Financial Development, Economic Growth, and Poverty Reduction

The frequent failure of financial liberalisation efforts in developing countries, and the serious damage which recent financial crises have imposed on these economies, have led to renewed attempts to understand the relationships between financial sector development, economic growth and poverty reduction, and to provide a more robust intellectual foundation on which to design efficient and pro-poor financial sector policies for developing countries. The paper examines the contribution that financial sector development can make to poverty reduction in developing countries. The linkages between financial and economic growth, and between economic growth and poverty reduction, are considered, and some preliminary empirical evidence is presented on these linkages. The paper goes on to argue that financial market imperfections are a key constraint on pro-poor growth, and that public policy directed at the correction of these financial market failures is needed to ensure that financial development contributes effectively to growth and poverty reduction. The final part of the paper examines in some detail the role of financial regulation and supervision policy as a key area for public intervention directed at enhancing the financial sector’s contribution to poverty reduction.