At a certain point of our economy, when financial development is experienced, there will also be diminishing returns and increasing costs.
According to a new study conducted by the International Monetary Fund, there is “financial deepening” when there is deeper markets and better access to various financial services that spurs growth of the economy, most especially in evolving markets.
Ratna Sahay, Martin Cihak, and Papa N’Diaye wrote in the study, “Our analysis uncovers evidence of ‘too much finance’ in the sense that 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.”
Financial Situations in Various Markets
Although a number of evolving markets, such as Ecuador and Gambia, experience financial deepening which affects their economic growth rate; several developed markets, such as the United States of America and Japan, on the other hand, are going on the opposite direction.
Former US Treasury Secretary Tim Geithner cited the concept of financial deepening as partial justification for stabilizing large banking institutions, on the fact that the US needs them in order to benefit from the economic growth in evolving markets.
The study also found that if the strong regulation works, it will blunt the bad impact of “too much finance” or too fast financial growth.
According to Sahay, Cihak, and N’Diaye, “The analysis shows that these tradeoffs can be improved by strong institutions and a sound regulatory and supervisory environment. In other words, regulatory forms can increase the benefits from financial development while reducing the risks.”
The Cost of Volatility
The problem in terms of finance is the quality of economic growth and the fact that over development of the financial sector may lead to crises; thus, it can be very volatile.
We experienced this volatility when the world suffered during the great financial crisis last 2008. This just goes to show that it imposes costs in terms of sup-par growth and large sunk costs from wrongly allocating the capital.
Lower Investment Efficiency
Another interesting finding from the study is that with high levels of financial development, there is also lower efficiency in term of investment.
To put it bluntly, highly developed markets have a huge amount of money that they can put to work; however they tend to do worse job at finding projects to use their capital.
Therefore, it is vital to note the pace of financial deepening in the economy in order to invest your money wisely. While credit may be needed for investment, it is also a smart move to determine the pros and cons of using Sky Blue Credit.