Governance and financial development: Evidence from a global sample of 120 countries

This study empirically investigates the impact of governance quality on financial development. The study employs a Dynamic Common Correlated Mean group technique using data from a global sample of 120 countries, among which 32 high‐ and 88 low‐income countries, for the period 2002–2017 to examine this linkage. Political stability and absence of violence, rule of law, control of corruption, regulatory quality, government effectiveness, and voice and accountability are used as proxies for governance quality, whereas financial institutions depth and credit to private sector are proxies of financial development. The following findings have been established. Regulatory quality and political stability and absence of violence are positively associated with financial development, whereas voice and accountability, and government effectiveness are negatively associated with it. Moreover, the degree of the impact of these governance indicators on financial development is relatively greater in high‐income countries as compared to low‐income countries. On the basis of these results, governments in high‐ and low‐income countries must implement the following policies in order to improve the development of their financial systems: Firstly, they should promote a better regulation quality by implementing sound policies and regulations that permit and improve private sector development. Secondly, they should maintain a stable political environment by allowing people to enjoy, but not excessively, their rights and freedoms under the constitution. Policy makers should lastly moderate their commitment towards certain public policies, such as imposition of high tax rate to the private sector.