Financial Sector Development Policy: The Importance of Reputational Capital and Governance

The performance and the effectiveness of financial institutions in an economy are an important consideration for policy makers concerned about economic growth. Growths, after all, is heavily dependent on investment, and a significant fraction of all investment flows through financial institutions. Furthermore, the experience of some countries with financial instability suggests that poor financial policies can have serious consequences. For example, when the Southern Cone countries liberalized financial markets before achieving macro-economic stability and low inflation, the performance of banks in thoese countries was diastrous. In the United States, the partial deregulation of the Savings and Loans (S&L) industry resulted in significant gambling and looting of depositors’ funds, ultimately costing taxpayers hundreds of billions of dollars.