Expanding Financial Sectors in Low-Income Countries

Financial sector development can help foster sustainability, spur growth

Paper assesses scope for sustainably "deepening" financial systems

Pilot studies to be conducted to inform IMF policy advice

The paper, which also discusses the types of policies that can help promote “healthy” financial sector development, says low-income countries should promote “financial deepening” to underpin economic growth and improve living standards.

Financial deepening refers to the process of enhancing and broadening financial systems by increasing the depth, liquidity, efficiency, and volumes of financial institutions and markets, diversifying domestic sources of finance, and extending access to banking and other financial services.

Part of the IMF’s efforts to strengthen its overall financial sector monitoring—or financial surveillance—in member countries, the paper highlights the linkages between financial deepening, macroeconomic policy effectiveness, and stability in low-income countries.

“There are important linkages between the degree of financial depth and the effectiveness of a country’s macroeconomic policies. This paper is an important first step in systematically highlighting these linkages,” said IMF Deputy Managing Director Min Zhu. “I am hoping that our bilateral surveillance in low-income countries will increasingly focus on these linkages to help countries better manage volatility and achieve strong durable growth.”

Many still excluded

Access to financial systems in low-income countries has broadened over the past two decades, with more people using banks, for example, but they remain small and relatively undiversified, with large segments of the population often excluded from formal financial services.

The paper points out that shallow financial systems limit fiscal, monetary, and exchange rate policy choices, and impede opportunities for hedging or diversifying risk, which are helpful in coping with sharp swings in commodity prices and fluctuations in external financing.

Promoting sustainable financial deepening can engender greater resilience and capacity to cope with external shocks, enhance policy effectiveness, and support sustained growth.

At the same time, the process of deepening itself can create new risks—such as those that arise from growing financial interconnectedness or the challenges from unregulated financial innovation—which need to be effectively managed.

Challenges for deepening

The paper attempts to assess...