You might think a big banking sector would be good for economies. After all, we all know that availability of credit for individuals and businesses is key for investment and consumer demand. It’s what allows us to buy things. But here’s the thing: it’s only good up to a point. Too much banking and too much credit can actually be counterproductive, a new study finds. It can actually inhibit growth.
This isn’t the analysis of an Occupy Wall Street protester, but the conclusion of a very serious paper from the Organization for Economic Cooperation and Development (OECD). Its economists queried 50 years of data for its 34 member-countries, looking at the relationship between credit levels (and types of credit) and economic growth. They found that when loans account for more than 60% of economic output (GDP), on average, growth starts to weaken.
“Over the past 50 years, credit by banks and other intermediaries to households and businesses has grown three times as fast as economic activity. In most OECD countries, further expansion is likely to slow rather than boost growth,” they say.
The OECD blames what it calls “excessive financial deregulation” and the phenomenon of “too-big-to-fail,” where governments offer banks implicit guarantees of emergency funding because of their systemic importance to the economy. These factors, and others, allow banks to issue more credit than they should, inflating prices for real estate and other large assets. The paper says over-lending to households has roughly twice the negative impact as over-lending to businesses.
As banks become bigger, they also cause inequality, the economists argue. Credit tends to be most available for higher earners, increasing advantages they already enjoy. As for employment, the finance sector pays more, so it has a tendency to suck away talent from more economically productive sectors. Finance workers make up 20% of earners in the top-1% of income bracket, despite representing only 4% of the overall workforce. “The wage premium for financial sector employees explains about half of the total effect of the financial sector on income inequality,” the OECD says.
To address these problems, the paper recommends forcing banks to reduce their own level of indebtedness, ending the concept of banks that are too big to fail, and changing tax regulations to encourage banks to issue more equity for financing (share or bonds), rather than relying on inter-bank funding. Reversing the deregulation mania of the 1990s and early-2000s might help too, one would think.