Financial Institutions and Efficiency of Financial System: Evidence from Montenegro

This paper examines the impact of the Montenegrin development financial institution (DFI) – Investment and Development Fund of Montenegro (IDF) on development dynamics and the overall efficiency of the financial system in Montenegro. The research was conducted using the unrestricted (reduced-form) vector autoregression (VAR) model in levels. This study shows that the Investment and Development Fund of Montenegro has a significant short-term influence on the interest rates of commercial banks, with the effect fading over time as the financial system matures. The IDF did not crowd out private borrowing. Findings highlight the valuable contribution of DFI in fostering competition in the emerging financial system. Limitations include the focus on small and underdeveloped financial system and the absence of analysis in larger and more developed systems. Future research should address these limitations, extending the scope for a more comprehensive result. The findings provide insight for policymakers regarding the DFI role in fostering development and efficiency on small and underdeveloped financial systems. This study contributes novelty by analysing the development impetus of DFIs on the incipient financial system, providing valuable insight for policymakers and guiding future research directions.