Back Matter
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

Appendix I. Facilitating Financial Deepening

Deepening is a gradual and largely organic process, and policy recommendations need to account for country-specific circumstances and institutions. While further work is needed to sketch out specific policy advice, some basic areas of emphasis that can nevertheless be extracted from the prevailing wisdom and some references to the literature are provided:

  • Macro policy framework. A sound policy framework is essential for macroeconomic and financial stability (World Bank-IMF Handbook, 2001; Eichengreen, 2008; Arvai and Heenan, 2008; Chami, Fullenkamp, and Sharma, 2009). It would support demand for domestic assets, and enhance the credibility of the government as an issuer of debt securities.

  • Market infrastructure. A robust market infrastructure is necessary. For instance, a benchmark yield curve is a key requirement for market development and facilitates the reliable valuation of financial assets. This, in turn, necessitates sound public debt management policies (Arvai and Heenan, 2008; Chami, Fullenkamp, and Sharma, 2009).

  • Legal framework. A strong and transparent legal framework is critical to investor protection and property and creditor rights. The regulator could, for instance, codify and enforce accurate and timely accounting standards, while the private sector could build the necessary infrastructure such as exchanges and credit bureaus. A robust payments and settlements infrastructure is also essential. The positive relationship among sound institutions, financial development, and long-term growth has been confirmed in many empirical analyses (Fergusson, 2006; Chinn and Ito, 2006).

  • Regulatory and supervisory regime. A sound regulatory and supervisory system needs to be established with the capacity to ensure financial stability. A balance is needed whereby regulation can foster prudent market conduct without hindering development: too rapid a deregulation risks engendering instability (Reinhart and Rogoff, 2008; Rodrick and Subramaniam, 2009), but highly restrictive rules may hinder financial market development (Chami, Fullenkamp, and Sharma 2009; Goswami and Sharma, 2011). Such regulation needs to address disclosure and transparency among market participants, limit market dominance, and enforce risk management practices. In addition, IMF (2002) discusses the linkages between financial sector development and capital account liberalization, setting out an operational framework for sequencing financial deregulation and liberalizing cross-border capital flows.

  • Cooperative mechanisms. There may also be a role for cooperative solutions, such as by countries in Asia to develop local currency bond markets. In particular, efforts aimed at addressing various impediments to bond market development—focusing efforts to achieve a critical scale, building information systems and transparency, improving market infrastructure and regulation, and creating a vibrant investor community—appear to have had a large impact (BIS, 2011).

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1

Udaibir Das and Robert Rennhack (MCM) provided valuable advice, for which we are grateful. We thank Ranjit Teja (SPR) for guidance and direction, and we thank Isabelle Mateos y Lago (SPR), David Marston (SPR), Jeff Chelsky (World Bank), seminar participants, and departmental reviewers at the IMF for helpful comments. Stephanie Segal and S. Ramachandran provided inputs at an early stage of the project. Swarnali Ahmed is a summer intern, currently at Oxford University.

2

The definitions of AMs and EMs are generally consistent with the classification used in the World Economic Outlook. However, a few economies defined as AMs in the WEO are treated here as EMs because they transitioned from the latter category during the period under investigation. These are the four Asian NIEs (Hong Kong SAR, Korea, Singapore, and Taiwan Province of China) and three transition economies in central and eastern Europe (Czech Republic, Slovakia, and Slovenia).

3

The experience of EMs varies, depending on the business model used by international banks in their respective jurisdictions. In particular, EMs where these banks funded their activities by raising local deposits experienced less volatility, as was the case of Spanish banks in Latin America (Kamil and Rai, 2010).

Financial Deepening and International Monetary Stability
Author: Mr. Shengzu Wang, Chris Marsh, Rishi Goyal, Narayanan Raman, and Mrs. Swarnali A Hannan