The current global financial crisis that has gripped western financial markets especially, and which will be felt by developing countries (albeit to a lesser extent) is unprecedented in the history of financial development.

As I had pointed out in my earlier articles on the sub-prime mortgages in the USA and its impact on other financial markets in the western financial markets, financial distress of the magnitude we are witnessing in USA, and other western financial markets will be felt in other financial markets especially if such market are integrated and have high levels of convergence.

For markets with high levels of convergence and this is true of western financial markets visa avis the USA financial markets, its impact will be approximately be close to unitary.

That is, given that, these financial markets are highly integrated, a financial distress in one, sends equal or near equal financial shock to the other market.

This is so because these financial market, are so close that buyers in one are sellers in the other market almost at the same time.

Globalisation of finance heightened by information technology also means that funds flows in and out of these financial markets are trended in these very regions showing severe impact on the underlying economies.

Thus, globalised finance out paced existing regulatory measures many economies had put in place so much so that, existing regulatory measures in western financial markets were inadequate to ensure efficient globalised financial markets.

In other wards, development of globalised finance was too fast for bureaucratic regulatory measure in place. The net effect of such a crisis is first and fore most credit squeeze with the consequential constrain on growth of these economies and in the extreme; recession.

Perhaps the biggest problem facing such financial markets is loss of confidence/trust by depositors/shareholders and yet this is the main asset and pillar of any financial system.

One has to appreciate the fact that, financial development is THE most important aspect of any economy in its pursuit for economic growth and development.

Indeed, various theories and a number of empirical generalisations have attempted to explain the relationship between financial development and economic development.

Prominent researchers in this area have posted thesis on how banks can provide the required impetus for the innovation necessary for development of underlying economies.

Others espouse the thesis on supply-leading and demand-following hypothesis which has served as a conceptual framework for development of banking industry in many countries.

Indeed by mid 1970s a consensus had emerged among leading researchers, to the effect that financial development is important to, and leads to economic development.

These and the work other many policy makers, academics and financial practitioners have been central to the causality debate between financial development and economic development, and has shaped and indeed influenced the perceptions of the World Bank as to the role of financial development in economic development, as is evident in the World Bank (1989) development report "Financial systems and Development”.

The contrary position, that financial development follows rather than leads to economic development is held by some writers, albeit a minority in this area of interest to policy makers.

Theories on the relationship between capital markets development and economic development have influenced, in part, the current neo-orthodox stance of the IMF and IFC regarding the role of capital markets in development.

Levine’s (1995-2000) theories and empirical generalisation of the role of capital markets’ development in economic development especially with reference to the Asian Pacific Rim, renders strong support for the development of capital markets.

Finance can indeed be regarded as the mainstay of modern economies, and its role in the process of economic development has been aptly put that: "Money as a unit of account and medium of exchange reduces the transaction and search costs involved in barter transactions.

Money as a store of value provides time for making purchase decisions, thus reducing the risk of ill-formed and hasty decisions.”

Thus, it is expected that the development of financial sectors of an economy would have both positive and direct impact on the overall development of the real sector.

The earliest recorded work on the influence of financial development seems to be that of Hamilton (1781). He argued that banks were the happiest engines that were ever invented to spur economic growth.

According to this view, banks would avail the required capital to facilitate the growth process by financing innovativeness, which would enhance the accumulation of goods and services.

The positive role of banks in economic development was also articulated by Schumpeter (1912), who contended that well-functioning banks spur technological innovations by identifying and funding those entrepreneurs with the best chance of successfully implementing innovative products and production processes.

According to Schumpeter, a banking system and entrepreneurship were two crucial factors and development agents.

He observes that the capacity of the banking system to create credit empowered entrepreneurs with the necessary purchasing power with which to command the directional use of productive resources to where there were better rewards.

Thus, the Schumpeterian view of the relationship between finance and development is premised on the impact of financial intermediaries on productivity growth and technological change.

The above researchers and others form a body of thinkers who have put a mark on the role of financial development in economic development, a market that has for many decades been authenticated by the response of the real sector to the development of the financial sector of which it is part.

There is thus no doubt that, financial development is important to; and influences economic development, and the response by governments to the financial crisis in western financial markets (and which will be felt by developing economies by way of limited export markets, reduced credit, FDIs and foreign aid) is expected.

The only problem facing policy makers in the western financial markets is to know exactly the extent, and effects of such crisis. So far the response undertaken (bail-out or nationalization of financial institutions) is the most prudent in these conditions to avoid total collapse of these financial systems and with them entire economies.

To appreciate the magnitude of this problem let us take a simple example of one financial institution Washington Mutual (WaMu) in the USA which went under following a run on its Seattle  braches that saw a withdraw of $ US 16.7 billion.

With assets totalling to US$ 307 billion, and deposits of US$ 188 billions it was USA’s largest savings and loans institution. Such a failure meant that, million of depositors in USA lost their savings, and so are the shareholders of this institution who saw their share market values wiped off.

This has a contagion effect on other western financial markets where WaMu had either lent/ borrowed, financed or re-financed projects and indeed international shareholders who had bought its shares on other western stock markets where such companies are cross-listed.

The net impact of such failure becomes an international problem because of the integration of western financial markets and by extension this erodes savers confidence in addition to their lost purchasing power which is felt in these economies for some time to come.

The author is a Senior Presidential Advisor on Economic Affairs