Does Financial Openness Lead to Deeper Domestic Financial Markets? - - PowerPoint PPT Presentation
Does Financial Openness Lead to Deeper Domestic Financial Markets? Csar Caldern (The World Bank) Megumi Kubota (University of York) FPD Academy Award Seminar The World Bank July 28, 2010 Motivation Salient features of the global
Salient features of the global economy:
Rapid integration of advanced countries and
Important changes in the patterns of saving and
Deepening of financial markets across industrial
FO leads to faster DFD through different channels:
Eliminating financial repression and shifting interest rates
Raising the degree of bank competition –i.e. adoption of
Displacing inefficient financial intermediaries and creating
FO, on the other hand, may lead to:
Risky behavior by banks and trigger boom-bust cycles (Allen
Agency problems (Allen and Gale 2000).
Buy risky assets during lending booms Bubbles may burst into banking crisis and recessions
Financial liberalization may generate short-run tensions
The effect of FO on DFD is theoretically ambiguous.
It becomes an empirical issue!
Prior: The effect of FO on DFD depends on some
Institutional framework Legal infrastructure
Goal of the paper: Test whether rising FO has led
Test whether the effects of FO on DFD may
the degree of institutional quality, investor protection, and trade openness
Contribution to the literature:
First paper to evaluate the effects on DFD of FO using
Complements existing evidence that more intense
Rising FO enhances DFD
It enlarges size/activity of financial intermediaries
Expansion of credit and higher assets
It improves the efficiency in the banking system
Reduction of net interest margins
It contributes to the deepening of local stock markets and
Raising stock market capitalization and total value traded
Increasing private bond market capitalization
Structure of foreign assets and liabilities appears to play
Accumulation of risky vs. riskless assets
Response of DFD to higher FO depends upon:
The level of institutional quality (IQ) The degree of investor protection (IP) International trade linkages of the domestic country (TO)
DFD enhanced by FO in countries with moderate to
Bank size/activity (i.e. credit, deposits, assets) Bank efficiency (i.e. net interest margin) Bond markets (i.e. private bond market capitalization)
Rising FO deepens domestic financial markets.
(+) impact on bank credit, bank assets, net interest margins,
Structure of foreign assets and liabilities appears to
Accumulation of risky vs. riskless assets
Response of DFD to higher FO depends upon:
The level of institutional quality The degree of investor protection International trade linkages of the domestic country.
Sample of 145 countries (24 industrial economies) Annual information, 1974-2007 (unbalanced panel) Domestic financial development (Beck, Demirguc-
Size and activity of financial intermediaries Efficiency and structure of commercial banking Stock market development Bond market development
Financial openness
Outcome measures: Foreign assets and liabilities (Lane and
Policy measure: Index of financial openness (Chinn-Ito, 2007)
Intensity of financial openness?
Control variables
PPP-adjusted real GDP Inflation Exchange rate regimes: dual and freely falling (Reinhart and
Challenges of panel data estimation
Presence of unobserved period- and country-specific effects Most explanatory variables are likely endogenous. Need to
Method: IV estimation
Need: Control reverse causation in financial openness
DFD may affect cross-border asset holdings.
Instruments for FO (Faria et al. 2007):
Institutional quality (summary index: rule of law, corruption, bureaucratic
quality, and democratic accountability)
Legal origin of the country (La Porta et al. 1998) Natural resource abundance, and area of the country Initial size of the country
Financial Integration and Domestic Financial Development Baseline IV Regression Analysis
Sample of 145 countries, 1974-2007 (annual observations) Dependent variable expressed as % of GDP, in logs
Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
Bank Bank Stock market Credit Assets Capitalization Explanatory variable
[1] [2] [3]
Financial Openness (FO)
0.094 ** 0.052 ** 0.349 ** Foreign liabilities (% GDP, logs) (0.03) (0.02) (0.08)
Control variables
Income per capita, lagged 0.641 ** 0.461 ** 1.048 **
(in logs)
(0.05) (0.04) (0.13) Trade openness, lagged 0.288 ** 0.289 ** 0.208 *
(Exports and imports, % of GDP, logs)
(0.04) (0.03) (0.11) Inflation, lagged
(in logs)
(0.03) (0.03) (0.07) Falling exchange rate
(lagged)
(0.04) (0.03) (0.08) Dual exchange rate regimes
(lagged)
(0.10) (0.08) (0.17)
Observations
2441 2453 1380
R**2
0.857 0.883 0.851
Country- and time-effects
Yes Yes Yes
Financial Integration and Domestic Financial Development Baseline IV Regression Analysis
Sample of 145 countries, 1974-2007 (annual observations) Dependent variable expressed as % of GDP, in logs Bank Stock Market Credit Deposits Assets Capitalization Traded value Foreign assets 0.0758 **
0.0414 ** 0.4988 ** 1.0874 ** (% GDP, logs) (0.024) (0.019) (0.020) (0.080) (0.126) Nobs. 2360 2401 2374 1338 1367 R**2 0.859 0.881 0.886 0.855 0.859 Foreign liabilities 0.1021 **
0.0394 * 0.3529 ** 0.4375 ** (% GDP, logs) (0.025) (0.019) (0.021) (0.075) (0.121) Nobs. 2360 2401 2374 1338 1367 R**2 0.860 0.881 0.886 0.856 0.858 Foreign assets and 0.1004 **
0.0394 * 0.4546 ** 0.7490 ** liabilities (% GDP, logs) (0.027) (0.021) (0.022) (0.084) (0.136) Nobs. 2360 2401 2374 1338 1367 R**2 0.859 0.881 0.886 0.856 0.859
We control for income per capita, trade openness, inflation, and exchange rate regimes. All these control variables are lagged one period. Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
Note: IV coefficient estimate of foreign liabilities (as % of GDP). [+] denotes a positive and statistically significant relationship, [ - ] denotes a negative and statistically significant coefficient, and [ 0 ] indicates a lack of significant in their relationship.
All Industrial Developing Dependent Variable Countries Countries Countries Activity of financial intermediaries
Private credit by deposit money banks (%of GDP, logs)
[+] [+] [ 0 ]
Private credit by financial system (% of GDP, logs)
[+] [+] [ 0 ]
Bank deposits (% of GDP, logs)
[ - ] [ 0 ] [ 0 ]
Financial deposits (% of GDP, logs)
[ - ] [ 0 ] [ 0 ]
Size of financial intermediaries
Total assets of deposit money banks (% of GDP, logs)
[+] [+] [ 0 ]
Total assets of the financial system (% of GDP, logs)
[+] [ 0 ] [+]
Liquid liabilities
[ 0 ] [ 0 ] [ 0 ]
Efficiency of financial intermediaries
Overhead costs (logs)
[ 0 ] [ 0 ] [ 0 ]
Net interest margin (logs)
[ - ] [ - ] [ - ]
Bank concentration (logs)
[+] [ 0 ] [+]
Stock markets
Stock market capitalization (% of GDP, logs)
[+] [+] [+]
Stock market total value traded (% of GDP, logs)
[+] [+] [ 0 ]
Number of listed companies (logs)
[ 0 ] [ - ] [+]
Bond markets
Private bond market capitalization (% of GDP, logs)
[ - ] [+] [ - ]
Public bond market capitalization (% of GDP, logs)
[ - ] [+] [ 0 ]
Our “baseline” estimates are robust to dropping from
Sharp variations in financial variables High inflation episodes
Does the structure of external assets and liabilities
Rising equity-related liability holdings leads to expansion of
Rising debt liability holdings is associated with contractions in
Test whether the impact of FO on DFD depends
Degree of institutional quality (IQ) Investor protection (IP) Extent of international trade integration (TO)
We model the coefficient γit as: Prior: γ1, γ2, γ3 >0 it it it it it it
1 1 1
Financial Integration and Domestic Financial Development: Role of Institutions, Investor Protection and Trade Openness
Sample of 145 countries, 1974-2007 (annual observations) Dependent variable expressed as % of GDP, in logs
Bank credit Bank deposit Stock market capitalization Foreign Foreign Foreign Foreign Foreign Foreign Foreign Foreign Foreign Assets Liabilities A & L Assets Liabilities A & L Assets Liabilities A & L [1] [2] [3] [4] [5] [6] [7] [8] [9] Financial openness (FO)
0.669
0.669 as % of GDP (in logs) (0.28) (0.25) (0.25) (0.20) (0.19) (0.19) (1.04) (0.93) (1.04) FO x Institutional quality 0.354 ** 0.266 ** 0.240 ** 0.348 ** 0.258 ** 0.228 ** 0.084 0.089 0.084 (0.04) (0.02) (0.02) (0.03) (0.02) (0.02) (0.11) (0.06) (0.11) FO x Investor protection 0.801 ** 1.409 ** 1.339 ** 0.457 ** 0.970 ** 0.888 **
(0.12) (0.17) (0.17) (0.08) (0.13) (0.13) (0.63) (0.80) (0.63) FO x Trade openness 0.086 ** 0.159 ** 0.123 ** 0.076 ** 0.136 ** 0.104 ** 0.007 0.088 0.007 (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) (0.08) (0.08) (0.08) Nobs. 2395 2395 2395 2424 2424 2424 1375 1375 1375 R**2 0.860 0.864 0.864 0.874 0.878 0.880 0.854 0.852 0.854
We control for income per capita, trade openness, inflation, and exchange rate regimes. All these control variables are lagged one period. Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
Foreign Liabilities (FL) Dependent variable FL FL x IQ FL x IP FL x TO Nobs. R**2 Activity of financial intermediaries
Private credit by deposit money banks
0.266 ** 1.409 ** 0.159 ** 2395 0.864
Private credit by financial system
0.273 ** 1.454 ** 0.135 ** 2404 0.872
Bank deposits
0.258 ** 0.970 ** 0.136 ** 2424 0.878
Financial deposits
0.213 ** 0.461 ** 0.113 ** 2442 0.870
Size of financial intermediaries
Total assets of deposit money banks
0.192 ** 0.986 ** 0.124 ** 2407 0.883
Total assets of the financial system
0.221 ** 0.927 ** 0.088 ** 1079 0.908
Liquid liabilities
0.160 ** 1.051 ** 0.134 ** 2368 0.860
Efficiency of financial intermediaries
Overhead costs
0.312
0.013 1281 0.851
Net interest margin
0.001 0.044 ** 0.003 * 1257 0.820
Bank concentration
0.593 **
1299 0.784
Stock markets
Stock market capitalization
0.089
0.088 1375 0.852
Stock market total value traded
0.309 0.124
0.105 1412 0.848
Number of listed companies
1.569 **
1267 0.914
Bond markets
Private bond market capitalization
0.685 ** 2.401 ** 0.419 ** 593 0.890
Public bond market capitalization
3.431 **
675 0.816
Numbers in parenthesis are robust standard errors. * (**) implies significance at the 10 (5) percent level.
Notes: Low (L) and high (H) levels of structural variables are computed as the 25th and 75th percentile of the distribution of the corresponding dimensions (with the other dimensions being evaluated at their medians). The p-value tests the null of equality in the effects whereas the alternative tests whether H is greater than L effect.
Response of bank credit Response of bank deposits Response of bank assets Response of liquid liabilities Structural Increase in: Increase in: Increase in: Increase in: Characteristic lfay lfly lfaly lfay lfly lfaly lfay lfly lfaly lfay lfly lfaly
Institutions
Low (L) [-] [0] [0] [-] [-] [-] [-] [0] [0] [0] [0] [0] Medium [0] [+] [+] [-] [-] [-] [+] [+] [+] [+] [+] [+] High (L) [+] [+] [+] [+] [0] [+] [+] [+] [+] [+] [+] [+] H vs. L (p-value ) (0.000) (0.000) (0.002) (0.000) (0.000) (0.000) (0.000) (0.001) (0.008) (0.000) (0.000) (0.003)
Investor protection
Low (L) [-] [-] [-] [-] [-] [-] [-] [-] [-] [+] [-] [-] Medium [0] [+] [+] [-] [-] [-] [+] [+] [+] [+] [+] [+] High (L) [+] [+] [+] [0] [+] [0] [+] [+] [+] [+] [+] [+] H vs. L (p-value ) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.168) (0.000) (0.000)
Trade openness
Low (L) [0] [0] [0] [-] [-] [-] [0] [0] [0] [+] [-] [-] Medium [0] [+] [+] [-] [-] [-] [+] [+] [+] [+] [+] [+] High (L) [+] [+] [+] [0] [0] [-] [+] [+] [+] [+] [+] [+] H vs. L (p-value ) (0.015) (0.000) (0.004) (0.005) (0.000) (0.001) (0.107) (0.000) (0.010) (0.047) (0.000) (0.000)
The Role of Structural Characteristics: Conditional response of domestic financial development to an increase in financial openness
(Response to doubling our measure of financial openness)
0.00 0.05 0.10 0.15 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank credit response to FO conditional on the level of institutional quality
0.00 0.02 0.04 0.06 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank deposit response to FO conditional on the level of institutional quality
0.00 0.05 0.10 0.15 0.20 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank credit response to FO conditional on the level of investor protection
0.00 0.02 0.04 0.06 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank deposit response to FO conditional on the level of investor protection
Notes: Low (L) and high (H) levels of structural variables are computed as the 25th and 75th percentile of the distribution of the corresponding dimensions (with the other dimensions being evaluated at their medians). The extreme values of the lines crossing the bars represent the 95% confidence interval.
Notes: Low (L) and high (H) levels of structural variables are computed as the 25th and 75th percentile of the distribution of the corresponding dimensions (with the other dimensions being evaluated at their medians). The extreme values of the lines crossing the bars represent the 95% confidence interval.
0.00 0.02 0.04 0.06 0.08 0.10 0.12 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank asset response to FO conditional on the level of investor protection
0.00 0.02 0.04 0.06 0.08 0.10 Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Bank asset response to FO conditional on the level of institutional quality
0.0% 0.2% Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Net interest margin response to FO conditional on the level of institutional quality
0.0% 0.2% Low Median High Low Median High Doubling FA/Y Doubling FL/Y
Net interest margin response to FO conditional on the level of investor protection
The estimates of our “augmented” model are robust
Excluding sharp variations in financial variables (associated
Changes in the measure of institutional quality
Political institutions, quality of institutions, socio-economic
Changes in the measure of investor protection
Disclosure index, director liability, and shareholder suits
World economy characterized by:
Rising financial globalization Rapid increase in cross-border asset trade Deepening of local financial markets
How does FO affect DFD?
Theoretically ambiguous Empirical issue Possible to determine causal impact?
Rising FO appears to enhance DFD by:
Raising bank credit and total assets of the banking system Reducing net interest margins Increasing stock market capitalization and total value traded Improving the capitalization of private bond markets
Response of DFD to greater FO depends on institutions,
E.g. Banking size and activity expands in response to greater FO