Bank-deposit contracts versus financial-market participation in emerging economies

Abstract

The financial sector of emerging economies in Africa is characterized by a noncompetitive banking sector that dominates any direct participation of agents in asset markets. We formally identify “market inexperience” as an explanation for agents’ willingness to pay high banking fees rather than to participate in asset markets. Whereas experienced agents choose ex ante investments that result, through trading on the future asset market, in the optimal (second-best) allocation, inexperienced agents are ignorant about the possibility that future market equilibria can improve welfare upon an autarkic investment. As a consequence, a monopolistic banking sector can exploit these agents because their only outside option is an autarkic investment project.