Role of institutions in promoting finance in emerging markets: A panel data analysis

Differences in institutions have garnered much attention in recent years as one of the primary reasons for long-term economic performance, and a vast corpus of theoretical and empirical research demonstrates that financial development can have a substantial impact on economic and financial performance. In fast-growing emerging markets, the demand for financial services has considerably increased, which amplified the need for an efficient regulatory framework to deal with the sensitive nature of financial activities. Surprisingly, the existing literature on the impact of institutions and finance is focused on developed economies, while emerging markets are rarely focused on. Since emerging markets are becoming increasingly important as a result of the swift evolution of institutional and financial transformation, it is crucial to examine how the growth of financial markets reacts to institutional quality. This study investigates the role of institutions in promoting finance in emerging economies using the balanced panel dataset of 21 emerging market. Given the endogenous relationship between institutions and finance, the paper applies a two-stage least squares estimator to test the settler mortality hypothesis in this context. Aligned with theoretical intuition, the empirical result shows that settler mortality is a relevant instrument to institutions. Furthermore, the study performs robustness, using framework that deals with heterogeneity, and cross-section dependence. This empirical effort validates La Porta’s Law and Finance Hypothesis in the context of emerging markets. The results of the study are found robust across the variety of alternative measures of institutions and finance, and standard error correction specifications. Therefore, the study offers useful insight into policy implications.