Impact of Financial Sector Reform on Financial Intermediation in Bangladesh -An Empirical Assessment

Abstract

Financial sector of n country plays crucial role in the process of economic development by efficiently mobilizing fi11nncial resources among the most productive uses. This role of financial sector came in tile forefront of development economics with the publication of two similar works by McKinon (1973) and Shaw (1973). Since then, numerous empirical works supported tire positive role of financial development in the process of economic development. Realizing this importance of financial sector, almost all developing countries in the world started reforming their financial sector since 1990 to make it more competitive and efficient. Like other developing countries Bangladesh also started reforming its financial sector since early 1980s by privatizing two nationalized commercial banks. Formal financial Sector Reform (FSR) was started by launching the Financial Sector Reform Project (FSRP) in 1990. This study makes an evaluation of FSR with respect to its impact on volume and effectiveness of financial development or intermediation. An econometric model is estimated for this purpose. Three measures of volume of financial in termination used in the model as dependent variables are broad monopoly (M2), private credit and bank deposit liabilities - all as percentage of Gross Domestic Product (GDP). Independent variables in the model are inflation, nominal exchange rate, interest rate differential, trade openness [= (Import + export)/GDP] and a dummy variable which takes 'O' value for 1974-1989 and '1' for 1990-2002. Granger causality test shows that financial intermediation causes economic growth, for this reason economic growth is not included in the regression model as an independent variable. Before estimating the model time series property of the data series are examined and it is found that all variables are co-integrated, that is, long run equilibrium relationship exists among the variables. Two variables - exchange rate and trade openness - are found to be highly correlated. To avoid the problem of multicollinearity these two variables are included in regression model separately. Estimation results show that financial intermediation deteriorated during the post reform period, i.e., during 1990-2002. Statistical test is conducted to examine whether effectiveness of financial intermediation, measured by the ratio of reserve money to total deposit and ratio of reserve money to quasi money, has been improved in the post-reform period and it is found that effectiveness of financial intermediation has not been improved during post reform period compared with pre-reform period. This deterioration of financial intermediation may be attributed to the stringent supervision on the banking sector in one hand lack of effective legal support to recover bad debts on the other hand. Banks did a lot have suitable credit avenues that could be recovered without putting lending banks in trouble.

In order to make the intermediary functions of banks more effective and efficient, the study makes some recommendations which include (i) providing Bangladesh Bank with greater amount of autonomy so that it can conduct monetary operation independently; (ii) making legal procedure regarding loan recovery more easier and flexible; (iii) proper training of credit officials; (iv) seeking help from political organizations to prohibit unethical activities of Collecting Bargaining Agents (CBA); (v) ensuring law and order situation, corporate governance and accountability on the part of bank managements and (vi)encouraging the development of more Non-bank Financial institutions (NBF!s) to make the intermediary function of the financial sector, which is mostly comprised of commercial banks, more competitive, hence efficient and effective.