The Dangers of Over-Financialisation and How to Combat It

What is Over-Financialisation?

Over-financialisation refers to a condition where an economy becomes excessively dependent on financial markets and products for growth. This reliance often occurs at the expense of productive sectors, leading to unsustainable economic practices, increased inequality, and heightened systemic risks.

Facts to Support the Phenomenon

• Economic Survey Insights: The Economic Survey indicates that financial markets now play a dominant role in meeting credit needs, while the contribution of conventional banks has significantly decreased.
• Global Examples: Many advanced economies are currently facing unprecedented levels of public and private debt due to over-financialisation.
• RBI Data: Recent data shows a decline in growth rates for credit to services, MSMEs, and industries, which highlights imbalances in credit distribution across various sectors.

Why is it Happening?

• Reliance on Financial Products: There is an increased dependence on financial instruments for growth, a trend exacerbated by events like the global financial crisis of 2008.
• Innovation in Financial Markets: Innovations such as open credit enablement networks (OCEN) and unified lending interfaces (ULI) have made financial products more accessible, yet they also introduce greater risks.
• Regulatory Gaps: Weak regulatory oversight has facilitated excessive risk-taking and securitisation practices within the market.
• Digital Economy Shift: Traditional banks are struggling to adapt to the evolving credit needs of digital households and businesses.

Consequences of Over-Financialisation

• Economic Instability: Over-financialisation can lead to crises, as illustrated by the 2008 financial meltdown, which was driven by poor regulation and reckless financial practices.
• Income Inequality: A heavy reliance on financial markets tends to widen the gap between the wealthy and the rest, as the benefits largely favor affluent investors.
• Hindered Growth: Beyond a certain threshold, financial development can obstruct real economic growth by generating market distortions.
• Misallocation of Resources: An overemphasis on financial returns can divert essential resources away from productive sectors.

Remedies to Address Over-Financialisation

• Strengthening Financial Market Regulations: Implementing stricter controls on speculative practices and high-risk financial products is essential.
• Promoting Traditional Banking: Encouraging conventional banks to fulfill credit demands, especially for MSMEs, industries, and rural areas, is crucial for balanced growth.
• Balancing Financial and Real Sector Growth: Maintaining a balance between financial innovation and productive investments is necessary for sustainable development.
• Encouraging Productive Investments: It is important to direct more capital towards infrastructure, manufacturing, and sustainable sectors instead of speculative markets.
• Financial Literacy and Awareness: Educating stakeholders about the risks of over-dependence on financial markets can help mitigate the negative impacts of over-financialisation.