Distinguished Lectures

The Importance of the Financial System for Development: Implications for Egypt

Publication Number: ECES-DLS6-E

May, 1997

Author : Gerard Caprio Jr. and Stijn Claessens

Type : Distinguished Lectures

Does finance matter to economic development? If so, why do so many developing countries find it difficult to reform their financial systems? Finally, what does all this mean for Egypt? The answers to these questions are less than obvious. Some distinguished economists such as Robert Lucas term the relationship between finance and development as "overstressed". Governments wait until banks fail, even in such developed economies as the United States, and despite notable progress, the financial system in Egypt has yet to develop sufficiently to cope with the growing needs of the real economy. In this publication, Jerry Caprio and Stijn Claessens provide convincing answers to these questions. Building on theory and international evidence, they show how and why efficient financial systems help economic growth-they mobilize and allocate resources, provide savings instruments, facilitate risk management, improve corporate governance, and provide means of payment. The authors cite evidence to support the view that equity markets are more than a casino, and the banking sector is more than a place to deposit money. In illustrating the difficulties of financial system reform, the authors identify common problem areas among developing economies, such as adverse political and institutional conditions, obstacles to regulatory and supervisory reforms, and initiating reform under crises. Notwithstanding these difficulties, they discuss how some countries-e.g. Chile, Malaysia-were able to successfully reform their financial systems. In comparing Egypt to successful reformers, Caprio and Claessens highlight the need to reduce domination by state banks, improve the incentive environment, and strengthen the supervisory role of the central bank. This advice stimulated a discussion in which participants raised questions about deposit insurance, evergreening policy, bank fragmentation, liability, and mutual funds. Caprio's responses, in combination with his presentation, constitute a valuable contribution to the debate on why Egypt's financial system needs reforming, and how to go about it.