Financial sector and the resource curse

This paper examines financial sector characteristics in resource-dependent economies. Using a unique dataset covering 133 countries, we present empirical evidence that the banking sector tends to be smaller in resource-dependent economies, even when controlling for several other factors which have been shown to have a significant effect on financial sector development in previous studies. Moreover, the threshold level at which the increasing resource-dependence begins to be harmful for domestic banking sector is very low. We also find evidence that the use of market-based and foreign financing is more common in resource-dependent economies. Further, we argue that a relatively small financial sector used to cater the needs of the resource sector might be unfavorable for emerging businesses, thereby hampering economic diversification and reinforcing the resource curse. 

That is the abstract of the new paper "Financial sector in resource-dependent economies" by Sanna Kurronen (2012). She argues:

Using a unique dataset covering 128 countries, we present empirical evidence that the banking sector indeed tends to be smaller in resource-dependent economies, even when controlling for several other factors which have been shown to have a significant effect on financial sector development in previous studies. 

Intuition says that resource wealth, like any other wealth, should be benign for financial development. Indeed, that seems to be the case at very low levels of resource dependence. We locate a threshold where the country’s mineral exports account for about 6% of total exports. With export dependence on minerals above the threshold level, correlation between resource export share and domestic banking sector size turns nega- tive.

The author argues that the financial sector that develops in the context of a resource-dependet economies plays a role in the resource curse:

Whatever the reason behind the financial development in resource-dependent economies, the financial sectors in those countries seem to have characteristics that are unfavorable to small and medium size enterprises and emerging businesses, which tend to be more dependent on the domestic banking sector than are the bigger and more mature firms. Consequently, we argue that financial sector development based on large resource endowments might play a role in the resource curse. A financial sector that is structured to serve large firms is perhaps unable to serve emerging sectors of the economy and thus restrains economic diversification.

She defines resource abundance in terms of mineral exports as a percentage of total exports. 

A similar analysis could be done for exports of agricultural commodities, which have historical importance for some countries, like coffee in Central America, or Cocoa in Ghana. In fact interest rate margins in Latin America are the highest in the world. Probably this is related to a small financial sector explained by economies concentrated on few agricultural commodities.