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A New Database of Financial Reforms
ABDUL ABIAD, ENRICA DETRAGIACHE, and THIERRY TRESSEL
This paper introduces a new database of financial reforms covering 91
economies over 1973–2005. It describes the content of the database, the
information sources utilized, and the coding rules used to create an index of
financial reform. It also compares the database with other measures of financial
liberalization, provides descriptive statistics, and discusses some possible
applications. The database provides a multifaceted measure of reform,
covering seven aspects of financial sector policy. Along each dimension the
database provides a graded (rather than a binary) score, and allows for
reversals. [JEL N20, G18, G28, P11]
IMF Staff Papers (2010) 57, 281–302. doi:10.1057/imfsp.2009.23;
published online 6 October 2009
The past decade has seen a rapid increase in the empirical literature
investigating the links between financial development and macro-
economic outcomes. In his comprehensive survey of the literature, Levine
(2005) draws three broad conclusions from these studies. First, countries with
more developed financial sectors grow faster. Through careful use of
instrumental variables and sophisticated econometric methods, the evidence
suggests that simultaneity bias is not driving this conclusion; finance does
seem to have a positive causal effect on growth. Second, the degree to which
Abdul Abiad and Thierry Tressel are senior economists with the IMF Research
Department. Enrica Detragiache is an advisor with the IMF Institute. The authors are grateful
to Aart Kraay, Ashoka Mody, Antonio Spilimbergo, and Barbara Stallings for helpful
comments and suggestions. The latest version of this database could not have been completed
without the expert contributions of Sawa Omori, Kruti Bharucha, and Adil Mohommad. The
authors also thank Radu Paun and Eun-Jue Chung for excellent research assistance.
IMF Staff Papers
Vol. 57, No. 2
&2010 International Monetary Fund
281
a country’s financial system is bank-based or market-based does not matter
much. This does not necessarily imply that institutional structure does not
matter for growth; rather, different institutional structures may be optimal
for different countries at different times. Third, industry- and firm-level
evidence suggests that one mechanism through which finance influences
growth is by easing external financing constraints on firms thereby improving
the allocation of capital.
This research raises the question of what can countries do to improve the
efficiency of their domestic financial systems. Influential work by McKinnon
(1973) and Shaw (1973) suggests that reducing the role of the state in the
financial system should be a point of departure. Indeed, until the 1980s
the financial sector was probably one of the sectors where state intervention
was most visible both in developing and developed countries. In many
countries, banks were owned or controlled by the government, the interest
rates they charged were subject to ceilings or other forms of regulation,
and the allocation of credit was similarly constrained and regulated. Explicit
or implicit taxation also weighed on the volume of financial intermediation.
Entry restrictions and barriers to foreign capital flows limited competition.
Since then, many countries have liberalized and deregulated their financial
sector, although the process is by no means complete. In some countries, the
IMF and the World Bank have played a major role in advising the authorities
about the reform process.
During the financial liberalization process, a number of countries have
experienced financial crises, characterized by various combinations of
banking sector insolvency, reversal of foreign capital inflows, sharp
currency depreciation, and difficulties in financing government deficits (see
Demirgu
¨c¸-Kunt and Detragiache, 1998; Kaminsky and Reinhart, 1999). The
question of whether crises have been fostered by the liberalization process,
perhaps because of inadequate sequencing of reforms or lack of sufficient
supervisory infrastructure, has been often discussed in policy circles and
research papers (see Demirgu
¨c¸-Kunt and Detragiache, 1999). The recent
subprime crisis in the United States has once again raised the question of
whether financial deregulation hinders financial stability.
A limitation of studies trying to understand both the determinants and
the effects of financial liberalization has been the lack of a comprehensive
data set documenting actual policy changes. This paper introduces a
database of financial reforms, covering 91 economies over the period 1973–
2005,
1
that will hopefully help researchers answer some of these questions.
2
The new database recognizes the multifaceted nature of financial reform and
records financial policy changes along seven different dimensions: credit
1
An earlier version of the database, covering 36 countries over the period 1973–96 and
slightly different categories of reform was used by Abiad and Mody (2005) to investigate how
political and economic factors shaped the financial liberalization process.
2
The database is available online at http://www.imf.org/external/pubs/ft/wp/2008/data/
wp08266.zip.
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
282
controls and reserve requirements, interest rate controls, entry barriers, state
ownership, policies on securities markets, banking regulations, and
restrictions on the financial account. Liberalization scores for each
category are then combined in a graded index that is normalized between
zero and one. This contrasts with most existing measures, which code
financial liberalization using binary dummy variables. Hence, the database
provides a much better measure of the magnitude and timing of financial
policy changes than was previously possible. In addition, since the data
set extends through 2005, the period following the major financial crises of
the 1990s is included in the sample, so that questions related to the effects
of the crisis on the liberalization process can be explored.
Because of the complex nature of the policy changes in question and the
difficulty in retrieving information, especially for countries that have not
been the object of specific case studies, the database remains a work in
progress, and would benefit from feedback on both its construction and on
the coding of specific countries. Government intervention in the financial
sector occurs in a myriad of ways, so the coding rules employed may not
always accurately capture the extent to which the government still influences
credit allocation. We have relied heavily on experts’ assessments of the true
extent of financial reform whenever possible, but feedback from those
who know these countries in-depth is always welcome. And although the
country coverage is already wider than that of existing liberalization
measures, and covers all regions and a wide range of income levels, the
database would be even more valuable if coverage could further be increased
to include more countries and recent years.
I. Construction of the Database
In the database, we distinguish between seven different dimensions of
financial sector policy. These dimensions, and the questions used to guide the
coding, are listed below (see Appendix I for more details):
Credit controls and excessively high reserve requirements. Many countries
required or still require that a minimum amount of bank lending be to
certain ‘‘priority’’ sectors (for example, agricultural firms, selected
manufacturing sectors, or small-scale enterprises) for purposes of
industrial policy, or to the government for purposes of financing
budget deficits. Occasionally these directed credits are required to be
extended at subsidized rates. Less frequently, governments set ceilings on
overall credit extended by banks, or on credit to specific sectors. Finally,
governments may impose excessively high reserve requirements, beyond
what can be reasonably expected for prudential purposes, and reserves
may not be remunerated at market rates of return. One extreme example
was Argentina’s Deposit Nationalization Law of 1973, which forced
banks to deposit all financial savings with the central bank, effectively
A NEW DATABASE OF FINANCIAL REFORMS
283
imposing a 100 percent reserve requirement (Bisat, Johnston, and
Sundararajan, 1992). In coding the database we use 20 percent as a
threshold for determining whether reserve requirements are excessive or
not. The questions used to guide the coding of this dimension are the
following: Are there minimum amounts of credit that must be channeled
to certain sectors, or are there ceilings on credit to other sectors?
Are directed credits required to carry subsidized rates? Is there a ceiling
on the overall rate of expansion of credit? How high are reserve
requirements?
Interest rate controls. One of the most common forms of financial
repression, interest rate controls were used even in some developed
countries until recently (for instance, the United States had in place
interest rate controls, known as Regulation Q, from the 1930s to the
early 1980s). In the most restrictive case the government specifies both
lending and deposit rates by fiat, or equivalently, sets ceilings or floors
tight enough to be binding in most circumstances. An intermediate
regime allows interest rates to fluctuate within a band. Interest rates
are considered fully liberalized when all ceilings, floors or bands are
eliminated. To guide the coding of this dimension, one needs to
determine, for deposit and lending rates separately, whether interest
rates are administratively set, including whether the government
directly controls interest rates, or whether floors, ceilings, or interest
rate bands exist.
Entry barriers. To maintain control over credit allocation, government
may restrict the entry into the financial system of new domestic banks or
of other potential competitors, for example foreign banks or nonbank
financial intermediaries. Entry barriers may take the form of outright
restrictions on the participation of foreign banks; restrictions on the
scope of banks’ activities; restrictions on the geographic area where
banks can operate; or excessively restrictive licensing requirements.
3
State ownership in the banking sector. Ownership of banks is the most
direct form of control a government can have over credit allocation.
Although often the result of a conscious policy decision by the authorities
(for example, in India beginning in 1969), state ownership can also be the
result of nationalization following a banking crisis (for example, Mexico
in 1982 or Indonesia in 1998). In coding the database, we look at the
share of banking sector assets controlled by state-owned banks.
Thresholds of 50, 25, and 10 percent are used to delineate the grades
between full repression and full liberalization. Surprisingly, there is still
no comprehensive panel database on state ownership of the banking
sector. We have had to rely on various reports (including IMF staff
3
On the latter, judgment needs to be exercised as some prudence is necessarily required in
the granting of licenses, so whenever possible we relied on other scholars’ assessments as to
whether a country’s licensing regime was excessively strict or not.
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
284
reports and Financial Sector Assessment Programs) and the World
Bank’s privatization database to code this dimension.
Financial account restrictions. Restrictions on international financial
transactions were often imposed to give the government greater control
over the flow of credit within the economy, as well as greater control over
the exchange rate. These restrictions included multiple exchange rates for
various transactions, as well as transactions taxes or outright restrictions
on inflows and/or outflows specifically regarding financial credits. There
are several existing measures of financial account openness that currently
exist, and that have a wider country coverage, which are surveyed in
Edison and others (2004).
Prudential regulations and supervision of the banking sector. Of the seven
dimensions, this is the only one where a greater degree of government
intervention is coded as a reform. To code this dimension, we ask the
following questions: Does a country adopt risk-based capital adequacy
ratios based on the Basel I capital accord? Is the banking supervisory
agency independent from the executive’s influence and does it have
sufficient legal power? Are certain financial institutions exempt from
supervisory oversight? How effective are on-site and off-site examinations
of banks?
Securities market policy. Here we code the different policies governments
use to either restrict or encourage development of securities markets.
These include the auctioning of government securities, establishment of
debt and equity markets, and policies to encourage development of these
markets, such as tax incentives or development of depository and
settlement systems. Also included here are policies on the openness of
securities markets to foreign investors.
An earlier version of this database, used in Abiad and Mody (2005), had six
rather than seven dimensions. It excluded securities market policy and
prudential regulations, but following Williamson and Mahar (1998), it
included a measure of operational restrictions—including government
control over managerial and staff appointments, or other restrictions on
banks’ operating procedures (for example, on advertising and branch
opening). Because the nature of these restrictions differed substantially
from country to country, it was difficult to create a coding rule that could
facilitate cross-country comparability. So this dimension was dropped,
although certain elements were folded into other dimensions (for example,
restrictions on the scope of banks’ activities or geographic restrictions on
bank branching were included under entry barriers).
Along each dimension, a country is given a final score on a graded scale
from zero to three, with zero corresponding to the highest degree of
repression and three indicating full liberalization.
4
In answering the questions
4
A raw score was first assigned to each dimension, on different scale. Next, each raw score
was normalized between 0 and 3 according to a rule.
A NEW DATABASE OF FINANCIAL REFORMS
285
and in assigning scores, it is inevitable that some degree of judgment is
exercised. To minimize the degree of discretion, a set of coding rules was
used, which can be found in Appendix I. Policy changes, then, denote shifts
in a country’s score on this scale in a given year. In some cases, such as when
all state-owned banks are privatized all at once, or when controls on all
interest rates are simultaneously abolished, policy changes will correspond
to jumps of more than one unit along that dimension. Reversals, such as the
imposition of capital controls or interest rate controls, are recorded as shifts
from a higher to a lower score. Given its detailed construction, the database
thus allows a much more precise determination of the magnitude and timing
of various events in the financial liberalization process.
Identifying the various policy changes included in our database was
facilitated by the available surveys of financial liberalization experiences.
These include Williamson and Mahar (1998), Fanelli and Medhora (1998),
Johnston and Sundararajan (1999), De Brouwer and Pupphavesa (1999), and
Caprio, Honohan, and Stiglitz (2001).
5
Other resources, including central
bank bulletins and websites, IMF country reports, books, and journal
articles, were also utilized heavily. In particular, IMF reports turned out to
contain a wealth of information on financial sector reforms. The primary
(publicly available) sources are identified in the working paper version of this
article (Abiad, Detragiache, and Tressel, 2008).
A few examples can give a sense of how the coding was done. Consider
for example the liberalization of interest rates. In some cases, coding is
straightforward: for instance, Pinto (1996, p. 100) states that ‘‘until 1987,
interest rates were traditionally set by the Portuguese authorities. The process
of gradual liberalization of interest rates started in January 1987, when the
interest rate ceiling on demand deposits of individuals was removed.’’ Based
on this information, interest rates on deposits were coded as fully liberalized
in Portugal in 1987. Pinto (1996, p. 101) also notes that full liberalization on
lending rates was achieved in 1988 (‘‘in September 1988 the ceiling on the
lending rate was also freed’’). In some other cases, judgment calls are
inevitable. In the case of China, interest rates on bank loans are coded
as partially liberalized in 2002 based on the following information from
Garcı
´a-Herrero and Santaba
´rbara (2004, p. 16): ‘‘Most recently the ceiling on
banks’ lending rates was lifted in several occasions. In particular, in 2002
banks were permitted to charge borrowers up to 1.3 times the central lending
rate. In January 2004, it was raised again to 1.7.’’ Interest rates on loans were
coded as fully liberalized in 2004, and deposit rates partially liberalized in
2002 based on the following information from Goodfriend and Prasad (2006,
pp. 21–22): ‘‘On Oct. 29, 2004, the ceiling on lending rates was scrapped
altogether (except for urban and rural credit cooperatives). Along with the
5
A recent paper by Schindler (2009) codes financial account restrictions using the IMF’s
Annual Report on Exchange Rate Restrictions for a sample of 91 countries over the period
1995–2005. Other existing indices of financial account restrictions are reviewed in Schindler
(2009).
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
286
liberalization of lending rates, banks were given more freedom to make
downward adjustments to deposit rates.’’
Coding of the competition dimension sometimes required some country-
specific knowledge. For example, in Spain, the banking system is dominated
by savings banks. So, while barriers on branching restrictions were lifted
in the early 1980s for commercial banks, we coded it as liberalized in 1992
only, when savings banks were allowed to open up branches anywhere in the
country. The case of China is even more complex. In the light of restrictions
for a subset of commercial banks, we coded it as nonliberalized.
6
II. Comparison to Other Databases
Recent papers have constructed alternative measures of financial liberal-
ization. Edison and Warnock (2003) calculate the proportion of total stock
market capitalization that is available to foreign investors, for 29 emerging
markets from 1989 to 2000. It is in the spirit of our measure inasmuch as it
provides a graded index of liberalization over time. However, it is not a
broad-based measure of financial sector liberalization, being narrowly
focused on capital controls in portfolio equity investment.
Closer in scope to our measure is the index constructed by Williamson
and Mahar (1998) who recorded financial reforms in 34 economies
over 1973–96, over six graded dimensions (credit controls, interest rate
controls, entry barriers, regulations, privatization, and international capital
flows).
Kaminsky and Schmukler (2003) also constructed a graded index of
financial reforms. This data set has three components: domestic financial
sector liberalization, especially of interest rate and credit controls; financial
account liberalization; and the openness of the equity market to foreign
investment. As with our approach, each component takes discrete values,
being classified as ‘‘fully liberalized,’’ ‘‘partially liberalized,’’ or ‘‘repressed.’’
Although the building blocks of the Kaminsky-Schmukler database are
similar to ours, their measure puts more weight on liberalization of capital
flows, whereas ours emphasizes reforms in the domestic financial sector. The
time coverage of the Kaminsky-Schmukler data set is slightly shorter (1973–
99), and their sample of countries is considerably smaller, covering 28
countries (14 developed and 14 developing countries) compared with 91
countries in our database.
Two data sets—Bandiera and others (2000) and Laeven (2003)—
characterize financial liberalization along six dimensions.However, the
country coverage in each case is much smaller, with 8 and 13 countries
covered, respectively. Moreover, in both of these data sets each liberalization
6
According to Garcı
´a-Herrero, Gavila, and Santaba
´rbara (2005), ‘‘Joint-stock
commercial banks (JSCB) are partially owned by local governments and state owned
enterprises, and sometimes by the private sector. They are generally allowed to operate at the
national level. City commercial banks are not allowed to operate at the national or regional
scale unlike the JSCBs, which is their major competitive disadvantage.’’
A NEW DATABASE OF FINANCIAL REFORMS
287
component is not graded, but is a binary variable. Despite the differences in
the construction of these data sets, they all show the same broad patterns of
financial sector reform as does our index.
Finally, Schindler (2009) has recently constructed a data set covering
the same 91 countries we cover, and providing disaggregated information on
capital controls by asset category, by the direction of flows, and by the
residency status of the transactor. These data, however, are available only
for 1995–2005, a much shorter time period than that covered by our data.
III. Descriptive Statistics
The financial reform database covers a diverse range of economies, both in
terms of regions and levels of economic development. Of the 91 economies in
the data set (Table 1), 16 are from South Asia and East Asia, 17 are from
Latin America and the Caribbean, 14 are from sub-Saharan Africa, 5 are
from the Middle East or North Africa, 15 are Western European countries, 9
are former Soviet Union countries, and the rest include a few other European
countries plus Australia, Canada, New Zealand, and the United States.
The database covers a period of over 30 years, mainly from 1975 to 2005.
Summary statistics for the aggregate index and each of its component are
in Table 2. According to our somewhat subjective classification system, in
our sample period financial systems were on average most liberalized in the
areas of interest rate controls, bank entry, and financial account restrictions,
but bank supervision and regulation lagged behind.
Tables 3a and b report correlations among the seven components of the
financial liberalization index. Not surprisingly, most of the components are
highly correlated, as countries with more restrictive policies in one area have
more restrictive policies in other areas as well (Table 3, panel a). However,
annual changes in the component indices are much less correlated, suggesting
that liberalization occurred at different times for different dimensions and in
different countries (Table 3, panel b).
7
Among the highest binary correlations
are those between interest rate and credit control liberalization, between
securities markets reforms and financial account liberalization, and interest
rate deregulation and financial account. Interestingly, changes in bank
privatization have a very low correlation with the other dimensions of
reform.
The seven dimensions of financial liberalization can be aggregated to
obtain a single liberalization index for each economy in each year. In
Appendix I and in the following analysis we report and use the sum of the
individual components, after normalization of the credit control component.
8
Since each of the seven components can take values between 0 and 3, the sum
takes values between 0 and 21.
7
Similar conclusions emerge if one uses changes over three-year periods.
8
Specifically, the credit control component was normalized to take values between
0 and 3.
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
288
According to this aggregate index, financial reforms advanced
substantially through much of the sample in the past 30 years (Figure 1).
Countries in all income groups and in all regions liberalized, though higher-
income economies remained more liberalized than lower-income economies
throughout. While trends appear smooth if we consider averages of group of
Table 1. Country Coverage of the Financial Reform Database
Albania Ecuador Kenya Russia
Algeria Egypt Korea Senegal
Argentina El Salvador Kyrgyz Republic Singapore
Australia Estonia Latvia South Africa
Austria Ethiopia Lithuania Spain
Azerbaijan Finland Madagascar Sri Lanka
Bangladesh France Malaysia Sweden
Belarus Georgia Mexico Switzerland
Belgium Germany Morocco Taiwan POC
Bolivia Ghana Mozambique Tanzania
Brazil Greece Nepal Thailand
Bulgaria Guatemala Netherlands Tunisia
Burkina-Faso Hong Kong SAR New Zealand Turkey
Cameroon Hungary Nicaragua Uganda
Canada India Nigeria Ukraine
Chile Indonesia Norway United Kingdom
China Ireland Pakistan United States
Colombia Israel Paraguay Uruguay
Costa Rica Italy Peru Uzbekistan
Coˆ te d’Ivoire Jamaica Philippines Venezuela
Czech Republic Japan Poland Vietnam
Denmark Jordan Portugal Zimbabwe
Dominican Republic Kazakhstan Romania
Table 2. Summary Statistics for Financial Liberalization Components and Index
Variables
Number of
Observations Mean
Standard
Deviation Minimum Maximum
Credit controls 2671 1.591 1.111 0 3
Interest rate controls 2671 1.778 1.324 0 3
Entry barriers 2671 1.769 1.179 0 3
Bank regulation and
supervision
2671 0.776 0.958 0 3
Privatization 2671 1.248 1.187 0 3
Financial account 2671 1.668 1.135 0 3
Securities market 2671 1.490 1.129 0 3
Financial reform index 2671 10.321 6.333 0 21
Financial reform index
(normalized)
2671 0.491 0.302 0 1
A NEW DATABASE OF FINANCIAL REFORMS
289
Table 3. Correlations Among Financial Liberalization Components: Levels and Changes
Credit
Controls
Interest Rate
Controls
Entry
Barriers
Bank
Regulations Privatization
Capital
Account
Securities
Market
Panel a. Levels
Credit controls 1
Interest rate controls 0.651 1
Entry barriers 0.565 0.550 1
Bank regulations 0.608 0.590 0.565 1
Privatization 0.494 0.437 0.435 0.481 1
Capital account 0.587 0.606 0.513 0.578 0.517 1
Securities market 0.624 0.628 0.545 0.642 0.492 0.676 1
Panel b. Changes
Credit controls 1
Interest rate controls 0.148 1
Entry barriers 0.030 0.041 1
Bank regulations 0.036 0.002 0.074 1
Privatization 0.013 0.043 0.021 0.012 1
Financial account 0.096 0.106 0.089 0.028 0.069 1
Securities market 0.098 0.079 0.053 0.023 0.015 0.117 1
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
290
countries, at the individual country level the reform process was typically
characterized by long periods of status quo, or no change in policy.
To examine the pace at which change took place, we classify policy
changes for each country-year into five categories. A decrease in the financial
liberalization measure by 3 or more points is classified as a large reversal; a
decrease of 1 or 2 points as a reversal; an increase by 1 or 2 points as a
reform; and an increase of 3 or more points is classified as a large reform.
Finally, years in which no policy changes were undertaken are classified as
status quo observations.
Table 4 shows the distribution of various policy changes in the whole
sample, as well as by region. Status quo observations represent the majority
of observations—over 65 percent of the whole sample. At about 5 percent
of the observations, reversals, especially large ones, are relatively rare,
suggesting that, once established, financial reforms are unlikely to be undone.
Reforms constitute another 25 percent of the sample, and large reforms
account for another 5 percent, so around 30 percent of the sample country/
years some change occurred. This underscores how pervasive financial sector
reforms have been in recent decades.
Figure 2 shows the distribution of liberalization over the sample period.
Changes were relatively rare in the early and late part of the sample, with
most reforms concentrated in the first half of the 1990s. This reflects, in part,
reforms in transition countries, but also significant changes in Western
Figure 1. Financial Liberalization Index by Country Groups
0
3
6
9
12
15
18
21
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Full Sample
Advanced Economies
Emerging and Developing Asia
Latin America and Caribbean
Sub-Saharan Africa
Transition Economies
Middle East and North Africa
A NEW DATABASE OF FINANCIAL REFORMS
291
Europe and Latin America. After peaking in 1995, the liberalization process
began to slow down, perhaps in part because a number of countries had
essentially completed the process.
Table 4. Distribution of Financial Sector Policy Change, Full Sample and by
Country Groups
(In percent)
Full
Sample
Advanced
Economies
Emerging and
Developing
Asia
Latin America
and Caribbean
Sub-
Saharan
Africa
Transition
Economies
Middle East
and North
Africa
Large
reversal
0.50 0.14 0.25 1.65 0.45 0.00 0.00
Reversal 4.42 1.70 5.64 7.72 3.57 5.16 3.57
Status quo 65.16 73.15 63.73 59.19 70.09 45.24 69.64
Reform 24.65 20.60 27.21 24.26 21.88 39.29 22.77
Large
reform
5.27 4.40 3.18 7.17 4.02 10.32 4.02
Total 100 100 100 100 100 100 100
Figure 2. Distribution of Financial Sector Policy Changes over Time (In percent)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Large Reform Reform Status Quo Reversal Large Reversal
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
292
Individual country data show evidence of regional clustering: countries
within certain regions have tended to liberalize their financial sectors at
roughly the same time, and in roughly the same way.
9
For instance, with
the exception of early reforms in Argentina and Chile in the 1970s, most of
the reforms in Latin America occurred in the late 1980s and early 1990s. The
two exceptions, Chile and Argentina, also illustrate that reform is not a
steady march forward: both countries reversed policy during the debt crisis
of 1982–83.
The process of financial liberalization in East Asia was much more
gradual than in Latin America (Figure 1). Countries opened up their
financial sectors in small steps in the early 1980s, with the whole reform
process stretching over a decade or more in most cases. Interestingly, and in
contrast to the Latin American experience in the 1980s, the 1997 crisis in
Asia did not see any sharp reversals of reform; instead, a slight decline in the
reform index in 1997 was followed by more gradual reforms. South Asian
financial sectors remained very repressed until the mid- to late 1980s; since
then reforms have proceeded at a steady pace.
In sub-Saharan Africa, financial liberalization accelerated sharply in the
1990s, and was most intense between 1993 and 1997, even though Kenya and
Nigeria experienced policy reversals. After 1998, liberalization slowed down,
and some policy reversals occurred in Kenya, Uganda, and Zimbabwe.
The fastest episodes of financial liberalization took place in transition
countries. By 2005, these countries were more liberalized than the other
regional groupings of developing and emerging countries, though still some
distance from the advanced economies. It is an interesting question to what
extent accelerated liberalization may be related to the current financial crisis
in Eastern and Central Europe. Finally, five Organization for Economic
Cooperation and Development (OECD) countries (Canada, Germany, the
Netherlands, the United Kingdom, and the United States) already had
liberalized financial sectors at the beginning of our sample period. The rest of
the OECD countries in our sample started the period with relatively
repressed financial systems but caught up and now have largely or fully
liberalized financial sectors via a gradual process beginning in the late 1970s
and early 1980s. Only New Zealand adopted a one-shot approach,
undertaking most of its financial reforms in 1984–86.
Table 5 shows the degree of liberalization attained in each dimension of
reform in each region by the end of our sample period. Bank regulation
and privatization are the least advanced dimensions in the sample as a whole,
and also in most groupings, such as advanced economies, emerging and
developing Asia, transition economies, and the Middle East and North
Africa. In the latter region, financial account liberalization also lagged
9
Two OECD members—Korea and Mexico—are included in their regional grouping
rather than in the OECD group. The income categories are based on the grouping in the
World Bank’s 2002 World Development Indicators.
A NEW DATABASE OF FINANCIAL REFORMS
293
Table 5. Degree of Financial Liberalization by Components, Average, 2005
Full
Sample
Advanced
Economies
Emerging and
Developing Asia
Latin America and
Caribbean
Sub-Saharan
Africa
Transition
Economies
Middle East and
North Africa
Credit controls 2.374 2.784 2.154 2.191 2.304 2.292 2.286
Interest rate controls 2.725 3.000 2.615 2.765 2.429 2.611 2.857
Entry barriers 2.725 3.000 2.385 2.706 2.714 2.778 2.429
Bank Regulations 1.978 2.636 1.538 1.706 1.500 2.167 1.857
Privatization 2.000 2.409 1.231 2.000 2.357 2.111 1.143
Financial account 2.363 3.000 2.154 2.412 1.500 2.556 1.857
Securities market 2.253 3.000 2.385 1.941 1.571 2.111 2.143
Note: All components in table vary between 0 and 3.
Abdul Abiad, Enrica Detragiache, and Thierry Tressel
294
behind other reforms in 2005. Interestingly, in sub-Saharan Africa, securities
market reforms, financial account liberalization, and measures to improve
bank regulation remained behind other countries, while the liberalization of
entry barriers was quite advanced.
The evidence on reforms of supervision and regulation confirms and
complements the stylized facts described by Williamson and Mahar (1998)
for a smaller sample of countries, namely that the push for regulatory
reforms often came after the first wave of financial reforms. In our larger
sample, we find that regulatory and supervisory reforms remain relatively less
advanced even many years after the beginning of financial reforms.
IV. Conclusions
The importance of the financial sector to growth and development is now
well established. Numerous studies, using various methodologies, have found
evidence that greater financial sector development has a positive causal
impact on key macroeconomic variables such as growth, productivity, and
even poverty. What is less clear from existing research, however, is how best
to achieve financial sector development and, more specifically, to what extent
financial sector policies can foster financial development. To answer this
important question, we have assembled a large cross-country data set on
financial sector policies, covering 91 countries over the 1973–2005 period.
The multifaceted and graded measure can be used to empirically investigate
the effects of reform on financial sector outcomes, such as increased financial
intermediation and improved allocative efficiency, and on macroeconomic
outcomes such as growth, productivity, and crisis vulnerability. The hope is
that this database, and the additional research it generates, can help provide
more concrete policy prescriptions that can deliver the gains associated with
financial sector development.
APPENDIX 1
Coding Rules for the Financial Liberalization Index
10
To construct an index of financial liberalization, codes were assigned along the eight
dimensions below. Each dimension has various subdimensions. Based on the score for
each subdimension, each dimension receives a ‘‘raw score.’’ The explanations for each
subdimension below indicate how to assign the raw score.
After a raw score is assigned, it is normalized to a 0–3 scale. The normalization is done
on the basis of the classifications listed below for each dimension. That is, fully
liberalized ¼3; partially liberalized ¼2; partially repressed ¼1; fully repressed ¼0.
10
This appendix was prepared by Kruti Barucha. The coding rules used in the index
follow closely those of Omori (2004), which extend the approach developed by Abiad and
Mody (2005). The main departure from Omori’s coding is the introduction of a new category
covering for restrictions on the quantity of credit.
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295
The final scores are used to compute an aggregate index for each country/year by
assigning equal weight to each dimension.
For example, if the raw score on credit controls and reserve requirements totals 4
(by assigning a code of 2 for liberal reserve requirements, 1 for lack of directed credit
and 1 for lack of subsidized directed credit), this is equivalent to the definition of fully
liberalized. So, the normalization would assign a score of 3 on the 0–3 scale.
Credit Controls and Reserve Requirements
1. Are reserve requirements restrictive?
Coded as 0 if reserve requirement is more than 20 percent.
Coded as 1 if reserve requirements are reduced to 10 to 20 percent or complicated
regulations to set reserve requirements are simplified as a step toward reducing
reserve requirements.
Coded as 2 if reserve requirements are less than 10 percent.
2. Are there minimum amounts of credit that must be channeled to certain sectors?
Coded as 0 if credit allocations are determined by the central bank or mandatory
credit allocations to certain sectors exist.
Coded as 1 if mandatory credit allocations to certain sectors are eliminated or do
not exist.
3. Are there any credits supplied to certain sectors at subsidized rates?
Coded as 0 when banks have to supply credits at subsidized rates to certain
sectors.
Coded as 1 when the mandatory requirement of credit allocation at subsidized
rates is eliminated or banks do not have to supply credits at subsidized rates.
These three questions’ scores are summed as follows: fully liberalized ¼4, largely
liberalized ¼3, partially repressed ¼1 or 2, and fully repressed ¼0.
4. Are there any aggregate credit ceilings?
Coded as 0 if ceilings on expansion of bank credit are in place. This includes
bank-specific credit ceilings imposed by the central bank.
Coded as 1 if no restrictions exist on the expansion of bank credit.
The final subindex is a weighted average of the sum of the first three categories (with a
weigh of 3
4), and of the last category (with a weigh of ¼).
Interest Rate Liberalization
Deposit rates and lending rates are separately considered, in coding this measure, in order
to look at the type of regulations for each set of rates. They are coded as being
government set or subject to a binding ceiling or floor (code ¼0), fluctuating within a
band (code ¼1) or freely floating (code ¼2). The coding is based on the matrix in
Table A1.
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Banking Sector Entry
1. To what extent does the government allow foreign banks to enter into a
domestic market?
This question is coded to examine whether a country allows the entry of foreign
banks into a domestic market; whether branching restrictions of foreign banks are
eased; to what degree the equity ownership of domestic banks by nonresidents is
allowed.
Coded as 0 when no entry of foreign banks is allowed; or tight restrictions on the
opening of new foreign banks are in place.
Coded as 1 when foreign bank entry is allowed, but nonresidents must hold less
than 50 percent equity share.
Coded as 2 when the majority of share of equity ownership of domestic banks by
nonresidents is allowed; or equal treatment is ensured for both foreign banks
and domestic banks; or an unlimited number of branching is allowed for foreign
banks.
2. Does the government allow the entry of new domestic banks?
Coded as 0 when the entry of new domestic banks is not allowed or strictly
regulated.
Coded as 1 when the entry of new domestic banks or other financial institutions is
allowed into the domestic market.
3. Are there restrictions on branching?
Coded as 0 when branching restrictions are in place.
Coded as 1 when there are no branching restrictions or if restrictions are eased.
4. Does the government allow banks to engage in a wide rage of activities?
Coded as 0 when the range of activities that banks can take consists of only
banking activities.
Coded as 1 when banks are allowed to become universal banks.
These four questions’ scores are summed as follows: fully liberalized ¼4 or 5, largely
liberalized ¼3, partially repressed ¼1 or 2, and fully repressed ¼0.
Table A1. Coding Matrix for Interest Rate Liberalization
Deposit Rates
Lending Rates 0 1 2
0FRPRPR
1PRPRLL
2PRLLFL
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Financial Account Transactions
1. Is the exchange rate system unified?
Coded as 0 when a special exchange rate regime for either capital or current
account transactions exists.
Coded as 1 when the exchange rate system is unified.
2. Does a country set restrictions on capital inflow?
Coded as 0 when restrictions exist on capital inflows.
Coded as 1 when banks are allowed to borrow from abroad freely without
restrictions and there are no tight restrictions on other capital inflows.
3. Does a country set restrictions on capital outflow?
Coded as 0 when restrictions exist on capital outflows.
Coded as 1 when capital outflows are allowed to flow freely or with minimal
approval restrictions.
These three questions’ scores are summed as follows: fully liberalized ¼3, largely
liberalized ¼2, partially repressed ¼1, and fully repressed ¼0.
Privatization
Privatization of banks is coded as follows:
Fully liberalized if no state banks exist or state-owned banks do not consist of any
significant portion of banks and/or the percentage of public bank assets is less
than 10 percent.
Largely liberalized if most banks are privately owned and/or the percentage of
public bank assets is from 10 to 25 percent.
Partially repressed if many banks are privately owned but major banks are still
state-owned and/or the percentage of public bank assets is 25 to 50 percent.
Fully repressed if major banks are all-state owned banks and/or the percentage of
public bank assets is from 50 to 100 percent.
Securities Markets
1. Has a country taken measures to develop securities markets?
Coded as 0 if a securities market does not exist.
Coded as 1 when a securities market is starting to form with the introduction of
auctioning of treasury bills or the establishment of a security commission.
Coded as 2 when further measures have been taken to develop securities markets
(tax exemptions, introduction of medium and long-term government bonds in
order to build the benchmark of a yield curve, policies to develop corporate bond
and equity markets, or the introduction of a primary dealer system to develop
government security markets).
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Coded as 3 when further policy measures have been taken to develop derivative
markets or to broaden the institutional investor base by deregulating portfolio
investments and pension funds, or completing the full deregulation of stock
exchanges.
2. Is a country’s equity market open to foreign investors?
Coded as 0 if no foreign equity ownership is allowed.
Coded as 1 when foreign equity ownership is allowed but there is less than
50 percent foreign ownership.
Coded as 2 when a majority equity share of foreign ownership is allowed.
These two questions’ scores are summed as follows: fully liberalized ¼4 or 5, largely
liberalized ¼3, partially repressed ¼1 or 2, and fully repressed ¼0. If information on the
second subdimension was not available (which was the case for some low-income
countries), the measure was coded using information on securities market development. If
information on securities markets only was considered, a 0–3 scale was assigned based on
the score on securities markets.
Banking Sector Supervision
1. Has a country adopted a capital adequacy ratio based on the Basel standard? (0/1)
Coded as 0 if the Basel risk-weighted capital adequacy ratio is not implemented.
Date of implementation is important, in terms of passing legislation to enforce the
Basel requirement of 8 percent capital adequacy ratio (CAR).
Coded as 1 when Basel CAR is in force. (Note: If the large majority of banks meet
the prudential requirement of an 8 percent risk-weighted capital adequacy ratio,
but this is not a mandatory ratio as in Basel, the measure is still classified as 1.)
Prior to 1993, when the Basel regulations were not in place internationally, this
measure takes the value of 0.
2. Is the banking supervisory agency independent from executives’ influence? (0/1/2)
A banking supervisory agency’s independence is ensured when the banking
supervisory agency can resolve banks’ problems without delays. Delays are often
caused by the lack of autonomy of the banking supervisory agency, which is
caused by political interference. For example, when the banking supervisory
agency has to obtain approval from different agencies such as the ministry of
finance in revoking or suspending licenses of banks or liquidating banks’ assets,
or when the ultimate jurisdiction of the banking supervisory agency is the
ministry of finance, it often causes delays in resolving banking problems.
In addition to the independence from political interference, the banking
supervisory agency also has to be given enough power to resolve banks’ problems
promptly.
11
11
According to Omori (2004, p. 13): ‘‘Quintyn and Taylor (2002) categorize the
independence of banking supervisory agencies into four: regulatory independence, supervisory
independence, institutional independence, and budgetary independence. In this dataset,
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299
Coded as 0 when the banking supervisory agency does not have an adequate legal
framework to promptly intervene in banks’ activities; and/or when there is the
lack of legal framework for the independence of the supervisory agency such as
the appointment and removal of the head of the banking supervisory agency; or
the ultimate jurisdiction of the banking supervision is under the ministry of
finance; or when a frequent turnover of the head of the supervisory agency is
experienced.
Coded as 1 when the objective supervisory agency is clearly defined and an
adequate legal framework to resolve banking problems is provided (the
revocation and the suspension of authorization of banks, liquidation of
banks, and the removal of banks’ executives, and so on) but potential problems
remain concerning the independence of the banking supervisory agency
(for example, when the ministry of finance may intervene into the banking
supervision in such as case that the board of the banking supervisory agency
board is chaired by the ministry of finance, although the fixed term of the
board is ensured by law); or although clear legal objectives and legal
independence are observed, the adequate legal framework for resolving
problems is not well articulated.
Coded as 2 when a legal framework for the objectives and the resolution of
troubled banks is set up and if the banking supervisory agency is legally
independent from the executive branch and actually not interfered with by the
executive branch.
3. Does a banking supervisory agency conduct effective supervisions through on-site and
off-site examinations? (0/1/2)
Conducting on-site and off-site examinations of banks is an important way to
monitor banks’ balance sheets.
Coded as 0 when a country has no legal framework and practices of on-site and
off-site examinations is not provided or when no on-site and off-site examinations
are conducted.
Coded as 1 when the legal framework of on-site and off-site examinations is set up
and the banking supervision agency have conducted examinations but in an
ineffective or insufficient manner.
Coded as 2 when the banking supervisory agency conducts effective and
sophisticated examinations.
independence is measured by combining institutional independence and supervisory
independence. In the case of central bank independence, a legal framework of a central
bank for developed countries and/or the frequency of turnover of governor of the central bank
for developing countries are often used indicators. However, as discussed above, since the
banking supervisory agency is not necessarily vested in the central bank, legal documents for
banking supervision are less available and obtaining the information for counting the
frequency of the turnover of the head of the banking supervisory agency is much more
difficult. In this vein, we basically relied on experts or researchers’ evaluation in coding the
independence of the banking supervisory agency. Lora (1997) also created the indicator based
on subjective judgment of the quality of banking supervision.’’
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4. Does a country’s banking supervisory agency cover all financial institutions
without exception? (0/1)
If some kinds of banks are not exclusively supervised by the banking
supervisory agency or if offshore intermediaries of banks are excluded
from the supervision, the effectiveness of the banking supervision is
seriously undermined.
Coded as 1 when all banks are under supervision by supervisory agencies without
exception.
Coded as 0 if some kind of financial institutions are not exclusively supervised by
the banking supervisory agency or are excluded from banking supervisory agency
oversight.
These questions’ scores are summed as follows: highly regulated ¼6, largely regulated ¼4
or 5, less regulated ¼2 or 3, not regulated ¼0or1.
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