An Analysis of the Economic Outcome of Financial Liberalization

In the last chapter, we have considered the impact of financial reforms program and the channels through which such outcomes were transmitted. Particularly, we have assessed the performance of various indicators expected to capture improvements in efficiency, competitiveness and allocational enhancements following the adoption of liberalized financial policies in our sample countries. From these results and assessments based on almost all conventionally used aggregates, it is observable that there has been modest contribution of financial liberalization in terms of promoting economic growth in Kenya and Malawi. Importantly, in both these two countries the monopolistic structure of the commercial banking system has limited the depth and breadth of the financial services offered even under liberalized financial regime. This chapter considers this issue further. Firstly, it provides a simple model within the framework of imperfectly competitive banking industry and looks at the behaviour of the interest rate spread. The strategy is to analyse the level of spread together with the impact of an entry by a new firm. In doing so, the model solution is initially given for liberalized market system and then extended for the case of repressed financial environment. Applying the solutions from these exercises, adverse effect of higher fixed (overhead) costs in terms of serving as a barrier to entry of new established financial institutions is considered. Secondly, with this theoretical treatment the chapter also provides empirical evidence on the issue of high fixed costs which explain the lack of entry by effective competitors in these economies.