Creating an Efficient Financial System: Challenges in a Global Economy

Financial sector development fosters economic growth and reduces poverty by widening and broadening access to finance and allocating society’s savings more efficiently. This paper first discusses three pillars, on which sound and efficient financial systems are built: macroeconomic stability and an effective and reliable contractual and informational framework. The paper then describes three different approaches to government involvement in the financial sector: the laissez-faire view, the market-failure view and the market-enabling view. Finally, the paper analyzes the sequencing of financial sector reforms and discusses the benefits and challenges that emerging markets face when opening their financial systems to international capital markets. * The author is with the World Bank’s research department. This paper was written for the G20 Seminar on Economic Growth in Pretoria, August 2005. The author is grateful to Robert Cull, Asli Demirguc-Kunt and Patrick Honohan for useful comments and Ed AlHussainy for outstanding support. This paper’s findings, interpretations, and conclusions are entirely those of the author and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.