Institutions for Financial Development: What are they and where do they come from?

Abstract

Abstract. Among the fundamental causes of long-run economic performance, differences in 'institutions' have received considerable attention in recent years. At the same time, a large body of theoretical and empirical work shows that financial development can have a big effect on economic performance. This raises the more fundamental question as to why some countries have developed financial markets while others do not. This paper reviews the theoretical and empirical research on this issue and shows that one of the channels whereby better institutions may have an effect on economic development is through the consolidation of larger and better financial markets. An issue that is left aside in this paper relates to what regulations and policies lead to better functioning capital markets. At some level, one can think of regulations and policies as particular types of institutions. Nonetheless, institutional problems are deeper causes leading to poor economic performance; bad policies might simply be part of the channels through which they influence performance. Thus, addressing the question of what determines the emergence of 'good' institutions – i.e. institutions that promote financial development – seems particularly important. Recent research providing some answers to this question is also reviewed.