Government intervention in the financial system, including the setting of interest rates, the imposition

of high reserve requirements and quantitative restrictions on credit allocation, was a fairly common
practice in the 1960s and 1970s, especially in developing countries. That practice was challenged
initially by Goldsmith [19691 and later by McKinnon [1973] and Shaw [1973], who saw it as being
responsible for low savings, credit rationing and low investment. They dubbed it 'financial repression.'
As an antidote the authors proposed the financial liberalization thesis, which essentially involved
freeing financial markets from government intervention and letting the market determine the price
and allocation of credit. The policy implications of this analysis are quite straightforward: remove
interest rate ceilings, reduce reserve requirements and abolish directed credit programs.

Financial liberalisation can be defined as a set of reforms and policy measures

designed to deregulate and transform the financial system and its structure
with a view to achieving a liberalised market-oriented system within an
appropriate regulatory framework. The success of
financial sector reform throughout the world has seen the introduction of
market-based procedures for monetary control, the promotion of competition
in the financial sector, and the relaxation of restrictions on capital flows.
Specifically, the move away from a tightly controlled financial sector to a
deregulated one results in greater flexibility in interest rates, enhancement of
the role of markets in credit and foreign exchange allocation, increased
autonomy for commercial banks, greater depth of money, securities, and
foreign exchange markets, and a significant increase in cross-border capital
flows.
The objective of bringing about these changes to the financial system is to
create more efficient and stable systems, which will facilitate better
performance in the economy. This means providing a foundation for
implementing effective stabilization policies and successfully mobilizing
capital and putting it to efficient use, which leads to achieving higher rates
of economic growth.1