A. The Rules and Their Limitations

Rules. The GATS rules set a general framework for the conduct of trade in services. Although they are based on basic disciplines familiar from trade in goods, the added limitations make them weaker than those in the GATT (General Agreement on Tariffs and Trade). Main GATS obligations are transparency and the MFN principle (all trading partners are to be treated equally). These apply to all sectors regardless of whether they are subject to specific liberalization commitments. The rules are weakened by the fact that national treatment (discrimination between foreign and national service providers) is not an automatic but negotiable right, and the other pillar of the GATT—the most−favored−nation principle—is subject to reservations. General exemptions for regional arrangements, balance of payments problems, public order and health, also apply. The Annex on Financial Services contains a prudential carve−out⁶ and definitions of financial services in three main sectors: insurance, banking, and securities.

Market access. The GATS allows for very conditional or limited liberalization of market access. The so−called schedules list sectors to be bound in four different modes of supply⁷ and under which conditions. For example, foreign ownership of banks can be limited to 20 percent of equity, or new banking licenses can be subject to an undefined economics needs test.⁸ The rules only apply to these listings (the so−called positive list approach). This has the major drawback of leaving innovations/subsectors outside the scope of national commitments, and making future negotiations more difficult. For example, new financial instruments are not covered by the agreement (except in countries that adhere to the “Understanding,”⁹ see below), which allows countries to impose discriminatory restrictions on their supply.

The scope of the agreement is also limited to supply of services. Whether GATS applies to a transaction depends very much where the service is supplied and consumed. For example, whether country A allows nonresident depositors (from country B) to make deposits in its banks or not is not covered by the GATS. In this case, GATS can only apply to country B (nonresident) to the extent that it may allow consumption abroad of deposits (Mode 2) for its residents.

During the UR, the negotiators tried to encourage broad−based liberalization by defining a basic package of commitments or formulae under the name of “Understanding.” The aim was to provide a broad−based agreement, especially on establishment (Mode 3), and in some cross−border trade (Modes 1 and 2). Mode 1 was restricted, as countries were relatively reluctant to allow foreign service providers to enter their markets to provide services without being able to monitor them on prudential grounds, e.g., in the absence of commonly acknowledged prudential standards, as the service provider would remain established abroad. Under Mode 2,¹⁰ cross−border trade is the responsibility of the consumer (he consumes abroad). In addition, it does not require capital account convertibility (see below). Mostly industrial countries agreed to base their commitments on the Understanding—with some limitations. Others listed sectors and conditions. Some developing countries made phased commitments.

Transfers. The GATS also failed to provide full external convertibility for the liberalized transactions. While payments on current account transactions related to the supplied/consumed services are to be free of restrictions, those related to capital account transfers are more restricted. Only Mode 1 requires that capital movements related to the underlying transactions of the services supplied/consumed in the opened sectors should be free of restrictions. Mode 2 entails no obligations to free capital transactions related to the services supplied. Thus, in Mode 2 countries seem to be free to set restrictions on capital transfers related to services supplied under the market access commitments made. In Mode 3, only capital inflows related to the services to be supplied (e.g., initial share capital of a bank) in sectors with market access commitments are to be free of restrictions.

The vague language of Articles XI and XII and the footnote to Article XVI leaves the exact coverage of capital account convertibility in the GATS a bit open. Article XI seems to imply more general convertibility, but has been interpreted, as discussed above, as not implying any general obligations in this regard (see, for example, EU (1995)). The weak capital account provisions can serve to limit the meaning of the commitments, especially in financial services, where a capital movement is often an essential part of the provision of services. In Mode 1, GATS may lead to a partial opening of the capital account (unless balance of payments exemptions are invoked) in countries that maintain capital controls. Investments or capital transfers may be biased in favor of some sectors, or restrictions on other sectors may be intensified, making balance of payments management more difficult. The scope of GATS in liberalizing capital flows in financial services is also limited by the less than universal number of participants.

Exemptions. Security of market access may also be reduced by several exceptions to the rules. Restrictions can be introduced (maintained) under certain conditions such as (i) balance of payments (BOP) difficulties (Article XII);¹¹ and (ii) prudential reasons (Annex on Financial Services). Restrictions on payments for current account transactions, or other restrictions on trade in financial services (such as limitations to commercial presence or licensing) related to BOP problems require prompt consultations with the WTO Committee on Balance of Payments Restrictions. Whether this has to take place despite the fact that the Fund independently approves restrictions on current account payments that fall under its jurisdiction is subject to interpretation, and there are no precedents. In practice, however, if the restriction on payments and transfers is either maintained or approved by the Fund, the BOP Committee’s role may be limited to approving what the Fund has already done under its mandate, or to approving other types of restrictions.

As the agreement requires unrestricted capital flows for Mode 1, or inflows for Mode 3 for the opened sectors, countries are free to introduce or maintain restrictions on flows related to other modes of supply. Restrictions can be introduced either at the request of the Fund because of outflows,¹² or for balance of payments reasons (Article XII) if consultations are held with the WTO BOP Committee. This can give the WTO BOP Committee an independent and potentially important role in approving capital account restrictions. For example, if a country that made commitments under cross−border trade (Mode 1) faced large capital inflows and was concerned about their immediate or potential impact on its balance of payments (exchange rate appreciation or sudden reversals) and wished to restrict inflows (or outflows) that affect the commitments, the country would have to consult (ex post) with the WTO BOP Committee to have the restrictions approved. The Fund would provide to the Committee an assessment of the country’s balance of payments and external financial situation. However, as at present relatively few countries (mostly some developing countries) have made commitments under Mode 1, the likelihood of these consultations happening in the near future is small.

Countries can also justify restrictions on payments on capital and current accounts, or other restrictions, on prudential grounds, although there is no definition of prudential rules. In general, prudential regulations are meant to increase transparency, market information and fair competition. However, the broad prudential carve−out in the GATS can imply very broad departures from the basic principles of the agreement. The measures can allow discrimination among countries on the basis of capital−adequacy ratios or discretion in approving banking licenses, which can both go against the MFN principle or national treatment. While prudential regulations are often read to mean enterprise−specific laws, such as licenses for the establishment of banks or minimum reserve or capital requirements, the GATS text seems to suggest much latitude in this respect. Controls can also be imposed “to ensure the integrity and stability of [a country’s] financial system.” Furthermore, the use of the GATS prudential carve−out can go unchallenged, as it does not require consultations in the WTO, nor the existence of a balance of payments problem. To prevent abuse, it is important that prudential rules at the country level be set in a clear and transparent way. Their use can be challenged under the WTO dispute settlement procedures. The Annex on Financial Services also states that such measures shall not be used as a means of avoiding commitments under GATS.

An interesting question is what will be the relationship between the GATS and the Multilateral Agreement on Investment (MAI), currently being negotiated among OECD members, which will also cover financial services? Although the scope of the agreement is narrower, as it only includes investment and not cross−border supply, its actual coverage of establishment is likely to be broader than that of the GATS. This is because it would allow for fewer exceptions, would aim at a broad definition of investment, and liberalization would take place with a negative list, e.g., all sectors are liberalized except for a few reservations. Its capital account provisions are also likely to be more liberal and cover all investment−related financial transfers. The MFN clause of the GATS may require countries to extend any negotiated MAI benefits to all GATS participants. If many non−OECD members become signatories of the MAI, the scope of the agreement is likely to approach that of the GATS in financial services. As the timing of the completion of MAI negotiations (spring 1997) is before that of GATS financial services (end−1997), the OECD agreement may result in more substantial actual liberalization and marginalize the GATS negotiations. The reverse may also happen if OECD negotiations are delayed.

A. Overview of the Literature on Financial Sector Reform

Policymakers need to balance the continued costs of inefficient banks with the potential costs of rapid opening of the sector. Slow reform prevents producers and consumer from benefitting from lower prices, the spreading of risk and increased variety of financial instruments. Apart from increasing costs to market participants, slow financial reform can slow down overall growth by reducing the efficiency of intermediation. While the benefits of open and market−based financial markets are widely recognized, the transition process may bear some adjustment costs. Imprudent opening can lead to financial crises affecting confidence in the system, which can bear long term costs to the economy and lead to policy reversals. Public bailouts raise moral hazard issues and can lead to excessive risk taking. The impact of liberalization on macroeconomic management can also be of concern. Rapid liberalization can result in the excessive growth of bank assets, over−indebtedness, and asset price bubbles. Financial sector reform can also lead to some reduction in national savings. The effectiveness of monetary policy may be constrained if banks do not respond to price signals (interest rates) that can occur if their balance sheets are fraught with nonperforming assets. Liberalized interest rates, and potential costs of bank failures may also put a strain on the government budget. External opening can increase the volatility of exchange rates and hamper macroeconomic management.

Many policymakers recommend a pragmatic case−by−case approach to financial opening (see, for example, Galbis, 1994; and Johnston, Lindgren, Garcia, and Saal, 1996²⁰). The exact sequencing depends on the state of development of the economy and of its financial sector. The rules of thumb are that financial sector reforms tend to succeed better if they are preceded by macroeconomic stabilization and supported by evolving prudential measures. The literature has also identified specific policies that facilitate financial opening. Among the most important identified are positive real interest rates (Gelb, 1989; and Fry, 1988). These studies have documented a positive association between real interest rates and the growth of savings deposits and broad money aggregates. Savings and financial sector development are also influenced by the stability of financial institutions. Savings mobilization may also be promoted by the diversification of financial markets from banking to the development of bond and equities markets. (For an empirical discussion of these issues see World Bank, 1993 and 1994.)

In general, internal financial sector reform tends to have four elements (Galbis, 1994):

• liberalization of interest rates and credit regulations;

• development of measures to develop financial markets (money markets, treasury bills, payments system and shift from direct to indirect monetary policy instruments);

• measures to strengthen the prudential framework and the supervisory system (recapitalization and liquidation of banks, deposit insurance scheme); and

• measures to strengthen competition in financial markets (among banks, privatization, licensing of new domestic or foreign banks).

In countries with undeveloped financial sectors that suffer from credit controls or negative interest rates, opening the financial sector to foreign participation may not produce the desired effects in terms of promoting financial deepening or better savings allocation. Restrictions on interest rates often make financial intermediation unprofitable and result in poor portfolios, and weak capital bases in banks. In these circumstances, few foreign banks may be interested in establishing themselves in the economy. Opening of the capital account with restrictions on financial transactions can lead to capital flight, which would tighten liquidity and repress demand. If banks are forced to call in credits, poor portfolios could expose unsound banks and lead to a systemic crisis (Lindgren, Garcia, and Saal, 1996). Should capital inflows increase, the increase in liquidity may lead to imprudent lending and further worsen the quality of existing portfolios. Any (external) shock to the system could again expose the poor portfolios and lead to a crisis.

Opening a weak banking sector to sounder foreign banks and capital, easing of controls on credit or interest rates, or replacing them by indirect monetary instruments (such as open market operations of central banks) may rapidly lead to bank failures unless some restructuring takes place previously as unsound banks with nonperforming portfolios will become more exposed. It is also often recommended that unsound banks be recapitalized and restructured before new prudential regulations are introduced to avoid large systemic risks. With opening to foreign competition, unsound banks may also fail, as high operating costs from large, poorly performing portfolios can hinder competition with sounder banks. In many countries, however, governments are reluctant to let banks restructure their portfolios for social or political reasons. Gradual opening to foreign banks or capital can speed the process and force domestic policymakers to domestic financial reform.

External opening may also require sequencing of policies. Recent experience tends to support the view that the freeing of capital account transactions should be undertaken subsequent to, or at least broadly simultaneously to other reforms (Quirk and Evans, 1995), such as financial sector reform and capacity to adapt fiscal policy. A well−functioning financial sector can better allocate foreign capital inflows to productive uses. Policies should ensure that interest rates are internationally competitive, which reduces pressure on the balance of payments and the exchange rate. The Southern Cone experience, for example, in the 1980s in capital account opening cautions against a too rapid opening of the capital account in the absence of relevant domestic reforms. Measures to limit short term foreign−currency−denominated borrowing by banks might be justified on prudential grounds, and broader measures to discourage excessive short−term debt creating or portfolio inflows might prove useful in some circumstances. It has, however, been stressed that capital flow restrictions should be viewed as temporary, and that openness can foster domestic policy discipline, as good economic management is likely to prevent volatility of the flows.

B. Link to GATS Liberalization

The above would suggest that commitments in the various modes of supply in the GATS could be linked to the state of development of a country’s financial sector. Binding financial sector reform in GATS Mode 3 (commercial presence) would make sense during the later stages of internal financial sector reform, and Mode 1 (cross−border) liberalization in the context of capital account opening. Commitments under Mode 2 (consumption abroad) can be a way of increasing competition in local financial markets in the context of gradual opening of the capital account. While allowing for some external opening, commitments under this mode provide policymakers with more liberty with capital controls. As previously mentioned, the agreement does not require capital account convertibility for these flows. The most demanding or liberal is Mode 1 commitment, which requires full capital account opening by the binding country for the liberalized activities and allows foreign providers to supply cross−border services to domestic residents. Restrictions on these flows can, however, be introduced on BOP grounds.

In summary, this means that those WTO members with less developed financial sectors should first see that basic policies on internal reform are in place. Once this is the case, Mode 3 commitments are advisable. Mode 1 and 2 commitments seem more appropriate when some external opening has taken place and appropriate prudential regulations and monetary conditions are fulfilled. This should, however, not be used as an excuse in either delaying reform or not making commitments in the multilateral negotiations.

C. Indicators of Openness and Financial Sector Development

Indicators on the level of development of a country’s financial sector (for examples, see Pill and Pradhan, 1995; Galbis, 1995; and World Bank, 1993) can be structural and related to key policy variables. The financial depth of an economy is used to indicate the extent to which an economy relies on a formal banking sector in financial intermediation. The measures used are aggregate of total financial assets in GDP such as narrow money (reserve money or M1), and broad money (demand and time deposits of deposit money banks or M2). A broader measure (financial liabilities or M3) is sometimes used (see, for example, World Bank 1993). Another measure of financial depth is the share of private credit in total economic activity.

The usefulness of these indicators depends on how representative the banking system is of total financial intermediation. At one extreme, if there is no banking system, broad money and bank lending are zero. If an informal sector is large or consumers hold assets outside the banking sector, the credit measure is naturally biased. Similarly, the GDP estimate is subject to valuation problems and the size of the informal sector.

Policy−related indicators on the development and policy framework of the financial sector can be the share of net claims on government in total credit, inflation, the level of real interest rates, or spreads in financial intermediation. Liberalization of interest rates and elimination of credit rationing are often first steps in financial sector reform. Therefore, positive real interest rates can be an indicator of development of the financial sector, as they are often a precondition to successful financial intermediation and incentives to save. If the government intervenes heavily in the credit markets, the share of government credit in total credit can be a good indicator of the existence of credit controls in the economy.

Openness in services has been discussed in recent literature under the heading of contestability of markets. Markets are considered contestable, i.e., open to foreign competition, when barriers to entry are low (Graham and Lawrence, 1996). This can cover barriers in both factor and product markets. Attempts have also been made to measure contestability despite the many practical difficulties involved. The indicators used have been related to either outcomes (market shares, prices, profitability) or comparing outcomes to benchmarks of competitive behavior.

Contestability or openness in banking and securities can be measured by a number of performance indicators. In open markets, return on assets and equity can measure the efficiency of resource allocation (Bossard, Wirth and Blattner, 1992). Interest margins can give an indication of the cost of traditional banking. Other outcome indicators can be foreign share in total banking assets or liabilities, relative shares of banking activities in the economy, concentration ratios, profit or intermediation margins. The nature of restrictions on transfer on payments and transfer on the current and capital accounts can also give some indication of the external openness of financial sectors. This study measures openness by the share of foreign liabilities in total banking sector balance sheets. Profits are measured by gross return to assets of banks. Concentration is measured by the share of the assets of the three largest banks in total banking sector assets. The benchmarks can be obtained from the banking sectors of OECD countries.

A note of caution, however, is in order in interpreting the contestability indicators, especially in the financial sector. Performance indicators can vary across countries for reasons such as perception of risk and size of market, with little relation to competition or openness as such. Prices can vary according to quality or differentiation of products. Profits in some markets can be high because risk premiums are high, or concentration ratios of banks can depend on the economic size of the market or the firm. These problems can be more obvious in developing countries, because of more distorted markets in general. Their markets tend to be more regulated and closed to international competition and suffer from structural rigidities, such as lack of certain infrastructure or policy frameworks. In these circumstances, high returns on assets or equity, or high interest margins, can be a sign of lack of competition and inefficient allocation of resources, while in a more open framework they can measure profitability.

Apart from conceptual limitations, the analysis is also subject to many practical problems. The data are not always compatible across countries, as regulations and banking systems differ. For example, in some countries banking and securities business is strictly separated for prudential reasons; in some others, so−called universal banks deal in all types of financial transactions.

D. Financial Sector Development among GATS Participants

This section analyses the efficiency of financial intermediation in developing countries by comparing indicators of the level of financial development and competition to those of industrial countries. The latter can serve as benchmark for efficiency. Nearly all of them have current and capital account convertibility and relatively competitive and liberal financial sectors. The results in general confirm that emerging markets have more developed financial sectors than the other developing country group, and that efficiency of intermediation in both has the potential to improve.

The broad money indicator (M2/GDP, Chart 5) shows that in several emerging market countries the broad money indicator is well above the OECD country average (50−60 percent). Brazil, the Czech Republic, Egypt, Hong Kong, Israel, Malaysia, Morocco, Singapore, Slovakia, and Thailand have rates above 60 percent. In the developing country group, only one exceeds this level (Kuwait). The high level may also indicate heavy reliance on the banking system compared to other forms of financial intermediation such as bonds or securities.

View Full Size

Financial Depth (M2/GDP) in Emerging Markets and Developing Countries, 1994 or latest

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: IFS

• Download Figure
• Download figure as PowerPoint slide

View Full Size

Financial Depth (private credit/GDP) in Emerging Markets and Developing Countries, percent, 1994 (or latest)

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: IFS.

• Download Figure
• Download figure as PowerPoint slide

A similar pattern can be observed in the other indicator of financial depth—private credit to GDP. Hong Kong, Korea, Malaysia, Singapore, and Thailand in Asia, Brazil in Latin America, the Czech Republic in Europe, and Israel in the Middle East have high private credit to GDP ratios, indicating more developed financial sectors. In the developing country group, financial depth in general is lower. Some countries show a large discrepancy between the two indicators of financial depth—broad money and private credit in GDP. One explanation for this can be a high share of government in total credit (see below). The discrepancy is even more pronounced in the developing country group.

In the emerging market group, most countries now have positive real interest rates (Chart 7)²¹. Only eight of the emerging market countries maintained negative interest rates in 1994. In the developing country group, nearly one−half of the countries for which data are available maintained negative real interest rates, suggesting that controls on interest rates or credit are still prevalent in many of these countries. This is supported by the data on government share (claims on government) in total credit (Chart 8), which in many of the countries is relatively high in general, or in comparison with the first group. Hungary, India, Morocco, Pakistan, and Poland show high shares of government (more than one−fifth) in total credit. In the developing country group, seven had a high share of lending going to the private sector.

View Full Size

Real Interest Rates in Emerging Markets and Developing Countries, 1994 or latest

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: IFS. Real interest rate = deposit rate - inflation.

• Download Figure
• Download figure as PowerPoint slide

View Full Size

Share of Government in Total Credit in Emerging Markets and Developing Countries, 1994, percent

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: IFS

• Download Figure
• Download figure as PowerPoint slide

Data on spreads (lending less deposit rates) (Chart 9) also indicate that they are in general higher in the developing country group compared to the emerging market one. In the former, spreads in many countries are in double digits. The comparable numbers in industrial countries are in general much lower—in the 3 to 5 percentage point range. This suggests the potential for improved efficiency of financial intermediation in many of the participating countries.

View Full Size

Spreads in Emerging Market and Developing Countries, percentage points, 1994 or latest

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: IFS. Spread = lending - deposit rate. Comparisons across countries are subject to measurement problems due to differing definitions.

• Download Figure
• Download figure as PowerPoint slide

Openness in the emerging—markets group, measured by the share of foreign assets in total financial sector assets, was very high in some countries—Hong Kong, Singapore, and Turkey have shares above 20 percent. This is still well below the rates in industrial countries (Chart 3). Data are available for the developing country group. Many of the emerging market group countries maintain restrictions on the current and capital account transactions, which reduces openness (Annex Table). If the openness indicators of industrial countries are of any guidance, there should be much potential for internationalization of banking activities in these emerging markets. Gradual opening to cross−border flows and to foreign presence in the WTO context can promote this process.

Profitability (Chart 10) indicators are higher in many emerging markets than in the OECD countries. In 1994 the data indicate that Malaysia, Pakistan, and Thailand had the most profitable banking sectors among the emerging markets. This could reflect limited competition, as many of these markets are relatively closed to foreign participation, either in establishment or in maintaining restrictions on cross−border flows (see Annex Table). Consumers in emerging markets would benefit from more competition in financial services. High profits can also indicate that banks could meet the challenge of liberalization. In this sense, U.S. insistence during the WTO negotiations on more rapid opening up of banking sectors in many Asian countries is understandable.

View Full Size

Profitability in Banking (1994 or 1993)

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Return on capital. Sample includes banks that are among the 1000 world largest in terms of capital. * = non-offshore only.

• Download Figure
• Download figure as PowerPoint slide

Inefficiency can also lead to losses in countries closed markets for foreign banks and whose banks are making losses. In such cases, the establishment of the health of the domestic financial system may be a precondition for opening. Allowing access to foreign providers or for cross−border flows can improve competition, but may not have any direct impact on the regulatory framework of the financial sector and could lead to widespread banking problems.

Concentration ratios²² (Chart 11) are slightly higher in emerging markets than in industrial countries. Among the emerging markets, Hong Kong has the lowest concentration ratio, while some transition countries have high ones, along with India, Israel, and Morocco. In some of these countries high concentration is likely to reflect lack of competition (India). In a number of transition countries, domestic banks struggle with large non−performing portfolios, which can create resistance to opening up to foreign competition.

View Full Size

Concentration in Banking in Emerging Markets and in Developing Countries, 1994

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: The Banker and IFS.

• Download Figure
• Download figure as PowerPoint slide

Capital adequacy ratios²³ are sometimes used to measure the soundness of banking in various countries (Chart 12). As seen in Chart 12, these are higher in developing countries than in the OECD countries. In general, this reflects regulatory frameworks and judgements by authorities on the riskiness of banking. High required ratios can also increase the cost of banking and affect the competitiveness of a country’s banks. However, cross−country comparisons are difficult, owing to significant differences in definitions of these ratios in different countries.

View Full Size

Capital Adequacy Ratios in Industrial Countries and Emerging Markets (1994 or 1993)

Citation: IMF Working Papers 1997, 055; 10.5089/9781451969221.001.A001

Source: The Banker and IFS. Capital adequacy = capital/total assets. Data from a sample including banks that are among the 1000 world largest in terms of capital.

• Download Figure
• Download figure as PowerPoint slide

Despite their deficiencies, the above indicators of the level of financial sector development and contestability, when taken together, tend to confirm a picture that banking sectors in the emerging market group are more developed than those in the other developing countries, which is no surprise. The contestability indicators also suggest that in many emerging markets more foreign participation could bring benefits of higher competition and reduce the high margins and provide a broader range of services. Many of these sectors also have relatively sound capital adequacy ratios, which also speaks for more opening. In the developing country group, basic financial sector reforms might be called for in many countries to improve savings mobilization and more efficient financial intermediation.

While the indicators provide some broad pictures of the nature of competition in banking in different countries, one should be cautious in using them for policy purposes. However, one should be even more cautious in using these indicators as specific targets of negotiations to liberalize the sectors. There is no correct ratio of openness or profits in which one can pin down negotiations.

E. Financial Development and GATS Commitments

In comparing the above financial sector data to the GATS bindings, it seems that the emerging market group was relatively cautious in binding their policies compared to the actual level of development of their financial sectors. This applies especially to cross−border trade, but bound access to their domestic financial markets also remains relatively limited. Industrial countries also bound less than the state of development of their financial sectors suggests. Nearly all have free cross−border trade, while few made commitments in Mode 1. The data suggest that financial sectors in many emerging markets are quite developed and generate high profits. This would mean that they also have plenty of room for additional unilateral or multilateral liberalization (bound or unbound). In the other developing country group, some commitments may be very liberal in view of the state of development of their financial sectors. The high spreads indicate that efficiency of intermediation could improve.

The above hypotheses were tested for developing countries with regression analysis. The dependent variable is an “indicator” of restrictiveness of the GATS commitments in each mode of supply (1,2,3). These were regressed on indicators of financial sector development, such as private credit/GDP ratio, M2/GDP, level of real interest rates or share of government in credit, and indicators of degree of competition, such as pre−tax profits and concentration ratios in banking. No correlation between GATS bindings and indicators of financial development or openness means that actual liberalization is very different from the bindings. Correlation of openness indicators with those of financial sector development would support this as well.²⁴

The regressions run on the key variables show that there is little correlation between the binding and the development or competition indicators. The variables of financial sector development or openness do not explain the variations in restrictions in the emerging market group. The t−statistics are not significant for any of the variables, and most signs are wrong (Table 2).

When actual openness is regressed on indicators of level of financial sector development, the results are better for the emerging market group. This would give support to the hypothesis that in reality actual openness tends to be larger in countries with more developed financial sectors. Openness is best explained by the ratio of private credit to GDP (positive and significant) and the share of government in total credit (negative and significant). The government share in total credit seems to explain the openness of countries’ financial sectors. Both are indicators of financial sector development and low involvement of the government in credit decisions of banks.

The above would suggest that countries did not make very rational bindings in the financial sector negotiations. In this sense, the multilateral liberalization only amounted to partial consolidation of existing financial sector policies. The bindings reflect more mercantilistic bargaining than economics. The high profit indicators in many emerging markets compared to industrial countries would also suggest that further unilateral liberalization would benefit efficiency. Also, industrial countries seem to have been keener to push for commercial presence in many of the emerging markets than in liberalizing cross−border flows into those countries. Many banking services by nature also require local presence. The latter would increase competition for existing and new banks in the sectors.