RESTRICTED  WORLD TRADE  
ORGANIZATION  S/FIN/W/76 
4 May 2011  
 
(11-2322) 
Committee on Trade in Financial Services  
  
 
TRADE IN FINANCIAL SERVICES AND DEVELOPMENT 
 
Background Note by the Secretariat
1 
  
 
I. INTRODUCTION 
1. This Note has been prepared at the request of the Committee on Trade in Financial Services, 
to serve as background information for a dedicated  discussion on this topic.  The debate on the 
relationship between trade in financial services a nd development is extremely important since it may 
affect not only the decision of policymakers to pursue financial sector reforms but also their choice of 
financial sector policies.   
2. Following the request by the Committee on Trade in  Financial Services, the Note focuses on 
the relationship between trade in financial services,  i.e. the supply of financial services by foreign 
suppliers through any of the four mod es of supply, and economic development.
2  The Note is 
organized as follows.  By way of introduction to this issue, the following section provides a brief 
review of the extensive empirical literature on fi nance and economic development.  Section III then 
reviews the empirical literature on the relationship between trade in financial services and economic 
development.  The literature review in sections II and III focuses on cross-country analyses, leaving 
aside individual country-case studies.  Members might want to address their individual experiences and perspectives during the dedicated discussion on this topic.  Section IV discusses relevant policy 
issues.  The final section concludes.  
II. FINANCE AND DEVELOPMENT 
3. The idea that an effective financial system plays an essential role in promoting economic 
development dates back at least to Schumpeter (1934), who assigned great importance to the role of financial intermediation in inno vation and economic development.  Empirical evidence on the 
relationship between finance and growth is more rece nt.  Goldsmith (1969) was the first to show the 
presence of a positive relationship between the size  of the financial system and long-run economic 
growth for a sample of 35 countries over the period 1949-1963.  He argued that this positive 
relationship was driven by financial intermediation im proving the efficiency rather than the volume of 
investment.  However, Goldsmith made no atte mpt to establish whether there was a causal link 
between financial development and economic growth.  Several economists  thus remained of the view 
that a large financial system is simply a by-produc t of economic development.  This position was well 
represented by Joan Robinson's (1952) claim that "…wh ere enterprise leads, fi nance follows", and by 
                                                     
 
1 This document has been prepared under the Secret ariat's own responsibility and without prejudice to 
the positions of Members and to their rights and obligations under the WTO. 
2 Trade in services is defined in the GATS as "the supply of service (a) from the territory of one 
Member into the territory of any other Member; (b) in th e territory of one Member to the service consumer of 
any other Member; (c) by a service supplier of one Member, through commercial presence in the territory of any other Member; and  (d) by a service supplier of one Member, through presence of natural persons of a Member 
in the territory of any other Member." S/FIN/W/76 
Page 2  
 
  Nobel laureate Robert Lucas (1988), who held that th e role of finance in the literature on growth has 
been "over-stressed".  Of course, other economists, such as Nobel laureate Merton Miller (1988) remained convinced that financial markets contributed to economic growth.
3 
4. Following Levine (1997), it has become common pl ace in the literature to identify five basic 
functions performed by the financial system that are critical for economic growth and development:  
savings mobilization; acquisition of information abou t investments and allocation of resources;  risk 
management; monitoring of managers and exercise  of corporate control;  and the facilitation of 
transactions.  While all financial systems perform  these financial functions, they differ in their 
effectiveness.  Financial development occurs when financial instruments, markets, and intermediaries 
ameliorate – though do not necessarily eliminate – the effects of informat ion, enforcement, and 
transactions costs and therefore become more effec tive in providing these financial functions (Levine, 
2005). 
5. At the most rudimentary level, the financial sector facilitates transactions in the economy by 
allowing economic agents to make purchases and receive  payment for sales in an efficient, low-cost, 
and low-risk manner.  This basic function is essentia l in any society that advances beyond barter, and 
commercial banks have generally provided such functi ons.  To this end, diverse mechanisms (apart 
from cash itself) have been created by the financia l sector:  checks, debit cards, wire and internet 
transfers, smart cards, etc.  Importantly, b ecause economic transactions are costly, financial 
arrangements that lower transaction costs facilitate  greater specialization and a more efficient 
allocation of resources, which in turn leads to productivity gains and allows more technological 
innovation and growth.  
6. Savings mobilization and investment financing can  be thought of as the two sides of financial 
intermediation.  Savers are unlik ely to have the time or capacity to collect, process and compare 
information on many different enterprises, manage rs, and investment projects before choosing where 
to invest.  Thus high information costs may prev ent capital from flowing to its best alternative.  
However, the existence of financia l intermediaries such as banks and fund managers, who, on the one 
hand, collect and process this information, and sh are the costs of doing so between them, and on the 
other hand, pool savings from people in exchange for financial claims that reward them for giving up 
the current use of those savings, will actually impr ove resource allocation and increase investment.  
Without access to this pool of savings, many pr oduction processes would not materialize or would 
alternatively be constrained to economically ine fficient scales.  Furthermore, mobilization involves 
the creation of all sorts of saving instruments (e.g. commercial bank deposits, money market funds, 
stocks, bonds, mutual funds, insurance policies) , catering for savers' needs and objectives.  
7. An important function carried out by the financia l system is to provide risk management to 
both savers and investors.  Financing the investment in  an individual project is riskier than investing 
in a wide range of projects whose expected returns ar e unrelated.  As savers are generally risk-averse, 
financial intermediaries that facilitate risk divers ification, such as banks and capital markets, allow 
investments to be made in riskier projects with hi gher expected returns in aggregate.  This again 
increases overall investment return s, improves capital allocation, and has therefore a positive impact 
on growth.  Financial systems that manage risk e ffectively will encourage an efficient allocation of 
resources and may also stimulate further saving and investments.  
8. An often neglected function of the financial sy stem is related to corporate governance – the 
monitoring and exercise of corporate control.  Besides reducing the costs of acquiring information ex 
ante, financial intermediaries and markets mitigate th e information acquisition and enforcement costs 
of monitoring firm managers and exerting corporate control ex-post , i.e. after financing the activity.  
                                                      
3 In Miller's (1988) words:  "that financial mark ets contribute to economic growth is a proposition 
almost too obvious for serious discussion."    S/FIN/W/76 
 Page 3 
 
 
  Corporate control is exercised not only by banks (e.g. bankers holding meeti ngs with firm managers 
to discuss business strategy) but also by debt and stock markets.  For example, public trading of 
shares that efficiently reflect information about fi rms allows owners to link managers' compensation 
to stock prices, and therefore helps align the interest s of managers with those of shareholders.  These 
mechanisms create the right incentives for firm mana gers or borrowers in ge neral to perform well, 
thus improving the allocation of capital.  
9. The same function can be supplied by differe nt financial institutions (Grosse, 2004).  For 
example, savings mobilization can be supplied not only by commercial banks (through different bank 
deposits), but also by money and capital ma rkets (through money mark et funds, stocks, bonds, 
investment funds) and insurance companies (through life insurance policies, sometimes coupled with 
capitalization schemes).  Risk protection mechanisms  include not only insu rance policies but also 
financial derivatives, such as futures and options.  Investment projects are not only funded by banks 
(e.g. loans), but also by the capital markets, th rough bond, stock, and commercial paper issues.  
Corporate control is exercised not only by banks but also by organized capital markets.  This points to 
a basic fact:  financial intermediaries and ma rkets are complements – not substitutes – and the 
development of each sector (banking, securities, in surance) strengthens the performance of the other 
by maintaining the competitive edge of individual firms (World Bank, 2001).  
10. A large body of empirical evidence has been built since the early 1990s supporting strong 
linkages (and even a causal link) between financial se ctor development and growth.  While there are a 
few studies which challenge this consensus (e.g. Favara (2003), who finds that the relationship 
between financial sector developmen t and growth is weak), the vast majority do provide support for a 
causal link.  This section describes some of the cross-country empirical evidence that has been 
produced.4 
11. King and Levine (1993) focus on 80 countri es over the period 1960-1989, and find that 
various measures of the level of fi nancial development (the size of th e formal financial intermediary 
sector relative to GDP, the importance of banks relativ e to the central bank, the percentage of credit 
allocated to private firms, and the ratio of credit issued to private firms to GDP) are strongly and 
robustly correlated with growth, and that the initial level of financial development is a good predictor 
of the subsequent rates of economic growth.  Their empirical specifications, especially the measures 
of financial development, have been widely used with some modifications in many recent studies. 
12. While King and Levine (1993) use banking va riables to proxy the level of financial 
development, some studies attempt to examine th e role of stock markets in promoting economic 
growth.  In a sample of 40 countries covering the period 1980-88, Atje and Jovanovic (1993) find a 
large effect of stock trading on subsequent ec onomic growth, but could not establish a similar 
relationship between bank liabilities a nd growth in a sample of 94 countries for the period 1970-88.  
Building on this study, Levine and Zervos ( 1998) find a strong correlation between overall stock 
market development and long-ru n economic growth for 41 countries over the period 1976-1993.  
Moreover, after controlling for the initial level of GDP per capita, initial investment in human capital, 
political stability, and measures monetary, fiscal, and exchange rate policy, stock market development 
remains positively and significantly correlated w ith long-run economic growth.  These findings have 
been also confirmed by panel and time-series estimation techniques (Beck, Levine, and Loayza, 
2000a; and Christopoulos and Tsionas).  Interestingl y, Beck, Levine, and Loayza (2000a) investigate 
not only the relationship between financial de velopment and economic growth but also the 
relationship between financial deve lopment and the sources of growth, e.g. private savings rates, 
                                                      
4 Identification problems, lack of relevant data, and potential reverse causality (from economic growth 
to finance, rather than from finance to growth) have always presented significant methodological challenges in this kind of studies.  For further discussion on the econometric methods used to overcome these problems, see 
Levine (2005) and Beck (2008). S/FIN/W/76 
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  physical capital accumulation, and total factor produc tivity.  They find a robust, positive link between 
financial intermediary development and both real per capita GDP growth and total factor productivity 
growth for 63 countries between 1960 and 1995.  These results are not due to biases created by 
endogeneity or unobserved country-specific eff ects.  They could not however document any 
relationship between financial devel opment and the other variables.  
13. To further understand the relationship between  financial developmen t and economic growth, 
research has also used both firm-level and indust ry-level data across a broad cross-section of 
countries.  Specifically, Demirguc-Kunt and Maks imovic (1998) use firm level data from 8500 large 
firms in 30 countries and a financial planning mode l to predict how fast those firms would have 
grown if they had had no access to external finance.   And they find that in each country the proportion 
of firms that grew faster than this rate was highe r, the higher the country’s financial development and 
quality of legal enforcement.  Rajan and Zingal es (1998) instead use industry level data across 36 
sectors and 41 countries and show that industries that  are naturally heavy users of external finance 
benefit disproportionately more from greater financ ial development compared to other industries.  
Beck, Demirguc-Kunt, Laeven and Levine (2006) use a Rajan and Zingales (1998) approach to 
highlight a distributional effect:  they find that i ndustries that are naturally composed of small firms 
grow faster in financially developed economies,  a result that provides additional evidence that 
financial development disproportiona tely promotes the growth of smaller firms.  Beck, Demirguc-
Kunt and Maksimovic (2005) also highlight the size eff ect, but using firm survey data: they show that 
financial development eases the obstacles that firms f ace to growing faster, and that this effect is 
stronger particularly for smaller firms.  More r ecent surveys also suggest that access to finance is 
associated with faster rates of innovation and firm dynamism consistent with the cross-country finding 
that finance promotes growth through productivity increases. 
14. Besides studies on the role of finance in economic  development, economists have also turned 
their attention to the relative importance of ba nk-based and market-based financial systems for 
economic growth (Allen and Gale, 2000; Demirguc-Kunt and Levine, 2001).  Research findings in 
this area have established that it is the financial services themselves that matter more than the way in 
which they are predominantly delivered.  Financ ial structure does change during the development 
process, with financial systems becoming more market-based as the countries develop (World Bank 2001).  
15. Increasing attention has been paid over recent year s to the impact of financial development on 
income distribution and poverty reduction (Demir güc-Kunt, 2008).  Theory provides conflicting 
predictions in this area.  Some theories ar gue that financial development should have a 
disproportionately beneficial impact on the poor  since informational asy mmetries produce credit 
constraints that are particularly detrimental to the poor.  Poor people find it particularly difficult to 
become entrepreneurs and fund their own investme nts since they lack resources, collateral and 
political connections to access finance.  More genera lly, some political economy theories also suggest 
that better functioning financial systems make fina ncial services available to a wider segment of the 
population, rather than restricting them to politic ally connected incumbents (Rajan and Zingales, 
2003).  However, other observers argue that financia l access, especially to credit, only benefits the 
rich and the connected, particularly at early stag es of economic development and therefore, even if 
financial development promotes growth, its impa ct on income distribution is not clear.   
16. The empirical evidence is limited.  For example,  Jalilian and Kirkpatrick (2001) examine the 
link between financial development and poverty redu ction using data for a sample of 26 countries, 
including 18 developing countries.  Their results  show that a 1 per cent change in financial 
development raises growth in the incomes of the poor  in developing countries by almost 0.4 per cent – 
a significant impact.  Honohan (2004) finds that fina ncial sector development is negatively associated 
with poverty, showing that a 10 percentage point cha nge in the ratio of private credit to GDP reduces 
poverty ratios by 2.5 to 3 percentage points.  S/FIN/W/76 
 Page 5 
 
 
  17. Clarke, Xu and Fou (2002) also test the re lationship between financial sector development 
and income inequality using data  from 91 countries between 1960 and 1995.  They use credit to the 
private sector by financial intermediaries, and clai ms on the nonfinancial domestic sector by banks as 
their measures of financial sector development.  Their findings support the theory that there is a 
negative relationship between financial sector deve lopment and income inequality rather than an 
inverted U-shaped relationship;  that is, they fi nd that financial developm ent reduces inequality, even 
where the initial levels of financial development are low.  
18. Beck, Demirguc-Kunt and Levi ne (2007) investigate the re lationship between financial 
development and changes in both income distribu tion and absolute poverty.  Looking at the 1960-
2005 period, they find that not only does a deeper financial system accelerate national growth, but it is 
associated with a faster increase in the income share of the poorest gr oup.  They also find a negative 
relationship between financial deve lopment and the growth rate of the Gini coefficient, suggesting 
that finance reduces income inequa lity.  In addition, by estimating the change in the share of each 
country's population below interna tional poverty lines resulting from financial deepening, they find a 
positive effect of finance on poverty reduction.  Coun tries with higher levels of financial development 
experience faster reductions in the share of popul ation living on less than a dollar a day over the 
1980s and 1990s.  
19. It is worth noting that all these cross-country  studies use traditional measures of financial 
sector development, which may not be directly rela ted to increases in access to financial services, and 
hence may be only capturing the indirect impact of  financial development on poverty through growth.  
III. TRADE IN FINANCIAL SERVICES AND DEVELOPMENT 
20. Allowing the supply of financial services by fo reign suppliers may stimulate financial 
development and thereby spur economic growth and development for at least three related reasons 
(Levine, 1996).  First, reducing impediments to the entry of foreign financial intermediaries may 
improve access to international capital. Second, easing restrictions on the supply of financial services 
by foreign suppliers should improve the availability  and quality of financial services by stimulating 
competition and by facilitating the application of mo re modern skills, management, and technology in 
the domestic market.  This should in turn improve the financial system performance in terms of the 
functions highlighted in the previous section.  Third, openness to foreign financial institutions may 
stimulate improvements in both financial policy and the financial infrastructure.  
21. Only a few studies have investigated the direct  link between trade in financial services (or, 
rather, the liberalization of restrictions on trade in  financial services) and economic growth.  One such 
study was conducted by Eschenbach, Francois  and Schuknecht (1999), who looked into the 
relationship between financial sector openness, fi nancial sector performance and growth performance 
for 93 countries in the period 1986-1995.  In thei r empirical analysis, the authors relate financial 
sector competitiveness with openness to trade in fina ncial services (measured through crude estimates 
of tariff-equivalents for financial services trade ba sed on GATS commitments).  They then relate per 
capita growth with competitiveness.  They basical ly find that more competitive financial sectors 
experience more rapid growth, and that competitiv eness can be achieved by more financial sector 
openness.  And the net effects of this mechanism are significant: the results suggest that moving from 
a closed to a relatively open financial services s ector is correlated with significant pro-competitive 
pressures, and ultimately with higher growth rates (in the range of 0.7 per cent for a typical developing country).  
22. Using the same variable for openness to trade in financial services, but a somewhat different 
econometric methodology, Eschenbach and Francois  (2002) also found a strong positive relationship 
between financial sector competition and financial sector openness, and betwee n growth and financial 
sector competition, for a sample of 130 countri es between 1990 and 1999.  Working from these S/FIN/W/76 
Page 6  
 
  estimates, and holding all else constant, if a "typi cal" lower income country were to move from the 
openness level characterizing the average lower income regime to the more liberal openness level characterizing the average higher income regime (i.e. a roughly 50% liberalization of financial 
services trade by these measures), their results suggest  that this would imply a difference in growth 
rates of between roughly 0.4 and 0.6 per cent.  
23. Using an openness indicator for the financia l services sector in 60 countries based on 
information drawn from GATS schedules of speci fic commitments, Mattoo, Rathindran and 
Subramanian (2006) found relatively strong econometric evidence that openness in financial services 
influences long run growth performance.  Their estimates suggest that between 1990 and 1999 countries with fully open financial services sectors be tween grew up to 1.3 percentage points faster 
than other countries, and that the impact of liberalization was strongest for the 37 developing 
countries in the sample.  
24. Also using a financial liberalization inde x constructed on the basis of GATS specific 
commitments made by 93 Members, and covering the 1994-2006 period, Wang, Shen and Liang (2006) show that the degree of liberalization is pos itively correlated with in come levels under modes 
1, 2, and 3, but not mode 4.  In addition, they  show that the liberalization of the banking sector 
directly enhances growth.  
25. Using an index of foreign restrictiveness of 23 middle and high income economies and the 
EU as a whole, McGuire and Schuele (2000) foun d that countries with a less restricted banking 
service sector tended to have higher GNP per cap ita than those countries where banking was more 
restricted.  
26. The literature shows that there is an indirect link between banking sector openness and 
economic growth, since foreign banks improve the effi ciency of domestic banking systems, there is 
limited evidence of a direct li nk between foreign bank participa tion and economic growth.  For 
example, Demirguc-Kunt, Levine, and Min (1998) cannot find any direct link between foreign banks 
and long-run economic growth after c ontrolling for other factors associat ed with growth.  More recent 
research however supports the presence of both types of links – direct and indirect.  Using a sample of 
28 developing and developed c ountries over the period 1994-2003, Bayraktar and Wang (2008) find 
that the asset share of foreign banks has an economi cally and statistically significant positive effect on 
the growth rate of GDP per capita after controllin g for other determinants of growth, indicating a 
direct link between the two variables.  Similarly, thei r results imply that there is also an indirect link 
between foreign bank participation and growth:  the first stage results show that a higher share of 
foreign banks lowers overhead costs and net inte rest margins of domestic banks, indicating higher 
efficiency;  while the second stage results show that higher banking sector efficiency increases 
economic growth.  
27. Recent studies have also focused on the relati onship between foreign ba nk entry and access to 
credit.  A long-standing concern is that foreign bank s engage in 'cream-skimm ing' practices, supplying 
services only to high-value customers, thus underm ining the financial conditio n of domestic banks, 
which would end up serving low-value (and more risky) customers.  In principle, this competition could 
be so destabilizing that some domestic banks would go out of business and the overall level of credit in 
the host country might decline.  Ultimately, however, wh ether this theoretical possibility is valid is an 
empirical question. 
28. Some cross-country level evidence suggests that foreign bank presence is associated with less 
provision of credit.  For example, foreign bank presence  is negatively associated with the average level 
of credit to the private se ctor (relative to GDP) and the growth rate in credit for low income countries 
over the period 1999 to 2002 (Detragiache, Tressel, and Gupta, 2008).   S/FIN/W/76 
 Page 7 
 
 
  29. Foreign and domestic banks seem to  have different lending styles.  Foreign banks tend to have 
difficulties in lending to borrowers th at find it difficult to prove their creditworthiness.  A study of 1600 
banks across 100 developing countries  from 1992 to 1999 concludes that foreign banks have access to 
external liquidity from their parent ba nks, but in return for that source of funding the local branch of a 
foreign bank has little discretion to make lending  decisions based on anything other than hard 
information on the borrower (Mian, 2004).  
30. This tendency for foreign banks to rely on hard  information in lending decisions may eventually 
result in less overall lending to small and medium-s ized businesses.  A descriptive study of banks in 
eleven countries in Eastern Eur ope and Central Asia from 1995 to 2006 concludes that while foreign 
banks contributed to financial development and st ability, those markets remain shallow and access to 
credit for SMEs limited (M arton and McCarthy, 2008).  However, so me survey evidence leads to the 
opposite conclusion.  Interviews with managers of foreign banks in Central Europe and the Baltics 
indicate that their intention was to incorporate le nding to small firms over time and that there was no 
intended bias toward lending to large multinationals (De Haas and Naaborg, 2006).  Evidence collected 
via surveys of banks in Latin Amer ica by De la Torre, Martinez Peri a, and Schmukler (2010) and in 45 
countries around the world by Beck, Demirguc-Kunt  and Martinez Peria (2008) shows that although 
foreign banks are more likely to rely on hard informat ion to lend to small and me dium sized enterprises,  
there is no difference in th e extent of their involvement with thes e firms relative to large domestic and 
government-owned banks.  
31. Empirical analysis based on large samples of firms and countries helps shed light on these 
issues.  A survey of over 3000 firms in 35 developing  and transition countries reveals that foreign bank 
presence is associated with impr oved financing conditions for all firm s, though the effects were greater 
for larger firms (Clarke, Cull and Martinez Peria, 2006).  Data from 60,000 firms from 14 countries in 
Eastern Europe and Central Asia from 1993 to 2002 i ndicates that foreign bank lending was associated 
with growth in firms' sales, assets, and leverage, although the ef fects were less pronounced for small 
firms (Giannetti and Ongena, 2009).  On the other hand, these effects were most pronounced for young 
firms, indicating that foreign banks help ed indeed broaden access to credit. 
IV. THE ROLE OF POLICY 
32. The main purpose of this section is to provide  an overview – without being prescriptive – of 
the role of policy in building effective a nd inclusive financial services sectors.   
33. Financial sector development necessarily in volves a wide range of policy actions and 
structural reforms.  The first priority should be  to ensure a stable political and macroeconomic 
environment.  Even if historical factors (e.g . legal origin, initial geographic endowments) are 
favourable to financial development, political inst ability and corruption will increase the cost of doing 
business and create uncertainty about property right protection, thus adver sely affecting financial 
activity, and ultimately financial development.  Empi rical research shows that political instability and 
corruption have a detrimental effe ct on financial development in low income countries (Detragiache, 
Gupta and Tressel, 2005), and on firm growth (Ayyag ari, Demirguc-Kunt and Maksimovic, 2005, and 
Beck, Demirguc-Kunt and Maksimovic, 2008).  
34. Financial systems also require a sound infrastruct ure, including inter alia the solvency regime, 
the protection of creditor rights, the enforcement of contracts, accounting systems, and information 
disclosure.  Available evidence is quite revealing in that regard:  studies show in fact that firms are 
able to access external fi nance in countries where lega l enforcement is stronger (La Porta et al., 1997;  
Demirguc-Kunt and Maksimovic, 1998;  Beck, De mirguc-Kunt and Maksimovic, 2008), and that 
better creditor protection increases credit to the priv ate sector (Djankov, McLiesh and Shleifer, 2007).  
The study by Detragiache, Gupta and Tressel ( 2005), already quoted, shows that better access to S/FIN/W/76 
Page 8  
 
  information and the enforcement of contracts are asso ciated with deeper financial systems even in low 
income countries.  
35. Sound financial sector regulation and supervision is crucial for financial development.  While 
most observers agree that there is a role for govern ment in the regulation and supervision of financial 
systems, the extent of this involvement is an issu e of debate.  And the per ceptions about the adequacy, 
the boundaries, and the appropriate instruments of re gulation evolve in line with developments.  In 
that connection, the recent financial crisis expo sed fundamental flaws in financial regulation and 
market incentives, which have prompted a significant agenda for regulatory reform.  
36. As shown in the previous section, financ ial services liberalization, understood as the 
elimination of restrictions to the access and operations  of foreign financial ser vice suppliers, may have 
a positive effect on financial sector development.  However, liberalization and deregulation policies 
implemented in the absence of adequate institutiona l development may increase risks that often result 
in financial distress and crisis (Demirguc-Kung and Detragiache, 1999).  Poor sequencing of financial 
sector reforms in a poorly prepared regulatory and supervisory environment may contribute to bank 
insolvencies as banks protected by implicit and explicit government guarantees aggressively take 
advantage of new opportunities to increase risk, wit hout the necessary managerial skills.  The goal of 
the orderly sequencing of financia l sector reforms is to safeguard financial stability during financial 
services liberalization and financial sector development.   Domestic and external financial reforms thus 
need to be pursued in a manner that builds the cap acity of regulators and financial institutions to 
monitor and manage the risks associated with a wide  range of financial market s, permissible financial 
transactions, and financial instruments (IMF, 2005).   
37. Policy should also pay attention to issues rela ted to market contestability.  Research has 
consistently shown that greater competition,  as understood by the GATS (lower market access 
barriers, and no discrimination against foreign financial service suppliers ) improves banking sector 
efficiency.  Banks' interest rate spreads are highe r in countries with higher restrictions on foreign 
banks.  Foreign trade restrictiveness was found by Kalirajan et al (2000) to be a significant 
determinant of the interest rate spread for banks  in 27 economies in the period 1996-97.  In countries 
that protected local banks from foreign competition,  interest rate spreads were 5-60 per cent higher 
than in the absence of trade restrictions.  Usi ng an 80-country sample of developed and developing 
countries between 1988 and 1995, another study by Claessens, Demirgüc-Kunt and Huizinga (2000) 
found that entry by foreign banks reduced both th e profitability and expens es of domestic banks.  
Since high profits reflect a lack of competition,  and high overhead costs a lack of efficient 
management, these results may be interpreted as supporting the assertion that foreign bank entry 
increases efficiency in the domestic banking system. 
38. State-ownership of financial institutions is another importa nt policy dimension, and has 
always been controversial.  Policymakers in many  countries still retain public  ownership of financial 
institutions, particularly banks.  The usual arguments  in favour of state-owne rship of banks revolve 
around improvements in access to financial servi ces (particularly by the poor or in remote 
geographical areas), the implementation of monetary  and financial policies,  and the promotion of 
competition in otherwise oligopolistic market struct ures.  It is worth noting, however, that despite 
isolated cases of success, the vast  majority of empirical eviden ce produced prior to the recent 
financial crisis – from cross-country studies to de tailed analysis of statistics on bank credit in 
individual countries – point to similar conclusions: lending by state-owned banks is associated with 
inefficiencies, increased risk of crises, and greater  concentration of credit (World Bank, 2001).  The 
recent financial crisis may lead to a re-evaluation of the role of state-owned banks, which in critical 
times may become a sort of safe haven for retail and interbank deposits, act as a firewall in the 
process of contagion, be able to sustain lending to  businesses, and even take  up activities of private 
financial institutions in di stress (The Economist, 2010).  S/FIN/W/76 
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  39. Access to financial services has received in creasing attention as of late, following realization 
that one of the vital purposes of the financial system  is to make savings, lending, payments, and risk-
management products available to as large a set of  economic agents as possible.  Without inclusive 
financial services sectors, poor individuals and small enterprises need to rely on their own resources 
to invest in their education, or take advantage of promising business opportunities.  As highlighted in 
previous sections, lack of finance is often the cr itical factor underlying persistent income inequality, 
and slower economic growth.  Hence, though s till far from conclusive, the bulk of the evidence 
suggests that developing the financial sector a nd improving access to financial services are likely not 
only to accelerate economic growth, but also to reduce income inequality and poverty. 
40. While many of the policies often recommended to enhance financial sector development, 
some of which have been hinted at in this section,  will also help increase acc ess to financial services, 
both sets of policies are not always the same.  A po licy reform package for the financial sector that 
does not explicitly prioritize access will tend to make different choices from one that does (World 
Bank, 2008).  That is why access to financial servi ces by the underprivileged should be addressed by 
means of specific policies and regulations, although it  is clear that sometimes difficult trade-offs will 
have to be made. 
V. CONCLUSION 
41. A large body of evidence has developed over th e last years showing that financial sector 
development can make an important contribution to  economic development.  Although more limited, 
there is also some evidence showing a positive ass ociation between trade in financial services and 
economic growth.  It could be expected that, through its impact on economic growth, trade in 
financial services also contributes to economic deve lopment more generally.  This evidence is 
particularly important for developing countries,  whose financial service sectors are in many cases 
relatively underdeveloped and may constitute a hindra nce on economic expansion.  The Note has also 
identified the main policy issues involved in the promotion of financial sector development. 
42. The discussion on the relationship between trade in financial services and development is 
extremely important since it may affect not only the decision of policymakers to pursue financial 
sector reforms, but also their choice of financial sect or policies.  The topic is admittedly vast, with 
many potential ramifications.  This Note is only a first approximation, as targeted as possible to the 
request made by the Committee.  Members might  wish to exchange their own experiences and 
perspectives on the issues raised by the Note, devel op some of the issues further or even identify new 
issues for discussion. 
 
 
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