Institutional Determinants of Financial Development in MENA countries

• Published date: 01 August 2016
• Date: 01 August 2016
• DOI: http://doi.org/10.1111/rode.12192

Institutional Determinants of Financial

Development in MENA countries

Mondher Cherif and Christian Dreger*

Abstract

Developed and well regulated financial markets are usually seen as a precondition for an efficient alloca-

tion of resources and can foster long term economic growth. This paper explores the institutional determi-

nants for financial development in the countries of the Middle East and North African (MENA) region.

Institutional conditions are from the International Country Risk Guide. Panel-econometric techniques are

applied to assess the development in the banking sector and the stock market. As a main finding, institu-

tional conditions are important in both financial segments, even after controlling for standard macroeco-

nomic determinants and fixed effects. For the banking sector, corruption seems to be most decisive. For the

stock market, the impact of corruption and law and order appear to be relevant. While per capita income

and inflation do not seem to play a vital role, openness to foreign trade is quite important for all areas of

financial development. Hence, overall, faster real economic integration is of key policy priority to improve

financial development as a condition for higher GDP growth. Better law and enforcement practices and

anti-corruption policies are strategies to accompany this process.

1. Introduction

Developed and well regulated financial markets are usually seen as a precondition for

an efficient allocation of resources and can foster long term economic growth. On

average, countries with better financial systems have experienced faster growth than

those with less developed systems (King and Levine, 1993). According to Levine and

Zervos (1998), developments in the bank and stock market are usually good predic-

tors for subsequent output growth. Industrial sectors that are exposed to external

finance expand faster in countries with more favourable financial markets (Rajan and

Zingales, 1998). This result holds independently of the nature of the financial system,

i.e. whether it is dominated by banks or is stock market based (Beck and Levine,

2002).

The main argument for linking financial development to output growth is that

developed financial systems perform critical functions to enhance the efficiency of

intermediation by reducing information, transaction and monitoring costs (Levine,

2004). Financial intermediation can allocate savings and resources to the most appro-

priate investment projects, boost the rate of technical progress by identifying entre-

preneurs with the best chances of successfully initiating new products and processes,

monitor managers, promote sound corporate governance, provide insurance, and

sectoral and intertemporal pooling of risk. There is widespread agreement that

countries should adopt appropriate macroeconomic policy measures, encourage com-

petition in the financial sector and develop a transparent institutional and legal frame-

work for the financial system.

* Dreger: DIW Berlin, Mohrenstr. 58, Berlin 10117, Germany. E-mail: cdreger@diw.de. Cherif: Université

de Reims Champagne-Ardenne, Laboratoire REGARDS, UFR des Sciences Economiques, Sociales et de

Gestion 57 bis, rue Pierre Taittinger, 51096 Reims, France.

© 2015 John Wiley & Sons Ltd

Review of Development Economics, 20(3), 670–680, 2016

DOI:10.1111/rode.12192