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University of Benin
Financial sector reform was part of the structural adjustment programme (SAP) adopted in the early 1980s by countries in sub-Saharan Africa (SSA) with the aim of promoting financial development and macroeconomic performance. Despite this, financial systems have only responded marginally in SSA, raising concerns on the significance of financial reforms in improving financial development, and its transmission effect on economic performance. Besides, empirical evidence explaining the effects of financial reforms on financial development and economic performance appear mixed. Thus, this study investigates the impact of financial reform on financial development, using both traditional panel and the generalised method of moments (GMM) estimator. Further, the study examines the effect of financial reform on economic performance, and lastly, test for causality among financial reform, financial development and economic performance using Multivariate Vector Autoregressive (MVAR) model. The data for the study were sourced from the 2013 World Bank’s World Development Indicators (WDI) and International Monetary Fund (IMF) for a sample of 14 SSA countries for the period 1980 to 2012. The findings from the study indicate that policies of financial reform (especially the reform of domestic banking sector) have led to financial development in the overall SSA countries. Furthermore, results show that financial reform positively and significantly support growth in real output, domestic investment, human development, but, however, reduces the occurrence of macroeconomic instability in the region. These results were significantly different using income and stock market effects, confirming their importance in explaining the effectiveness of financial reform on financial development and economic performance in the continent. Specifically, financial reform has a negative, but significant effect on financial development in low income economies, whereas the impact was positive and significant in countries classified as lower-middle-income and upper-middle-income economies. Financial reform significantly promote growth in real per capita GDP in both low-income and lower-middle-income economies (same with results obtained for the overall sample) but adversely affect per capita income growth in upper-middle-income countries. Results also show that financial reform has a positive effect on human development, irrespective of income classification of sampled countries. However, financial reform generates economic instability in both lower-middle-income and upper-middle income countries, but was found to restrain the occurrence of macroeconomic uncertainties in low-income economies. The results show that the presence of domestic stock market (even in country-specific analysis using data from Nigeria and South Africa) improves the positive transmission effect of financial reform across all performance metrics, but raises the possibility of occurrence of macroeconomic instability in the region. From the causality test analysis, financial reform causes financial development in about 36% of the entire sample countries, while reverse causality holds in 14% of the countries, and another 14% showing evidence of feedback effects between financial reform and financial development. In addition, about 36% of the countries studied show that financial reform causes growth in per capita income, 7.0% revealed that per capita income growth intensifies the need for financial reforms, while 57.0% showed no clear flow of causality. Also, the causality test result shows financial reform lead to human development in over a third of countries covered, while no causation was observed in 57% of the entire sample. Lastly, 21.3% of countries showed that financial liberalisation lead directly to macroeconomic instability, 14.3% shows reversed causality, whereas the remaining 64.3% of sampled countries did not indicate any form of causality. This study recommends that policy makers in SSA should simultaneously consider the financial and real sectors as interdependent. Governments of countries in SSA should make a conscious effort to reduce or eliminate the negative effects of inflation and natural resource dependence on domestic financial development, and other economic performance fundamentals. Improving access to more diversified financial services/products induced by policies of financial reform would support inclusive growth that reduces poverty and boost human development. Lastly, monetary authorities in the region should promote a prudential framework in line with the unique economic structures of their economy and ensure that policies of financial liberalisation are cautiously implemented in a stable economy with appropriate institutional framework to avoid undesirable outcome.