Democracy, Institutions, and Economic Drivers of Financial Sector Growth in OECD and Non-OECD Economies

Abstract

This paper explores the intriguing relationship between financial development and democracy from a modern point of view in the 146 countries of the globe from 1990 to 2024. Lastly, while democratic governance is normally outlined as the capability to govern transparently, answerably, and capaciously, these standardized varieties of fiscal systems are not without exception exactly linear, either positive or pertaining to most societies. The empirical literature finds a U-shaped function relationship between democracy and financial development through which the quality of financial systems initially is worse because of instability of the democracy and weakness of institutions, and then much improved as democracies mature and institutional trust is established. Disaggregated results corroborate the finding that in non-OECD countries, relatively fragile democratic frameworks are likely to retard financial growth, whereas consolidations of the democratic framework on the economic front encourage robust financial growth in the latter. Apart from political institutions, the results underscore the importance of human capital, economic prosperity, and trade integration among the steady incentives of financial deepening, as well as the more context-specific aspects of inflation and unemployment. The findings of the study are that democracy alone is no longer a sufficient precondition for the financial sector's development; only a very stable form of governance, good institutions, and other complementary reforms can make this possible. These findings a critical implications for policymakers in the developing countries, who need to closely interact with, and improve institutional frameworks and governance capacity, after carrying out democratic reforms, if a sustainable financial development is to be achieved.