The Role of Banking Sector Policies in Financial Development: The Case of Iran

The paper aims to investigate empirically the effects of several types of financial restraints on financial development for the case of the Iran. Two hypotheses addressed and discussed in the context of the McKinnon/Shaw and the monopoly bank model. A conditional co-integration model has been employed to carry out the empirical investigations. The long and short-run analysis show that financial restraints in general as well as ceilings on lending rates have had a negative effect on financial depth in Iran, supporting that the financial restraints policy has hindered rather than helped financial deepening. Therefore, in the context of the financial system imperfections (the monopoly bank model) which is the case in Iran, the finding could be interpreted that the authorities have used a severe financial repression policy which has caused a negative effect on financial development rather than developing financial intermediation. In addition, our findings show that the per capita output is not weakly exogenous with respect to financial development, stating that financial development may bring economic growth in the long-run. Thus, policies that affect financial development are also likely to influence economic growth. The main implication of this paper is that if the government continues to tighten financial restraints in the banking sector, this policy does not develop financial sector therefore, it may damage the economic growth which is the main aim in the FYDPs.JEL: G18 G21 E44 E58