Financial integration and development: liberalization and reform in sub-Saharan Africa by MACHIKO NISSANKE and ERNEST ARYEETEY. (London and New York: Routledge, 1998, Routledge studies in development economics, pp. xiv+330, £65 h/bk)

✍ Scribed by Peter Lawrence

• Publisher: John Wiley and Sons
• Year: 2002
• Tongue: English
• Weight: 30 KB
• Volume: 14
• Category: Article
• ISSN: 0954-1748
• DOI: 10.1002/jid.855

✦ Synopsis

While liberalization and institutional reform have been part of African governments' policy agendas since the 1980s, the authors acknowledge that this does not appear to have affected the key performance indicators: economic growth rates, savings rates, private investment rates or financial deepening. The need to explain why this has not happened is not surprising given the orthodox view that financial liberalization is a necessary condition for economic growth. The authors rightly take issue with the financial repression school on empirical grounds and follow the more sophisticated Stiglitz-Weiss school. This emphasizes information costs and asymmetries which generate market failure in the financial sector and therefore require some limited financial repression. The authors draw attention to the instability effects of rapid financial liberalization, especially in Asia, and rightly stress the importance of developing an institutional framework which can support full financial market liberalization.

An important focal point of the authors' enquiry is the fragmentation of financial markets not only into formal, semi-formal and informal sub-sectors, but also across the sub-sectors. Financial liberalization ought to result in the increasing integration of previously fragmented sectors as they supply and compete for funds in the same liberalized market. Increasing competition for funds at liberalized interest rates should lead to an increase in the channelling of small saver funds into the formal sector, either through existing informal financial institutions, or directly via formal mediation. Focusing on financial integration as the key issue allows the authors to investigate existing links between fragmented sectors and the bottlenecks impeding greater links. This allows them to identify possible policies which might remove barriers to increasing the effectiveness of financial reforms.

What do the authors find? First, that there has effectively been a 'post-liberalization creditcrunch'. An inadequate information base makes formal lenders highly risk-averse in the new climate. Given their inheritance of non-performing loans resulting from previous credit-rationing policies, this inability to manage risk results in a high-level of liquidity. Finance to the risky private sector is replaced by finance to the government sector which offers high-yielding securities. Meanwhile, the study reports that the informal financial sector is growing because real economy growth has been in the small scale private sector which is only able to borrow informally. So ironically, financial liberalization has led to both increased financing of the government sector and growth of the informal financial sector because of the high degree of fragmentation. The structural characteristics of the formal and informal institutions support this process. The formal lenders regard informal agents and small-scale borrowers as too risky and too costly and unreliable in terms of gaining information and the quality of the information gained. Informal lenders are conversely effective at getting information about their clients because of their local knowledge.

The authors emphasize the institutional constraints limiting the financial sector. The constraints include problems of contract enforcement resulting from a poor legal framework and a lack of regulatory and supervisory agencies and mechanisms. These increase risks to both lending