Chapter 1

Introduction
1.1 Statement of the Problems
The topic of the project paper or report is to find out the impact of interest rate reforms or liberalization
on financial development and thereby economic growth. The statement of the problems is to whether
interest rate liberalization as originally prescribed by the McKinnon and Shaw hypotheses or can
unambiguously lead to economic growth.

1.2 Title of the Report

It is necessary to select a topic in writing a report. A well-defined topic reflects what is going on to be
discussed throughout the report. The topic Impact of Interest Rate Reforms or Liberalization on
Financial Development & Economic Growth selected by me is duly approved by the respective
supervisor. The report has discussed how the interest rate liberalization enhances financial development
and thereby causes economic growth.
The Title of the report Impact of Interest Rate Reforms or Liberalization on Financial Development
& Economic Growth especially focuses on SAARC.

1.3 Origin of the Study

As a partial requirement of B.B.A. program we are required to prepare internship report. This report has
been prepared during the three months Internship Program in Bank Asia Limited, Dhanmondi Branch. In
the classroom we get the opportunity to know the theoretical part of the subject. But without practical
orientation it is somewhat difficult to grasp the core concept. In the project paper I have collected data
from World Bank (Data). Beside this I have also collected data from published literature, Central Bank of
selected countries. The main variables are deposit interest rate, lending interest rate, inflation rate, gross
national income, M2 over GDP and GDP growth rate. In this report, I have tried to find out the
relationship between interest rate liberalization and financial development and thereby economic growth.

1.4 Rationale of the Study

This report is a part of my academic program. The BBA program having 120 credits in total
contains three (3) credit hours on the Internship Program and Project Paper. The internship
program has been set for three (3) months period. I believe this study will be beside me in future,
especially if I get myself involved in banks and other financial institutions. The program has
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helped me a lot to understand the organizational atmosphere and behavior in general banking.
From the internship program I have become familiar with different aspects of banking operations
like customer service, clearing & cash department, accounts department, credit department and
foreign trade department as an intern in Bank Asia Limited.

1.5 Objectives of the Study

The primary purpose of writing this report is to fulfill the requirement of BBA program and the general
purpose of the study is to analyze the impact of interest rate liberalization on financial development and
economic growth. The findings from the empirical study and some recommendations have been made.
However, the specific objectives of the study are as follows:
Specific Objectives:

To find out the overall interest rate movements of the selected countries.
To indentify the effect of interest rate liberalization on the economy.
To find out the causes of positive and negative impact of interest rate liberalization on economy.
Drawing a conclusion on interest rate liberalizations impact on financial systems and economy
with recommendations.

1.6 Scope of the Study

For the purpose of partial fulfillment of the study, I have chosen the project on The Impact of Interest
Rate Reforms or Liberalization on Financial Development & Economic Growth. The study is
mainly done based on SAARC and four other countries named South Africa, Zambia, Indonesia and
China. The scope of this report is to analyze the impact of interest rate liberalization on financial
development and thereby economic growth. To find out this impact I have used graphical and financial
deepening model. After analyzing the impact I have drawn a conclusion based on the findings.

1.7 Limitations of the Study

To complete this project paper I have faced few problems. I think these problems are faced due to some
limitations of the study. However, these limitations can be presented in the following lines;

The first limitation is the lack of intellectual thought and analytical ability to make it the most
perfect one.

The analysis is based on some limited data, so it has become difficult to draw a complete figure.

Lack of in-depth knowledge for writing such kind of project paper.

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Chapter 2
Overview of the Topics
The relationship between interest rate liberalization and economic growth has attracted considerable
attention and debate in recent years. The thrust of the debate has been whether interest rate liberalization
as originally prescribed by the McKinnon and Shaw hypotheses or can unambiguously lead to economic
growth. Since the re-invention of the financial liberalization concept in the 1970s, many countries have
made attempts to liberalize their financial sectors by deregulating interest rates, eliminating or reducing
credit controls, allowing free entry into the banking sector, giving autonomy to commercial banks,
permitting private ownership of banks and liberalizing international capital flows.
A number of empirical studies have been conducted on the link between interest rate liberalization and
economic growth in many developing countries. In particular, the dynamic linkage between interest rate
reforms and economic growth in different countries has not been fully explored.
Previous empirical studies on this subject suffer from three major limitations.
First, the majority of the previous studies on this subject have attempted to examine the relationship
between interest rate reforms and economic growth directly. The relationship between interest rate
reforms and economic growth is an indirect one. Interest rate liberalization impacts on economic growth,
through its influence on financial deepening.
Secondly, the majority of the previous studies on this subject have mainly used a causality test. The causal
relationship between financial development and economic growth suffer from the omission-of-variable
bias.
Thirdly, some of the previous studies have relied on the cross-sectional data to examine the relationship
between interest rate reforms and economic growth. Cross-sectional method may not satisfactorily
address the country-specific effects.
The current study, therefore, attempts to examine the dynamic relationship between interest rate reforms,
financial development and economic growth in mainly SAARC and four other countries named China,
Zambia, South Africa and Indonesia.

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Chapter 3
Literature Review
The debate regarding the relationship between financial liberalization in general and interest rate in
particular and economic growth has attracted considerable attention. Since the re-invention of the
financial liberalization concept in the 1970s, many countries have made attempts to liberalize their
financial sectors by deregulating interest rates. According to the so-called McKinnon-Shaw hypotheses
(1973), the liberalization of interest rates enables savers to switch some of their savings to financial
assets. Hence, it expands the supply of credit in the economy. In this way, financial liberalization impacts
on economic growth, through its influence on financial deepening and savings. Shaw (1973), McKinnon
(1973) concluded that in a financially repressed economy, real deposit and lending rates are often
negative, with adverse consequences for the development of financial system, and savings and investment
generally.
A number of empirical studies have been conducted on the link between interest rate liberalization and
economic growth in many developing countries. On the empirical front, a limited number of studies have
been conducted in developing countries to examine the relationship between interest rate liberalization
and economic growth - with varying results. Nicholas M Odhiambo (2009-2010) in his article of Interest
Rate Deregulation, Bank Development and Economic Growth) showed M2 over GDP as an indicator of
financial depth and GDP growth rate as an indicator of economic growth. Two models have been
employed to examine this linkage in a stepwise fashion. In the first model, the impact of interest rate
reforms on financial depth is examined using a financial deepening model. In the second model, the
dynamic causal relationship between financial development and economic growth is examined by
including investment as an intermittent variable. The empirical results of the study show that there is a
positive and significant relationship between interest rate reforms and financial deepening in South Africa
and Zambia. In addition, the study results show that lagged financial depth in South Africa and Zambia
also leads to further financial deepening in the country. Economic development in South Africa is driven
largely by the growth of the real sector rather than the financial sector. The studies showed that savings
and economic growth cause each other and financial development causes savings in Zambia. The findings
of this study, therefore, support the interest rate liberalization policy, which has been ongoing in Zambia
since the 1990s. Yiping Huang, Xun Wang, Bijun Wang and Nian Lin (2010) conducted a study on
Financial Reform: Progresses and Challenges. The studies showed that economic reforms not only
changed the lives of millions of Chinese people, they also transformed the world economy by reversing a
long-term declining trend of the Chinese economy. Financial deepening is the proportion of money supply
to GDP, which rose from 32 percent in 1978 to 178 percent in 2009. Similarly, the proportion of financial
4 | Page

assets to GDP increased from 51 percent to 200 percent during the same period. But the financial sector
still exhibits almost all typical characteristics of financial repression. They suggested that China need to
establish two types of market-based interest rates: interbank rates and risk-free bond yield. The
government must completely give up its intervention in credit allocation. Banking reforms need to be
completed.
Gordon Newlove Asamoah, Kwame (2008) showed, in their article of Financial Sector Reforms on
Savings, Investments and Growth of Gross Domestic Product (GDP), that there is a positive relationship
between private investment and real interest rate. This study has reviewed some major issues in interest
rate reform and financial liberalization. The approach to interest rate policy and financial sector
liberalization generally should take into account the initial state of the economy. Financial intermediation
can affect economic growth by acting on the saving rate. The research found out that financial services
stimulate savings, investment and growth of GDP and for that matter economic growth. Anthony K.
Ahiawodzi (2012) focused on financial market efficiency. Interest rate liberalisation involved the
deregulation of interest rates (both deposit and lending rates) in order to reduce the high level of the
financial market distortion, and to encourage competition among the banks. Consequently, financial
intermediation would improve, leading to increased mobilization and allocation of resources in the
financial sector in particular and in the economy as a whole. Tomola M. Obamuyi and Sola Olorunfemi
(2011) demonstrated that financial reforms and interest rates have positive and significant effect on
economic growth. The results show that there exist a unique long-run relationship between interest rates
and economic growth. Again J.U.J. Onwumere, Okore Amah Okore and Imo G. Ibe (2012) have
identified a negative non significant impact on savings of deposit rate liberalization. They also found that
liberalized lending rate had a negative significant impact on investment in Nigeria. They recommend that,
in determining the appropriate sequencing of interest rate liberalization in Nigeria, the authorities need to
distinguish not only between loan and deposit transactions but also between wholesale and retail
transactions.
Just like the relationship between interest rate liberalization and economic growth, the causal relationship
between financial development and economic growth has been very controversial and, therefore, remains
an empirical rather than a theoretical construct. Elijah Udoh (1970-2008) presents that policy directed at
interest rate liberalization is relevant for financial depth, and financial depth in turn affects economic
growth, through its effects on investment. Kevin Greenidge and Alvon Moore argues that the success of
liberalization policies largely depends on the institutional structure of the countries. The main finding of
the paper is that the direct effects of financial liberalization on financial development varied across the
countries.
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In Bangladesh one study had been made by Subrata Ghatak and Jalal U. Siddiki on Financial
Liberalisation and Endogenous Growth: The Case of Bangladesh. The paper theoretically and empirically
explored the impact of financial liberalization (FL) in the form of an increase in real interest rates. The
paper used the time series techniques and annual data from 1975-95. Another study on Liberalization and
Growth in Bangladesh: An Empirical Investigation by Omar K M R Bashar & Habibullah Khan
(2009) reveals that economic liberalization entails either trade liberalization or financial and capital
account liberalization or both. Findings suggest that trade liberalization has had significant positive
impacts on economic growth in Bangladesh.
The relationship between financial development and economic growth is very controversial. However,
recent empirical studies have shown that the relationship between financial development and economic
growth differs from country to country and over time. Studies have shown that the causal relationship
between these sectors is very sensitive.

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Chapter 4
Methodology
The report will begin with the formal specification of the relationship between interest rate liberalization
and financial deepening. The impact of pre-interest rate reforms and liberalization and post-interest rate
reforms and liberalization will be discussed.
After collecting data from the World Bank (Data Section) - GDP growth rate, M2 over GDP, inflation,
GNI per capita, deposit interest rate, lending interest rate, interest rate spread, net lending, the following
analysis will be done;

Graphical presentation of GDP growth rate as an indicator of economic growth.

Financial deepening over the year.
Spread of interest rate (Positive / Negative).
Trend of deposit or lending interest rate.
Commercial bank and other lending trend.

I will regress the financial depth variable on real income, deposit rate, inflation and the time period. The
motive behind this specification is to verify whether real interest rates positively or negatively affect
financial depth. The model can be expressed as follows:
Financial Deepening = 0 + Deposit Interest Rate + Lending Interest Rate +
Inflation + GNI per Capita + Lagged Financial Depth + Et
Deposit rate is expected to capture the impact of interest rate liberalization on financial deepening. The
coefficient of deposit rate in the financial deepening model is expected to be positive based on the
financial intermediation thesis that higher deposit rate encourage surplus households to save more thereby
making more funds/finance available for investment and economic growth. The inclusion of inflation rate
is meant to capture the impact of inflation on the various components of money. The lending interest rate
is expected to provide the information about investment opportunities in the country. So, the coefficient
should be negative to reflect financial deepening properly. Gross National Income and lagged financial
depth lead further financial deepening and thereby causes economic growth. So the coefficient of these
two variables should be positive and statistically significant.
Before using financial deepening model in aggregate, we will analyze the impact of interest rate
liberalization on financial development and thereby economic growth by using graphical presentation.

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Chapter 5
Data Source & Definition
I have taken mainly SAARC countries and four other countries named South Africa, Zambia, China and
Indonesia. The variables that I have taken are deposit interest rate, lending interest rate, inflation, gross
national income, GDP growth rate, M2 over GDP and commercial bank and other lending to analyze the
impact of interest rate liberalization on financial development and economic growth. I have used
approximately last thirty two years data from 1980 to 2011 to analyze the impact of interest rate reforms
or liberalization on financial development and economic growth. The prescribed data set are collected
from World Bank Data Centre. The definition of those variables and some important term is described
below;
Financial Liberalization:
Financial Liberalization refers to reduction of any sort of regulations on the financial industry of a given
country. Basically, Financial Liberalization means lessening restrictions on various types of lending
institutions and instruments.
Interest Rate Liberalization:
Interest rates are defined as the rental payments for the use of credit by borrowers or the return for parting
with liquidity by lenders. Interest rate liberalization means making it more free market dictated rather
than government regulated means.
Economic Growth:
Economic growth means an increase in a countrys productive capacity. So, economic growth refers to the
increase in the capacity of an economy to produce goods and services, compared from one period of time
to another.
GDP (Gross Domestic Product):
GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and
minus any subsidies not included in the value of the products. It is calculated without making deductions
for depreciation of fabricated assets or for depletion and degradation of natural resources.GDP per capita
is gross domestic product divided by midyear population. GDP at purchaser's prices is the sum of gross
value added by all resident producers in the economy plus any product taxes and minus any subsidies not
included in the value of the products.

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GNI (Gross National Income):

GNI is the sum of value added by all resident producers plus any product taxes (less subsidies) not
included in the valuation of output plus net receipts of primary income (compensation of employees and
property income) from abroad. GNI, calculated in national currency, is usually converted to U.S. dollars.
GNI per capita (formerly GNP per capita) is the gross national income, converted to U.S. dollars, divided
by the midyear population.
Inflation:
Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the
average consumer of acquiring a basket of goods and services that may be fixed or changed at specified
intervals, such as yearly.
M2 over GDP:
Money and quasi money comprise the sum of currency outside banks, demand deposits other than those
of the central government, and the time, savings, and foreign currency deposits of resident sectors other
than the central government. This definition of money supply is frequently called M2.
Deposit Interest Rate
Deposit interest rate is the rate paid by commercial or similar banks for demand, time, or savings
deposits.
Lending Interest Rate
Lending interest rate is the rate charged by banks on loans to prime customers.
Interest Rate Spread
Interest rate spread is the interest rate charged by banks on loans to prime customers minus the interest
rate paid by commercial or similar banks for demand, time, or savings deposits.
Commercial banks and other lending:
Commercial bank and other lending includes net commercial bank lending (public and publicly
guaranteed and private nonguaranteed) and other private credits.

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Chapter 6
Analysis & Findings
6.1 Graphical Presentation
To examine the impact of interest rate liberalization on economic growth we have used models, graphs
and causality linkage in a stepwise fashion. The efficacy of interest rate liberalization is examined by
regressing the interest rate on the level of financial deepening at the end of the graphical analysis of all
countries aggregately. Now the graphical analysis of each country and impact of the liberalization is
described below in details;

Bangladesh
Starting from mid-1980s, Bangladesh gradually introduced various liberalization measures. First of all,
Bangladesh liberalizes its international trade. Then it liberalizes its financial and capital accounts in
1990s.
Bangladesh adopted financial liberalization under the Financial Sector Reform Project (FSRP) during the
first half of the 1990s. This kind of financial liberalization deals with the banking sector. The financial
sector reforms in Bangladesh include liberalization of interest rates, improvement of monetary policy,
abolishing priority sector lending, strengthening central bank supervision, regulating banks, improving
debt recovery and broadening capital market development.
Now, the impact of interest rate liberalization on financial deepening of Bangladesh is shown below
graphically;
100

10

50
0
1970

5
1980

1990

2000

2010

M2 as % of GDP
Deposit Int. Rate %

2020

0
1970

1980

1990

2010

Int. Rate Spread

Fig: 1.1
(Sources of Data: World Bank Data; Indicators)

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2000

Fig: 1.2

2020

100000000

10

50000000
5
0
1970

0
1970 1980 1990 2000 2010 2020
-50000000
1980

1990

2000

2010

2020

GDP Growth Rate %

Commercial Bank & Other Lending

(current US$)

Fig: 1.3

Fig: 1.4

(Sources of Data: World Bank Data; Indicators)

In figure 1.1, we can see that deposit interest rate and financial deepening was identical and represented a
positive relationship. During the period from 1980 to 1991 during the pre liberalization period deposit
interest rate was constant over time and there was less financial deepening. But, after the liberalization of
interest rate M2 over GDP has increased continuously over time. In figure 1.2, after the interest rate
liberalization in 1990s, there is a positive trend of interest rate spread and thereby net commercial bank
and other lending has increased and quite stable (Fig: 1.3). So, interest rate liberalization causes financial
development and thereby financial deepening.
However, there were and are still some limitations to grow economy on behalf of financial deepening.
The key constraints to improved growth performance include;

Non-existence of market oriented monetary policy instruments

Inefficient credit delivery system and insufficient mobilization of savings

The biggest obstacles to sustainable development in Bangladesh are overpopulation, poor

infrastructure, corruption, political instability and a slow implementation of economic reforms

Many important aspects of governance are very weak
Urbanization has been rapid and largely imbalanced
Capital markets are extremely shallow

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Sri Lanka
After 1977 the process of liberalization has started by initiating the task of revising tariff structure,
reducing restrictions on foreign investment, announcing new incentives to export-oriented foreign
investment under a Free Trade Zone scheme. After that the financial deepening gradually increases over
time.
In early 1980s the consequences regarding financial liberalization was ambiguous. This is because of
first shift in policy priorities away from structural adjustment. There also prevailed political appealing
glamorous investment projects. Secondly, the intensification of the ethnic conflict between the Sri Lankan
Tamil and the government forces is further responsible for the situation. So effect of liberalization was not
too good because of countrys political situation.
50.00

10
5

0.00
1970 1980 1990 2000 2010 2020
M2 as % of GDP

0
1970
-5

1980

1990

2000

2010

2020

-10

Deposit Int. Rate %

Int. Rate Spread

Fig: 2.1

Fig: 2.2

(Sources of Data: World Bank - Data; Indicators)

In the above two figure, we observe that after the deregulation of interest rate trend of interest rate spread
(Fig: 2.2) is negative and financial deepening (Fig 2.1) is quite stable.
However in the following figures we observe that there exist rising trends in GDP growth rate after the
year of 2001. Sri Lanka is the country where interest rate liberalization did not properly induce financial
deepening.
10
5
0
19751980 1985 1990 1995 2000 2005 2010 2015
-5
GDP Growth Rate %

Fig: 2.3
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(Sources of Data: World Bank Data; Indicators)

Beside this, economic growth is fluctuated in 2001 and in 2008 but there exists positive trend. So, there is
no significant positive relation of financial Liberalization in money demand and economic growth of Sri
Lanka which was supported by McKinnon and Shaw (1973).

Nepal
Nepal began to eliminate regulatory policies present in the financial and economic system and started to
liberalize different sectors (such as financial, foreign trade and public enterprises) of the economy from
the mid of 1980s. The primary objective of liberalization was to minimize the role of government in the
economy. The country gave importance to the private sectors role in stimulating economic growth. The
main targets of implementing the policy reforms are to develop the financial system and promote
economic growth.
During the 1980s, the central bank took steps to deregulate the financial system which constrained the
banking sector to function freely in the market. In the first step of deregulation, the monetary authority
removed existing entry barriers of banks and other financial institutions.
In the changing financial environment, the central bank realized the need of development banks for
development activities. For this, Agriculture Development Bank was allowed to carry out commercial
bank activities since 1984.
The credit control measures imposed before liberalization were gradually removed after liberalization,
and commercial banks were left freer to allocate credit. In this way the country got the benefit from
interest rate liberalization and led to financial development and economic growth.
Now the graphical presentation of data is shown below;
100

10

50
0
1970

5
1980

1990

2000

2010

M2 as % of GDP
Deposit Int. Rate %

Fig: 3.1

2020

0
1970

1980

1990

2010

Int. Rate Spread

Fig: 3.2

(Sources of Data: World Bank Data; Indicators)

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2000

2020

20
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
-10
GDP Growth Rate %

Fig: 3.3
(Sources of Data: World Bank Data; Indicators)
Graph representing the financial deepening and deposit interest data are presented in figure 3.1. Here, we
see that financial deepening has been increasing over the time period of liberalization. In the post
liberalization period the deposit interest rate is more or less stable or represents same trend. The proxy for
economic growth represented by GDP growth rate also shows the same trend in the post liberalization
period. Figures also indicate that all indicators have same trending behavior. Similarly, the series are
trending more sharply in the post liberalization than in the pre-liberalization period.

Pakistan
Government of Pakistan introduced several reforms for the improvement of banking sector. State Bank of
Pakistan (SBP) has taken many influential steps in order to increase performance of banks in Pakistan.
Fewer lending to small and medium enterprises was given before the reforms. Medium enterprises
generated most of development and employment in the country. State Bank of Pakistan (SBP) has taken
many influential steps in order to increase performance of banks in Pakistan.
Before the reforms there was no balanced structure in banks. In mid 1980s public sector banks were
dominating the financial sector. Government allowed local private banks to operate and privatize national
banks in 1990s. Main aim of these reforms was to restructure banking sector and make banks compatible.
After financial reforms the banking sector of Pakistan witnessed highly positive financial results. Though
banks maintained upward trend in profitability, following factors created challenges for SBP;

Changing ownership structure,

Transformation in banking system composition,
Growing market competition,
Technological advancement,
Enhanced focus on corporate governance culture and internal disputes.

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Now the graphical presentation of data of liberalization is shown below from 2000 to 2011;
10

5
2000 2002 2004 2006 2008 2010 2012
M2 as % of GDP

0
2000 2002 2004 2006 2008 2010 2012

Deposit Int. Rate %

Int. Rate Spread

Fig: 4.1

Fig: 4.2

15
10
5
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
GDP Growth Rate %

Fig: 4.3
(Sources of Data: World Bank Data; Indicators)
Financial reforms have a significant impact on the banking sector and economic growth. The interest rate
spread (Fig: 4.2) in the post liberalization period represents a stable trend. But because of political clash
and internal dispute decreases the confidence of interest rate reforms or liberalization. The financial
deepening or development (Fig: 4.1) and economic growth (Fig: 4.3) is not so good for the above
mentioned reasons. The inflation rate also contributed in this situation.

South Africa
South Africa was one of the first developing countries to liberalize its interest rates, which occurred in
1980. However, like many developing countries, South Africa adopted a rather rapid approach to financial
liberalization, with reversal in some instances.
For example, the credit ceilings were abolished in 1972, but were later re introduced in 1976. Between
1977 and 1979, the ceilings were further tightened before being abolished in 1980. During the same year,
constraints on mortgage rate were also removed. More reforms were undertaken in the financial sector in
1982 and a substantial number of new banks were allowed to start operation in South Africa.

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The liberalization of interest rate in South Africa, however, was initiated in 1980. During the 1960s and
1970s the South African interest rates, just like other financial prices, were quantitatively controlled. The
rationale for this rapid interest rate liberalization was to allow banks greater flexibility and to encourage
competition.
After the liberalization of interest rates, banks were able to vary rates charged to borrowers according to
their cost of funds and according to the creditworthiness of different borrowers. Although the monetary
authorities expected interest rates to be positive in real terms after their deregulation but remained
negative in real terms. This was largely due to the high inflationary pressures during the 1980s. It was not
until the 1990s that a distinct positive interest rate was attained. After 1990, the rates remained fairly and
consistently positive over and above inflation, with the exception of 1992, when rates fell drastically.
These results are shown in the following graphs;
100

10

50
0
1970

5
1980

1990

2000

2010

2020

M2 as % of GDP

0
1970

1980

Deposit Int. Rate %

4000000000

2000000000
1990

2000

2010

GDP Growth Rate %

Fig: 5.3

2010

2020

Fig: 5.2

10

1980

2000

Int. Rate Spread

Fig: 5.1

0
1970
-5

1990

2020

0
Commercial
Bank & Other Lending
1970 19801990 2000 20102020
(current US$)
-2000000000
-4000000000
-6000000000

Fig:5.4

(Sources of Data: World Bank Data; Indicators)

Financial deepening or development (Fig: 5.1) has increased over the year with the positive interest rate
spread (Fig: 5.2). But during the year of 2009s due to inflationary pressure interest rate spread indicates
negative trend. Beside this GDP growth rate (Fig: 5.3) as an indicator of economic growth except 2009
has remained stable. Investment opportunities (Fig: 5.4) has also maintained a stable trend over the year
in post liberalization period.

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Zambia
The liberalization of the financial sector, which was implemented in 1991, led to the entry of new
financial institutions into the industry. Since then the financial sector in Zambia has grown phenomenally.
The financial sector currently consists of the Central Bank, commercial banks, non-bank financial
institutions comprising the three building societies, some micro-finance institutions, the National Savings
and Credit Bank (NSCB), the Development Bank of Zambia (DBZ), the 37 Bureaux de Changes and
leasing companies, insurance companies, pension funds and the capital market.
In Zambia interest rate was liberalized in 1992. The financial sector since the onset of financial
liberalization, the Zambian financial system has remained relatively small and underdeveloped. Though
the development of financial depth and economic growth has increased over time is not satisfactory. The
trend of the deposit interest rate and financial deepening (Fig: 6.1) is described and shown below;
200

30

100

20

0
1970

10
1980

1990

2000

2010

M2 as % of GDP

2020

0
1970

Deposit Int. Rate %

Fig: 6.1

1980

1990

2000

2010

2020

Int. Rate Spread

Fig: 6.2

(Sources of Data: World Bank Data; Indicators)

In the above graphical representation of the trend of deposit interest rate and financial deepening, we can
easily identify the interest rate liberalization period. Before the interest rate liberalization the deposit
interest rate was very high. But after the interest rate liberalization the deposit interest rate were
determined by the competitive market. On the other hand, interest rate spread (Fig: 6.2) represents
positive trend and stable in the post liberalization period.
Financial deepening influences economic growth rate substantially. In the case of Zambia, interest rate
was liberalized in 1992. From the financial deepening graph we have found out the increasing trend in
17 | P a g e

financial development. In this graphical representation of economic growth (Fig: 6.3) as GDP growth rate
we can easily identified the interest rate liberalization period.
10
0
1975 1980 1985 1990 1995 2000 2005 2010 2015
-10
GDP Growth Rate %

Fig: 6.3
(Sources of Data: World Bank Data; Indicators)
After the interest rate liberalization economic growth was sharply increased. So we can easily conclude
after analyzing graphical representation that interest rate liberalization influences financial deepening and
thereby affect economic growth.

Indonesia
Financial sector is one of the most profoundly regulated sectors in developing countries. By controlling
the activities of financial institutions, governments can determine the direction and cost of investment in
all sectors of the economy. Being a developing country, the economy of Indonesia also experienced such
sort of government restrictions. From the 1950s to the early 1980s, the Indonesian government frequently
resorted to controls on bank lending and special credit programs (at subsidized interest rate) to promote
favored groups. Toward the end of this period, the state banks that administered government programs
were criticized as corrupt and wasteful which made reformation of financial system inevitable.
The Indonesian financial development program over the period 1983 to 1992 aimed to transform the
countrys financial system as a part of a wider economic renewal program that included reform of the
taxation system, international trade regulation and governance. The program was adopted in response to
the deteriorating economic situation, particularly in the oil industry Indonesias major export - and was
intended to strengthen the economy through greater diversification.
The very first and major economic reform of the 1980s permitted a greater degree of competition between
state and private banks. In June 1983, credit quotas were lifted and state banks were permitted to offer
market-determined interest rates on deposits. Many of the subsidized lending programs were eliminated,
although certain priority lending continued to receive subsidized refinancing from Bank Indonesia. In
addition, important restrictions remained, including the requirement that state enterprises bank at state
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banks and limitations on the number of private banks. In October 1988, further financial deregulation
essentially eliminated the remaining restrictions on bank competition. Limitations on licenses for private
and foreign joint-venture banks were lifted. By 1990 there were ninety-one private banks--an increase of
twenty-eight in a single year--and twelve new foreign joint-venture banks, bringing the total foreign and
joint-venture banks to twenty-three. State enterprises were permitted to hold up to 50 percent of their total
deposits in private banks. Later, in January 1990, many of the remaining subsidized credit programs were
eliminated. From 1983 to 1996 the economy grew fast at above 7% annually as shown below (Fig: 7.2);

20

1970

1980

1990

2000

2010

M2 as % of GDP

2020

0
1970

1980

1990

2000

2010

2020

-20

Deposit Int. Rate %

GDP Growth Rate %

Fig: 7.1

Fig: 7.2

(Sources of Data: World Bank Data; Indicators)

Financial sector reform in Indonesia started with the interest rate liberalization in 1983. From the figure
7.1, we can see that the ratio of M2 over GDP grew incredibly since government liberalized the financial
sectors. This growth of M2 over GDP represents the financial deepening of the economy.

China
Chinas financial policies were highly repressive, evidenced by the governments regulation on interest
rates and intervention in capital allocation. Economic theory predicts that financial repression reduces
efficiency and increases risks.
Contribution of reform policies to economic growth in China has been well documented. Economic
reforms not only changed the lives of millions of Chinese people, they also transformed the world
economy by reversing a long-term declining trend of the Chinese economy.
The reform period witnessed rapid growth of financial activities. Thirty years ago, the financial industry
was close to non-existence. Today, China already has a wide range of financial institutions, from banks to
securities companies.
We have collected data from 1980 to 2011. Now the graphical representation of data is shown below;
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20

10
1970

1980

1990

2000

2010

M2 as % of GDP
Deposit Int. Rate %

2020

0
1970

1980

1990

2000

2010

2020

GDP Growth Rate %

Fig: 8.1
Fig: 8.2
(Sources of Data: World Bank Data; Indicators)
Here we see that in figure 8.1, financial deepening indicates a positive trend and economic growth (Fig:
8.2) is stable in post liberalization period. So, interest rate liberalization causes financial deepening and
thereby causes economic growth. In China, interest rate spread is also positive or there exists a positive
trend in the post liberalization period.
During the 1990s the state sectors dominance of financial resources, especially bank loans, has a major
negative impact on economic growth. Whenever economic growth slowed, the Chinese government relied
on the state sector as well as fiscal and monetary policy to support economic activity. Such policy
approach, however, effectively suppressed private investment and probably reduced overall efficiency of
economic activities in China.

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6.2 Financial Deepening Model

In our previous analysis of the impact of interest rate reforms or liberalization on financial development
and economic growth graphically, we can easily find out the impact of interest rate liberalization on
financial development and thereby causes economic growth.
In this section, the relationship between interest rate liberalization and financial deepening is examined by
regressing the financial depth variable on deposit rate, lending rate, expected inflation, gross national
income and the lagged value of financial depth. The research question in this case is whether real interest
rates positively or negatively affect financial depth. The model can be expressed as follows:
Financial Deepening = 0 + Deposit Interest Rate + Lending Interest Rate + Inflation + GNI per
Capita + lagged financial depth + Et
The rationale for including different variables in the financial deepening model is based on the following
theoretical arguments;
The inclusion of deposit rate is expected to capture the impact of interest rate liberalization on financial
deepening. The coefficient of deposit rate in the financial deepening model is, therefore, expected to be
positive and statistically significant.
The lending interest rate is expected to provide the information about investment opportunities in the
country. So, the coefficient should be negative to reflect financial deepening properly.
The inclusion of inflation rate is meant to capture the impact of inflation on the various components of
money. There has been an argument that inflation adversely affects the holding of all classes of financial
assets. The coefficient of inflation in this study is, therefore, expected to be negative and statistically
significant.
Gross National Income and lagged financial depth lead further financial deepening and thereby causes
economic growth. So the coefficient of these two variables should be positive and statistically significant.
In this study, I have selected mainly SAARC and four other countries named South Africa, Zambia,
Indonesia and China. I have mainly taken on an average 30 years data to reflect the effect of interest rate
on financial development. The outcome of the financial deepening model is shown and described in the
next page;

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Where, m2gpdp = Financial Deepening

depositr = Deposit Interest Rate
lendingr = Lending interest Rate
inflatio = Expected Inflation Rate
gnipc = Gross National Income Per Capita
lagdepth = Financial Deepening Lagged Once
In this financial deepening model, we can see that the overall R-sq: 0.9379. There exists a very high
degree of relationship between independent and dependent variables. So, R-squared = 0.9379 indicates
that explanatory variables explain 93.79% of dependent variable.
Now in this interpretation section, the derived equation is as follows;
m2gdp = 3.013758 + 0.5370516depositr - 0.3691736lendingr 0.0649485inflatio
+ 0.0004597gnipc + 0.7956677lagdepth
Here, the coefficient of deposit interest rate in the financial deepening model is positive and statistically
significant. The coefficient of deposit interest rate is 0.5370516. So, 1 percent increase in deposit interest
rate it will change dependent variable by 0.5370516 percent. So, deposit interest rate positively affects
financial deepening.
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Next, the coefficient of lending interest rate in the financial deepening model is negative and statistically
significant. The coefficient of lending interest rate is - 0.3691736. So, 1 percent increase in lending
interest rate it will decrease dependent variable by - 0.3691736 percent.
The coefficient of expected inflation rate in the financial deepening model is negative and thereby affects
financial development negatively. The coefficient of expected inflation rate is 0.0649485. So, 1 percent
increase in lending interest rate it will decrease dependent variable by 0.0649485 percent.
The coefficient of gross national income in the financial deepening model is positive and thereby affects
financial development positively. The coefficient of gross national income is 0.0004597. So, 1 percent
increase in gross national income it will increase dependent variable by 0.0004597 percent.
Finally, the coefficient of lagged financial deepening in the financial deepening model is positive and
statistically significant. The coefficient of lagged financial deepening is 0.7956677. So, 1 percent increase
in lagged financial deepening it will change dependent variable by 0.7956677 percent. So, lagged
financial deepening causes further financial development.
After analyzing financial deepening model, it is proved that interest rate liberalization causes financial
development. Here, we can also conclude that lagged financial depth leads to further financial deepening.

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6.3 Findings
After analyzing the impact of interest rate reforms or liberalization on financial development and
economic growth graphically and by using financial deepening model, the following findings can be
drawn;

There is a positive & significant relationship between interest rate reforms & financial deepening.
The relationship between financial development and economic growth differs from country to

country and over time.

The success of liberalization policies largely depends on the institutional structure and political

condition of the countries.

Interest rate liberalization is relevant for financial depth, and financial depth in turn affects

economic growth, through its effects on investment.

Financial development causes savings in the long run.
Savings and economic growth cause each other.
Lagged financial depth leads to further financial deepening.
Interest rate liberalization reduces unemployment rate through foreign direct investment.
Inflation rate affect the mode of interest rate liberalization.
Interest rate liberalization improves financial intermediation, leading to increased mobilization
and allocation of resources in the financial sector in particular and in the economy as a whole.

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Chapter 7
Summary & Conclusion
This project paper presents a framework of analysis for examining the impact of interest rate reforms or
liberalization on financial development and economic growth. I set out with the analysis of the rich
literature on the interest rate and financial liberalization of different countries and of different writers.
This literature review provided me a vital insight to analyze the impact of interest rate reforms or
liberalization on financial development and economic growth. The empirical results of the study show
that there is a positive and significant relationship between interest rate reforms or liberalization and
financial deepening. Interest rate liberalization contributes to economic growth through financial
deepening or development. In addition, the study results show that lagged financial depth also leads to
further financial deepening.
The policy implication of this study is therefore straightforward; a departure from rigidly fixed deposit
rate of interest will enhance financial depth and improve the countrys rate of economic growth. The
financial reforms should be directed at achieving a more deregulated deposit rate of interest.

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Chapter 8
Summary of Internship Activities
As a partial requirement of the BBA Program, I am currently attached with the Bank Asia Limited,
Dhanmondi Branch as an intern under internship program. I was appointed as an intern from January 15,
2013 under internship program. The length of the program is 3 months (15.01.2013- 15.04.2013). So, at
this moment I am adjacent to complete my internship program.
During the internship program I was and still acquainted with the following orientation program to
familiarize myself with different aspects of banking operations.

Customer Service
Clearing and Cash Department
Accounts Department
Credit Department
Foreign Trade Department

Now, what have I learned and am still learning from the internship program of Bank Asia Limited is
described below;
Customer Service: In the customer service department I have gathered experience in the following
issues;

Meeting customer inquiry

Opening new accounts
Entry and preparing report on pay-order, demand-draft etc.
Issuing new Cheque Books
Providing deposit slip
Providing account statement
Providing Bank Solvency Certificate

Clearing & Cash Department: On the other hand in clearing & cash department I was act as a teller. So,
I made receive and payment of the customer. I also received the pay in slip of students of Munshi Abdur
Rauf Public School & College and Birshreshtaha Nur Mohammad Public School & College. I also
became familiarize with the following issue;

Cash withdrawal
Some important points to be noticed while receiving a cheque
Cash deposit
Cheque deposit
Transfer of funds
Determining Daily Cash Position

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Credit Department: In credit department, I mainly deal with the analysis of financial statement of
different companies. Based on the published or audited financial statements I have to prepare pro-forma
or projected financial statements. I also prepare the Credit Risk Grading (CRG). Bank Asia Limited
considers the following issues in dealing with credit risk. Credit risk for counterparty arises from an
aggregation of the following:

Financial Risk

Business/Industry Risk

Management Risk

Security Risk

Relationship Risk

Based on the above credit risk categories under corporate office every companies or organizations have to
acquire 75 marks out of 100 to get approval to get loan. In credit department I have also learned how to
find out PNW (Personal Net Worth). To get loan approval this PNW is also an important factor.
I also worked in trade and foreign exchange department and accounts department. However, I basically
worked in customer service, cash department and credit department.
Internship Program related documents like job rotation and certificate are annexed to the report in
appendix 2
.

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References
Text Books:
1. Development Finance
Rao, P.K.
2. Economic Development Finance
Karl F. Seidman

Internet Based Materials:

1. en.wikipedia.org
2. http://www.google.com.bd
3. http://data.worldbank.org/indicator
4. http://www.bangladesh-bank.org
5. http://uk.answers.yahoo.com
6. http://www.thefinancialexpress-bd.com

Literatures:
1. Interest rate deregulation, bank development and economic growth in South Africa: an empirical
investigation--Nicholas M Odhiambo, PhD, University of South Africa, South Africa.
2. Financial liberalization in Bangladesh and economic growth--Subrata Ghatak and Jalal U. Siddiki.
3. Interest Rate Liberalization and Economic Growth in Zambia: A Dynamic Linkage-- Nicholas M.
Odhiambo.
4. Interest Rate Liberalization, Financial Development and Economic Growth in Nigeria (1970-2008) -Elijah Udoh & Uchechi R. Ogbuagu.
5. Interest rate convergence in Bangladesh-- Dewan Mostafizur Rahman & Kohinur Akter.
6. Liberalization and Growth in Bangladesh: An Empirical Investigation--Omar K M R Bashar &
Habibullah Khan.
7. Trade Liberalization, Financial Sector Reforms and Growth-- Muhammad Arshad Khan.
8. The Role of Financial Development in Promoting Economic Growth: Empirical Evidence of Indonesia
Economy (Jurnal Keuangan dan Moneter Volume 6 Number 2), written by Abdurahman and published in
2003.
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9. Financial Reform in China: Progresses and Challenges- Yiping Huang, Xun Wang, Bijun Wang and
Nian Lin China Macroeconomic Research Center, Peking University, China.
10. The Effect of Financial Liberalization Policy on Financial Market Efficiency in Ghana: An Empirical
Study- Anthony K. Ahiawodzi Department of Banking and Finance, Institute of Professional Studies,
Accra, Ghana.
11. The Impact of Interest Rate Liberalization on Savings and Investment: Evidence from Nigeria- J.U.J.
Onwumere, Okore Amah Okore and Imo G. Ibe.
12. Liberalization and Growth in Bangladesh: An Empirical Investigation- Omar K M R Bashar,
Habibullah Khan.
13. Impact of Financial Policy Reforms on Financial Development and Economic Growth in NepalBhim Prasad Bhusal, Graduate School of Economics, Kyushu University.
14. Financial Development and Economic Growth in SAARC Countries- Afaque Memon, Niaz Ahmed
Bhutto, Ranjeeta Sadhwani, Hazoor Bux & Falahuddin Butt.
15. Banking Reforms and Economic Growth: a Case Study of Pakistan- Wali Ur Rehman, M. Phil
Leading to PhD Scholar, Foundation University.
16. Several literatures based on Bangladesh by M.A. Baqui Khalily.

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