IMPACT OF COUNTRY GOVERNANCE IN DEFINING BANKS

Country governance is a powerful tool for the formulation and implementation of decisions. The
indicators of governance describe the effectiveness of state policies. They elaborate the application
and creation of rules and regulations of a region. The whole process of selection, evaluation and
replacement of authority is represented by these factors. The primary and essential determinant of
country’s economic performance is its social infrastructure, which is basically the policy of
administration to provide incentives for the firms. The significance of good governance is
universally accepted as it has a major impact on the stability of country’s economy. Many scholars
have strong debate that states authority is one of the significant factor not only for the development
of country but it is the strongest aspect of economic growth and strength of financial institutions.
(Schepens,2013).

The importance of banks in an economy is unquestionable,as they are main source of business
financing. The effectiveness of monetary policy transmission is reliant on an efficient banking
scheme. The regulated banks contribute to flexible financial structure. All emerging countries have
primary goal of setting up an efficient banking system. Financial stability in a state is an important
issue under consideration of developing economies. The relationship between degree of banking
sector stability and subsequent evolution in the economic world can depict the overall financial
position of a country.

In addition, accountability covers a wide range of ideas about how the citizens define their
priorities and protect their rights. Voice and empowerment are the source to make demand to the
state for gaining the better and productive outcomes (Adegbite,2016). The degree to which the
country’s citizen are able to participate in the selection of their government defines the application
of rule of law in that state. The assurance that the particular sector will be evaluated for their
performance or behavior for which they are responsible will lead to the better functioning of
institutions. The concept of being accountable to activities in financial institutions promote the
concept of devotion and loyalty. Political stability and economic growth are interrelated. The stable
environment promotes the performance of financial institutions. Any uncertainty in the
circumstances may lessen the investments and speed of economic growth. Political unrest can
sometimes lead to government collapse that ultimately affects the activities of organizations
related to it. The correct and efficient use of government resources can boost up country’s
monetary conditions. Stability of banks is highly dependent on the state’s activities. Corruption is
considered to be a native issue that requires a large number of unacceptable outcomes. The
influence of corruption on financial institution and soundness is vital. A decreasing factor of
corruption had a useful influence on bank security. Corruption considerably declines the standards
of bank lending and is associated with more sustainable credit development. Also corruption
decreases the value of private investments and finally decreases economic growth. Government
should discover means to diminish corruption. The stability in overall banking sector is a necessary
condition for the rule of law to drive (Shahid, 2014). Economic sciences have explored the relation
between principles of rule of law with economic growth development. The government control,
protection of corruption, realization of obligations influence the implementation of rule of law in
country and its influence on bank performance.

The indicator of government effectiveness expresses the nature of community services and the
quality of the public service and the level of is freedom from administrative influence. It
additionally demonstrates the nature of strategy selection, evaluation and reliability of the authority
loyalty. Better governance leads to the better improved outcomes like commercial growth, public
finance, foreign direct investment and public support. Regulatory quality determines the ability of
the state to create and apply rules and regulations that develop economic sector. In most advance
countries the banking system is highly monitored. Moreover, it also has an objective of initiating
a sound and flexible banking structure. The object of government policies is to secure and boost
the development of the financial sector. The object of banking policies is to decrease bank’s
disclosure to risky asses. It can also protect investors from economical runs.

Problem statement

Measurement of economic activity becomes difficult in the existence of violence. Conflict can
relate with economy through different and complex ways. After the violence recedes it can have a
direct and indirect effect on the economy. Delicate and developing states often make efforts to
maintain flexibility against the shocks. This factor can disrupt the banking sector in multiple ways
and its effects are persistent. Presence of violence in the state is one of the aspect that influence
the performance of financial institutions and their stability.
The factor of corruption can have an adverse influence on long term economic development. It
also enhances the government inadequacy and have unfavorable effect on sustainable
development.it can have an undesirable effect on bank lending and risk taking. As it can decrease
the mechanism of capital allocation from banks to economy, which proves to be very costly for
the monetary activity of a state. Due to influence of corruption banks finance less efficient projects
of firms that use incorrect ways to obtain loans. Studying the impact of this factor on bank’s
soundness is very important as this can help to identify ways to eradicate it completely. Political
stability is considered to be an important factor since it is recognized as an element which plays a
part in country’s success. Most of the researchers have found that the instability and uncertainty
in the political activities can disturb the market activities and labor relations. Such circumstances
have an adverse impact on the productivity. The level of investments is lowered as consequences
of such situations.

The aspect of accountability is so difficult to understand for development that without it society
constantly remains undeveloped. It is a situation in which individuals who apply control are
influenced by outside challenges and inside standards (Chandler and Plano. 1988). Individuals
who didn’t get chance to explore the ventures of public organizations, institutions; accountability
adversely affected and people are bound to tolerate from the depression of authority. Bank
regulation and administration have an adverse effect on banking risk in established and developing
countries. Capital regulation and authority power decreases the intensity of banking risk.
Moreover, to control financial risk is beneficial only through limitations on liquidity and activities
performed, when institutional surroundings is strong enough.

Reduction in poverty and increase in societal well being is highly determined by the success of
financial sectors and their reforms. The uncertainty in financial market whether due to failure of
domestic market or due to external activities can cause an intense economic downfall and damage
to financial wealth. From that prespective, it is priority for South Asian countries to sustain and
grow the institutional framework. Advancing such regulatory structure can facilitate and increase
the stability of financial sector. Many South Asian countries have undertaken financial market
reforms already due to the fact the beginning of the 1990s, while others embarked on such a system
solely lately.The beginning factor of reform is no longer the only difference; South Asian countries
have also followed slightly special techniques of reform. One method stresses the improvement of
each the monetary sector’s effectivity and the allocation of home savings. Within that approach
liberalization and deregulation have been “core pillars of the reform measures”(Akhtar, 2006).

Figure 1: Correlation mix of worldwide governance indicators (2012)

Source: Geovisualist (2012)

Figure 2: Trends in WGI rankings for Pakistan

Source: Thomson reutors

Literature review

Research work of Chan and Kareem (2010) have focused on environmental aspects that affects
bank productivity,as they are considered necessary for examining national factors and regulatory
changes on bank efficiency. The key variables for analysis of performance of banks were providing
loans,cash holdings and contribution to economy. The method of study is based on regression
analysis.The findings of work indicates that economic worth of banks clearly provide the
information about the bank’s position in financial market. This study is significantly contributing
while covering the gap in literature from context of economic researchers.However the core
limitation of study is failing to have proper information access.

The study of Aftab Hussain Tabassam (2016) has explored the effect of political instability on
financial institutions of Pakistan.Also,they have reported its unpredictability over period of last 22
years.The key terms used were terrorism,performance of organizations,strikes and elections.The
technique of research is based on descriptive statistics as ARCH and GARCH models have been
used to examine the effects of political uncertainity on the performance of banks and overall
economic progress.The overall results indicate that political unrest has negative impact on
economy of a country and government should take corrective measures to bring stability. This
work is significantly contributing as by providing the detailed analysis. The constraints to research
are limited time period and ignoring other economic variables.

Reseach of Sunil Kumar (2010) have focused to evaluate the efficiency and performance of public
sector banks working in India and to find out the effects of rule of law on the banking sector.Data
development analysis has been used for computing the efficacy and scores for PSBs.The empirical
results reveal that a strong and positive relation exists between existence of regulations and banks
activity.The practical consequences of research findings is that in the attempt to increase the
performance they will contribute to whole economy and also Indian PSBs will pay more devotion
to income producing abilities.

Hussain G Rammal (2012) have studied the Islamic banking sector and its accountability and
regulation in Pakistan. The major factors that taken into account are Islamic theocracy, government
accountability, regulatory strategies, bank’s performance and market response. The technique
which is preferred is complete historical analysis. The findings disclose the difficulty and
challenges to reform Pakistan’s banking sector into entirely Islamic –based system and the conflict
between central banks, religious authorities and economic progress. The limitations of study are
the different school of thoughts and opinions of people.

The study of Lambsdorff (2005) have focused on the influence of corruption on both the economic
progress and performance of banking sector by using data from various countries over the period
of 2002-2004.The microeconomic variables were used as key terms to study. The method of study
is based on regression analysis. As, the results of various regressions provide the proof that
corruption give rise to problems with bad loans and in what ways corruption lowers the overall
economic prosperity.

Research work of Syed Sohaib Zubair (2014) have focused on finding out the relationship between
world governance indicators and overall economic growth using estimations related to
Pakistan,provided by world bank. They have made an effort to find out which governance indicator
have more impact on activity of financial institutions.The key variables which are used are
different factors of financial growth.A quantitative research strategy and different statistical tools
have been used to test the hypothesis.the study concludes that out of four dimensions of good
governance political stability contributes toward higher performance of country economy.This
study is meaningfully contributing providing the information about the main factors contributing
towards development.

Hall and Jones (1999) have studied the effect of good governance in economic development of
western Balkan countries. They have specifically considered the impact on rate of change in GDP
as an important factor.The technique of research is based on quantitative methodology
approach.The outcomes of study explains that the WGI have different impacts on the financial
sectors of Albania,Bosnia,Kosovo and Serbia.This analysis is contributing to the data for the
research about economic prosperity of western countries. The limitations of research is limited
data and time frame of 1996-2000.

The study of Diezsche and Lozano-Vivas (2000) have paid significant attention to involvement of
the country’s environmental variable is significant in the cross-country assessment of bank
proficiency level using a sample of 752 banks from 87 countries around the world. The key
variables for study are cost and profit efficiency. The method of study is critical statistical analysis
and regression analysis. The results reveal that non-traditional outputs does not alter the directional
impact of environmental variables on bank inefficiency and regulations.This research contributes
to research in studying the impact of environmental variables.

Research of Park (2012) have focused on effect of corruption on bank loaning affairs and economic
development using statistics for 70 countries, for the period 2002-2004. The important factors of
study were credit risk, economic worth and financial soundness.the method of study used is
Corruption Perceptions Index to proxy the country’s corruption level. The results show that
delayed bank enhances the unproductive progress and is linked to the bank’s finances. Similarly,
lower quality of bank credit reduces financial development.The study contributes while covering
the gap in literature.the major constraints can be availability of data.

Variables

Government effectiveness reveals the value of public services,quality of civil services,pressure

free political environment,effectiveness of policy designing and implementation process and
behavior of government in its practical application.It is measured by considering the index of
effectiveness as a high index indicates that state’s authority is strongly indulged and devoted in
formulating public policy,which will led to sustainability in financial activities .As growth of
economy depends on good governance and this factor is considered to enhance the bank efficiency
and an optimistic future conditions.Lensink (2008) further elaborated the higher effectivenesss
decreases the cost of banking operations as it lowers the bureaucracy.

Control of corruption index determines the efforts involved in dealing with the rate of
fraud,dishonesty etc in society.It measures the potential of government and officials to have a
strong hold over corruption level between public administration and citizens. A high index reflects
the low level of corruption and higher bank performance.This correlation can be explained as the
factor increases the cost of doing business that ultimately results in reduction of proficiency levels.
Freedom from such activities promotes the impartial actions, improves the regulatory efficacy and
improved allocation of resources.