AI and governance quality - twin pillars in the evolution of financial development

Chua, Sien Ruo and Law, Cheng Xin and Tan, Jing Ruo and Wong, Chu Hui (2025) AI and governance quality - twin pillars in the evolution of financial development. Final Year Project, UTAR.

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Abstract

The growing importance of Artificial Intelligence (AI) as a transformative force in financial systems is gaining recognition, particularly in developing economies. However, the combined impact of AI adoption and governance quality on financial development remains insufficiently explored. This study examines the roles of AI integration and governance standards across 58 developing countries over the period of 1996 to 2021. The analysis reveals that: (1) increased adoption of AI technologies significantly supports the development of the financial sector, and (2) strong governance, particularly political stability, reinforces financial system security and fosters long-term financial growth. These effects are especially evident in countries facing higher levels of financial exclusion and where financial institutions demonstrate greater efficiency. The variables used to measure financial development, AI penetration, and governance quality include domestic credit to the private sector, digital infrastructure indicators, and political stability, respectively, sourced from the World Bank and other global databases. Employing the two-step system Generalized Method of Moments (GMM) estimator, the study ensures robustness against endogeneity and autocorrelation, while accounting for country specific heterogeneity. The findings highlight key policy implications: (1) governments should focus on establishing politically stable and transparent institutions, and (2) strategic investment in AI technologies should be prioritized to enhance financial inclusion and accelerate economic development. Keywords: Artificial Intelligence. Governance Quality, Financial Development, GMM, Financial Inclusion, Financial Performance, Macroeconomic Variable

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