Effects of financial liberalization on financial development: an empirical study with reference to Sri Lanka

Abstract

Introduction :

The relationship between liberalization and financial development has been well documented in literature. A considerable body of theoretical literature suggests a positive relationship between capital account liberalization and financial development. Klein and Giovani (2000) showed a statistically significant relationship between liberalization and financial development. They also argued that openness of capital account affects financial deepness and economic growth. Empirical results of Chinn and Hiro (2005) suggest that financial openness does contribute to equity market development, but only when a threshold level of general development of legal systems and institutions has been attained. Eichengreen et al. (2009) find reasonably strong evidence that financial openness has positive effects on the growth of some industries, although these growth-enhancing effects evaporate during financial crises. Also there is evidence that the positive effects of capital account liberalization are limited to countries with relatively well-developed financial systems, good accounting standards, strong creditor rights and rule of law. In the case of Sri Lanka, there is a dearth of studies that empirically examines the impact of capital account liberalization on financial development and we will focus on that issue.