Growing pains: How fast is too fast for financialisation


Global Economy Watch - July 2014

Financialisation: The $9 trillion opportunity and what to do with it

Financial markets are growing in emerging markets

One of the most important global economic trends over the past few decades has been the deepening of financial markets, or “financialisation”. The two key hallmarks of this have been the increasing amounts of leverage in the private sector (both for companies and households) and the increasing importance, size and sophistication of the financial sector. In the G7, for example, domestic credit as a proportion of the economy has increased from around 100% of GDP to 160% in less than 25 years (although this became excessive in the run up to the 2007-8 crisis).

Emerging markets still have some way to catch up to reach financialisation levels similar to those in the advanced economies (see Figure 4). However, global megatrends, like the shift in economic power from the West to the East and rapid urbanisation, coupled with better technology, have set in motion a process of convergence in credit ratios between the E7 and G7, although this still has a considerable way to go. The size of the potential increase is huge. If E7 credit to GDP ratios were to converge to the average of the G7, it would imply additional lending of around $ 9 trillion (calculated in 2012 US dollars).

In China, credit has been rising even faster than in parts of the Eurozone before the crisis

The biggest and most visible example of a rapidly financialising emerging market is China (see Figure 5). Some sources estimate that total credit in China has approximately doubled since the financial crisis hit as the government there has sought to boost China’s domestic investment. Specifically, the boom in credit extended to the corporate sector has been even greater than that seen in the peripheral Eurozone countries prior to the financial crisis.

There are serious risks associated with overly rapid financialisation

Growing financial markets can facilitate the transfer of capital to productive areas of the economy. However, if the speed of market development or the breadth of different financial markets is too great, the risks of destabilising “boom and bust” cycles increase.

At the same time, spillovers into less regulated “shadow banking” sectors can lead to markets which are hard to monitor and regulate effectively. The rapid growth of “shadow bank” property lending in China is a good example of this. Figure 6 shows the sharp upward trend in “social financing” in China, which is a broader measure of credit that includes non-official sources of lending. This has been growing at around 21% per annum, which is significantly faster than nominal GDP growth. If not managed and monitored properly, these spillovers could affect the real economy by potentially amplifying credit-fuelled booms and busts.

What can be done about these risks?

As financialisation takes hold, regulators need to adjust and develop regulations that reflect the changes in the financial system. At a macroeconomic level, this involves a strong financial governance framework and appropriate monetary policy. Alongside this, certain more dynamic and faster growing markets may require more tailored approaches. Macro-prudential regulation, for example, allows for more targeted intervention in specific asset classes (e.g. property market lending or share trading) without affecting the wider real economy too badly.