Summary :

Our project is organized as follow. First, we assess the development of the MENA financial sector and we compare it to this of European Accession Countries. The second part is devoted to covering the relationship between the financial sector and economic growth in the MENA world and the main factors that determine the financial sectors in 12 MENA countries during the period 1960-2006. The part 3, examined the effect of financial intermediary development on economic and productivity growth. The last part is concerned by the linkage between financial development and poverty alleviation with a special focus on the MENA region.

To sum up, we present our main results:

Part 1: Financial development in MENA region, in contrast to Eastern Europe

Using the narrower measures of financial depth , the results of the first section demonstrate that in the last decade MENA countries have relatively a well developed financial system compared with the European Accession countries.

Over the last few decade most of the MENA countries have engaged in implementing economic reform and structural adjustment programs. The financial sector is no exception and much progress has been made, with many countries beginning comprehensive reforms at the beginning of the 1990s. European Accession countries have also come a long way in terms of financial development since the early 1990s.

The indicators of the overall size of financial system have showed that MENA countries have relatively a well developed financial system compared with Accession European countries. However, since 2004 a reversed trend has been observed in the evolution of the both domestic credit provided by banking sector and the domestic credit to private sector to GDP ratios. For example, since 2005 the European Accession countries ratio of the domestic credit provided to banking sector has exceeded this in MENA countries by around 7%. These indicators have also showed that while European Accession countries have a comparable level of financial development, the financial development level differs significantly across MENA countries.

Using the interest rate spread as indicator of financial system efficiency, we have found that MENA countries have the more stable financial system. However, the European Accession countries have showed an important efficiency gains. Thus, since 2000 the European Accession countries efficiency has exceeded this in MENA countries.

In examining the banking sector issues in more details in MENA versus European Accession countries banking sector our main findings show that while the development of banking sector has grown much faster in European Accession countries, MENA countries remain to have the more developed banking sector. In fact, both deposit money bank assets and bank deposit to GDP ratios are the highest in MENA countries. When we consider the private credit, MENA countries show also a more developed banking system.  In term of efficiency, MENA countries have also the more efficient banking system.

The evolution of the indicator of stock market size show that the European Accession stock markets remain very small compared with these in MENA countries. In 2006, the market capitalization to GDP ratio is around 73% and 25% in MENA and European countries respectively.  Similarly, to stock market size, MENA countries present relatively the more liquid stock markets.

In contrast to other financial sub-sector, the evolution of the two indicators of the insurance industry development over the last decade shows that MENA countries have the less developed insurance industry compared with European accession countries. Although the indicators of insurance development have risen in both MENA and Accession European countries, the insurance industry remains very weak in the two regions.

Finally, we have found that MENA countries have relatively the less developed institutional environment compared with European Accession countries. In fact, MENA countries have the lowest scores of rule of law and corruption and the lowest protection of property rights.

Part 2: What drives financial sector development in the MENA region?

The study has considered determinants of financial sector development in the MENA region. Four indicators of financial development are under consideration: banks’ indicators (liquid liabilities and credit to the private sector) and non-bank indicators (the size of the stock market and its depth). The determinants under consideration include macroeconomic fundamentals (real growth, price inflation, savings, investment, trade openness, and financial liberalization), a fiscal policy indicator (government consumption) and institutional quality indicators (bureaucracy, corruption, and democratic accountability).

In general, growth does not promote banking activity; it promotes development of the stock market. The difference indicates the underdevelopment of the banking system in MENA countries, implying limited efforts to press ahead with further development in response to higher growth. In contrast, a surge in stock market activity has been responsive to higher economic activity that creates opportunities for financial diversification in light of the underdevelopment of the banking system.

Another major difference between bank and non-bank development relates to the role of inflation, which discourages banking activity as agents fear the effect of inflation on the value of liquid assets in the banking system. Alternatively, agents seek more risky opportunities in the stock market as they may perceive potential return as an opportunity to hedge against the risk of higher inflation.

Apparently, the bulk of savings is absorbed outside the banking sector and the stock market. Various development indicators respond negatively to higher savings, implying more attractive opportunities in real estate and other physical assets. The effects of investment are in sharp contrast between bank and non-bank financial development. Higher investment mobilizes resources in the banking sector with positive effects on development indicators. In contrast, investment growth diverts resources away from stock market development.

The impact of trade openness is robust on indicators of bank and non-bank financial development. Across various specifications, openness promotes financial activity in support of more trade integration. Similarly, financial liberalization increases inflows that contribute to further financial development.

Higher government spending crowds out private activity, which hinders financial development. Institutional quality, particularly rule of law, promotes financial development by signalling confidence in the quality of the legal system in support of economic activity.

Overall, the results send strong signals regarding the role of macroeconomic fundamentals and institutional quality in promoting financial sector development. Bank and non-bank sectors appear, in general, complementary with respect to various determinants, necessitating parallel tracks in both sectors to maximize the value added of financial development on economic activity. A more developed financial system would support further growth, promoting even larger and deeper financial sector.

Part 3: The impact of financial sector development on Economic and total factor productivity growth

This project examined the effect of financial intermediary development on economic and productivity growth. We used three econometric approaches. The first, GMM in system dynamic panel estimators, are well designed to correct all the drawbacks of previous studies on finance and growth nexus: simultaneity and omitted variable bias. As a consistency check we use Pooled Mean Group and Mean Group estimators to control for the presence of business cycle. Further, we controlled for business cycle by using 5 year mean variable, we introduced capital market variables to have a complete picture of financial sector development and we excluded MENA oil countries to preserve homogeneity for our estimators.

To sum up, it seems that financial sector development and especially Credit to Private Sector by banks in the MENA region slow economic and total factor productivity growth. It means that reforms should be implemented in the banking sector in order to invert the impact. Additionally, stock markets in the MENA region are not sufficiently developed to positively impact growth and productivity. Therefore, reforms are needed to enable capital market to be growth conducive in the MENA region. Finally, the reduction of inflation and a reinforcement of trade openness are key elements to spur economic and productivity growth in the region.

Part 4: The Impact of Financial Sector Development on Inequality and Poverty: Evidence from MENA Region

The purpose of the study is to examine the linkage between financial development and poverty alleviation with a special focus on the MENA region. Although many empirical works highlight that financial development boost the growth rate of per capita GDP, this finding does not necessary imply that financial development helps the poor and reduces inequality. While data limitation presents a major hurdle, such conflicting predictions seem to hold in MENA countries where there is little evidence that greater financial development is associated with poverty alleviation. Future work needs to examine the linkages between particular policies toward better governance, financial development and poverty alleviation in the MENA region.