Functioning of financial system is vitally linked to economic growth


Jan 03 - 09, 2005




"Poverty alleviation" has become a common slogan. Without effective and strong national financial system poverty reduction and economic growth are never possible. Financial system that develops unevenly and lack transparency and proper regulation is more vulnerable to financial shocks and prone to distress. It is proved that these shocks and crises disproportionately affect poor people.

Weak financial system, exacerbate poverty levels by providing inadequate access to capital and financial services to individuals and to small and medium enterprises, which are key to economic growth.

Now economists have recognized that the financial system is essential for development. Improving the financial system can lead to higher growth and reduce the likelihood and severity of crises. It is essential in understanding the causes of business cycles and the working of monetary policy.

"Pakistan may suffer various types of economic crisis which would be triggered by weak banking and financial regulation polices. One of the major indicators of the economy is stock exchange condition. Does it show a stable and natural growth?. Rarely become bullish, such a huge market just depends on large few industries, there is no new investment but the shifting of investment making price bubbles. In this scenario the imposition of capital value tax and badla financing what will happen next?.

This is the time to prevent these financial crises. Avoiding crises should be a top priority in any anti-poverty strategy.

Government needs to improve the prudential regulation and supervision of financial intermediatries, introduce new standards for data dissemination and implement corporate bankruptcy reform. At the same time, a cautious approach should be taken to capital account liberalization. Controls on capital can be an appropriate instrument for tempering the volatility of capital flows. There is evidence that capital controls can shift the composition of capital flows towards longer maturing investment.

Other initiatives and measures are also important for avoiding crises, such as mechanism to diversify and insure against risk. But one thing should be kept in mind that actions at the national level may not be enough to prevent economy wide crises. Domestic actions will have to be complemented by actions at the international level to foster global financial stability and help countries.

In thinking about financial reforms, we need to treat liberalization as a means rather than an end. Instead of pushing for immediate deregulation, we should be trying to understand the important role government plays in financial system. These steps will not only result in the better and more stable allocation of domestic capital, but also help country to manage international capital flows.

If we discuss the role of the financial system individual entrepreneurs rarely have enough of their own capital to undertake investments themselves. Individual savers without pooling their money, would not be able to take advantage of the potential increasing returns to scale of their investment and would face a large degree of risk with little liquidity. Despite that effective financial system solves these problems by agglomerating capital from many smaller savers, allocating capital to the most important uses, and monitoring to ensure that it is being used well. At same time the financial system transfers, pools, and reduces risk, increases liquidity and conveys information.



Well functioning financial system does a very good job of selecting the most productive recipients for these resources and ensuring that they are using them in high return activities.

What is happening in Pakistan our financial system is very poor that's why allocation of capital is often in low productive investments. So difference in terms of growth and total factor productivity is going to be enormous.

If our government gives these financial sector priorities in three ways we can strengthen our financial system (1) knowledge dissemination, (2) lending and technical assistance, and (3) partnerships, Government actively disseminates research and knowledge in a variety of ways. An emerging issue of our time is electronic finance and electronic security. Electronic finance, which is becoming key to financial infrastructure, presents great opportunities to reduce the costs of financial and commercial transactions. If there is a provision of financial sector knowledge and information services, with a dedicated team of analysts, serves as hub of communications, research and resources on financial sector issues.

Government control and its increased concern over money laundering and the financing of unlawful activities, particularly as the devastating economic and social consequences are magnified with fragile financial system. Government should adopt a Financial Sector Assessment program, which helps to identify financial system strengths and vulnerabilities and helps to reduce the political crises.

Financial Sector Reform and Strengthening program has to establish with a mechanism to supports technical assistance such as risk-based approaches to supervision, the use of early warning tests and the regulatory ladder. In this way we can expose our supervisors on international standard.

Another big problem is lack of access to financial services. About 3 to 6% of the Pakistani have access to day-to-day bank and payment services compared with more than 90% in developed countries. Government has to widen the access to financial services in the country, by improving the efficiency of regional payment infrastructures and by promoting the delivery of payment instruments and services to individuals and to small and medium enterprises. Our country would become more attractive for the investors.

In conclusion it is clear that the functioning of financial system is vitally linked to economic growth. A country with larger banks and more active stock markets grow faster. Industries and firms that rely heavily our external financing grow disproportionately faster in countries with well-developed banks and securities markets than in countries with poorly developed financial system.

The weight of evidence suggests that financial system are a fundamental feature of the process of economic development and that a satisfactory understanding of the factors underlying economic growth requires a greater understanding of the evolution and structure of financial system.