Too Much Finance?

IMF Working Papers, June 1, 2012

Source details

This paper examines whether there is a threshold above which financial development no longer has a positive effect on economic growth.
Different empirical approaches are used to show that there can indeed be "too much" finance.
Key quantitative finding: finance starts having a negative effect on output growth when credit to the private sector reaches 100% of GDP.
The results are consistent with the "vanishing effect" of financial development and are shown not to be driven by:
- output volatility,
- banking crises,
- low institutional quality,
- differences in bank regulation and supervision.

Finance has diminishing returns to economic growth and can become harmful beyond a threshold.
Identified threshold: credit to the private sector = 100% of GDP.
The negative effect on output growth begins at that threshold.

Multiple empirical approaches are applied to test for a threshold effect.
Robustness checks indicate results are not driven by:
- output volatility,
- banking crises,
- low institutional quality,
- differences in bank regulation and supervision.

Subjects: Bank supervision; Banking crises; Credit; Economic sectors; Financial crises; Financial markets; Financial regulation and supervision; Financial sector; Financial sector development; Money.
Keywords: Bank supervision; Banking crises; Banks; Credit; credit to the private sector; decreasing returns; dummy variable; economic development; Economic Growth; Finance-growth nexus; Financial development; Financial sector; Financial sector development; mis-specification error; point estimate; positive correlation; Stock Markets; System GMM; WP.

Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/too-much-finance-26011