A study conducted by Boris Cournède and Oliver Denk for the OECD too much of the wrong type of finance can hamper economic prosperity and social cohesion. This calls for a better architecture of the financial system.
Since the 1960s, credit by financial institutions to households and businesses has grown three times as fast as economic activity. Stock markets too have expanded enormously. The study looked at data from the past 50 years and found out that credit expansion has reduced economic prosperity on average across OECD countries. In particular, an increase in credit by financial institutions is negatively correlated to long-term growth.
Three main channels were identified as linking the long-term expansion of credit with lower growth:
- Excessive financial deregulation: initially with a positive effect on the economy, relaxation of regulation however went too far and resulted in too much credit.
- The structure of credit: on the lender side, bank loans are related with lower growth than bonds; on the borrower side, instead, reduced growth was registered when credit went to households rather than businesses.
- Too-big-to-fail guarantees encouraged too much credit.
The research also found out that excessive finance led to increased inequality. This is mainly due to:
- The high concentration of workers in finance at the top of the earnings distribution: only a few financial sector employees are in low-income brackets, while most are higher up in the income distribution.
- Unequal bank lending: banks generally concentrate their lending on higher-income borrowers.
- Unequal distribution of stock market wealth: stock market wealth is concentrated among high-income households who thus get most of the income and capital gains generated through capital markets.
As a conclusion, Boris Cournède and Oliver Denk states that a reform of finance in the OECD countries is necessary to foster growth and more equality. This reform should target avoiding credit over-expansion, by, for instance, implementing caps on debt-service-to-income ratios, reducing explicit and implicit subsidies to too-big-to-fail financial institutions and leveling the playing field for competition between large and small banks. Furthremore it should aim at improving the structure of finance, using tax reforms to reduce the so-called debt bias, which leads to too much debt, and not enough equity.
In such architecture of the financial system as envisioned by the two researchers, it looks like there is space for securities crowdfunding to play an interesting role, fostering the competition in the lending sector and facilitating access to equity capital.
Reference and more information: http://oecdinsights.org/2016/03/29/finance-growth-and-inequality/