Development and efficiency of the financial sector and links with trust: Cross-country evidence

In this article, we explore the links between trust and a broad range of financial development measures for a cross-section of countries during the period 1980-95. To do this, we use a recent World Bank data set that provides the most comprehensive coverage of financial development and structure to this date. We find that trust is correlated with financial depth and efficiency when taking into account the level of the development of the country, human capital, macroeconomic stability, and, in particular, the rule of law. With respect to the latter, we show that trust appears to have an additional impact on financial depth and structure in addition to that of the rule of law, and, moreover, we find a differentiated response in countries with different levels of law enforcement.24 Countries with lower law enforcement have higher impacts of trust on financial performance and efficiency. Trust appears to be a key complement of formal institutions when a society has little regard for the latter or vice versa, that is, when trust in a society is low, the development of formal institutions to help uphold the rule of law appears to become particularly crucial in a society. Our results hold when an instrumental variables approach is used. Moreover, they are robust to changes in specification when we use a formal Sala-i-Martín sensitivity analysis.