The degree of development of the financial sector is a sound indicator of long-term economic growth. Jalian and Kirpatrick (2005) showed that even for developing countries, improved financial systems speed up the pace of per capita productivity and production growth as they channel the resources of society toward fruitful activities that translate into productivity gains.

Rioja and Valev (2004) point out that the intensification of financial intermediation will undoubtedly have an impact on growth if banks reach a certain level of development measured by private credit/GDP ratio of at least 14%.

There is a strong correlation between a healthy financial sector and economic growth due to the positive effects the former has on private savings and resource allocation. The State has a major role to play in encouraging the development of institutions involved in long- term financing, specialized institutions, and supporting instruments suited to particular types of needs. The measures expected from the State largely involve improving the regulatory and legal framework (competition, prudential rules, tax system, interest rates, credit and recovery law, etc.).

Nevertheless, stringent regulations often hobble development of the banking system in developing countries. Financial repression (Agénor and Montiel, 1999) arises when banks are required to maintain high ratios of mandatory liquidity and reserves. When combined with legal and institutional gaps, such controls are considered as a major cause of underdevelopment in the financial sector. These gaps involve: (i) information on borrowers; (ii) exercise of property rights; and (iii) guarantees and land registry.

Background

Low public confidence in the banking sector and its limited role in financial intermediation have resulted from the civil war and political upheaval that prevailed over the last three decades. After achieving independence in 1953, Cambodia's economy showed robust growth for a decade until the introduction of a planned economy policy in the 1960s, with the banking and foreign trade sector being nationalized in 1963.