Progress, Constraints and Limitations of Financial Sector Reforms in the Least Developed Countries

The paper evaluates the achievements, limitations and constraints of financial sector reforms implemented in eight Least Developed Countries (LDCs): Madagascar, Malawi, Tanzania, Uganda and Zambia in sub-Saharan Africa (SSA), and Bangladesh, Laos and Nepal in Asia. All are low-income countries characterized by shallow and non-diversified financial sectors, which have experienced considerable financial fragility.

The research is based on an financial sector reform UN Conference on Trade and Development project undertaken during 1995-97 which entailed financial liberalization and institutional reforms for prudential regulation and supervision and distressed public sector banks. The objectives of the reforms are to build more efficient, robust and deeper financial systems, which can support the growth of private sector enterprise.

The research suggests that the banking systems dominate the financial sectors of these LDCs and have been the major focus of the reforms, although some of the countries have begun reforms intended to develop capital markets and encourage the growth of non bank financial institutions (NBFIs) such as leasing and finance companies.

Efficiency entails two components:

• Improved credit allocation (i.e credit allocated to borrowers with higher expected returns for given levels of risk) and more, or higher quality, financial services for a given level of inputs (e.g. bank staff);
• Increased competition, with competition resulting from liberalised entry and/or removal of regulations which restrict competition, such as interest rate controls.

The paper asserts that improved credit allocation could be derived from reduced government intervention in directing credit or setting interest rates so that banks would have more freedom to allocate credit according to commercial criteria.

The literature includes some skepticism about the effectiveness of financial liberalisation in low-income countries.

The rest of the paper is organized as follows:

• Introduces the main concepts and reasoning behind the research;
• Outlines the main components of the financial sector reforms implemented in the eight LDCs;
• Assesses the impact of the reforms on financial depth, on competition in the banking system and on credit allocation factors related to the efficiency of financial intermediation;
• Examines the extent to which the reforms have created more robust financial systems. Analyses the causes of financial distress and evaluates measures to rehabilitate government banks and the reforms to the prudential system.