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Chapter 2 reviews the literature to understand the relation (theoretical as well as empirical) between financial development and economic growth, and discusses the concepts of financial development and financial access. This chapter also provides a broad conceptual base on which the methodology of the study is specified to analyse the basic issues. Theoretical arguments and empirical studies show that financial development plays a critical role in enhancing economic growth. The concept of financial development goes beyond passive financial intermediation and is viewed in terms of diversity of financial institutions and instruments, physical outreach of the financial system, and coverage of real sector activities. The concept of financial access or financial inclusion is taken broadly as availability of financial services to all without any barriers—price and non-price.

This chapter explores China's financial reform. It begins by explaining the framework of asymmetric market liberalization with which China's reform is patterned after. Asymmetric market liberalization refers to the combination of rapid financial development and serious financial repression in order to achieve the policy goal of the fastest growth possible. The chapter then presents an overview of China's initial and current reforms, followed by a brief review of the theoretical and empirical literature on the relationship between growth and finance. Subsequent sections analyze the development and reform of the banking system, as well as the regulation of the capital markets in China. The chapter finally describes the establishment of the central bank, the evolution of monetary policy, and the development of the financial regulatory framework.

Chapter 1 begins with the overview of the financial sector policies—pre- and post-reform India. In the background of policy reforms, it presents the research issues and salient features of the study. This chapter states the basic research objectives of the study: assessment of the state of financial development and financial access in the post-reform period in India, and two extensions of these objectives, namely, international comparison of specified aspects of the Indian financial sector and the extent of private sector participation. The chapter notes the special features of the study, including macroeconomic growth approach and assessment of financial access in terms of availability and adequacy of financial resources from the formal financial system for the productive investment purpose at different levels of economy.

The rapid rise of the entrepreneurial private sector in China is one of the key reasons for the success of its transition from a centrally planned economy toward becoming a market-oriented one since the late 1970s, which was explored in part in the last chapter. At the same time, China is a country known for its incomplete legal system, which includes the lack of an independent judiciary, and adjudication is not free from interference from the executive branch. In addition, there is evidence of financial repression whereby legal and institutional constraints impede the development of financial intermediaries, thereby retarding the development of the financial sector. In China, this is manifested insofar as the rules favour state-owned enterprises (SOEs) despite three decades of reform. SOEs still dominate credit allocation, such that the majority of private small- and medium-sized enterprises (SMEs) obtain no bank financing even in 2006 (Lin 2007). This chapter investigates the impact of lagging financial and legal systems on private sector development and complements the previous one.

This chapter examines historical variations in the scale and the distribution of various key policy instruments: currency debasement, default, inflation, devaluation, and financial repression. It looks at aggressive and defensive debasements and the importance attached to control of precious metals, including alchemy. The chapter analyses the factors explaining variations in use of default, including war debt and reparations, regime change, and revolution. It also examines historical myth and reality in the cases of Edward 1 and Edward III of England and Philip II of Spain. Particular attention is paid to the historic European arc of default and the role of bondholder organizations and the League of Nations. Key case studies include Bulgaria, Egypt, Greece, Ottoman Turkey, Portugal, and Spain. Finally, the chapter addresses the issue of core–periphery and the role of empire.

The London Stock Exchange before 1914 was the largest in the world in terms of the number and value of its quoted securities. The ratio of quoted domestic corporate securities to UK GDP, perhaps as high as 250%, was substantially higher than other major economies at the time or than many today. London was also a global market and increasing its share of world listings: by 1912 more than two-thirds of the world’s largest companies (most of them headquartered abroad) had securities quoted there. By this measure it was as dominant globally as the NYSE was within the USA, though national and regional exchanges had a higher share of smaller overseas corporate issues. After 1914 financial repression caused a ‘Great Reversal:’ with the ratio of the UK’s quoted (foreign or domestic) securities to GDP falling by the 1970s to below the level of the 1850s.

If debt is too high, what policies are available to governments to reduce these debt obligations? This chapter goes through all options, short of default. It begins by introducing the standard debt accumulation equation, noting the key terms, such as the growth–interest rate differential; and their relation to policies. Once this is established, the more conventional strategies for reducing debt—promoting growth and fiscal consolidation—are explored. Particular emphasis is given to the impact of fiscal multipliers, and the factors that influence their magnitude. The chapter then moves on to more unconventional policies, such as inflation, seigniorage and financial repression.

This chapter argues that the World Bank reform agenda for the financial sector has been driven largely by financial repression theory, despite its rather shaky theoretical premises. It begins with a critical review of the theory underlying orthodox financial liberalization. It then discusses the way in which the theory has influenced the World Bank and the way the Bank has explained the failure of financial sector loans, while adhering to the same core orthodox policies. Next, it examines the influence of new institutional economics on the Bank's approach to financial liberalization. The latter part of the chapter considers an institutional approach to finance and attempts to generate an alternative strategy based on the institutional matrix developed in Chapter 5.

This chapter examines the ongoing debt crisis in advanced economies in historical perspective, with a view to identifying significant drivers of debt accumulation and subsequent debt reductions. The findings indicate that the Great Accumulation episode of the 2000s reflected a combination of primary fiscal deficits, higher real interest rates, and stock-flow adjustments related to the banking and currency crisis, while unfavorable interest-rate growth differentials contributed to the debt accumulation of the Great Depression during the 1930s. For large debt reductions since 1880, the primary fiscal balance did the heavy lifting, except in the post-World War II period, when negative interest-rate growth differentials in the context of capital controls and financial repression contributed favorably.

Although vital, the dollar standard's rehabilitation does not require international monetary reform. Rather, it is largely conceptual, and can be phased in through collaboration within just the G-2. China, a creditor country with a net saving (trade) surplus, can’t eliminate it by appreciation. Instead, both countries should phase out the saving (trade) imbalance by (1) increasing personal disposable income and hence consumption in China, and (2) raising net saving by eliminating the fiscal deficit in the United States. The trade imbalance would then take care of itself. The Federal Reserve Bank should commit to raising short-term interest rates toward 2 percent in the near future while leaving long rates to fluctuate “normally.” China should phase out its sterilization of hot money inflows as U.S. interest rates increase, and keep the yuan/dollar rate stable while continuing with its countercyclical credit policies. Once the G-2 succeed in harmonizing their financial policies, other countries can adjust their exchange rates as they see fit.

China, like India, presents a case of growth with increasing income inequality. In China this has gone hand in hand with a number of serious structural imbalances. It is clear that China’s problems of growing inequality and of structural imbalance are closely linked. The forces that produced imbalance also enlarged inequality. Both imbalance and inequality are byproducts of a growth model dominated by a combination of surplus labour, on one hand, and government policies that have repressed consumption and hindered employment growth, on the other. While the government has tried without much success to alter this growth model, rebalancethe economy and reduce economic disparities, two recent developments have had a major impact: First, China began to encounter shortages of labour. Second, the stimulus package launched to counter the 2008 recession itself affected the rebalancing objective in complex and conflicting ways.

In this chapter, we summarize the main results of a recent empirical research concerning European banks. We first explore the main drivers of the differences in risk-weighted assets (RWAs) across a sample of fifty large European banking groups. We then assess the impact of RWA-based capital regulations on those banks’ asset allocations in 2008–14. We find that risk weights are affected by bank size, business models, and asset mix. We also find that the adoption of internal ratings-based (IRB) approaches is an important driver of RWAs and that national segmentations explain a significant (albeit decreasing) share of the variability in risk weights. As for the impact of internal ratings on banks’ asset allocation in 2008–14, we uncover that banks using IRB approaches more extensively have reduced more (or increased less) their corporate loan portfolio. This effect is somewhat stronger for banks located in Eurozone periphery countries during the 2010–12 sovereign crisis. We do not find evidence, however, of internal models producing a reallocation from corporate loans to government exposures, suggesting that other motives prevailed in driving banks towards sovereign bonds during the Eurozone sovereign crisis, including the so-called ‘financial repression’ channel.