Financial market reform has risen to the forefront of public policy debates in recent years. The burgeoning literature on economic growth has come to recognize the crucial role that welloperating financial markets play in promoting rapid economic growth.1 Indeed, it is now well recognized that the structure of financial markets helps explain why many countries remain poor while others grow richer. Financial market reform to produce an efficient financial system is thus now seen as a key element in raising countries out of poverty.
The banking and financial crises of recent years in emerging market and transition countries (and even in industrialized countries like Japan) have also demonstrated that when things go wrong with the financial system, severe economic contractions can be the result. Thus another impetus behind the recent interest in financial market reform is the desire to prevent banking and financial crises so that the worst business cycle contractions can be avoided. Furthermore, banking crises impose substantial costs on taxpayers, often in excess of 10% of GDP.2 Financial reform to avoid these costs has thus also become a central issue for public policy.
This paper examines financial market reform by first outlining an asymmetric information framework that provides a rationale for government intervention in the financial system. This framework is then used to outline what direction governments should take in financial market reform.