Financial deepening and bank productivity in Latin America

Abstract

Financial intermediation in Latin America has experienced profound changes due to financial liberalization, which also resulted in further financial deepening. The bulk of the literature on financial deepening focuses on its macroeconomic dimension and its implications for growth. In this paper, we shift our attention to its microeconomic implications by shaping the environment within which banks operate. In particular, we examine the possible effects of financial deepening on bank productivity changes as well as the possibility of a two-way causality. We obtain bank productivity estimates using the non-parametric Malmquist methodology. We find strong evidence of causality from financial deepening to bank productivity and also evidence of reverse causality. Our results suggest that a virtuous circle between financial deepening and financial institutions’ productivity may exist.