Academic journal article Journal of Economic Cooperation & Development

Does Financial Deepening Spur the Economic Growth? Evidence from Bosnia and Herzegovina

Academic journal article Journal of Economic Cooperation & Development

Does Financial Deepening Spur the Economic Growth? Evidence from Bosnia and Herzegovina

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The establishment of a stable market environment for financial institutions in Bosnia and Herzegovina (B&H) has a fundamental importance in terms of the transition of this country from a centrally planned towards market-oriented economy. In recent years, this transition process has been characterized by a substantial progress in strengthening the resilience of the banking sector and opening a new dimension in terms of improvement of its potential.

In the era of transition, B&H has restructured its financial system and established a new framework of financial markets, in a profound and lasting manner. In its nature, the financial market of B&H is viewed as; shallow and underdeveloped, with a high concentration of the banking sector. As a small country with a small market size, with the poor level of coordination among different government and institution levels, the B&H also has some problems with the existence of well-functioning financial markets. At the same time, infant capital market and its segments, in particular, equity markets and corporate bond markets, generally, have not been developed. The strong credit expansion and credit contraction in B&H in pre-crisis times was the result of financial deepening and restructuring of the financial system.

Moreover, the process of acceleration of financial consolidation was intensified through different tendencies; such as: deregulation, privatization and entry of foreign banks. The process of privatization and sound reforms of the banking sector aimed at overcoming the debt problem. These activities accumulated in the past and resulted in the elimination of the most vulnerable segments of the banking sector. Accordingly, it should be noted that the number of banks was significantly reduced from 1997 (when first post data appeared). A transition to the new era of market oriented commercial banking was marked by the processes of mergers, acquisitions and consolidations of banks, where the number of commercial banks has declined from 76 (in 1997) to 28 banks (in 2012). The analysis of the financial depth (measured as the ratio of M2 to GDP) and financial intermediation (measured as the ratio of private credits to GDP) ratio over a given time period (shown in figure 1) implies some positive trends in the banking industry in B&H.

As shown in the Figure 1, in 2007, the share of commercial banks' activities in financial intermediation was well over 89% of GDP, thus, performing an important function in the financial system of B&H. A further feature of the development of the domestic banking sector is represented in the enhanced role of bank-based financial intermediation. Figure 1 gives an overview of some indicators, as the share of assets, loans and deposits in GDP of B&H.

As illustrated in Figure 1, financial intermediation, measured by banks' assets to % of GDP, has shown a marked increase from 2000 (e.g. 30.6% of GDP) to 2007 (e.g. 89.6% of GDP). Adverse effects of the global financial crisis translated into reduction of financial intermediation of banks and its slight decline to 80.4% of GDP (2012). During the initial period, the growth of the deposit funding base of banking sector (i.e. as measured as % of bank deposits to GDP) caused the growth of banks' private credits. The total deposits held by banking sector have almost tripled between 2000 and 2007. Meanwhile, by the end of 2012, the share of deposits to GDP reached 50.6 percent, while the share of banks' private credits to GDP reached 56.7 percent. It must be noted that the ratio of private credits to GDP measured at 24% in B&FI has crossed the threshold of underdeveloped countries (measured at 20%), in 2001. The share of banks' loans in the total loans to the private sector was slightly above 50%, indicating insufficient development of the financial market. While banks' deposits to GDP ratio reached a historical peak of 59. …

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