Financial systems and development

countries' financial institutions insolvent. Still, that the pace and sequencing of liberalization
many institutions continue to lend to their most should depend on the initial structure of a counimpaired
customers and to accrue unpaid interest. try's financial system and the degree of macroeco-
The allocation of scarce resources to insolvent nomic stability. Countries with unstable econofirms
has delayed adjustment. Restructuring the mies and price systems that do not reflect the
insolvent firms and institutions is an important scarcity of resources will need to deregulate their
part of the adjustment process.
financial systems gradually. In countries without
Restructuring the financial system provides a fully liberalized markets, policymakers should
unique opportunity to reconsider what sorts of in- make sure that interest rates reflect market forces
stitutions will be best suited to the economic envi- and that directed credit programs are limited to a
ronment of the 1990s. Although commercial banks modest share of total credit. When a country lacks
will continue to dominate financial systems in macroeconomic stability, decontrol of external fimany
developing countries, greater emphasis than nancial transactions may cause destabilizing capiin
the past should be placed on ensuring the avail- tal flows. Hence, although the objective is an open
ability of a broad array of financial services. Many market, countries should not remove all capital
countries should develop contractual savings sys- controls until other economic and financial reforms
tems, and the more advanced should develop se- are in place.
curities markets. Governments should provide a Like previous World Development Reports, this
tax and regulatory environment that is neutral is a study by the staff of the World Bank, and the
with regard to different types of financial activities. judgments in it do not necessarily reflect the views
Informal financial institutions have proved able to of the Board of Directors or the governments they
serve the household, agricultural, and microen- represent.
terprise sectors on a sustained basis. Measures that
link informal institutions to the formal financial
system will improve that service and ensure a competitive
environment.
In recent years some countries have experimented
with varying degrees of financial liberali-
Barber B. Conable
zation. Their experience with both domestic liber-
President
alization and full or partial decontrol of the capital
The World Bank
account has been mixed. Nevertheless, it suggests June 1, 1989
This Report has been prepared by a team led by Millard F. Long and comprising Yoon Je Cho,
Warren L. Coats, Jr., Eirik Evenhouse, Barbara Kafka, Catherine Mann, Gerhard Pohl, Dimitri Vittas,
Robert Vogel, and Robert Wieland. The team was assisted by Anastasios Filippides, Lynn Steckelberg
Khadiagala, Clifford W Papik, Anna-Birgitta Viggh, and Bo Wang. The work was carried out under
the general direction of Stanley Fischer.
Many others in and outside the Bank provided helpful comments and contributions (see the bibliographical
note). The International Economics Department prepared the data and projections presented
in Chapter 1 and the statistical appendix. It is also responsible for the World Development
Indicators. The production staff of the Report included Les Barker, Pensri Kimpitak, Cathe Kocak,
Victoria Lee, Walton Rosenquist, Nancy Snyder, and Brian J. Svikhart. Library assistance was provided
by Iris Anderson. The support staff was headed by Rhoda Blade-Charest and included Trinidad
S. Angeles and Maria Guadalupe M. Mattheisen. Clive Crook was the principal editor.
iv