Financial Development, Financial Fragility and Growth

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Financial Development, Financial Fragility and
Growth

• Norman Loyza Romain Rancière The Worldbank
  CREI

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What do we know about Long and Short run effects
of Financial Development?

• Empirics
• The long run growth enhancing effect of financial
  intermediation.King and Levine (1993) Beck,
  Loayza and Levine (2000)
• Lending boom, banking crisis and growth slowdown.
  Demirguc-Degatriache (1997), Gourinchas and alli
  (2000)
• -gt integrated view Kaminsky-Schmukler (2002)
• Theory
• Financial Development fosters growth by reducing
  liquidity risk and allocate efficiently savings.
  Greenwood-Jovanovic (1990),Bencivenga and Smith
  (1991),
• Lending Boom and Growth Slowdown financial
  accelerator effects, limited monitoring and
  enforcement, bailout guarantees.Aghion and alli
  (1999), Schneider-Tornell (2004)

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What do we do?

• Provide an empirical framework to help reconcile
  the apparent contradiction between two strands of
  the literature on the effects of financial
  intermediation on economic activity.
• Short and Long Run growth effects of financial
  intermediation on Growth
• Link with other aspects of financial
  intermediation Volatility and Banking Crises
• Discussions
• Theory Can we rationalized those results?
• Policy Implications

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A Direct evaluation on short and long run growth
effects of financial development using an annual
data panel

• Application of the pooled estimation methodology
  of long run relationship in heterogeneous panel
  proposed by Pesaran-Shin and Smith
• Error correction model allowing for short run
  dynamics to differ from long run equilibrium and
  to be represented by an Autoregressive
  Distributed Lag Model (ARDL)

Long run equilibrium Short Run
Adjustment
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• Annual Panel Data 1960-2000
• Financial indicators liquid liabilities / GDP
  private credit/ GPP
• Control set of variables Initial Income
  government size, trade openness, Inflation rate
• Control for time effects
• Optimized selection of ARDL process by
  information-based criteria
• Model choice
• Hausman test of homogeneity restrictions

Model Pooled Mean Group Mean Group Dynamic Fixed Effects
Long Run Coefs Homogeneity Heterogeneity Homogeneity
Short Run Coefs Heterogeneity Heterogeneity Homogeneity
Intercept Heterogeneity Heterogeneity Homogeneity
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Short Run Dynamics Is there a link with Banking
Crises and Volatility?

• A cross-country distribution of short run
  coefficient from PMG estimation
• A cross-country distribution of volatility of
  credit/gdp over 1960-2000
• A cross-country distribution of frequency of
  Systemic Banking Crises

  Short-run coefficients Number of crisis Financial volatility
Short-run coefficients 1 -0.303 -0.379
Short-run coefficients 1 (0.008) (0.001)
Number of crisis -0.2693 1 0.449
Number of crisis (0.0195) 1 (0.000)
Financial volatility -0.2980 0.3947 1
Financial volatility (0.0094) (0.0005) 1
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What did we learn?Results from Pooled Mean
Group estimation

• Result 1 An homogenous positive long term
  relationship between financial development and
  growth
• Result 2 An heterogeneous on average negative
  short run adjustment.
• Result 3 A mapping between countries with a
  negative short run dynamics between financial
  development and growth, and countries with an
  experience of systemic banking crisis and
  financial volatility

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Theoretical Discussion

• DellArricia and Marquez (2004) banks incentive
  to screen project are reduced in the aftermath of
  financial liberalization. Adverse Selection among
  banks.
• Rajan (1994) strategic complementary among
  lenders in credit policy gt finance bad project
  in good times and squeeze credit in bad times-gt
  the role of supervision.
• Ranciere-Gaytan (2003). Liquidity Role of Banks
  and Effects on Growth at different level of
  economic development.

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Final Remarks

• Negative short run effects of financial
  development coexists with a positive long run
  relationship for a large set of countries
  including most of the countries with an
  experience of financial crisis.
• More work to integrate the dual effect of
  financial liberalization and financial
  development on growth and to draw policy
  implications.