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Column diminishing returns from financial deepening james saft

´╗┐(The opinions expressed here are those of the author, a columnist for Reuters.)By James SaftMay 7 Like so many things it is easy to get a taste for, beyond a certain point, financial development brings diminishing returns and rising costs. Sometimes called financial deepening, deeper markets and better access to financial services can still spur economic growth, especially in emerging markets, but this is not an endless process, according to a new study by the International Monetary Fund."Our analysis uncovers evidence of 'too much finance' in the sense that beyond a certain level of financial development, the positive effect on economic growth begins to decline, while costs in terms of economic and financial volatility begin to rise," Ratna Sahay, Martin Cihak and Papa N'Diaye, three of the authors of the study, write.( here )While many emerging market countries, notably Gambia and Ecuador, can likely still see further financial deepening and get an increasing impact on their economic growth rate, several developed nations such as Japan and the U.S. now look to be on the downslope. The concept of financial deepening was cited by former U.S. Treasury Secretary Tim Geithner as partial justification for preserving large banks, on the grounds that the U.S. needed institutions which could benefit from what he expected would be huge growth in emerging markets in the consumption of finance. This study is significant then, in part because it carries the imprimatur of the IMF which has at times in the past shown an enthusiasm for the concept of financial deepening. It also tends to undermine the argument for big banks, to the extent that, if policy-makers take notice, we should see less, and less fast, development of finance. Crucially, the study found that strong regulation can work to blunt the negative impact of too much finance, or of too fast a growth in finance.

"The analysis shows that these tradeoffs can be improved by strong institutions and a sound regulatory and supervisory environment. In other words, regulatory reforms can increase the benefits from financial development while reducing the risks," Sahay, Cihak and N'Diaye write. The study uses a broader definition of financial deepening than most previous studies, which usually use bank credit. Instead the IMF looks at the size and liquidity of markets and institutions, access of individuals to services, and measures of efficiency such as capital markets activity. HIGH COST OF VOLATILITY

The problem with finance isn't that it doesn't accelerate growth, clearly it does. Instead the issue lies with the quality of that growth and the way in which financial over-development can lead to crises and, or, volatile economic growth. As with investment, so it is with economic growth. Volatility, especially the kind of steep downturn the world suffered after the great financial crisis in 2008, imposes costs, both in terms of sub-par growth after the fact and in the huge sunk costs from mis-allocations of capital. One of the interesting findings of the study was that high levels of financial development don't slow capital accumulation but lead to lower efficiency in investment. In other words, it isn't that overly financialized economies have a dearth of money to put to work, but rather that they tend to do a worse job of finding good projects in which to deploy that capital.

Think here of the acres, and probably miles, of granite countertops which went into speculative real estate development, or indeed were put in by owners of houses who were borrowing against their equity. Putting aside the dubious pleasure of granite work surfaces, those were often seen as investments but yielded poor returns. Similarly, think of all the countertop installers, and construction workers, who gained skills in the housing boom for which they found poor demand afterwards. The pace at which financial deepening happens is important, with faster growth being linked to GDP and inflation volatility and financial instability. The study did find that strong institutions, good regulations and strong supervision can help to blunt the negative effects of rampant financialization."One of the effects of the global regulatory reforms has been a deleveraging in advanced countries, implicitly confirming that there had been 'too much finance.' A complete implementation of these regulatory reforms would augur well for the growth and stability prospects of all countries", the report said. For investors, one potentially interesting implication of this study is the relationship between returns and financial deepening. The study did not address this, but it may be that investors should concentrate on the sweet spot of countries which are both allowing financial deepening, regulating it well, and not now encumbered with a too big financial sector. Two benefits to this strategy seem possible. One it is a way to identify lower volatility economies. And secondly these economies might see better use of capital and higher quality of corporate stewardship, both of which may lead to better returns to investors. So, Ghana looks worth a look, but perhaps not, on this measure, Japan.(James Saft) var $relatedItems = $('lia "/article/uruguay-inflation-idUSE6N1AD00O"Uruguay consumer prices fall 0.55 pct in December, up 8.1 pct 2016/a/lilia "/article/usa-mortgages-idUSL1N1EU0KP"UPDATE 1-U.S. mortgage activity stabilizes as loan rates slip -MBA/a/li'), $relatedItems = $relatedItems.slice(0,10), relatedBlockLimit = Number('6'), relatedItemsTotal = $relatedItems.length, $paragraphTags = $('#article-text p'), contentParagraphs = 0, minParagraphs = Number("8"); for (i=0; i $paragraphTags.length; i++) { if ($paragraphTags[i].innerText.trim().length 0) { contentParagraphs = contentParagraphs + 1; } } if (contentParagraphs minParagraphs) { setTimeout(function(){ if (relatedItemsTotal relatedBlockLimit) { $('.first-article-divide').append('div class="related-content group-one"h3 class="related-content-title"Also In Economic News/h3ul/ul/div'); $('.second-article-divide').append($('.slider.slider-module')); $('.third-article-divide').append('div class="related-content group-two"h3 class="related-content-title"Also In Economic News/h3ul/ul/div'); var median = (relatedItemsTotal / 2); var $relatedContentGroupOne = $(' ul'); var $relatedContentGroupTwo = $(' ul'); $.each($relatedItems, function(k,v) { if (k + 1 = median) { $relatedContentGroupOne.append($relatedItems[k]); } else { $relatedContentGroupTwo.append($relatedItems[k]); } }); } else { $('.third-article-divide').append($('div class="related-content group-one"h3 class="related-content-title"Also In Economic News/h3ul/ul/div')); $('.related-content ul').append($relatedItems); } },500); } Next In Economic News UPDATE 1-British consumers borrow at fastest rate in 11 years as inflation threat rises LONDON, Jan 4 British consumer borrowing increased by the biggest amount in more than 11 years in November, boosting the unexpectedly robust post-Brexit vote economy in what could prove to be a big spending spree ahead of an expected rise in prices. Georgia's inflation rises 1 pct month-on-month in December TBILISI, Jan 4 Consumer prices in Georgia were up 1 percent in December in month-on-month terms after rising by 0.6 percent in November, the State Statistics Service said on Wednesday. Annual inflation in December was 1.8 percent. CONSUMER PRICE INDEX

Dec 16 Nov 16 Dec 15 to previous month +1.0 +0.6 -0.6 to previous year +1.8 +0.2 +4.9 HSBC raises world economic growth, inflation forecasts, dubs moves "rare treat" LONDON, Jan 4 Economists at HSBC on Wednesday raised their forecast for global growth and inflation over the next two years based on robust manufacturing activity, a resilient China and above all the fiscal boost expected to come in the United States. MORE FROM REUTERS window._taboola = window._taboola || []; _taboola.push({ mode: 'organic-thumbnails-a', container: 'taboola-recirc', placement: 'Below Article Thumbnails - Organic', target_type: 'mix' }); Sponsored Content @media(max-this site) { #mod-bizdev-dianomi{ height: 320px; } } From Around the Web Promoted by Taboola window._taboola = window._taboola || []; _taboola.push( { mode: 'thumbnails-3X2', container: 'taboola-below-article-thumbnails', placement: 'Below Article Thumbnails', target_type: 'mix' } ); window._taboola = window._taboola || []; _taboola.push

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Money funds soothed by lack of fed rate cut talk

´╗┐Money market fund managers breathed a sigh of relief on Wednesday after minutes from the Federal Reserve's June policy meeting showed no indications the central bank was considering cutting the interest rate it pays on excess reserves to banks. Many fund managers believe any cut in the rate, which currently stands at 0.25 percent, would cause disruptions in funding markets, especially money market funds. Minutes from the Fed's June meeting, released on Wednesday, showed the central bank was open to the possibility of buying more bonds to stimulate the economy, although the recovery might need to weaken for a consensus to build. The minutes did not include any discussion of a possible cut in interest rates the Fed pays on excess reserves on banks. Such a cut has been posited as an economic stimulus option for the central bank, as it would then be less profitable for banks to leave their excess reserves with the Fed, and might encourage banks to make more loans and invest in higher-yielding securities. But some analysts believe any cut in the interest rate would hurt money market funds.

"Money funds are prohibited from buying assets with negative yields. So what would they buy if interest on excess reserves was lowered and caused all market rates to move to zero percent or less?" asked Joseph Abate, money market strategist at Barclays Capital in New York, adding "they would have to close shop."Meanwhile, in Europe, euro-zone bank-to-bank lending rates hit new all-time lows on Wednesday, as the European Central Bank's move to cut its main refinancing and deposit rates to historic lows weighed on market rates. The ECB's overnight deposit rate, which it cut to zero on Thursday, acts as a floor for money market rates as banks only lend to rival banks if they are able to earn a better rate of interest than at the ECB.

The ECB hopes its unprecedented move, which means banks will now get nothing if they park their spare cash with the central bank, will boost interbank lending by forcing banks to look for more profitable options. Although some money market experts fear the cut could backfire and kill off parts of the market, the move has had an immediate impact on bank-to-bank rates. Three-month Euribor rates, traditionally the main gauge of bank-to-bank lending, on Wednesday hit a new all-time low of 0.512 percent, down from 0.521 percent.

Other key rates saw similar drops. Six-month Euribor rates fell to 0.795 percent from 0.805 percent and shorter-term one-week rates decreased to 0.145 percent 0.158 percent. Overnight rates which do not yet factor in the benefit of the ECB's cut - coming into force overnight Wednesday - inched down to 0.323 percent from 0.325 percent. Euribor rates are caught up in a manipulation scandal centered on the counterpart Libor bank-to-bank rates, after it emerged a number of banks were falsely submitting the rates they pay to the committee that aggregates the data. Dollar-priced three-month bank-to-bank Euribor lending rates also fell on Wednesday, dropping to 0.97571 percent from 0.978 percent, with overnight rates falling to 0.34286 percent from 0.346 percent. Euribor rates are well above the euro-priced Libor rates, one reason being that Euribor figures include prices from more of Europe's struggling banks than Libor.