Financial sector in advanced economies is too big, says IMF

The role of the financial sector in the US, Japan and other advanced economies has grown too big, the International Monetary Fund has warned.

In a new study IMF economists say that emerging economies need to learn the lessons of the 2008 global financial crisis and avoid allowing their banking systems and financial markets to grow faster than regulators can keep up with.

They also point to growing evidence that at a certain stage banks and other financial institutions assume too big a share in economies and end up contributing more to financial instability than economic growth.

"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."

Just what role banks should play in national economies and how governments should regulate them to mitigate the worst effects of market volatility has been an enduring question since the 2008 crisis.

But the IMF research tackles the broader question of how big a role banks and other financial institutions should play in healthy economies. It follows similar work by economists for the Bank for International Settlements which concluded that growth in financial sectors can be a drag on economies while crowding out growth in other, more productive sectors.

The IMF economists 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.

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Countries suffering from what they call "too much finance", the researchers argue, 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, the researchers said, adding that good regulation could often limit the negative impact of runaway financial sector growth.

But the IMF researchers did not identify 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 IMF also did not release data for other big economies such as Germany and the UK, where finance plays a significant role.

Ratna Sahay, deputy director of the fund's monetary and capital markets department and the study's lead author, said the researchers were still working on assembling all the data to share publicly.

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