Can there be too much finance? A complex answer to a simple question

The early development literature did not focus on finance. Growth models such as Harrod-Domar focused on the need for capital accumulation but ignored the question of how this capital is used. The 1980s and 1990s saw not only endogenous growth theory focusing on productivity growth (including by recent Nobel Prize winners Philippe Aghion, Peter Howitt and Paul Romer) but also an emerging theoretical literature focusing on how more efficient financial intermediaries and markets can contribute to productivity and economic growth. Starting with King and Levine (1993 a, b) an expansive body of empirical evidence has shown a positive association of indicators of financial development with GDP per capita growth. This is robust to controlling for omitted variables, reverse causation and measurement biases.

Starting with Arcand et al. (2015), an emerging literature has focused not only on the non-linearities between financial and economic development, with any growth effect at higher GDP per capita levels becoming insignificant, and even a negative relationship at very high levels of financial development.

In a recent essay, I provide a critical review of the ‘Too Much Finance’ literature, both in its academic contribution and in response to the earlier finance and growth literature (Beck, 2026). One first important observation is that while the Too Much Finance literature focuses on non-linearities in the finance-growth relationship at the upper end of financial development, and thus primarily high-income countries, the original finance and growth literature focused on developing countries.

Second, the challenge in properly measuring financial development has often been ignored. The gauges of financial development used in the literature, however, are crude proxy indicators. At the same time, the literature’s ‘favourite’ financial development indicator – claims of regulated financial institutions on households and enterprises, divided by economic activity (private credit to GDP) – has also been used in the credit cycle and banking crisis literatures. While the growth literature has focused on the level of private credit to GDP, the banking crisis literature has used growth in credit as predictor of systemic financial distress. But under what circumstances does a sustained increase in financial intermediation deepening lead to more growth, and under what circumstances might a credit boom lead to systemic distress?

Third, the question of whether there can be too much finance actually contains three separate questions. Can there be too much credit? Can the financial sector grow too large? And can there be too much financial development? Empirical evidence has shown that, yes, there can be too much and too quick credit growth in the economy. There is also evidence that the financial sector can grow too big relative to the real economy, which it is supposed to support, resulting in rent extraction and brain drain from the real into the financial sector.

The third question – can there be too much financial development? – should be restated as what structure of the financial system is the most growth-enhancing? One reason for a limited growth effect of financial institutions and markets at high level might be that banks focus on household rather than firm credit. The liquidity of public capital markets is driven by high-frequency trading and non-bank segments such as venture capital and angel financiers are ignored.

When asking whether there is too much finance, it is important, however, to differentiate between these three questions, because their answers imply different policy responses, be they of a macroprudential nature or reducing bailout expectations.

References:

Arcand, J.L., Berkes, E. and Panizza, U. 2015. “Too much finance?” Journal of Economic Growth, 20, 105-148.

Beck, T. 2016. “Can there be too much finance? A complex answer to a simple question,” Manchester School, forthcoming.

King, R. and Levine, R. 1993a. “Finance, entrepreneurship and economic development,” Journal of Monetary Economics 32, 513-542.

King, R. and Levine, R. 1993b. “Finance and growth: Schumpeter might be right,” Quarterly Journal of Economics 108, 717-737.