Size of Financial Sector - Essay Example

Size of Financial Sector Size of Financial Sector Introduction The report from PWC on the survey of the financial services indicate that most industries indicate more growth in business though the there is a mixed projection for the future. Domestic demand from both the private persons and corporate have driven the increase in volume of the business sector. Even though the confidence of the insurance sector varies with the insurance sector being slightly pessimistic, firms from most sectors anticipate increase in volume of their business. Benoit (2014) illuminate that most financial service firms exclusive of the banks have embraced their rising cost though not to the detriment of the performance their finances. Moreover, profitability across all the financial sectors has improved except the insurance sector and it is anticipated to remain strong in the first quarter of the year 2015. Unfortunately, for the insurance and the building society the forecast suggests otherwise. The number of employment in the banking and insurance sector has decreased in comparison to other sectors while the training expenditure has risen. Department, I. M. F. M. C. M. (2014) suggests that this is a clear indication of the existence of shortage of skills and talents in the financial labor market. The financial sector has enormously grown over the last decades. Gloria (2015) illustrates that the parameters that measure these growths are: quantity of the financial market; the share of the GDP; wages; and employment. For instance, the economy of the UK has grown faster since the financial crisis of 2007/2008. It expanded by approximately by 1.9% in 2013. The growth is also attributed to the securitization in the financial market; intermediation of credit; and the subsectors of finance in the financial sector. On the other hand, the insurance sector has been steadily growing (at a steady pace). In addition, the growth is also evident in the increase in the financial claims and contracts such as bonds, stock, fund shares, and derivatives. Before the 200/2008 financial crisis, central banks use a simple modality that would effectively maintain and stabilize the inflation rate. However, in 2009 the interest rates were slashed to a level close to zero (zero lower bound). Jeucken’s (2001) notion indicates that below this benchmark would have been practical but wouldn’t have achieved the desired results. Central bank faced an uphill task of dealing with the increasing rate of unemployment as well as the collapse in the output. At some instances central banks have adopted the unconventional policies which entail either the purchasing of asset or forward guidance. Cerra & Saxena (2008) explain that quantitative easing, QE, (a concept of printing currency with the aim of purchasing assets) was incorporated by the central banks in Britain, Japan, and America during the crisis by purchasing numerous stocks of financial assets. Through the QE, central banks focused on the effects portfolio balancing by buying assets with varied risks and maturity. The past decades has been relatively characterized by the movement of the financial sector from bank based to market based financial sector. The bank based economy is characterized by the underdevelopment of the capital market since only a section of the needs in terms of corporate finance are met. They needs are met through the issuance of securities. On the other hand, market based system in the economy entails companies covering their financial needs by giving securities to the investors. Robin & David (2013) believed that the global crisis prompted the European Central Bank to rethink on the financial sector responsibility in the real economy. The financial system has the mandate of ensuring that there is productive incorporation of the physical capital especially in the interest rates, asset prices, and the spread of risk which over the past decades have changed the output towards a different view of the consumers’ perception of value. Arguments for larger financial system and Application of the financial theories The two major responses to the financial crisis of the 2007/2008 have emanated from individuals who want reforms in the financial systems of the developed economies. One of the approaches illuminates the need to have a smaller and simpler financial system where the size, complexity, and the power of the system are bounded. On the other hand, the other approach suggest otherwise by arguing that the large financial sector is not the problem or challenge but calls for the need to readjust its goals since it only carters for the interest of big corporations and wealthy individuals thus neglecting the society. Herrmann (2003) briefs that they further assert the need for a large but democratic financial sector instead of the smaller one. Larger firms are indeed not the problem but there are various factors within the system that should be filtered in the screen of reality and truth. There is the existence of products that are complex and characterized with high risks that lack security in the financial sector. Various bodies or entities mandated with the task of providing supervision and regulation of the economic systems, trading patterns and monetary flow have been inconsistent and incompetent. Moreover, some undisclosed interest of various players or cartels in the developed economies has proved to be challenging in the attempt of providing solutions the impact of the crisis. According to Demirguc-Kunt (2001), the best response to the recent global crisis is a clear comprehension of the factors that lead to it. Reports reveal that there was wild and widespread failure of the supervision and regulation of the financial sector. Apparently, the corporate governance as well as the risk management at the different financial institutions had failed to provide oversight roles in ensuring that rules and regulations of financial systems were complied and adhered to the latter. Financial institutions encouraged borrowing with little or lack thereof limitations and delved in risky investments that later on proved to be detrimental. In addition, these institutions had not inculcated or lacked transparency in their operations. The crisis was precipitated further by the various governments in industrialized nations not being prepared and equipped with the necessary requirements that would have provided the correct antibiotic the situation. The ideal way economists can employ in ensuring that the large financial sector thrives to the optimum standards and eliminated the bureaucracy associated with this system is by having a well structured technique in the accountability and ethical standards in the financial market. The mortgage lending and securitization parameters should be reviewed using high definition quality glasses. Levine (2005) vindicate that the large diversification of the financial sector provides a platform for the global competition and is vital in the financial leadership. For instant, large banking institution provide value to businesses, consumers, investors among others. This is important to not only the growth of the economy but also the in creation of job opportunities. Besides the job creation large financial institutions such as banks provide greater percentage of loans to small business or enterprises. Das, Papaioannou, & International Monetary Fund (2010) highlight that they also provide higher percentage of credit to consumers as well as provision of mortgages in comparison to smaller business entities that Adair Turner tends to argue that they are smaller and simpler. Large institutions such as global corporations or multinational companies uniquely meet the needs of their consumers in terms financial products and services. Beck & Loayza (2000) discuss that these companies need substantial credit which can only be provided by the large banking financial sector (banks). This evidently illuminates that the large sector is not the problem and that changes should be incorporated in the system instead of delving on financial capitalism. Condemning the financial capitalism as an irresponsible system will not provide an amicable solution to the response of the crisis (Międzynarodowy Bank Odbudowy, Rozwoju & Effron, 2006). Instead focus needs to be geared towards supporting goals such as the corporate social responsibility and ethical practices for the betterment of the society. To achieve this, there is the need to correct, expand, and realign the financial system in the sector in discussion. It is for these reasons that Goldsmith (1969) argued that the financial structure and development have significant implications of the economic growth. He further revealed that banks become relatively large than nations output while the other financial sectors growth are usually relative to that of banks as country’s economy continue to expand. His argument was based on positive relationship between the size of the financial system and economic growth in the long run as being driven by the financial intermediaries. These intermediaries improve efficiency and not investment volume. Claessens & Feijen (2007) argue that innovation has played a significant role in the ever rapid growing of the financial sector. This has facilitated the emergence of complex financial products which in turn provide room for the expansion of the financial institution. The financial sector has a great impact in the GDP concept. For instant, in the UK, before the crisis, the financial sector averaged slightly above 6% per year in the output growth while the overall GDP of Britain was 3%. However, the growth of the output of the financial services has been relatively low in the recent past though the impact on the rate of growth on the GDP has been minimal. Lawrence & Heidi (2013) point out that the reforms in the financial sector have been conscious to the factors that are perceived to have precipitated or extrapolated the global financial crisis. Most of the reforms are geared towards the optimization of the regulation and supervision standards of the European Union (EU) institutions and financial markets with the European Central Bank playing a crucial role. The regulations focus on interest rates on loans, securitization, mortgaging, among other facets. Criticism of larger financial sector According to Arcand, Berkes and Panizza, (2012), the complexity and the bureaucratic nature of the large financial system tend to make it difficult to control. Controlling the sector encompasses strategies that tend to align the interest of all the players in the financial arena. Promoting large financial sector may create the fear where countries financial systems becoming bigger than the size of their domestic economy. The large financial sector provides difficulty in creating regulations and supervision in the climate of finance. Wolf asserts that the financial systems are fast becoming masters of the economy rather than being servants. Rodik (2008) contradicts the above narrative by asking evidence of the innovation of finance making lives measurable and better. However, Rojan (2005) while illuminating the problems of the development of financial system explained that the complication within the financial system increases the chances of disaster meltdown. Gennaioli et al. (2010) supports Rojan by vindicating that financial innovation has the potential of optimizing the fragility of finances. It enhances more complexities. Besides, the large financial may consequently lead to the minimization of distribution of talents and skills. The returns of financial sector on social aspects are less than the private returns. Moreover, the large sector may lure talents from other productive talent. The economic crisis which was characterized by credit default swap, CDOs, and moral hazards has the potential of harming the society as well as the economy. The growth of financial sector into large systems may result into misallocation of resources which may result into costly crisis as well. Moreover, the risks associated with growth can lead to volatility in growth. If the credit to the private sector reaches between 80-100% of the GDP, the implications of the financial development in the growth of the economy become negative (CAFRAL, 2011). Conclusion There have been two main approaches to reforms that attempt to respond to the recent economic crisis. One of the approaches tends to fault the large financial system in the climate of finance while the other approach plays down the large financial sector as the problem by extrapolating that there are other factors that should be incorporated while trying to enact appropriate reforms. The size of the sector; its growth; the movement from bank based to market based; and the need for the financial sector to serve the real economy are significant in the financial reform processes. Those in support for the large financial sector argue that the financial systems should provide support to goals that are oriented towards making the society better. On the other hand critics perceive the system to having the potential of providing challenges to not only control but also failures to regulate. References: Demirguc-Kunt, A. (2001). Financial structure and economic growth: A cross-country comparison of banks, markets, and development. Cambridge, Mass. [u.a.: MIT Press. Gennaioli et al., (2010). Neglected Risks, Financial Innovation, and Financial Fragility. NBER Working Papers 16068 Rodrik, D (2008). Nows the time to sing the praises of financial innovation Retrieved on 30th March 2015 from: http://rodrik.typepad.com Wolf, M., (2009). Why dealing with the huge debt overhang is so hard. Retrieved on 30th March 2015 from: http://www.ft.com/intl/cms/s/0/b048d69c-ec90-11dd-a534-0000779fd2ac.html#axzz3Vt22b6Qv Rojan, R, G., (2005). Has financial development made the world riskier?Retrieved on 30th March 2015 from: http://www.kansascityfed.org/publicat/sympos/2005/pdf/rajan2005.pdf Goldsmith, R, W., (1969), Financial Structure and Development, Yale University Press, New Haven. Cerra, V & SC Saxena (2008). Growth Dynamics: The Myth of Economic Recovery. American Economic Review, 98(1):439-457. Levine, R., (2005). Finance and growth: Theory and evidence in P Aghion and S Durlauf (eds.), Handbook of Economic Growth, 1(12):865-834. Beck, T, R & Loayza (2000). Finance and the sources of growth. Journal of Financial Economics, 58(1-2):261-300. Benoit,C., (2014). On the Optimal Size of the Financial Sector. Retrieved on 30th March 2015 from: http://www.ecb.europa.eu/press/key/date/2014/html/sp140902.en.html NBER-East Asia Seminar on Economics, Itō, T., & Rose, A. (2009). Financial sector development in the Pacific Rim. Chicago: University of Chicago Press. Gloria, T., (2015). Financial Services: contribution to the UK economy.Retrieved on 30th March 2015 from: http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=7&cad=rja&uact=8&ved=0CEoQFjAG&url=http%3A%2F%2Fwww.parliament.uk%2Fbriefing-papers%2Fsn06193.pdf&ei=aPEYVaC0LYXbuQSy2ILYDg&usg=AFQjCNEZiCnQQfOfYGl83B22ondDPz4_iw&sig2=yqp1TOvvfqHdkOyTg2e1Nw&bvm=bv.89381419,d.c2E PWC (2015). CBI/PwC Financial Services Survey – March 2015.Retrieved on 30th March 2015 from: http://www.pwc.co.uk/financial-services/publications/cbi-pwc-survey.jhtml Claessens, S., & Feijen, E. (2007). Financial sector development and the Millennium Development Goals. Washington, D.C: World Bank. Lawrence, M & Heidi S., (2013).A Decades of Flat Wages. Retrieved on 30th March 2015 from: http://www.epi.org/publication/a-decade-of-flat-wages-the-key-barrier-to-shared-prosperity-and-a-rising-middle-class/ Herrmann, H. (2003). Foreign direct investment in the real and financial sector of industrial countries: With 85 tables. 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S., Papaioannou, M. G., & International Monetary Fund. (2010). Unwinding Financial Sector Interventions: Preconditions and Practical Considerations. Washington, D.C: International Monetary Fund. Department, I. M. F. M. C. M. (2014). Canada. Washington: International Monetary Fund. Międzynarodowy Bank Odbudowy i Rozwoju., & Effron, L. (2006). IEG review of World Bank assistance for financial sector reform. Washington: World Bank. Read More