani, Dario; Ricci, Martino
  14. The provision of long-term credit and firm growth By Florian Leon
  15. Aggregate Consumption and Wealth in the Long Run: The Impact of Financial Liberalization By Gardberg, Malin
  16. Cyclical Lending Standards: A Structural Analysis By Kaiji Chen; Patrick C. Higgins; Tao Zha
  17. Do non-performing loans matter for bank lending and the business cycle in euro area countries? By Huljak, Ivan; Martin, Reiner; Moccero, Diego; Pancaro, Cosimo
  18. Institutional Diversity in Domestic Banking Sectors and Bank Stability: A Cross-Country Study By Christopher F. Baum; Caterina Forti Grazzini; Dorothea Schäfer
  19. The intertwining of credit and banking fragility By Jérôme Creel; Paul Hubert; Fabien Labondance
  20. Financial Inclusion and Bank Stability: Evidence from Europe By Gamze Danisman; Amine Tarazi
  21. Parameters of Profitability: Evidence From Conventional and Islamic Banks of Bangladesh By K. M. Golam Muhiuddin; Nusrat Jahan

  1. By: Florian Léon (CREA, Université du Luxembourg)
    Abstract: This paper has two main objectives. First, it attempts to distinguish the effects of house- hold and enterprise credit on economic growth for a large sample of developing and developed countries. Second, it investigates the channels through which household credit affects economic growth. To do so, a new database covering 143 countries over the period 1995-2014 is employed. Econometric results show that household credit has a negative effect on growth, while business credit has a positive, albeit non significant, impact on growth. The literature provide two possi- ble explanations to justify the negative effect of household credit. On the one hand, household credit expansion can induce more financial fragility. On the other hand, the negative impact of household credit could be explained by its effect on saving behaviors. Results provide some evidence indicating that the negative effect of household credit is more driven by the latter than the former.
    Keywords: Financial development; Household credit; Growth; Savings.
    JEL: E44 G21 O16
    Date: 2019
  2. By: Bento, Pedro (Texas A&M University); Ranasinghe, Ashantha (University of Alberta, Department of Economics)
    Abstract: We document new evidence that financial under-development is associated with higher borrowing rates, lower investment in productivity, a smaller share of large firms, and smaller average firm size, both in manufacturing and services. To account for these patterns, we develop a two-sector economy with heterogeneous entrepreneurs that face financial frictions in the form of borrowing rates that rise with the cost of monitoring risky investments. The model is tractable and can be solved analytically, making clear predictions for the impact of high borrowing costs on investment, the share of large firms, and average firm size across sectors, consistent with the evidence we document. Varying monitoring costs to generate observed cross-country differences in borrowing rates, the model can account for one-third of the log-variance of observed average firm size across sectors, over 20 percent of the variation in investment, and a 30 percent drop in aggregate productivity, all substantial relative to the literature.
    Keywords: financial development; borrowing; firm size; investment; aggregate productivity
    JEL: O10 O14 O41 O43
    Date: 2020–05–28
  3. By: Maurizio Iacopetta (Observatoire français des conjonctures économiques); Raoul Minetti (Michigan State University); Pietro Peretto (Duke University)
    Abstract: This article introduces corporate governance frictions into a growth model with endogenous market structure. Managers engage in corporate resource diversion and empire building. Shareholders discipline managers with incentive compensation contracts. A reform that mitigates corporate governance frictions boosts firms’ entry and, for a given market structure, has an ambiguous impact on incumbents’ return to product improvement. However, as the market structure adjusts, becoming more diffuse, incumbents invest less in product improvement. Calibrating the model to U.S. data, we find that a reform of the kind recently enacted in several advanced economies can lead to a welfare loss.
    Keywords: Financial markets; Industry dynamics; Growth
    Date: 2019–07
  4. By: Pablo A. Guerron-Quintana; Tomohiro Hirano; Ryo Jinnai
    Abstract: We study a regime-switching recurrent bubble model with endogenous growth. The economy experiences both bubbly and bubbleless regimes recurrently. Innitely lived households expect future bubbles, which crowds out investment and reduces economic growth. Because realized bubbles crowd in investment, their overall impact on economic growth and welfare crucially depends on both the level of nancial development and the frequency of bubbles. We examine the U.S. economic data through the lens of our model, nding evidence of recurrent bubbles. Furthermore, counterfactual simulations suggest that 1) the IT and housing bubbles together lifted U.S. GDP by almost 2 percentage points permanently; and 2) the U.S. economy could have grown even faster if people had believed that asset bubbles would not arise.
    Date: 2020–05
  5. By: Nasreen, Samia; Mahalik, Mantu Kumar; Shahbaz, Muhammad; Abbas, Qaisar
    Abstract: This paper examines the role of financial globalization, institutions and economic growth on the development of financial sector in European countries. We use panel data covering the period of 1989-2016. Using the composite index of financial development covers various dimensions of financial market, that is, depth, access and efficiency and four-way classification of institutions as suggested by Rodrick (2005) and Law et al. (2018), the empirical results indicate that economic growth and institutional quality are positively associated with financial development. Contrarily, financial globalization hinders the process of financial sector development. The results are robust to using alternative proxies of economic growth, institutional indicators and capturing the period of financial crisis. These empirical findings suggest policy guidelines to develop financial sector by using globalization, institutional quality and economic growth as economic tools.
    Keywords: Economic Growth, Financial Development, Financial Globalization, Institutions
    JEL: G0
    Date: 2020–05–07
  6. By: Fidelis 0. Ogwumike; Davidson A. Omole (University of Ibadan)
    Abstract: This study focuses on the role of the capital market in mobilizing domestic resources for economic development in Nigeria, with emphasis on the role of the Nigerian Stock Exchange (NSE). The objectives of the study are to identify the major problems confronting the stock market and to determine the impact of government policies on the operations of the Exchange. In addition to secondary data, the study used primary data derived from a survey of 251 companies, 192 of which were not listed on the Nigerian Stock Exchange. The results show that in spite of the growth witnessed during the period under study, the Nigerian stock market still lacks depth and breadth. The volume and value of transactions are still very low and financial instruments are few. Security pricing policy has constrained the rapid development of the NSE. Government policies need to provide market friendly incentives that can enhance the number of companies listed and the value and volume of transactions on the stock market.
  7. By: R.W. Ngugi; J.W. Kabubo (University Of Nairobi)
    Abstract: For financially repressed economies, financial liberalization was expected to allow for positive real interest rates, and for stimulating the mobilization and efficient allocation of domestic financial resources. At the same time, as the market becomes competitive the costs of intermediation go down, an indication of efficiency in the intermediation of financial assets. But, for successful liberalization, prerequisites must be put in place together with proper sequencing procedures. The study explored the sequencing and actions so far taken in the liberalization process in Kenya. The study also examined the interest rate levels, spreads and determining factors, as an indicator of financial sector response to the reform process. The study found that although much had been accomplished, the financial system was characterized by repression factors including negative real interest rates, inefficiency in financial intermediation and underdeveloped financial markets. This may indicate that the economy is facing secondary financial repression. Interest rates were more responsive to the policy activities during the period than to the fundamentals. Interest rates were a monetary phenomenon with an adjustment speed of 77% to disequilibrium in the monetary sector. The study concluded that there are several loose knots that need to be tightened for the economy to experience significant positive effects of financial liberalization.
  8. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Famagusta, via Mersin 10, Northern Cyprus, Turkey); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Theshne Kisten (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa)
    Abstract: This article examines the connection between economic uncertainty and financial market conditions in South Africa, documenting that the macroeconomic implications of an uncertainty shock differs across financial regimes. A non-linear VAR is estimated where uncertainty is captured by the average volatility of structural shocks in the economy, and the transmission mechanism is characterised by two distinct financial regimes (i.e. financially stressful versus normal periods). We find that while the deterioration of output following an uncertainty shock is much more prominent during normal periods than during stressful periods, it is much more persistent during stressful financial times. The share of output variance explained by the volatility shocks in good financial times is more than double the share in bad times. Uncertainty shocks are found to be inflationary in both regimes, with the impact being larger in the stress regime. While our estimates reveals that financial frictions do not amplify the impact of uncertainty on real output, it does increase the impact on prices.
    Keywords: Uncertainty, Financial regimes, South Africa, Non-linear VAR, Stochastic volatility
    JEL: C32 E32 E44 G00
    Date: 2020–05
  9. By: Vanessa S. Tchamyou (Yaounde, Cameroon)
    Abstract: The aim of this paper is to investigate policy instruments by which the persistence of inequality is affected through financial development channels in 48 African countries for the period 1996 – 2014. Financial dynamic channels of depth (money supply and liquid liabilities), efficiency (at banking and financial system levels), activity (from banking and financial system perspectives) and stability are used. Political (“voice and accountability†and political stability), economic (government effectiveness and regulation quality) and institutional (rule of law and corruption-control) governance policy instruments are also involved. The empirical evidence is based on the Generalised Method of Moments (GMM). The results show that financial depth and financial stability are the best channels of reducing inequality. Moreover, the relevance of these financial channels is significantly apparent when policy instruments are exclusively governance variables. The comparative relevance of governance dynamics in the persistence of inequality is discussed. The study responds to two recent policy and scholarly challenges, notably: the persistence of inequality in Africa and the relevance of governance in addressing income inequality by means of financial access.
    Keywords: Finance; Governance; Inequality; Modelling; Africa
    JEL: O16 O10 I30 C50 O55
    Date: 2020–01
  10. By: Simplice A. Asongu (Yaoundé/Cameroon); Joseph Nnanna (The Development Bank of Nigeria, Abuja, Nigeria)
    Abstract: The study examines the use of governance tools to fight capital flight by reducing the capital flight trap. Two overarching policy syndromes are addressed in the study. It first assesses whether governance is an effective deterrent to the capital flight trap in Africa, before examining what thresholds of government quality are required to fight the capital flight trap in the continent. The following findings are established. Evidence of a capital flight trap is apparent because past values of capital flight have a positive effect on future values of capital flight. The net effects from interactions of the capital flight trap with political stability, regulation quality, economic governance and corruption-control on capital flight are positive. The critical masses at which “voice & accountability†and regulation quality can complement the capital flight trap to reduce capital flight are respectively, 0.120 and 0.680, which correspond to the best performing countries. Policy implications are discussed.
    Keywords: governance; capital flight; capital flight trap; Africa
    JEL: C50 E62 F34 O55 P37
    Date: 2020–01
  11. By: Sandrine Kablan (Centre Ivoirien de Recherche en Economie et en Sociologie/Universite de Paris 10)
    Abstract: This paper measures the efficiency of WAEMU banks and its determining factors, after the banking system reforms from 1993 to 1996. Data envelopment analysis (DEA) was used for assessing technical efficiency and a stochastic frontier analysis (SFA) for cost efficiency. Results suggest similar evolutions for the two types of efficiency for all WAEMU countries except Côte d’Ivoire and Burkina Faso. A detailed analysis per banking shareholder’s equity group reveals that local private banks are the most efficient ones, followed by foreign and then state-owned banks. Despite the technological changes that occurred in the banking system, the Malmquist index shows that the increase of technical efficiency is much more a factor of scale efficiency change than of the incorporation of technological innovations. Lastly, WAEMU banks’ efficiency is sensitive to variables like financial soundness, the ratio of bad loans per country, the banking concentration and the GDP per capita.
  12. By: Tetsuji OKAZAKI; Koji SAKAI
    Abstract: This paper examines capital market integration in prewar Japan, using a methodology that allows for multiple equilibria in convergence. Specifically, we apply the method of log t regression and the club convergence test proposed by Phillips and Sul (2007) to examine the convergence of prefectural loan rates and detect the convergence clubs that followed heterogeneous transition paths. Whereas prefectural loan rates were converging towards two equilibria from 1888–1900, all the prefectural loan rates converged towards a unique equilibrium from 1901–1926. From 1927, however, the prefectural loan rates diverged again, and four different convergence clubs emerged. Restrictive regulation imposed by the Bank Law of 1928 reduced competition in local markets, increased barriers to interregional capital mobility, and, thereby, reversed capital market integration.
    Date: 2020–03
  13. By: Bonciani, Dario (Bank of England); Ricci, Martino (European Central Bank)
    Abstract: In this paper, we analyse the effects of a shock to global financial uncertainty and risk aversion on real economic activity. To this end, we extract a common factor from the realised volatilities of about 1,000 risky asset returns from around the world. We then study how shocks to the factor affect economic activity in 44 advanced and emerging small open economies by estimating local projections in a panel regression framework. We find that the output responses are quite heterogeneous across countries but, in general, negative and persistent. Furthermore, the effects of shocks to the global factor are stronger in countries with a higher degree of trade and/or financial openness, as well as in countries with a higher level of vulnerabilities.
    Keywords: Global uncertainty; global risk aversion; global financial cycle; small open economies
    JEL: E32 F41 F65
    Date: 2020–05–22
  14. By: Florian Leon (CREA, Université du Luxembourg)
    Abstract: This paper investigates whether a higher level of long-term credit provision affects the growth of small and young firms. Firm-level data from more than 20,000 firms in 62 countries are combined with a new hand-collected database on short-term and long-term credit provided to the private sector. Using a difference-in-difference framework, our results indicate that, contrary to short-term credit, long-term credit does not stimulate growth of small and young firms. This finding is, at least partially, explained by the differential impact of short-term and long-term credit provision on small and young firms' access to credit. While the provision of short-term credit alleviates credit constraints faced by small and young firms, a larger provision of long- term bank loans has an opposite impact. Our findings are in line with the hypothesis that an increase of long-term credit provision reects a lender's choice to provide more financing to existing clients (intensive margin) to the detriment of firms without previous access to finance (extensive margin).
    Keywords: Long-term finance; firm growth; financial development; credit constraints
    JEL: G21 L25 O16
    Date: 2019
  15. By: Gardberg, Malin (Research Institute of Industrial Economics (IFN))
    Abstract: This paper investigates the impact of financial liberalization on the relationship between consumption and total wealth (i.e., the sum of asset wealth and human wealth). We propose a heterogeneous agent framework with incomplete markets where financial liberalization, by signalling a future reduction in the incomplete markets component of consumption growth, increases the current consumption-wealth ratio. From the model, an aggregate long-run relationship is derived between consumption, total wealth and financial liberalization which is estimated by state space methods using quarterly US data. The results show that the trend in the consumption-wealth ratio is well-captured by our baseline liberalization indicator. We find that the increase in this indicator over the sample period has increased the consumption-wealth ratio with about ten to sixteen percent. Additional estimations suggest that financial liberalization has predictive power for aggregate consumption growth, a result that provides support for the incomplete markets channel put forward in the paper.
    Keywords: Consumption; Wealth; Financial liberalization; Incomplete markets; State space model
    JEL: C11 C32 E21
    Date: 2020–05–18
  16. By: Kaiji Chen; Patrick C. Higgins; Tao Zha
    Abstract: Lending standards are a direct measure of credit conditions. We use the micro data merged from three separate sources to construct this measure and document that an uncertain macroeconomic outlook, rather than banks' balance sheet positions, was an important reason that a majority of banks tightened bank lending standards during the Great Recession. Our extensive data analysis disciplines how we introduce credit frictions in the banking sector into a macroeconomic model. The model estimation reveals that an exogenous shock to credit supply drives cyclical lending standards and accounts for a significant portion of fluctuations in bank loans and aggregate output.
    Keywords: endogenous regime switching; asymmetric credit allocation; land prices; heavy GDP; debt-to-GDP ratio; nonlinear effects; GDP growth target; heavy loans; real estate
    JEL: C51 C81 C82 E32 E44 G21
    Date: 2020–05–21
  17. By: Huljak, Ivan; Martin, Reiner; Moccero, Diego; Pancaro, Cosimo
    Abstract: We contribute to the empirical literature on the impact of non-performing loan (NPL) ratios on aggregate banking sector variables and the macroeconomy by estimating a panel Bayesian VAR model for twelve euro area countries. The model is estimated assuming a hierarchical prior that allows for country-specific coefficients. The VAR includes a large set of variables and is identified via Choleski factorisation. We estimate the impact of exogenous shocks to the change in NPL ratios across countries. The main findings of the paper are as follows: i ) An impulse response analysis shows that an exogenous increase in the change in NPL ratios tends to depress bank lending volumes, widens bank lending spreads and leads to a fall in real GDP growth and residential real estate prices; ii ) A forecast error variance decomposition shows that shocks to the change in NPL ratios explain a relatively large share of the variance of the variables in the VAR, particularly for countries that experienced a large increase in NPL ratios during the recent crises; and iii ) A three-year structural out-of-sample scenario analysis provides quantitative evidence that reducing banks' NPL ratios can produce significant benefits in euro area countries in terms of improved macroeconomic and financial conditions. JEL Classification: G21, C32, C11
    Keywords: euro area countries, hierarchical priors, non-performing loans, panel Bayesian VAR
    Date: 2020–05
  18. By: Christopher F. Baum; Caterina Forti Grazzini; Dorothea Schäfer
    Abstract: This paper analyzes the causal relationship between institutional diversity in domestic banking sectors and bank stability. We use a large bank- and country-level unbalanced panel data set covering the EU member states’ banking sectors between 1998 and 2014. Constructing two distinct indicators for measuring institutional diversity, we find that a high degree of institutional diversity in the domestic banking sector positively affects bank stability. The positive relationship between domestic institutional diversity and bank stability is stronger in times of crisis, providing evidence that diversity can help to absorb both financial and real shocks. In particular, greater institutional diversity smooths bank earnings risk in times of crisis. Our results are economically meaningful and offer important insights to the ongoing economic policy debate on how to reshape the architecture of the banking sector.
    Keywords: Institutional diversity, Shannon Index, Gini-Simpson Index, bank stability, financial crisis, bank competition
    JEL: G01 G20 G21 G28
    Date: 2020
  19. By: Jérôme Creel (Observatoire français des conjonctures économiques); Paul Hubert (Observatoire français des conjonctures économiques); Fabien Labondance (Observatoire français des conjonctures économiques)
    Abstract: Although the literature has provided evidence of the predictive power of credit for financial and banking crises, this article aims to investigate the grounds of this link by assessing the interrelationships between credit and banking fragility. The main identification assumption represents credit and banking fragility as a system of simultaneous joint data generating processes whose error terms are correlated. We test the null hypotheses that credit positively affects banking fragility—a vulnerability effect—and that banking fragility has a negative effect on credit—a trauma effect. We use seemingly unrelated regressions and 3SLS on a panel of European Union (EU) countries from 1998 to 2012 and control for the financial and macroeconomic environment. We find a positive effect of credit on banking fragility in the EU as a whole, in the Eurozone, in the core of the EU but not at its periphery, and a negative effect of banking fragility on credit in all samples.
    Keywords: Banking fragility; Credit growth; Nonperforming loans; SUR model
    JEL: E44 G20
    Date: 2019–12
  20. By: Gamze Danisman (Faculty of Management, Kadir Has University, Istanbul, Turkey); Amine Tarazi (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges)
    Abstract: The Great Recession of 2007-2009 piqued the interest of policymakers worldwide, prompting various initiatives to stabilize the financial system and advance financial inclusion. However, few studies have considered their interconnectedness or whether any synergies or trade-offs exist between them. This paper investigates how financial inclusion affects the stability of the European banking system. The findings indicate that advancements in financial inclusion through more account ownership and digital payments have a stabilizing effect on the banking industry. A deeper investigation shows that such a stabilizing impact is mainly driven by the targeting of disadvantaged adults who are young, undereducated, unemployed, and who live in rural areas. Hence, along with its known benefits to society as a whole, financial inclusion has the additional benefit of improving the stability of the financial system. Such findings call for policy configurations that are specifically designed to achieve financial inclusion for disadvantaged individuals.
    Keywords: Financial Inclusion,Bank Stability,Account Ownership,Digital Payments,Disadvantaged Adults
    Date: 2020–05–26
  21. By: K. M. Golam Muhiuddin; Nusrat Jahan
    Abstract: This paper evaluates the commercial banks of Bangladesh in terms of profitability dimension of performance and also examines the impact of selected determinants and banking system on this dimension of performance. Evaluation of trend in profitability of listed commercial banks of Bangladesh reveals that, on an average, profitability is exhibiting a decreasing trend over the selected period; however, the profitability performance of Islamic banks remained rather high compared to Conventional banks. Profitability measured by Return on Asset is found to be significantly affected by the bank-specific factors, industry-specific factor and the banking system. However, macro-economic factors evidently have no significant impact on profitability of commercial banks of Bangladesh.
    Date: 2020–05

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