Academic journal article International Journal of Business and Management Science

Financial Liberalization and Banking Fragility within Tunisian Financial Sector

Academic journal article International Journal of Business and Management Science

Financial Liberalization and Banking Fragility within Tunisian Financial Sector

Article excerpt

INTRODUCTION

Since independence Tunisia engaged in developing a more efficient production system through several economic development plans. Until the mid 80's, the Tunisian economy was heavily state regulated affecting the financial system with more control. The scope for manoeuvre was narrow as the products which they were authorized to offer, interest rates, credit management as well as core banking policies were directed by the Central Bank of Tunisia. As a result, a competitive banking sector was absent in the economy. In 1986, with the support of the International Monetary Fund, Tunisia had undertaken a Structural Adjustment Plan, aimed a re-orientation of the economic policies towards the substitution of a state regulation mechanism by a market regulation one, and a greater participation of the private sector in the economic activity. A liberalization process was then launched.

The banking system liberalization strategy in Tunisia was implemented more effectively since 1986 and also reinforced in the mid 90's. The change was perceived by the monetary authorities as a strategic choice to increase the capacity of the financial system by mobilizing savings to finance the productive investments. Furthermore, the liberalization attempt was expected to create competitive business environment within the sector. It should be noted that the financial liberalization process was done in concomitance with the liberalization of the exchange transactions. Indeed, Tunisia had issued the current convertibility of the Tunisian Dinar in December 1992.

Tunisia was not a separate case in this financial liberalizing process. In fact, in the last three decades, many developed and developing countries moved towards a liberalized financial system (the United States and the United Kingdom in the mid 70's, Latin American countries such as Argentina, Chile, Uruguay towards the end of the 70's, and the southern Asian countries such as South Korea and Taiwan at the beginning of 80's.). They reduced government intervention in credit allocation decisions, lifted bank interest rates ceilings, lowered reserve requirement and entry barriers, and privatized many banks and insurance companies. Also, countries liberalizing their financial system have often developed their local stock markets and encouraged the entry of foreign financial intermediaries (Khatkhate, 1998). However, the multiplication of banking crises which struck many of the developing countries and emerging market economies during the 90's, launched a new debate on the advantages and the risks of financial liberalization (Diaz-Alejandro, 1985; Demirguc-Kunt and Detragiache, 1998). It was argued that a premature and badly controlled financial liberalization is one of the major factors behind the rise of the financial instability and the banking fragility in these countries.

Before the financial deregulation, the lack of competition is regarded as one of the main features of the banking sector in these countries. This sector was state supported to the restrictive entry barriers in the banking industry. Once financial sector liberalized, banks will be in a situation characterized primarily by the free entry to the banking industry. In the same way, in this new environment, interest rates will be only determined by demand and supply. Financial liberalization thus implies a radical change in the rules according to which banks operate. This change of financial institutions' framework combined with the lack of banking supervision is behind the appearance of new practices on behalf of the banks. Indeed, the creation of new financial markets and the entry of new national and foreign financial institutions resulted in a greater competition and a more risky activities aiming to increase profits.

Historically, the concept of financial liberalization emerges when McKinnon (1973) and Shaw (1973) presented their thesis in which they criticized the situation of financial repression and suggested liberalization as solution for the developing countries to carry out a durable economic growth. …

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