David F. Tennant

Responding to financial crisis: The case of Jamaica

Abstract The adverse economic and social effects of the financial crises that have afflicted many developing countries in recent years have highlighted the need to develop a policy response which addresses the vulnerability of financial systems to systemic instability and crisis. The article examines the experience of Jamaica, a country which managed a financial sector crisis during the 1990s, without the assistance or involvement of the International Monetary Fund. Lessons are drawn from the Jamaica case study for the domestic management of banking sector failures in lower-income countries.

Empirical exercises in estimating the effects of different types of financial institutions’ functioning on economic growth

While recent studies of the finance-growth nexus have focused on the use of proxies which more accurately capture the theorized functioning of the financial sector, they have tended to focus either on the functioning of the financial sector as a whole, or on the dominant institutions within the sector. Little attention has been paid to a comparison of the relative effects of different types of financial institutions on economic growth. This article attempts to get a deeper understanding of the finance-growth process by disaggregating the total financial sector impact and examining the individual and relative effects of each type of institution in the financial sector. We explore the empirical properties of alternative specifications of models of the impact of financial institutions’ functioning on economic growth, by conducting a number of exercises. These exercises experiment with various model specifications to represent the long- and short-run impacts of the financial institutions’ functioning on economic growth, using cointegration and error correction methodologies.

Modelling the Effects of Financial Sector Functions on Economic Growth in a Developing Country: A Cointegration and Error Correction approach

This study develops proxies for each of Levines (1997) five functions of the financial sector, and models the relationship between these functions and economic growth using methods that more accurately conform to theory, and which broaden our understanding of the mechanisms through which the financial sector impacts on growth. Our analytical models provide for inferences about the relative importance of each of the functions of the financial sector and cointegration and error correction methods are used to distinguish between the long and short-run impacts of financial sector intermediation on economic growth. Our results suggest that if financial sector reforms are to be more effective, greater focus has to be placed on mechanisms through which savings mobilization can be maximized, and the allocation of resources to productive uses can be facilitated. Policymakers should also not expect immediate results from such reforms, as although the functions of the financial sector were shown to have statistically significant long-run impacts on GDP, none of the functions had significant short-term effects on growth.

The Impact of Foreign Direct Investment, Financial Crises and Organizational Culture on Managers' Views as to the Finance-Growth Nexus

Numerous theoretical models argue that financial institutions can facilitate the creation of economic growth through three main channels ? by mobilizing savings, by allocating savings to the most productive investments,1 and by facilitating the smooth flow of trade needed in any market-driven economy2 (Levine 1997, 689-701). Such models are typically rooted in neoclassical economic theory where it is assumed that managers and officers of financial institutions fill these roles because it is rational for them to do so as utility-maximizing agents. Institutional economics, suggests that viewing individual agents as utility-maximizing is inadequate, as the decisions made by individuals are affected by institutional, cultural and historical factors (Hodgson 2000, 318; Elliot and Harvey 2000, 397). Such factors are not usually accounted for in empirical studies on the finance-growth relationship, as they are not easily quantified. Their omission has led to an incomplete understanding of the finance-growth process, and to confusion as to why similar empirical tests yield completely different results in different countries.3 More importantly, failure to understand the factors that impact and influence the direction of financial sector intermediation has led to broad policy prescriptions that may not be applicable in specific country circumstances. This article addresses these issues by analyzing and reporting the results of a survey of views of selected financial sector managers. The Jamaican case study allows for the investigation of an interesting paradox expansion of the financial sector, as the economy simultaneously experienced declining growth rates.4 Analysis of the views of key stakeholders in this environment leads to some important conclusions as to the validity of the theorized functions of the financial sector; the constraints facing the sector in effectively performing those functions; and suggestions for improved performance.

Debt and Development in SIDS: An Urgent Call for Action

The years 2008 to 2011 have marked a period of unprecedented global instability, recession, and crisis. Poverty and deprivation in developing countries have been exacerbated because of the increases in food and fuel prices. Also, because of the financial crisis–induced recession in the developed world, reduced demand for developing country exports, reduced private financial flows, and falling remittances have all adversely affected livelihoods in poor countries.1 This has all been occurring while greenhouse gas emissions continue to increase, causing further rises in temperatures and sea levels.2

Financial Intermediation and Stock Market Volatility in a Small Bank-Dominated Economy

In many small developing countries, the benefits of capital market development are not realized, as banks dominate and stock markets struggle to establish a firm footing in the economy, remaining relatively illiquid and volatile. This paper examines the determinants of stock market volatility in such conditions, specifically investigating the role that banks play in engendering volatility. Although significant amounts of research have been conducted on the determinants of stock market volatility in large developed country and emerging market exchanges, the stock exchanges in small developing countries have largely been ignored, as has been the relationship between banking operations and stock market volatility. Using a Generalized Autoregressive specification, this paper investigates the conditions under which banks in conducting their core functions impact stock market volatility in a small, bank-dominated developing country. The results show that factors which affect banks’ profitability, such as inefficiency, ill-advised financial transactions and overly stringent or inconsistently applied regulations, can increase stock market volatility. They also indicate that in an economy wherein most listed real-sector firms survive through a combination of equity and credit financing, the effectiveness of financial intermediation impacts stock market volatility by affecting the profitability of such firms. We show that in small bank-dominated economies, profitable, well-functioning banks are needed if capital markets are to develop. Suggestions are provided as to how banks, regulators and policymakers can aid in the reduction of stock market volatility.

Explaining related party transactions in commercial banking: looted lending and information-based investments

In the context of constrained credit markets, the information view of related party transactions (RPTs) is used to argue that such transactions are efficient, as they make the best use of limited information. The looting view of RPTs is, however, used to make the opposing argument – during periods of financial distress, bank insiders use their control over lending policies to loot banks. Properly understanding RPTs, minimizing the attendant risks and capitalizing on any extant informational advantages will only be possible when the motivations behind such transactions are investigated. Using dynamic OLS and error correction methodologies, this article examines the conditions under which commercial banks engage in RPTs to ascertain whether evidence can be found for either the looting or information views. The results indicate that the looting and information-based motivations distinctly and separately impact on different types of RPTs, with related party loans (RPLs) being influenced more heavily by looting and related party investments (RPIs) by information efficiencies. The policy implications are significant. Whereas the traditional approach of restricting RPLs seems to be justified, there is a case for encouraging RPIs, particularly in an environment wherein information is fragmented and costly to obtain.

Introducing Greater Rigor— Methodological Approach

This chapter presents an approach for identifying whether biases exist. Some methodological improvements to the current credit rating literature are introduced, which bore in mind the criticisms of the existing empirical studies. The approach controls for: (1) a core set of theorized and quantifiable indicators of debt quality; (2) a complex qualitative aspect of the credit rating process—the behavior of CRAs in trying to balance rating timeliness and rating stability and (3) fixed effects such as time invariant political and institutional characteristics of sovereigns within an ordered response framework. This framework allows us to estimate a lower threshold below which debt quality changes can lead to a downgrade and an upper threshold above which debt quality changes can lead to an upgrade. We allow the data to determine whether the upper threshold systematically varies across different groups of sovereigns. This forms a new modeling approach for more rigorously assessing the existence of bias.

Trends in Sovereign Debt Ratings: Are There any Preliminary Signs of Bias?

This chapter highlights trends in rating levels and actions that raise questions about potential bias. The chapter uses descriptive techniques and trends to analyze foreign currency sovereign debt ratings for 132 countries over the period from 1997 to 2011. The analysis highlights interesting distinctions between the rating actions taken for rich countries (defined as high income) and poor countries (defined as lower-middle and low income), and between regional groupings of poor countries. While interesting, the trends identified in this chapter are not used to make conclusive statements about bias, as the descriptive and trend analysis does not allow for such conclusions. It, however, highlights the need for the more rigorous methodology and econometric evidence that are presented in subsequent chapters.

Establishing the Determinants of Sovereign Debt Ratings: Is There Really Room for Bias?

This chapter examines the determinants of sovereign debt ratings to ascertain whether there is sufficient transparency and consistency to preclude any concerns about the existence of biases. It first presents the long list of variables that the CRAs consider in making their determinations. It then reviews the empirical studies that have sought to econometrically reproduce the ratings assigned by the big-three CRAs, to determine a short list of determinants that have been empirically shown to be of importance to the CRAs’ ratings assignments. The chapter concludes by showing that there is room for bias in sovereign debt rating actions, regarding which determinants are considered and how they are weighted. The recent history of sovereign debt ratings highlights issues with opacity and subjectivity in the rating process, which opens opportunities for biases to be introduced.