West African Financial Sector Development: Empirical Evidence on the Role of Institutional Quality and Natural Resource Rents

Abstract

The paper examines the effect of natural resource rents and institutional quality on financial sector development in West Africa. Using pooled OLS, fixed effect and system generalized method of moments (GMM) estimations with several robustness checks, the results indicate that natural resource rents have an adverse effect on financial development. Further evidence shows that institutional indicators, based on control of corruption, rule of law and government effectiveness, positively influence financial sector development. In contrast, the interaction of natural resource rents with various institutional measures consistently alters the relationship. Thus, findings show that the indirect effect of natural resource rents on financial development process is detrimental through the channel of institutional quality, as increased natural resource wealth could exacerbate the incidence of corruption and gross mismanagement in the public sector. In addition, natural resource windfalls encourage high tendencies for divestment in financial sector in the sub-region. Based on these findings, the paper argues that strong institutions could help enhance the performance of financial sector in West Africa. However, to achieve this aim, policy makers across countries should formulate policies anchored on effective governance system to enhance efficiency of the financial sector in West Africa. Also there should be right mix of policies that will mitigate the incidence of gross mismanagement of natural resource wealth, and thus infuse improved demand for financial credit and market services within the sub-region.

Keywords: Financial Development, Institutional Quality, Natural Resource Rents and West Africa.