Relationship between financial system and overall economic development

relationship between financial system and overall economic development

Request PDF on ResearchGate | On the relationship between financial system and economic growth | This paper studies the importance of the development of. The literature review gives an overall idea about the importance of financial The financial system acts as a mediator between those in need of on the relationship between financial development and economic growth. The objective of this course is to develop students' understanding of the main economic relationships that arise between the financial sector and the 'real.

By channeling savings into the business sector through loans — and also offering loans to individuals to buy cars and homes — banks boost overall economic growth and development.

relationship between financial system and overall economic development

Financial Markets Stock markets provide an opportunity for individuals to invest in companies. By issuing shares, public companies pay off debt or raise capital for their operations. The bond market provides another means to raise money.

When an individual or an investment company buys a bond, it receives a steady stream of interest payments over a set period. The bond market is accessible to companies as well as governments, which also need a reliable stream of funds to operate.

Without the bond market, a government could only raise money by levying taxes, an action that tends to dampen business activity and investment. Video of the Day Brought to you by Techwalla Brought to you by Techwalla Financial Crashes In any country, confidence and trust in the banking system are crucial to economic health.

If banks cannot redeem savings accounts, and savers begin to fear a loss of their money, a bank run results; this quickly drains cash from the bank and can eventually cause the institution to fail. Bond and stock markets rise and fall with the demand for investment; when individuals fear risk or lose their trust in the markets, they sell their securities and cause the value of companies to fall.

This, in turn, makes it difficult for businesses to raise money, either from banks or capital markets. Monetary Policy Issuing currency and setting interest rates is the function of government-operated central banks, such as the U. Federal Reserve, which are responsible for monetary policy.

They pointed out that industrialization in most developing countries was largely due to the availability of financial systems to mobilize productive, financial capital. In this argument, Bagehot and Hicks seem to find a common ground on the input of financial services on economic growth.

Levinin his argument states that, the development of financial markets and institutions play an incredibly critical task in the expansion of different sectors of the economy, Cline, Growth in this case induces an expansion of the financial system.

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The lack of financial growth is a manifestation of the lack of demand of financial services as the real side of the economy develops. Economists hold different views on this matter based on both empirical and theoretical framework. Demand following view iii.

Mutual impact of finance and growth iv. Null relationship view The first view supports the fact that growth could be directly related to upward mobility in the financial sector. This view is of the fact that financial development causes economic growth by allocating financial resources to highly productive sectors of the economy. Patrick explains this view by arguing that the transfer of financial resources from the low to the high growth sectors leads to improved production of commodities which induce a demand for financial services and thus leading to subsequent growth in other sectors of the economy, Cline, The second view is of the agreement that the financial sector responds a lot to changes in the real regions of the country.

The third view is of the fact that growth in the financial services could be followed by an equal response in growth from the economy. Previous research on this topic does not give consistent results on their findings on this issue. Chistopoulas and Tsional examine the long run relationship between financial development growth and economic growth for ten developing countries by using panel Co- integration analysis to find a uniform correlation on this issue.

Demetriades and Hussein find that the availability of funds is relevant to the growth of any sector of the economy. A majority of these studies come to one conclusion that an upward transgression in the monetary environment leads to economic growth.

  • What Is the Role of the Financial System in Economic Development?

Most countries in the emerging economies are striving to better on their financial sectors. Abu-Quran on their discussion paper No. This paper seeks to establish whether financial development leads to growth by examining the role of the financial sector and their possible impact on the economy. Financial Liberalization and Economic Growth Financial liberalization refers to the reduction of any regulation on the financial sector of any given country. It refers to the removal of restrictive barriers that may hinder the smooth performance of this sector.

Financial liberalization has been the subject of controversy by many economists.

relationship between financial system and overall economic development

Economic expansion could be defined as the rise in the amount of goods and services by economy overtime. It could be measured as the percentage pace of increase in actual GDP and could be usually calculated in real terms.

relationship between financial system and overall economic development

By liberalising the market, interest rates, should yield positive real interest rates. This will in the event increase the resources existing to the financial system.

Since bank deposits offering a competitive return will attract savings, this will result in more borrowers taking in loans to finance their productive ventures which will in turn generate revenue to them.

Financial Systems and Economic Development

The revenue generated by these borrowers from their capital investments will enable them repay their loans and make subsequent borrowing expand their investments. Impact of Financial Development on Economic Growth McKinnon suggests that liberalization of financial markets allows penetration of financial services among the rural population. This group of people are always on the lower cadre of the social cycle. Therefore, providing them with accessible tools of finance could be considered a very significant step towards achieving economic growth.

What Is the Role of the Financial System in Economic Development? | Bizfluent

This is because peasant communities could be mainly left out due to poor infrastructure, insecurity and abject poverty. This increases the long run growth path of a country and eventually improves the interests and affluence of producers and consumers with access to financial services.

Although Brazil has a relatively low degree of financial sector liberalization, financial access remains one of the greatest strength of this economy. Although India has a weak financial access, its strong financial intermediation bolstered robust results in its foreign exchange stimulates her growth. Russia continues to show strong results in financial intermediation and the non-banking financial sector. In order to ascertain whether financial development and economic growth have any relationship, this paper takes a look at the economic index of the BRIC countries i.

This analysis will prove a clear view on this matter, Lee, By looking at this data, these economies are on an upward trend. According to HSBC Emerging Markets Index, emerging nations are on the upward trend and project that bythe top 3 economies in the world are likely to be China, U.

S and India with Mexico and Brazil emerging among the top10 economies in the world. Conclusion From the analysis made in this paper, it is evident that financial development is particularly vital in determining economic growth in emerging markets.

Various sectors of the economy depend on the financial sector for growth and, therefore, without the input of the financial sector, economic growth seems unrealistic since no economy performs without finances.