How harmful is the role of the banking system for emerging economies? IMF knows
In a new research conducted by economists of the International Monetary Fund it was investigated that the role of the financial sector in the US, Japan and other advanced economies has grown too big. Meanwhile, emerging economies should not forget of the 2008 global financial crisis and never allow their banking systems and financial markets to grow faster than regulators can keep up with, the Financial Times reported.
“Financial development entails trade-offs,” the study’s authors wrote in an accompanying blog. “Beyond a certain level of financial development, the positive effect on economic growth begins to decline, while costs in terms of economic and financial volatility begin to rise.”
The question of what role banks should play in national economies and how authorities
should regulate them to mitigate the hectic effects of market volatility has been disturbing since the 2008 crisis. However, the IMF economists went further to tackle the wider issue of how big a role banks and other financial institutions should play in healthy economies.
They used
data for 128 countries collected between 1980 and 2013 to establish a
“financial development index”. The index is designed to reflect not just
how much raw credit banks and other financial institutions issue but
also broader measures such as countries’ depth of access to bank
accounts and financial products.
The results of the research showed that economies such as Ireland, Japan and the U.S. had already crossed a line when financial sector expansion began to have a smaller impact on growth that eventually turned negative.
The economists argue that countries suffering from “too much finance” use their financial resources less efficiently. They are allocated less and less to productive activities meaning that the overall productivity growth in economies slows.
Most emerging economies had not yet reached that point, with good regulation often limiting the negative influence of runaway financial sector growth.
There were, however, vivid inaccuracies in the research. The IMF economists did not underscore any emerging economies that had passed the point of diminishing returns. China is one emerging economy where the financial sector has grown fast in recent years, but the new study did not include data for the country.
The institution also did not issue data for other big economies such as Germany and the UK, where finance plays a significant role.
