Financial Development and Credit Creation in Developing Countries-The Sri Lankan experience.

Abstract

Private credit plays an important role in fostering healthy economic growth through facilitating higher level of investment. This paper investigates the impact of real interest rates and the spread of banking services to the accumulation of bank deposits and expansion of credit based on the data on Sri Lankan financial system during 1990 and 2009. The paper argues that spread of banking services positively contributes to deposit mobilization and subsequent credit creation by the banking system. Moreover, as deposits are less sensitive to interest rates, interest rate controls still can play a role in fostering financial development through creating rent opportunities for banks to induce expansion of branch network, provided the prevailing inflation rates are relatively low so that deposit rates are non-negative.