Financial Development, Openness Relation and the Role of Financial Institutions: A Case of Pakistan

Muhammad Shahbaz1, Naveed Aamir2 and Muhammad Shahbaz Shabir3

1&3COMSATS Institute of Information Technology, Lahore Campus, Pakistan. 2Social Policy and Development Centre, Karachi, Pakistan.

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There is a lack of empirical research on the specific relationship between financial institutions, capital account liberalization and trade-openness; but there is no particular and comprehensive study on the theme in case of Pakistan. This study investigates the importance of financial institutions, net financial capital inflows and trade-openness for financial sector’s development. Further, it also examines the hypothesis by Rajan and Zingales (2003). In doing so, three approaches i.e. Johansen test, DOLS and ARDL bounds testing approach to cointegration have been applied for long-term relationship. The empirical results reveal that long-term relationship among variables is robust. Coefficient of net capital inflows is having positive impact on financial development. Trade openness is the main contributor to financial sector’s development. On the other hand, financial institutions and economic growth also improve the efficiency of financial markets in the country. The rise in inflation declines the performance of financial sector.

Keywords: Capital Account Liberalization, Financial Development, Trade Openness