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FINANCIAL INSTITUTIONS AND
ECONOMIC GROWTH
__________________________
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Marijana Ćurak - University of Split, Faculty of Economics
Academic year 2014/2015
10/21/2014
International Week – New Frontiers in Finance and Accounting 2014
University of Economics in Katowice
These lecture slides are dominately based
on:
Čihák, M., Demirgüç-Kunt, A., Feyen, E. and
Levine, R. (2012), Benchmarking Financial
Development Around the World, Policy
Research Working Paper 6175, World Bank
10/21/2014
Marijana Ćurak - University of Split, Faculty of Economics
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AGENDA
Introduction
Financial development
Theory of endogenous growth
Measures of characteristics of financial institutions
Data on characteristics of financial institutions
Review points
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10/21/2014
Marijana Ćurak - University of Split, Faculty of Economics
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INTRODUCTION (1)
A growing body of evidence suggests that
financial institutions exert a powerful
influence on economic development, poverty
alleviation, and economic stability (Levine,
2005)
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Marijana Ćurak - University of Split, Faculty of Economics
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INTRODUCTION (2)
When banks screen borrowers and identify firms
with the most promising prospects, this is a key
step that helps allocate resources, expand
economic opportunities, and foster growth
When banks mobilize savings from households
to invest in promising projects, they foster
economic development
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Marijana Ćurak - University of Split, Faculty of Economics
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INTRODUCTION (3)
When financial institutions monitor the use of
investments and investigate managerial
performance, they boost the efficiency of
corporations and reduce waste and fraud by
corporate insiders
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Marijana Ćurak - University of Split, Faculty of Economics
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INTRODUCTION (4)
When financial systems perform these functions
poorly, they tend to disrupt economic growth,
reduce economic opportunities, and destabilize
economies
Financial development vs. financial repression
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL DEVELOPMENT (1)
It occurs when financial instruments,
markets, and intermediaries mitigate –
though do not necessarily eliminate – the
effects of imperfect information, limited
enforcement, and transactions costs
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL DEVELOPMENT (2)
Improvements in the quality of five key
financial functions:
producing and processing information about
possible investments and allocating capital
based on these assessments
monitoring individuals and firms and exerting
corporate governance after allocating capital
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL DEVELOPMENT (3)
facilitating the trading, diversification, and
management of risk
mobilizing and pooling savings
easing the exchange of goods, services, and
financial instruments
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL REPRESSION (1)
Underdevelopment of financial systems
Underdeveloped financial system leads to
a low state of economic development and
economic growth
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL REPRESSION (2)
The problems are institutional
environment of
a poor legal system
weak accounting standards
inadequate government regulation
government intervention through directed
credit programs and state ownership of banks
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Marijana Ćurak - University of Split, Faculty of Economics
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DIFFERING VIEWS (1)
Lucas (1988) dismissed finance as an over-
stressed determinant of economic growth
According to Robinson (1952, p. 86) "where
enterprise leads finance follows."
From this perspective, finance responds to
demands from the non-financial sector; it does
not cause economic growth
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Marijana Ćurak - University of Split, Faculty of Economics
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DIFFERING VIEWS (2)
Miller (1988, p.14) argued that the idea
that financial markets contribute to
economic growth ― „is a proposition too
obvious for serious discussion”
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Marijana Ćurak - University of Split, Faculty of Economics
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DIFFERING VIEWS (3)
Finance is an important determinant of
economic growth
Bagehot (1873)
Schumpeter (1912)
Gurley i Shaw (1955)
Goldsmith (1969)
McKinnon (1973)
Merton Miller (1988)
Levine (2005
)
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Marijana Ćurak - University of Split, Faculty of Economics
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ENDOGENOUS GROWTH THEORY (1)
AK models
Steady-state growth rate (g)
g=Asφ-δ
A = marginal productivity of capital
s = saving rate
φ = proportion of saving funneled to investment
δ = depreciation rate
Pagano (1993)
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Marijana Ćurak - University of Split, Faculty of Economics
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ENDOGENOUS GROWTH THEORY (2)
Schumpeterian growth models
Technological innovations as channel through
which the growth could be affected
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Marijana Ćurak - University of Split, Faculty of Economics
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ENDOGENOUS GROWTH THEORY (3)
Marginal productivity
of capital
Proportion of saving
funneled to
investment
Savings rate
Technological
innovations
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Marijana Ćurak - University of Split, Faculty of Economics
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The models shows four channels from financial development to
economic growth:
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FINANCIAL DEVELOPMENT AND
REDUCTION OF POVERTY (1)
Finance can also shape the gap between the rich and
the poor and the degree to which that gap persists
across generations (Demirgüç-Kunt and Levine, 2009)
The financial system
increases investment in the education and reduces the
substitution of children out of schooling
stimulate new firm formation and help small, promising firms
expand as a wider array of firms gain access to the financial
system.
accelerates economic growth, intensifies competition, and boosts
the demand for labor
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL DEVELOPMENT AND
REDUCTION OF POVERTY (2)
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Marijana Ćurak - University of Split, Faculty of Economics
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Izvor: Čihák, Demirgüç-Kunt, Feyen, Levine, (2012), p. 7.
EMPIRICAL LITERATURE (1)
Cross-country level studies
Studies at the country level
Industry-level studies
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Marijana Ćurak - University of Split, Faculty of Economics
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EMPIRICAL LITERATURE (2)
Economies with higher levels of financial
development grow faster and experience faster
reductions in poverty levels (Levine 2005)
Results of some empirical studies do not support
hypotesis that financial development contribute
to economic growth
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Marijana Ćurak - University of Split, Faculty of Economics
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THE PROBLEM OF THE EMPIRICAL
RESEARCH
Although the evidence on the role of the
financial system in shaping economic
development is substantial and varied,
there are serious shortcomings associated
with measuring the central concept under
consideration: the functioning of the
financial system
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Marijana Ćurak - University of Split, Faculty of Economics
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CHARACTERISICS OF FINANCIAL
SYSTEM
Depth
Access
Efficiency
Stability
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Marijana Ćurak - University of Split, Faculty of Economics
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NOTE
There are the measures for both, financial
institutions and markets
In this lectures we are focused on the
measures of financial institutions’
characteristics only
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Marijana Ćurak - University of Split, Faculty of Economics
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DEPTH (1)
Private sector credit to GDP
Financial institutions’ assets to GDP
M2 to GDP
Deposits to GDP
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Marijana Ćurak - University of Split, Faculty of Economics
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DEPTH (2)
Pension fund assets to GDP
Mutual fund assets to GDP
Insurance company assets to GDP
Insurance penetration - insurance premiums
(life) to GDP, and insurance premiums (non-life)
to GDP
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Marijana Ćurak - University of Split, Faculty of Economics
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ACCESS
Accounts per thousand adults (commercial
banks)
Branches per 100,000 adults (commercial banks)
% of people with a bank account
% of firms with line of credit (all firms)
% of firms with line of credit (small firms)
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Marijana Ćurak - University of Split, Faculty of Economics
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EFFICIENCY (1)
The efficiency is primarily constructed to
measure the cost of intermediating credit
Net interest margin
Lending-deposits spread
Non-interest income to total income
Overhead costs (% of total assets)
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Marijana Ćurak - University of Split, Faculty of Economics
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EFFICIENCY (1)
Profitability (return on assets, return on
equity)
Measures of banking market structure
(Herfindahl)
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Marijana Ćurak - University of Split, Faculty of Economics
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STABILITY (1)
Z-score (or distance to default)
Z=(
k
+
μ
)/
σ
where
k
is equity capital as percent of assets,
μ
is return as percent of assets, and
σ
is standard deviation of return on assets as a proxy for return
volatility
It is inversely related to the probability of a financial
institution‘s insolvency, i.e. the probability that the value
of its assets becomes lower than the value of its debt
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Marijana Ćurak - University of Split, Faculty of Economics
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STABILITY (2)
Capital adequacy ratios
Asset quality ratios
Liquidity ratios
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Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL SYSTEM CHARACTERISTICS –
FINANCIAL INSTITUTIONS (1)
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Izvor: Čihák, Demirgüç-Kunt, Feyen, Levine, (2012), p. 25.
Note: The summary statistics refer to the winsorized and rescaled variables (0–100), as described in the text. Financial
Institutions—Depth: Private Credit/GDP (%); Access: Number of Accounts Per 1,000 Adults, Commercial Banks; Efficiency: Net
Interest Margin; Stability: z-score. Financial Markets—Depth: (Stock Market Capitalization + Outstanding Domestic Private Debt
Securities)/GDP ; Access: Percent Market Capitalization Out of the Top 10 Largest Companies (%); Efficiency: Stock Market
Turnover Ratio (%); Stability: Asset Price Volatility.
Marijana Ćurak - University of Split, Faculty of Economics
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FINANCIAL SYSTEM CHARACTERISTICS –
FINANCIAL INSTITUTIONS (2)
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Izvor: Čihák, Demirgüç-Kunt, Feyen, Levine, (2012), p. 25.
Note: The summary statistics refer to the winsorized and rescaled variables (0–100), as described in the text. Financial
Institutions—Depth: Private Credit/GDP (%); Access: Number of Accounts Per 1,000 Adults, Commercial Banks; Efficiency: Net
Interest Margin; Stability: z-score. Financial Markets—Depth: (Stock Market Capitalization + Outstanding Domestic Private Debt
Securities)/GDP ; Access: Percent Market Capitalization Out of the Top 10 Largest Companies (%); Efficiency: Stock Market
Turnover Ratio (%); Stability: Asset Price Volatility.
Marijana Ćurak - University of Split, Faculty of Economics
FINANCIAL SYSTEM CHARACTERISTICS –
FINANCIAL INSTITUTIONS –
By income groups
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Izvor: Čihák, Demirgüç-Kunt, Feyen, Levine, (2012), p. 26.
Notes: The summary statistics refer to the winsorized and rescaled variables (0-100).
Marijana Ćurak - University of Split, Faculty of Economics
CONCLUDING REMARKS RELATED TO
THE DATA (1)
Financial systems are multidimensional
It is therefore necessary to examine not
only financial depth, but also access,
efficiency, and stability, to arrive at a
relatively comprehensive picture of
financial systems
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Marijana Ćurak - University of Split, Faculty of Economics
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CONCLUDING REMARKS RELATED TO
THE DATA (2)
Comparisons by levels of development and
by region confirm that while developing
economy financial systems tend to be
much less deep and also somewhat less
efficient and providing less access, their
stability has been comparable to
developed country financial systems
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Marijana Ćurak - University of Split, Faculty of Economics
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CONCLUDING REMARKS RELATED TO
THE DATA (3)
Important differences remain across
regions and income groups
Sub-Saharan Africa scoring the lowest on
average on most of the dimensions, and
high income countries scoring the highest
on most dimensions
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Marijana Ćurak - University of Split, Faculty of Economics
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REVIEW POINTS (1)
Channels through which financial
institutions affect economic growth:
Marginal productivity of capital
Saving rate
Proportion of saving funneled to investment
Technological innovations
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Marijana Ćurak - University of Split, Faculty of Economics
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REVIEW POINTS (2)
Many empirical studies confirm financial
institutions’ contribution to economic growth
New measures of financial institutions
characteristics:
Depth
Access
Efficiency
Stability
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Marijana Ćurak - University of Split, Faculty of Economics
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REFERENCES (1)
Čihák, M., Demirgüç-Kunt, A., Feyen, E. and Levine, R. (2012):
Benchmarking Financial Development Around the World, Policy
Research Working Paper 6175, World Bank
Demirgüç-Kunt, Aslı, and Ross Levine (2009): Finance and
Inequality: Theory and Evidence, Annual Review of Financial
Economics 1, pp. 287–318.
Levine, R. (2005): Finance and Growth: Theory and Evidence,
Handbook of Economic Growth, in: Philippe Aghion & Steven
Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1,
chapter 12, pp. 865–934.
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Marijana Ćurak - University of Split, Faculty of Economics
REFERENCES (2)
Lucas, R. E. (1988): On the Mechanics of Economic
Development.‖ Journal of Monetary Economics, 22, pp.
3–42.
Miller, M. (1998), Financial Markets and Economic
Growth, Journal of Applied Corporate Finance, 11, pp. 8–
14.
Pagano, M. (1993): Financial markets and growth,
European Economic Review, Vol. 37, p. 613-622.
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Marijana Ćurak - University of Split, Faculty of Economics
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REFERENCES (3)
Robinson, J. (1952): The Generalization of
the General Theory, (In: The Rate of
Interest and Other Essays), London,
MacMillan
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Marijana Ćurak - University of Split, Faculty of Economics
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