4 The remainder of this paper proceeds as follows. Section 2 discusses the role of the financial system in economic development more generally. Section 3 discusses the difficulty associated with measuring the operation of financial systems and the paper‘s development of indicators of financial depth, access to finance, the efficiency of financial systems, and the stability of financial systems for both financial institutions and financial markets—the 4x2 measurement framework—as a strategy for empirically characterizing financial systems around the world and tracing their development over time. The section also introduces the Global Financial Development Database, an extensive world-wide database that combines and updates several financial data sets. Section 4 uses this database and the ―4x2‖ measurement framework to examine and compare financial systems. Section 5 summarizes the key findings.

# **2. The Concept of Financial Development and Its Importance**

There has been a considerable debate among economists on the role of financial development in economic growth and poverty reduction, but the balance of theoretical reasoning and empirical evidence points towards a central role of finance in socio-economic development. Economies with higher levels of financial development grow faster and experience faster reductions in poverty levels. This section introduces the concept of financial development and provides a brief review of the literature on the linkages between financial development, economic growth, and poverty reduction.

# _2.1 Concept of Financial Development_

Markets are imperfect. It is costly to acquire and process information about potential investments. There are costs and uncertainties associated with writing, interpreting, and enforcing contracts. And, there are costs associated with transacting goods, services, and financial instruments. These market imperfections inhibit the flow of society‘s savings to those with the best ideas and projects, curtailing economic development and retarding improvements in living standards.

It is the existence of these costs—these market imperfections—that creates incentives for the emergence of financial contracts, markets and intermediaries. Motivated by profits, people create financial products and institutions to ameliorate the effects of these market imperfections. And, governments often provide an array of services—ranging from legal and accounting systems to government owned banks—with the stated goals of reducing these imperfections and enhancing resource allocation. Some economies are comparatively successful at developing financial systems that reduce these costs. Other economies are considerably less successful, with potentially large effects on economic development.

At the most basic, conceptual level, therefore, financial development occurs when financial instruments, markets, and intermediaries mitigate – though do not necessarily eliminate – the effects of imperfect information, limited enforcement, and transactions costs. For example, the creation of credit registries tended to improve acquisition and dissemination of information about potential borrowers, improving the allocation of resources with positive effects on economic development. As another example, economies with effective legal and regulatory systems have facilitated the development of equity and bond markets that allow investors to hold more diversified portfolio than they could without efficient securities markets. This greater risk