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Supporting research

Over the past decade and more, an increasing body of academic evidence has pointed to the links between financial sector development and positive socio-economic outcomes.

A DFID Working Paper (Ellis et al 2004 – The Importance of Financial Sector Development for Growth and Poverty Reduction) summarises much of the early literature on the subject.

For example, King & Levine 1993a and 1993b explored the relationship between financial intermediation and economic growth, finding evidence of a strong, positive relationship between financial development and growth.  Dollar & Kraay 2001 found that policies that benefit growth, including financial development, benefit the poor as much as typical households, which means that investing in financial sector development should reduce poverty, indirectly, through the positive impact this will have on growth.

Rajan & Zingales 2003 argued that closed financial systems entrench the position of incumbent elites and thus financial sector development, by opening up financial systems, can have positive impacts for inequality.

Claessens and Feijen 2006 considered the poverty reducing impact of finance through the lens of the Millennium Development Goals, presenting examples of how access to finance could improve access to health, education and nutrition. More recently, a CGAP paper from 2016 (Achieving the Sustainable Development Goals: The Role of Financial Inclusion) showed how finance could help towards achieving the Sustainable Development Goals.

Some literature has also explored the relationship between finance and job creation. In Beck 2016 (Financial Inclusion in Africa) the author argues that “the effects of financial deepening on employment and poverty alleviation do not necessarily come through the “democratization of credit” but rather a more effective credit allocation”.  

Demirgüc-Kunt et al. 2017, in a recent working paper from the World Bank (No. 8040 – Financial Inclusion and Inclusive Growth – A Review of Recent Empirical Evidence) explore how financial inclusion can contribute to inclusive growth and economic development.

The impact of financial sector development on women’s economic empowerment has also been extensively examined (see Napier et al. 2013 – Promoting Women’s Financial Inclusion).

The two World Bank publications Making Finance Work for Africa (2007) and Financing Africa Through the Crisis and Beyond (2011) provide exceptionally helpful analyses of the state of financial sector development in Africa at the time of publication, with recommendations for policy reform which remain very relevant today.

Research on the impact of capital markets development on both growth and poverty reduction, especially in Africa, is less extensive but also generally positive.  Levine & Zervos 1998 find that stock market liquidity is positively and significantly correlated with current and future rates of economic growth, capital accumulation, and productivity growth, while Yartey & Adjasi 2007 find evidence that African stock markets have contributed surprisingly well to corporate growth, albeit through financing large companies.  Given the fact that access to long term finance, especially in local currency, is one of the most intractable challenges in financial markets in Africa, more research is needed to strengthen the arguments for policy reform in long term finance markets.

Notwithstanding the overwhelming volume of literature that points to a positive correlation between financial sector development and poverty reduction, some evidence remains contested and there are gaps in research.