Investigating the Effect of Institution Quality on Financial Development in Developing Countries

Document Type : Research Paper


1 Assistant Professor of Economics, University of Kurdistan

2 Master of Economics, University of Kurdistan


Since the Financial development through direct and indirect channels helps to economic growth and development, and achieving optimal economic growth is one of the goals of countries; therefore, the present study seeks to identify the factors affecting financial development in developing countries.
 In this study using the System GMM method, the impact of institutional quality on financial development in two groups of selected developing countries in during 2000-2019 has been investigated. The index used for financial development of the first group is the domestic credit provided to the private sector as a ratio of GDP and the index of financial development used for the second group is the Stock market capitalization to GDP. Also, six Good Governance Indicators have been used as a measure of institutional quality.
The result shows that the Good Governance indicators have a positive effect on credit except for the voice and accountability. In addition, Control of Corruption, Government Effectiveness, Regulatory Quality and Rule of Law have a positive effect on the stock market capitalization. Therefore, enhancing institution quality would encourage the development of financial markets in the country studies, and policymakers must adopt appropriate policies to improve the quality of institutions


  1. Acemoglu, D. Johnson, S. & Robinson, J. A. (2001). The colonial origins of comparative development: An empirical investigation. American economic review, 91(5), 1369-1401.‏
  2. Ashrafi, Y., Khodaparast Mashhadi, M., & Salimifar, M. (2014). The Government Role on Financial development: A Case Study of OPEK Countries. Journal of Economic Research and Policies, 205-222. (In Persian).
  3. Ashrafzadeh, H., & Mehregan, N. (2014). Advanced panel data econometrics. Tehran: noore elm. (In Persian).
  4. Cherif, M. (2020). Institutional and macroeconomic determinants of stock market development in MENA region: New results from a panel data analysis. International Journal of Banking and finance, 7(1), 139-159.
  5. Ghudjani, A. (2018). Constitutions and Commitment: The Evolution of Institutions “Governing Public Choice in Seventeenth-Century England”, by Douglass C. North & Barry R. Weingast. (1989). Pooyesh fekri. (In Persian).
  6. Kaidi, N., Mensi, S., & Amor, M. B. (2019). Financial development, institutional quality and poverty reduction: worldwide evidence. Social Indicators Research, 141(1). 131-156.
  7. Kaufmann, D. Kraay, A. & Mastruzzi, M. (2011). The worldwide governance indicators: methodology and analytical issues. Hague Journal on the Rule of Law, 3(2), 220-246.‏
  8. Khodaparast Mashhadi, M., Falahi, M., & rajabzadeh, N. (2016). Investigating the Role of Institutional Quality on Financial Development in selected Countries of the Islamic Conference. Monetary and Financial Economics. (In Persian).
  9. La Porta, R. Lopez‐de‐Silanes, F. Shleifer, A. & Vishny, R. W. (1997). Legal determinants of external finance. The journal of finance, 52(3), 1131-1150.‏
  10. Law, S.H., & Azman-Saini, W.N.W. (2008). The quality of institutions and financial development.
  11. Le, T.H., Chang, Y., & Park, D. (2016). Trade openness and environmental quality: International evidence. Energy policy, 92, 45-55.
  12. Mehregan, N., Keramatfar, M. (2014). Capitalism: Rise treasons, merits. Tehran: noore elm. (In Persian).
  13. Mirdamadi, M., & Naeimipoor, M. (2017). In the shadow of violence: politics, economics, and the problem of development, by Douglass C, North, John Joseph Wallis, Steven B. Webb, & Barry R. Weingast. Tehran: rozaneh. (In Persian).
  14. Patrick, H. T. (1966). Financial development and economic growth in underdeveloped countries. Economic development and Cultural change, 14(2), 174-189.
  15. Pesaran, M. H. (2004). General diagnostic tests for cross section dependence in panels.‏
  16. Pesaran, M. H. (2007). A simple panel unit root test in the presence of cross‐section dependence. Journal of applied econometrics, 22(2), 265-312.‏
  17. Rajan, R. G., & Zingales, L. (2003). The great reversals: the politics of financial development in the twentieth century. Journal of financial economics, 69(1), 5-50.
  18. Sahabi, B., Etesami, M., & Aminpour, Kh. (2013). Effect Good Governance and Government Size on Financial Development in Selected Countries. Journal of Economic Growth and Development Research. Number 12, 105-118. (In Persian).
  19. Westerlund, J. (2005). New simple tests for panel cointegration. Econometric Reviews, 24(3), 297-316.