Academic journal article Journal of Global Business and Technology

Key Drivers for Soundness of the Banking Sector: Lessons for Developing Countries

Academic journal article Journal of Global Business and Technology

Key Drivers for Soundness of the Banking Sector: Lessons for Developing Countries

Article excerpt

ABSTRACT

Soundness of banks is important for the economic development of a country. In this paper we empirically examine the impact of key factors such as Infrastructure (ICT infrastructure), Intellectual Capital, Institutions, Integrity (Governance), Interaction (Strategic Partnership) and Innovation (henceforth will be referred to as the6I's) on the soundness of the banks in developed, developing and under-developed countries. The study was conducted for the year 2004. The empirical results showed the developments of the 6I's in developing and underdeveloped countries were significantly lower than that in developed countries. The study also showed that well developed institutions, good integrity system and high innovative capacity contribute positively to the soundness of the banks. Key policies and strategies to facilitate the banking sector in developing and under-developed countries to leapfrog to higher stages of financial soundness are discussed in this paper.

INTRODUCTION

The banking sector is an integral part of the economy. Hence this sector plays a key role in the wellbeing of the economy. A weak banking sector not only jeopardizes the long-term sustainability of an economy, it can also be a trigger for a financial crisis which can lead to economic crises. As such developing countries should take cognition of the lessons learned from the financial crisis that plagued the Nordic countries in the early 1990s, Mexico in 1994, the Asian financial crisis in 1997-98, Russia in 1998 and Argentina in the year 2001 among others, which had an impact on the stability of the financial systems. In most of these cases the crises had left an impact on the credit portfolios of many countries and had caused a slow down in the economic activities in these countries with a contagion effect on countries in the region. The adverse outcomes of weak financial systems and their impact on economic well-being brought about renewed interest within the international financial community.

Most studies have argued that the financial sector is vital for the socioeconomic development of a country. For example studies by De Gregario and Guidotti (1995), Levine and Zervos (1998), Rousseau and Wachtel (1998), Beck et.al. (2000) and Levine (2003) among others, suggests that a well developed and sound financial system can contribute significantly to economic growth by recognizing the important role financial intermediaries play in bridging the disequilibrium between savings and investment needs within an economy. These authors argued that economic growth can be sustained only if scarce resources are mobilized efficiently and transformed effectively into productive investments and this function is efficiently conducted by the financial intermediaries. Most of these studies were conducted for developed countries where significant reforms were undertaken over the last two decades to enhance the efficiency and competition of the financial sector. While the financial sector is a key catalyst for sustainable development of a country, much of the developing and under-developed countries are grappling to keep up with the forces of globalization and liberalization that are transforming the global financial architecture.

The primary objective of this paper is to examine the key drivers for enhancing the soundness of the banking sector. This study will use a general framework to assess key factors such as Infrastructure, Intellectual Capital, Institutions, Integrity, Interaction and Innovation on the soundness of the banking sector. This study is different from other studies in the literature in that it incorporates a broader set of factors that enhances the soundness of the banking ecosystem. From the empirical analysis, to advocate information, key policies and strategies to enhance the soundness in the banking sector to the developing and the less developed countries so as to 'catch up' with the developed nations.

The rest of this paper is organized as follows. …

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