Banking System Reform in Algeria

Banking System Reform in Algeria

The importance of financial development sector

Developing countries attach great importance to financial sector development and deepening in the pursuit of their poverty reduction goal.
Although economists disagree sharply about the role of the financial sector in economic growth, some of them argue that finance does not cause growth where “Finance is not even discussed in a collection of essays by the pioneers of development economics [Meier and Seers (1984)]” (Levine, 2004, 867). At the other extreme, Nobel laureate Merton Miller (1998) argues that financial markets contribute to economic growth is a proposition too obvious for serious discussion.

Defining financial system

A financial system has become the cornerstone of most economies around the world and as a result it has gained a lot of attention from economists, who research mainly the causes and impacts of its development.
According to Hubbard (1997) a financial system is « a network of markets and institutions that brings savers and borrowers together ». The main function of a financial system which is bringing savers and borrowers together can be performed either through direct financing or indirect financing. Direct financing takes place through financial markets (such as stock markets, bond markets, and derivatives markets) deficit spending units who issue debt (direct securities) and surplus spending units who buy and hold these financial assets (Gurley et al., 1955, 518). While indirect financing is done through financial intermediaries (such as banks, mutual funds, and insurance companies), they issue their own debt in seeking loan able funds from surplus units and allocate them to deficits units (Gurley et al., 1955, 519). The potential savers and borrowers consist of households, businesses and governments.

Structure of a Financial System

A financial system can be classified as either bank based or market based. A bank based system highlights the positive role of banks in the allocation of funds in the economy, while a market based system highlights the positive role of the financial markets emphasizing their comparative advantage over banks in allocation efficiency (Beck and Levine, 2002).
Banking sector of an economy generally performs three very primary functions which include the facilitation of payment system, mobilization of savings and allocation of funds to stakeholders like government, investors, consumers, and business community who can utilize them for the generation of economic activities. By virtue of its pivotal role, the banking sector can exert its positive influence on various segments of the economy. On the one side, it allocates funds for the highest value use while on the flip side, it limits the magnitude of risks and costs, thereby creating a level playing field for economic agents to flourish and generate economic activities. This aspect of banking sector gives it a privilege over other competing sector (Jaffe et al. (2001), Wachitel (2001)).
Besides debates concerning the role of financial development in economic growth, financial economists have debated the comparative importance of bank based and market
based financial systems for over a century. (Gerschenkron, 1962; Goldsmith, 1969 ; Boot et al., 1997 and Demirguc- Kunt and Levine 2001)
In our study we concentrate on the Bank based system because the Algerian financial system is bank based.
Rajan et al., (1998) stress that powerful banks with close affinity to firms may be more effective at exerting pressure on firms to repay their debts than atomistic markets.
In sum, proponents of Bank-based systems argue that there are fundamental reasons for believing that market-based systems will not do a good job of acquiring information about firms and overseeing managers. This will hurt resource allocation and economic performance.
Banks do not suffer from the same fundamental shortcomings as markets. Thus, they will do a correspondingly better job at researching firms, overseeing managers, and financing industrial
expansion (Levine 2004, 883).
As a result, bank based arrangements can produce better improvement in resource allocation and corporate governing than market based institution (Stiglitz, 1985; Blide, 1993).
The theory of bank based financial system stresses the positive role of banks in development and growth, and also, emphasizes the draw backs of market based financial systems as discussed by Stiglitz (1985), Shleifer et al. (1997), De Anglo et al. (1983). The theory opines that banks can finance development more effectively than markets in developing economies, and in the case of state owned banks, market failures can be overcome, and allocation of savings can be undertaken strategically ( Gerschenkron, 1962).
In fact, bank-based financial systems are in a much better position than market-based system to address agency Problems and short terms (Stiglitz, 1985; Singh, 1997).

The role of banking sector on economy

Moving forward, the banking sector is expected to have a greater role in facilitating and catalyzing economic growth. As discussed, financial intermediaries can improve the (i) acquisition of information on firms, (ii) intensity with which creditors exert corporate control, (iii) Provision of risk-reducing arrangements, (iv) Pooling of capital, and (v) ease of making transacting (Levine, 2002).
Financial intermediaries can play a number of important roles in promoting the development of a healthy growing economy. First by they create money and organize the payments system of a country, this reduces the inefficiencies which are associated with barter.
Secondly, financial intermediaries bring together economic agents who wish to save with those who which to invest. The financial saving can be channeled to economic units which are in deficit.
Banks reduce transaction costs associated with finding a firm or an individual who is seeking to borrow funds. It also can reduce the information costs and thus reduce the credit risk associated with lending for investment purposes.
The intermediary has the expertise to determine where it should invest and how much.
Banks gains from diversification if one of its loans goes bad; this is likely to be cancelled out by others which have been a success. It reduces the illiquidity associated with direct lending.
Financial intermediaries can create liquidity by borrowing in short term and lending long term. It have the advantage that they can put together large amount of finance where investment projects tend to be large in relation to the average amount which individuals wish to save (Gibson et al., 1992).

What is financial development?

There are many different ways in which the financial sector can be said to « develop » for example:
 The efficiency and competitiveness of the sector may improve.
 The range of financial services that are available may increase.
 The diversity of institutions which operate in the financial sector may increase.
 The amount of money that is intermediated through the financial sector may increase.
 The extent to which capital is allocated by private sector financial institutions, to private sector enterprise, responding to market signals, rather than government directed lending by state owned Banks, may increase.
 The regulation and stability of the financial sector may improve.
 Particularly important from a poverty reduction perspective, more of the population may gain access to financial services.
Financial development occurs when financial instruments markets and intermediaries ameliorate the effects of information enforcement, and transactions costs and therefore do a correspondingly better job at providing the five financial functions which are identified by Levine (1997).
To understand why financial sector development, under certain conditions, may be positively related to economic growth, it is necessary to understand the critical function of the sector provides to the economy. The financial sector is unique because of the risk and uncertainty faced by both savers and investors (Stiglitz, 1998). Savers are often unable to select the investment project that best matches their personal risk appetite and without pooling their money, savers cannot take advantage of increasing returns to scale in investments (Stigliz, 1998).
Moreover, individual entrepreneurs or investors commonly lack sufficient capital to proceed with projects on their own. Commercial banks provide an intermediation service that brings savers and investors together, theoretically channeling investment funds to the uses that yield the highest rate of return, thus increasing specialization and the division of labor (Todaro, 2003).
The five basic channels, through which an efficient financial sector influences economic growth, may be represented by figure (1) below, which illustrates how financial arrangements provide five functions that affect savings and allocation decisions, and how these functions, then influence economic growth trough two channels, namely capital accumulation and capital productivity.

Easing Trade

The core elements of Adam Smith’s (1776) wealth of nations were the links between facilitating transactions, specialization, innovation and economic growth he argued that with greater specialization division of labor, workers are more likely to invent better machines or production processes ( Smith, 1776, 3).
Smith (1776) focused on the role of money in lowering transaction costs, Permitting greater specialization, and fostering technological innovation this in terms of the way compared to barter.
The financial sector facilitates transactions in the economy, by providing the mechanisms to make and receive payments, and by reducing information costs. So by providing financial intermediation in this way, the financial sector reduces transactions costs, and facilitates the
trading of goods and services between business and households. In doing this, the financial sector allows greater specialization which in turn facilitates productivity gains and allows more technological innovation and growth.
Risk is pooled, transferred, and reduced by commercial banks while liquidity and information increase through the use of progressively more sophisticated financial products and technology. Neoclassical growth models tell us that an increase in the efficient investment of savings in new and innovative projects is one of the main engines of economic growth.
The contribution of financial development (the relationship between FD and Economic growth):
There are both theoretical and empirical evidence suggesting that the development of financial sector accelerates economic growth. The idea that financial development plays a leading role in economic growth traces its origins to Schumpeter (1911) who argued that financial development induces economic growth. His main point was that through the services that financial intermediaries bring about, like mobilizing saving, managing risk, facilitating transactions or evaluating projects, technological and economic development is stimulated.
Technological change is the key in Schumpeter’s reasoning. His idea of “creative destruction” is a process of constant replacement of old production methods and goods with better procedures, commodities, and services by invention and innovation. And financialintermediaries enable this technological innovation.

Table des matières

Dedication
Acknowledgements
Abstract
Table of contents
List of tables
List of figures
List of appendixes
Introductory Chapter
1.1. Preface
1.2. Research Problematic
1.3. Research Hypothesis
1.4. Importance of the Study
1.5. Objectives of the Study
1.6. Justification for the choice of subject
1.7. Data and Methodology
1.8. Previous Studies
1.9. Difficulties of the Study
1.10. Limitations of the Study
1.11. Structure of the Study
Chapter Two: Theoretical Framework
Introduction
2.1. The importance of financial development sector
2.1.1. Defining financial system
2.1.2. Structure of a Financial System
2.1.3. The role of banking sector on economy
2.1.4. What is financial development?
2.1.5. The relationship between FD and Economic growth
2.1.6. The hypotheses of financial development
2.2. The impact of financial liberalization
2.2.1. Financial repression before financial liberalization
2.2.1.1. Rational for and policies of financial repression
2.2.1.2. The effects of financial repression
2.2.2. The process of financial liberalization
2.2.2.1. The theoretical arguments for financial liberalization
2.2.2.2. Elements of financial liberalization
2.2.2.3. The McKinnon Shaw paradigm (analysis)
2.2.2.4. Extensions and criticisms of the McKinnon Shaw approach
2.2.2.5. Financial liberalization and banking performance and efficiency
2.2.2.6. Potential benefits qualifications and risks to liberalization
Conclusion
Chapter Three: Empirical Evidence
Introduction
3.1. East Asia and Pacific
3.2. Europe and Central Asia
3.3. Latin America and the Caribbean
3.4. Sub-Saharan Africa
3.5. Middle East and North Africa
3.6. South Asia
Conclusion
Chapter Four: Banking System Reform in Algeria
Introduction
4.1. Algerian banking system under financial repression
4.1.1. From 1962 to 1979
4.1.2. From 1980 to 1989
4.2. Financial liberalization of the Algerian banking system
4.2.1. Algerian banking system under the law 90/10
4.2.2. Development of the Algerian banking system after the law of 90/10
4.2.3. The Adoption of the financial liberalization in the Algerian banking system
Conclusion
Chapter Five: Econometric Methodology and Results Discussion
Introduction
5.1. General Framework and Objectives of the Econometric Study
5.2. The Decision Rule
5.3. Data, Methodology and the Model Used
5.3.1. Data
5.3.2. Research Methodology and Model Specification
5.3.2.1. Research methodology
5.3.2.2. Model specification
5.4. Presentation and interpretation of empirical results
5.4.1. Results of stationary tests
5.4.2. Results of first selections
5.4.3. Results of second selections
5.4.4. Results of third selections
5.4.5. Results of fourth selections
5.5. Results discussion
Conclusion
General Conclusion
References
Appendixes

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