Tài liệu Notes on Financial Liberalization 1

Notes on Financial Liberalization 1



E. Murat Ucer


Financial liberalization has come to be most commonly associated with interest rate
liberalization, although it comprises a much broader set of measures including those
pertaining to the banking sector, the external sector, and the institutional framework of
monetary policy. The purpose of this note is to provide a background on issues surrounding
financial liberalization and guide the reader through this very broad topic. The note comprises
five sections. The first section provides a conceptual background to the early themes as well
as the scope of financial liberalization. The second section reviews the record with financial
liberalization. Early record has been disappointing in terms of its strong association with very
high real interest rates and banking crises. However, the econometric evidence on the link
between finance and growth is favorable, suggesting that financial development, as has been
originally advocated, indeed helps growth. The conciliatory view, which is discussed in the
third section, is that while financial liberalization does benefit countries, countries need to be
careful with a number of “initial conditions” as well as “sequencing issues” prior to full
liberalization. The fourth section is devoted to some specific aspects of the experience of
Turkey with financial reform. A final section offers some concluding remarks.


I. On the Concepts: Financial Liberalization, Repression, Deepening, Reform, etc.


Financial liberalization is the process of breaking away from a state offinancial repression.
As financial repression has been most commonly associated with government fixing of
interest rates and its adverse consequences on the financial sector as well as on the economy,
financial liberalization, in turn, has come to be most commonly associated with freeing of
interest rates. This is pretty much the old view. We now understand financial liberalization as
a process involving a much broader set of measures geared toward the elimination of various
restrictions on the financial sector, such as the removal of portfolio restrictions on the banking
sector, the reform of the external sector, as well as changes in the institutional framework of
monetary policy. This section develops these issues.


Financial repression, by-now a classic phrase, originated in the works of Ronald I.
McKinnon and Edward S. Shaw in the early 1970s, to describe a developing country
environment whereby “the financial system is repressed (kept small) by a series of
government interventions that have the effect of keeping very low (and often at negative
levels) interest rates that domestic banks can offer to savers” (p.152 , Agenor and Montiel,
1996); the most common forms that these interventions would take were interest rate
regulations, directed credit schemes, and high reserve ratios.


The main motive behind financial repression is fiscal. The government wishes to promote
development, but lacks the resources to do so. Through imposition of large liquidity and
reserve requirements, it creates a captive demand for its own interest bearing or non-interest
bearing instruments, respectively, and uses it to finance its own priority spending (p.152 ,
Agenor and Montiel, 1996). It puts a cap on rates, which creates excess credit demand, and
directs credit to its own priority sectors. An additional means for financial repression involves
limiting the menu of instruments that the public can hold (e.g., foreign exchange deposits) in
order to ensure greater “seigniorage” revenue.3


1 Background notes prepared for an EDI seminar on “Macroeconomic Management: New Methods and


Current Policy Issues” held in Nairobi, Kenya and Ankara, Turkey.
2 Murat Ucer was Adjunct Faculty, Center for Economics and Econometrics, and Economics


Department, Bogazici University and Advisor, Yapi Kredi Bank, Istanbul, Turkey when these notes
were prepared. He is now an economist with Credit Suisse First Boston, Istanbul Office.
3 Seigniorage is government revenue arising from the issuing of paper money.


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