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

Abstract:

In this paper we assess and measure the effect of financial liberalization on the Tunisian bank's risk exposure. Our objective is to compute the probability of banking failure. Firstly, we analyze the financial liberalization process and the mechanisms through which financial deregulation may increase banking sector fragility. Secondly, we present an overview of the Tunisian banking sector before and after financial liberalization reforms. Finally, we consider a model to assess the interaction between financial liberalization process and the probability of Tunisian's banks failure. Estimation exercises shows that the increase in loans supply in Tunisian banks is positively correlated to the probability of banking failure. Furthermore, the financial liberalization increases the banking deposits, which are negatively correlated to the probability of banking failure. Our results provide strong evidence of negative relationship between return on banking assets and the probability of failure.

Key words: Financial liberalization, banking fragility, risk exposure, Tunisia

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; Demirgüc-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. …

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