Banking and Financial Structure: An efficient and sound financial structure is critical for growth and development. An economy’s financial system intermediates between savers and investors and helps allocate and discipline capital. The financial system also is the conduit for monetary policy, which affects the overall level of macroeconomic activity in the economy. Research makes clear that finance and deve lopment go hand in hand, particularly when the legal environment is clear. A deeper financial system populated with a variety of bank and non-bank financial institutions is both associated with and leads to higher levels of income.
This type of financial environment is also more resilient to downturns and economic volatility. 10 Competition, both from home and from abroad, increases the range of financial activities and improves the disciplining role of the financial market in allocating capital. Evidence suggests that domestic financial institutions do remain active in the home marketplace even when that market is opened to foreign competition because of their unique knowledge of the domestic marketplace. 11 Thus, liberalization to allow foreign competition does not eliminate the domestic financial sector but instead often enhances the range of financial services and price and performance of service providers.
Because of the pivotal role in the whole economy played by a robust financial sector, policymakers should want to avoid policies that protect poorly run domestic financial sectors which will operate at the expense of the whole economy. With the New Economy, performance of banks and other financial institutions and the financial skills of the people in these institutions are key. Allocating capital to new ventures, cutting-off capital to activities that are no longer viable, and working with businesses to transform their operations to make them viable requires both technology and people.
Moreover, financial institutions have to be well supervised, resilient in the face of change, and able to see new opportunities as they arise. The networked ICTs of the New Economy can create databases of information and best practice, but knowledgeable people are needed to analyze and interpret this information. But don’t stop the chain of reasoning there—the overall policy environment must support these bankers and financiers as they act on the information to make loans and take risks on new ventures. Thus, the synergies among the four policy domains.
12 10 Beck, Thorsten, Ross Levine, and Norman Loayza (1999) “Finance and the Sources of Growth,” Policy Research Working Paper 2057, Washington: World Bank . Levine, Ross, Norman Loayza and Thorsten Beck (1999) “Financial Intermediation and Growth: Causality and Causes,” Policy Research Working Paper 2059, Washington: World Bank and World Bank, Finance for Growth: Policy Choices in a Volatile World, A Policy Research Report. 11 Demiruc-Kunt, Asli and Ross Levine (1999) “Bank based and Market based Financial Systems: Cross Country Comparisons. Policy Research Working Paper 2143. Washington: World Bank.
12 Notably for some of the APEC members, it is not enough to simply fix the existing “bad-loan problem” at domestic institutions. People must be trained to spot new ventures that will turn into profitable business for the financial institutions. These risk takers must be allowed to make those bets. For more discussion of the difference between writing off bad loans and making good new loans, and the skills and institutional structure that is needed, see Catherine L. Mann (2000) “Korea and the Brave New World of Finance,” Joint US-Korea Academic Studies, vol 10, pp. 55-68. - 17-