To Liberate or to Regulate: The Balanced Approach to Financial System Transformation in Developing Countries (original) (raw)

Financial system mobilises savings and allocates loans as well as stimulating new investments that support economic growth, while the regulatory framework sets the rules and controls activities within the system, providing stability for investors. However, inflexible rules and regulations tend to slow down the economic progress, making a developing country less attractive for new investors, and closed to financial innovations. Developing countries with predominantly bank-oriented financial systems and lacking market depth are not attractive to new investors. Maintaining status quo in these conditions means further economic deterioration and reduced chances for success. Thus, it is essential that developing countries consider steps towards financial liberalization or deregulation, which will help open the borders for capital flows and attract new investments and ideas. Deregulating steps can involve changes to interest rates determination, restructuring of financial institutions, abolishment of direct loans allocation practices, promotion of prudential regulation, establishment of new banks/multi-facets financial institutions, etc. Deregulation affects all sectors of the economy, i.e. increased savings bring new investments, directly contributing to higher production and employment growth, spreading the tax burden to a larger group, and enabling further savings and investments. However, financial deregulation does not guaranty quick economic growth for developing countries because changing financial rules could motivate the domestic capital going abroad, increased volatility can create serious challenges for banks, while overly relaxed rules can make investors nervous. The key to success is in determining the appropriate balance between the level of financial liberalization and sufficiently flexible and effective regulatory framework that will support economic growth and maintain investor confidence. The main goal of this paper is to analyse and critique the process of financial liberalization in developing countries and to motivate the policy makers to consider available lessons when creating their balanced approach to financial liberalization and regulation processes towards financial development, openness, and integration in the global financial landscape. Keywords: financial liberalization, financial regulation, economic development, developing countries