Hero or villain? The financial system in the 21st century

Abstract

The paper reviews the literature and data on the role of finance in socioeconomic development. The evidence suggests that a well-developed financial system can certainly enhance people's prosperity, but an excessively large and poorly regulated financial system can do more harm than good. We start by making the important distinction between traditional finance (retail banking, insurance, etc.) and modern finance (financial "innovation" and asset trading). We then document that the financialization trend of the past four decades has largely transformed modern finance from "hero" into "villain." We discuss the driving forces behind this, as well as some policy reform proposals that could in principle make modern finance a hero once again.