The chapter serves to discuss the importance and contribution of Financial Markets in the Economic Growth of a country. The author discuss as how the financial market serve to marshall the general savings in the economy and channelize them to the most productive avenues of the firms undertaking investment activities. By this, the author puts forward a view in contrary to classical view that an economy dependent on Financial Markets for its growth will need to rely less on the banking system and will thus experience economic growth. Before discussing the pros and cons of Banking system, author cites the example of US Economy and East Asia, that were struck with economic disaster because of high reliance on banking technology during 1989-90 and 1997 respectively.
Calling the Banking system- ‘’A Miracle’’, as the the banking system converts the most ill-liquid investments into highly liquid investments as the depositors can get their deposits converted into cash without any substantial cost or time delay. Also the depositors, with the help of loan officers can invest their in such ill-liquid assets which help them earn higher returns than what they could earn on their own. However, the main point of discussion is as how an economy suffers from excess reliance on Banking System. Author cites that of all the contributing factors to the economic growth, banking system remains most fragile. The whole banking system is dependent on the depositors and this is the only fact which makes the system highly vulnerable. If all the depositors lose their faith in banking system, the banking system is sure to fall. In order to tackle this issue, although, the governments uses its sovereign powers to guarantee the deposits, for instance US Government guarantees $100000/account, but still even this promissory provision has not turned to be much successful as recently when Thai Central Bank in order to bail out deposits of Failing Banks, increased the Thai Money Supply, it was counter attack to its effort to mop up the liquidity and sent a confusing signal to the market as what actually the central bank is trying to do.
However, whether the guarantee is explicit or implicit, it requires back up in the form of Basel regulations on the bank. On the liability side of the bank, international norms has been established where banks are required to have 8% first tier capital requirements while on the asset side, the basel approach has tried to deal with credit risk of the banks by imposing Risk Based Capital Requirements. However, since these regulations are not self enforcing, banks are required to face multiple auditors and regulatory teams and thus this system is criticized on the basis that it in force beureaucrization and heirarchy in the structure. A recent example of failure of rules and regulations on bank was failure of banking system in East Asia where the regulatory structure produced worse ever credit crunch.
- Fall of Japanese Stock Market which continues today also
- Collapse of Real Estate Prices after a heavy portion of bank funding was diverted to risky real estate ventures.
- Non-Performance of Business Loans
In the concluding section, author cited use of Money Market Mutual Funds as a substitute of Banking System. Since money market mutual fund invests in highly liquid money market instruments like Treasury Bills and highly rated commercial papers, they are most likely to serve the investors and borrowers need in a better position and thus economy can experience growth and development without facing any consequence of banking system.
Works Cited
Miller, M. Financial Markets and Economic Growth. In M. Miller. Chicago: University of Chicago.
