Raghuram Rajan (University of Chicago Professor) – Remarks on Financial Development at Central Bank of Argentina (Sep 2016)

Chapters

00:00:31 Financial Development and Its Importance
00:05:14 Key Challenges in Financial Development and Stability
00:11:12 Building a Stable Financial Foundation for Sustainable Growth
00:15:09 New Financial Institutions in Developing Countries
00:20:15 Approaches to Fintech Regulation and Development
00:24:53 Payments, Financial Distress, and Financial Inclusion in Financial Development
00:30:38 Overcoming Opposition to Financial Development

Abstract

Financial Development in Thailand: Challenges and Opportunities

Abstract:

This article explores Thailand’s financial development, encompassing its critical role in economic growth, the political economy shaping its progress, the delicate balance between financial stability and inclusion, and the challenges and obstacles encountered. Drawing insights from experts like Robert Townsend and Raghuram Rajan, as well as examples from India, it provides a comprehensive overview of Thailand’s financial development landscape.

Introduction

Financial development is a cornerstone of Thailand’s economic prosperity. Experts like Robert Townsend and Raghuram Rajan emphasize its importance in facilitating credit flow, productive investment, and consumption. However, the journey towards a robust financial system is laden with complexities, including political economy challenges, the necessity for financial stability and inclusion, and the delicate balance between rapid development and economic stability.

Core Aspects of Financial Development

Economic Growth and Financial Development

The relationship between financial development and economic growth is intricate. While there is a clear correlation, the causal relationship remains debated. Financial development nurtures economic growth by enabling optimal credit allocation and productive investment. However, the pace of financial system development must be carefully managed to avoid economic destabilization, as seen in Japan’s experience in the 1980s.

Political Economy and Financial Development

Rajan emphasizes the impact of political economy on financial development. Political interests and policies significantly influence financial systems, sometimes leading to inefficiencies. Addressing these challenges is vital for ensuring that financial development benefits the broader economy.

Financial Stability and Inclusion

A bank-dominated financial system poses risks, concentrating financial risks within banks. Diversification through bond and derivative markets can enhance stability. Additionally, financial inclusion is crucial for integrating more individuals into the formal financial system, thus fostering political stability and supporting sustainable growth.

The Role of Macro Stability

Macro stability, characterized by low inflation, moderate fiscal and current account deficits, and positive real rates, is fundamental for financial development. Institutions that convey policy credibility and promote domestic demand are essential for sustainable growth.

Challenges and Opportunities in Financial Development

Banking System Stability

A stable banking system is paramount. Attractive returns from deposits encourage savings, contributing to financial stability. High-quality regulation and supervision are imperative for maintaining a stable banking sector.

Forbearance vs. Clean-up

The approach to managing bad assets is critical. Prompt clean-up is often more effective than forbearance, which can lead to further complications.

Fintech and Financial Systems

Fintech presents both challenges and opportunities for financial systems. A sandbox approach, allowing for experimentation with light regulation, is essential in the early stages. This needs to be balanced with caution, as peer-to-peer lending scandals demonstrate.

Payments and Financial Distress

Technological advancements in payment structures have revolutionized the sector, enhancing financial development. Moreover, strengthening the recovery process and balancing recovery laws are vital for a fair and functional financial system.

Financial Inclusion and Political Economy

Shifting the focus to financial literacy and responsible money management before offering credit is crucial for sustainable financial inclusion. Overcoming opposition from vested interests who benefit from the status quo is a significant challenge in financial development.

Strategies for Overcoming Challenges

Incremental Approach and Communication

An incremental approach to reforms, starting with small changes, can be effective. Central banks play a pivotal role in communicating the benefits of financial reforms to counter resistance and spread awareness.

Conclusion

Financial development in Thailand is a complex, multifaceted process with numerous challenges and opportunities. Balancing economic growth, financial stability, and inclusion, while navigating the political economy, requires strategic planning and effective communication. Central banks and policymakers must adopt a gradual, informed approach to ensure sustainable financial development.

Supplemental Update Integration:

Macroprudential Surveillance

Domestic and external macroprudential surveillance is necessary for manageable credit growth and foreign borrowing.

Creating New Institutions

Establishing new financial institutions can facilitate lower rates, easier recovery, better information, and reduced moral hazard. Political opposition to new institutions is generally lower compared to competition-inducing measures.

Case Study: India’s Financial Reforms

India’s banking system was opened up, allowing new players without significant opposition. The Payment Bank was introduced to allow mobile companies to offer banking services like payments and transfers, but not lending. The Small Finance Bank was created to enable microfinance companies to become banks, focusing on lending to smaller players. Both new structures have attracted interest, but their long-term impact remains to be seen.

Fintech Competition

Financial systems face competition from fintech, posing a significant challenge.

Preventing Regulatory Arbitrage

Establish a central bank or supervisor to oversee all institutions involved in fintech to ensure consistent regulation. Promote a level playing field by applying the same regulations across the board.

Encouraging New Markets

Allow a wide range of new financial instruments to enter the market without unnecessary restrictions. Adopt a flexible regulatory approach that allows new markets to flourish while addressing potential risks as they emerge.

Payments

Rapid advancements in technology have revolutionized payment structures. Digital payment systems bring more economic activity into the formal financial sector, enabling better taxation and transparency. India has implemented an interoperable mobile payment system accessible to anyone with a bank account and a mobile phone. The goal is to eliminate cash usage and create a system that works across a common public platform.

Financial Distress

Strengthening the recovery process is crucial for improving financial development. Initially, lax recovery laws favor large players with easy access to credit. However, strict recovery laws can become draconian, disproportionately harming small borrowers who lack resources to protect themselves. Balancing the interests of small and large borrowers is essential for fair and effective recovery processes.

Financial Inclusion

Modern views on financial inclusion prioritize financial literacy and money management skills before offering credit. Easy access to credit without proper management skills can lead to financial distress. The focus has shifted towards helping individuals manage payments, make savings, and understand basic financial principles before offering credit.

Political Economy

Financial development can face resistance from vested interests who benefit from the existing system. These interests may try to influence policies and regulations to maintain their advantages.

Overcoming Opposition to Financial Development:

– Some people oppose financial development due to false notions or fear of zero-sum gains.

– To overcome this noise, one can experiment gradually, showing that small changes do not have significant negative effects.

– Another approach is to sneak in reforms, making them difficult to oppose once they are in place.

Spreading the Virtues of Financial Development:

– Central banks in emerging markets should actively promote financial development and communicate its benefits to the public.

– This is important because financial development is essential for economic growth and poverty reduction.

– Central banks can use various communication tools to educate the public about financial development, such as speeches, press releases, and social media.

The Role of Central Banks:

– Central banks in emerging markets have a unique role to play in promoting financial development.

– They can use their expertise and credibility to advocate for reforms and to educate the public about the benefits of financial development.

– By doing so, central banks can help to overcome opposition to financial development and create a more favorable environment for economic growth.

Notes by: TransistorZero


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