Research Finance

Advancing Financial Regulation in Low and Middle Income Countries

, by Weiwei Chen
Nicola Limodio has secured funding from the European Research Council to study how tofine tune policies of financial regulation and government intervention to promote structural transformation and development

Banks operating in Italy and most low- and middle-income countries face an almost identical level and structure of financial regulation, despite operating in profoundly different environments. For instance, financial institutions in low- and middle-income countries are more exposed to specific sectors like agriculture; face stronger political economy frictions; enjoy weaker legal and contractual protection; interact frequently with networks of informality and trust; and undergo the effects of religion in the choice of financial instruments, among other factors.

Nicola Limodio, Assistant Professor at Bocconi's Department of Finance, has received an ERC Starting Grant of €1.5m for his project FINDEV (Financial Institutions and Development). The project aims to provide policymakers with the knowledge needed to design and implement financial regulation based on consideration of the specific frictions and constraints faced by financial institutions along the path to development.

FINDEV is composed of three empirical projects to advance our understanding of the specific conditions and frictions faced by financial institutions operating in low- and middle-income countries. Understanding these aspects is crucial to formulating policies of financial regulation and government intervention that promote structural transformation and development.

The first project entitled "Ethnic Banking and Central Bank Independence" plans to study the political economy frictions behind financial regulation in Africa. Combining bank balance sheets and information on bank chief executive officers (CEOs), it will measure the ethnic connotation of banks and the co-ethnicity between CEOs and regulators. It will then investigate the existence of ethnic favoritism in banking, the political use of financial regulation and the role of central bank independence in alleviating this friction.

The second one, called "Branch Organization, Multiculturalism and Conflict", is focused on Ethiopia, a country that embedded multiculturalism and multiethnicity in the country's constitution as a distinguishing feature of national identity, but has suffered a devastating outbreak of ethnic conflict in recent years. In particular, the project tries to address the following question: "How does the internal organization of banks reflect multiculturalism? Does it react to the emergence of conflict that are polarizing the differences between workers and, if so, how?"

The third project, entitled "Market Incompleteness and Non-Performing Loans (NPLs)", plans to study the introduction of a government-owned financial institution that creates a market for non-performing loans (NPLs) in China. Non-performing loans (NPLs) are loans in a state of default, or close to it.

Bank Regulation in Developing Countries

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