The Importance of Financial Sector Development for Growth and Poverty Reduction

This paper points out that Financial Sector Development (FSD) is essential for growth and poverty reduction, and that without it, development may be held back.

The paper enlists different ways in which the financial sector can be said to develop:

• Improvement in efficiency and competitiveness of the sector;
• Enhancement in the range of available financial services;
• Diversification of institutions operating in the financial sector;
• Increase in the amount of money intermediated through the financial sector;
• Augmentation in the regulation and stability of the financial sector.

The paper explores the linkage between FSD and growth through studies conducted in various countries. These highlight:

• FSD has a causal impact on growth, and vice versa.
• The longer is the period examined, the bigger is impact of FSD on growth; this suggests that the full impact takes time to come through.
• Over long periods, the impact of growth on FSD becomes insignificant, even in developed countries.

The paper concludes that financial sector development can make an important contribution to economic growth and poverty reduction. By increasing the savings rate and the availability of savings for investment, facilitating and encouraging inflows of foreign capital, financial sector development can boost long-run growth.