Page 72 - BFSI CHRONICLE 10 th Issue (2nd Annual Issue ) 23062 COPY.indd

BFSI Chronicle, 2 Annual Issue, 10 Edition July 2022
th
nd
Another feature of economic organization system becomes increasingly important either
that Hicks (1969) and North (1981) identify as as a facilitator of economic growth (if it is
being central to the development process is performing its functions and developing with
increased specialization.’ By its very nature, the rest of the economy) or as an inhibitor (if
increasing specialization in an economy it remains underdeveloped). When economic
implies that economic agents produce goods activity is at its most basic, carried out within
and services which they may not consume, and a confined geographical area with much
consume goods and services which they may subsistence activity, a relatively small fraction
not produce. In addition, it likely implies that of total economic output is traded, and hence
producers will not be well-diversified in the the need for money and finance is limited.
absence of financial markets, and that therefore Reliance on family finance can serve as a
they will desire the risk-sharing services and sufficient source of funds for small and even
access to external funding provided by such larger businesses.
markets. Thus increasing specialization will
As the variety of economic activities increases,
require the support of a variety of trading
institutions. not only in manufacturing, but also in
agriculture and services, ease of recognition of
A final point raised both by Hicks and North is "best projects" becomes more difficult. Reliance
that there are important fixed costs associated on family finance soon starts to inhibit growth.
with the formation of markets. Therefore, More financial intermediation is needed if
growth in the size of a potential market will incremental resources are to be allocated
reduce the costs to each participant of being efficiently, because of constraints otherwise
active in that market. As an implication, a imposed on the growth of more profitable
particular market may not become active activities, especially when small. Banking comes
until the economy has developed to the point to play a greater role in increasing resources for
where the market can sustain enough activity high-return activities and reducing the amount
to make it ‘cost-effective’. In other words wasted in lower return ones. But, with healthy
‘threshold effects’ will be observed in market growth, competition is important, and both
formation. The connection between financial risk and return considerations are important.
intermediation and growth has been modelled Hence, the financial system must grow in its
recently by Greenwood and Jovanovic (1990), ability to allocate resources.
Bencivenga and Smith (1991), and Obstfeld
As the economy grows, and grows more
(1994). They have largely stressed on the fact
that financial intermediation promotes growth complex, the financial sector needs to keep
by permitting a larger fraction of investment pace. Banks need to grow and become more
cultured in their capability to assess prospects
to be directed to activities with high (social)
returns. for risks and returns; and, in parallel, there
needs to be the development of other financial
We have long known about the importance of sources of investment capital. Sustained and
the financial sector in supporting an efficient rapid growth needs to be underpinned by a
allocation of resources and economic growth. augmentation and deepening of the financial
But it has perhaps not been so well recognized system, capable of serving the needs of all parts
that as economies develop, the financial of the economy. Those economies that have

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