Financial Sector Development In IGAD Region

Financial development and domestic capital formation are principal driving force behind any country’s sustainable growth, and effective financial institutions are important facilitators. Financial institutions are the key channel between savings and investment, and their efficiency is a key determinant of a country’s economic growth. This strong positive relation between financial sector development and economic growth has been supported by theoretical and empirical studies. The countries with advanced economies exhibit well developed and mature financial systems and dual causality is postulated in economic literature.

Both theory and evidence support the proposition that enhancing finacial sector perfomance results in higher economic growth. The theoretical argument for linking financial sector development to growth is that well-developed financial system performs several critical functions to enhance the efficiency of intermediation by reducing information, transaction and monitoring costs. A modern financial system promotes investment by identifying and funding good business opportunities; enables the trading, hedging, and diversification of risk; and facilitates the exchange of goods and services. These functions result in more efficient allocation of resources, a more rapid accumulation of physical and human capital, and faster technological progress, which in turn feed economic growth. Thus, getting the financial system of developing countries to function more effectively in providing the full range of financial services promotes high sustainable economic growth.

By: Ali I. Abdi (PhD) and Emerta A. Aragie (MSc)