CHAPTER ONE: INTRODUCTION
Background of the study
The debate about the significance of the financial sector to economic growth has been on-going for decades. In recent times, the interlinkages between financial sector development, poverty alleviation and economic growth provide compelling reasons why the financial sector is essential to developing countries especially those in sub – Saharan Africa. Mu, Phelps and Stosky (2013) found that deeper financial markets are beneficial to growth as the development of these markets improve financial intermediation and enable economic stability in the sub-region. Furthermore, the increase in funds and an improvement in the efficiency of the financial sector in SSA is reported as good for sustainable growth (Mlachila, Cui, Jidoud, Newaik, Radzewicz-Bak, Takebe, Ye & Zhang, 2016).
Inasmuch as there is extant literature documenting the relationship between the financial sector and economic growth, it is crucial to revisit the nexus because the widely used proxies to measure financial sector development either use the depth of a financial sub-sector or monetary aggregates. Due to unavailability of data, previous studies have used measures that represent a component of the financial system (Levine, 2003). The financial depth variables include liquid liabilities to gross domestic product, domestic credit to the private sector and stock market capitalisation while the monetary aggregates include broad and narrow money.
The problem is that these proxies do not reflect the financial intermediary role of financial institutions and markets which is the essential feature of the finance-growth nexus debate (De Gregorio & Guidotti, 1995) and may not provide a holistic picture of the financial sector. Von
Furstenberg and Fratianni (1996) argued that there is no consensus on the type of indicators for financial development. Cihak, Demirguc-Kunt, Feyen and Levine (2013) also pointed out that the empirical measurement of the financial sector development is quite challenging thus the use of the different dimensions as the basis of reporting on the level of financial development. This argument thus provides an insight into the need for a proxy that encapsulates all financial institutions and markets.
Svirydzenka (2016) introduced financial development indices that capture the depth, access and efficiency dimensions of the financial sector which this study adopts. First, it is essential to clarify that financial development is used synonymously with financial sector development in this study. The concept is also based on the definition of Sahay et al. (2015) which referred to financial development as a “combination of depth, access, and efficiency”. Conceptually, this definition reflects the multidimensionality of financial intermediaries.
Financial sector development is vital to the sustainable development discourse because an inclusive finance sector which is a by-product of a well-developed financial sector is instrumental to poverty reduction (Imboden, 2005). A higher degree of financial development reduces the barriers that affect access to external capital and lessens the financial constraint faced by enterprises (Caballero & Krishnamurty, 2001).
Mukhopadyay, Arizala, Haines, Newiak, Pani and Willems (2016) argued that an improvement in financial development will stimulate an additional annual economic growth by about 1 and a half percentage points. Consequently, the volatility associated with growth will be mitigated as financial sector development improves. Thus, the development of the financial sector can propel
SSA countries to attain the level of economic growth similar to developing countries with similar structural and macroeconomic fundamentals.
Both theoretical and empirical studies have concluded that the development of both institutions and markets contribute to and predict economic growth. The financial market of which the capital market is a significant component cannot be understated as it promotes the mobilisation of savings from spending units and information sharing, manages risk and facilitates the diversification of portfolios (Rajan & Zingales, 1998). Osei (1998) confirmed the benefit of stock market development to the operations of a capital market. A sound environment where the various financial intermediaries can function efficiently and effectively is desired, and that should be the aim of regulators and policymakers. The financing needs of infrastructure, housing, climate adaptation and mitigation are staggering. The funding gap in these areas can be filled in the capital market.
Figure 1.1: Comparison of Bank and non-bank sector assets in Sub-Saharan Africa, 2012
Source: Mlachila et al. (2016)/ IMF Regional Economic Outlook (2016)
Figure 1.1 shows the sectoral distribution of financial sector assets between bank and non-bank intermediaries in SSA. The diagram shows that the majority of the Sub-Saharan Africa economies hold relatively more assets in the banking sector than in the non-bank sector which is predominantly financial markets. This trend is similar across oil exporting, other resource- intensive and non-resource-intensive economies in the sub-region. This also suggests that it may be problematic for SSA countries to concentrate on the banking sector which may not yield the expected growth as the implementation of the Basel accords have not been carried through in most of their economies. Moreover, it seems that credit allocation is inefficient as banks predominantly finance government budget deficits, lend to politically affiliated groups instead of gearing funds towards entrepreneurial ventures (Allen et al., 2011).
