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Roles of Finance

The aim of this paper is to see how the financial systems and their regulation in African low-income countries (LICs), still in their early stages of development, could be better shaped to achieve simultaneously the goals of financial stability and inclusive growth. This draws on an understanding of the features of financial systems in LICs, both their challenges and their relative strengths, and on possible lessons arising from the global financial crisis, as well as previous experiences of crises in emerging economies, which tended to arise from excessively liberalized and little regulated financial systems.

Finance is crucial for development. Without a well-functioning financial system that channels finance to the right places in the right form, inclusive growth is impossible. This is not just a question of the quantity of finance, although this is extremely important, but also what we might call its quality. Different types of economic activities (and actors) require different types of finance in terms of cost, maturity, and risk characteristics. The more financial systems are able to meet these needs, the more likely they are to be supportive of inclusive growth. As well as its potential to foster growth, however, the financial sector, especially if very liberalized and poorly or insufficiently regulated, can also generate instability and crises, with devastating consequences for development. Increasing understanding of the role that financial structure and regulation can play in balancing these objectives in low-income countries is the aim of this paper.

More broadly, the international community has defined sustained and inclusive growth as its main economic aim, as reflected, for example, in the UN adopted Sustainable Development Goals. At a national level, governments are broadly committed to the same goals. Additionally, in a globalized world economy, countries and enterprises need to be internationally competitive to sustain such growth.

A well-functioning financial sector, both national and international, needs to play important roles to achieve these aims. Indeed finance has been compared to the blood circulating in the body, enabling it to live and function well.

To achieve this key positive role, the financial sector needs to encourage and mobilize savings (for example, by protecting the safety of savings), intermediate these savings at low cost, ensure savings are channeled into efficient investment, as well as helping manage the risks for individuals and enterprises. Because the financial sector has such important effects throughout the economy it also needs to adhere to a key principle of the Hippocratic Oath that medical doctors swear to, which is to do no harm to the rest of the economy. Therefore there should be as few and as small crises that stem from the financial sector, as these have huge costs, both fiscal and on growth, employment and investment.

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