# **Introduction**

**Financial development, especially if starting from low levels, promotes capital accumulation, a more efficient allocation of investment, productivity growth, and ultimately economic development.** It has also been shown to reduce income inequality and is strongly associated with poverty alleviation.<sup>1</sup> Therefore, financial development can, at least in theory, help countries affected by state fragility deal with both the symptoms and the causes of their fragility.

**At the same time, state fragility can obstruct the process of financial development.** Financial markets and, more broadly, financial activity rely critically on well-functioning institutions that protect property rights and provide a minimum of certainty; on an environment of trust among economic agents; and on the ability of policy makers to provide stable macroeconomic conditions. Fragile states, where these elements are in short supply, can be expected to have less developed financial institutions and markets—although the evidence on this is mixed.<sup>2</sup>

**The close relationship between fragility and financial development means that financial reforms and policies are almost always part of the strategies that states follow in order to exit from fragility.** However, the content and focus of these financial sector reforms and policies, their sequencing, and the priority they are given relative to other policy interventions vary widely from country to country. Are there lessons to be learned from the variety of country experiences? Is there an optimal formula or best practice for financial reforms that countries trying to exit fragility should follow? To the best of our knowledge, the extant literature is largely silent on these issues.

**This paper attempts to shed some light on these questions by investigating and comparing the experience of a sample of countries that successfully exited fragility.** The target audience is policy makers in fragile states, including those who support them with advice, financial assistance, or policy conditionality—notably donors, international financial institutions (IFIs), and other development partners. The paper analyzes the financial sector reforms these countries implemented as part of their exit strategy and examines whether there are lessons to be drawn for countries in similar circumstances. Since financial sector reforms are usually part of World Bank and IMF policy programs, the paper relies on material collected by an archival search of World Bank and IMF documents for these countries.

**The remainder of the paper is organized as follows.** The next section provides a primer on the conceptual and measurement issues related to fragility and the state of knowledge regarding exit strategies. The following section discusses the sample of countries and the sources of the material

> 1 Beck, T., A. Demirgüç-Kunt, and R. Levine (2007), “Finance, Inequality and the Poor,” _Journal of Economic Growth_ , 12(1): 27-49; Levine, R. (2005), “Finance and Growth: Theory and Evidence,” in: Aghion, P. and S. Durlauf (eds.), _Handbook of Economic Growth_ , Amsterdam: Elsevier.

> 2 See Barajas, A., R. Chami, and C. Fullenkamp (2021), “The State of Finance in Fragile States, in: Chami, R., R. Espinosa, and P. Montiel (eds.), _Macroeconomic Policy in Fragile States_ , Oxford University Press.

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