“Only about 15% of the money coming from financial institutions goes into business investments, the rest is spent buying and selling existing financial instruments”, says Rana Foroohar in her book Makers and Takers. Her book serves as a great reminder to policymakers and practitioners about the role of financial system in an economy.

Financialization is defined as the “growing scale and profitability of the finance sector at the expense of the rest of the economy and the shrinking regulation of its rules and returns.” The success or failure of the financial sector has had a serious effect on the rest of the economy and most of the returns in this sector have gone to the wealthy, driving the inequality up, says Mike Collins of The Wall Street Journal.

The alarming state that developed countries have entered is unfortunately labelled as ‘Financialization of Capitalism’, heavily researched and analysed by Harry Magdoff and Paul Sweezy. Their series of essays in Monthly Review over the past three decades brought attention to the term ‘financialization’ and its roots which lie in the Marxist theory of capital accumulation and surplus value. Has Capitalism entered a new stage? I don’t think so. In my opinion, what we see today is a version of amplified Capitalism where firms are profiting even without producing. As John Bellamy Fosters says in “Financialization of Capitalism”, the basic problem of accumulation within production remains the crux of Capitalism, thereby making it unreasonable to categorise this as a new stage altogether.

What is the role of financialization? In the past, the primary contribution of the financial system to a region’s growth has been to mobilise large pools of savings which would be then used to finance profitable investment opportunities. The surplus profits earned from these investments would then be re-invested to expand economic activity and further accumulate surplus. However, sooner or later, corporations would barely sell the current level of goods to consumers which limit the absorbing capacity of surplus profits in productive investments. Eventually, the surplus profit earned cannot be reinvested in expanding businesses since the maximum capacity of production is reached and the consumer demand is met. The limitations in real investment opportunities lead to speculative investments in the financial industry, a platform for the capitalists to multiply their money for higher returns by investing in futures, options, derivatives, hedge funds etc. It is, therefore, important to analyse a company’s investment activities, both real and speculative. Has the growth in financial development made productive investment easier or has it simply expanded the pockets of Capitalists? Before demanding financial development of an economy, it is important to first consider the impact of financialization on income inequality, productivity, and economic growth, along with the risk factor associated with it.

When is the right time for financialization? As an economy develops, the dependence on its own banking sector decreases as firms find other sources to raise funds. During the early stages of development, an economy depends upon its banking sector to fund growth in the manufacturing sector and provide heavy capital requirements. However, as the financial sector develops, it becomes more efficient in allocating resources providing alternatives that diversify the sources of raising capital, subsequently diversifying the risk.


When it comes to India, its rapidly growing economy has an immediate need for credit to feed its booming investments. As shown in Figure 1, the domestic credit to private sector grew till the financial crisis of 2008-2009 hit the Indian markets, which resulted in the growth to fall below 0.1%. The credit market did bounce back post-crisis but the growth could not be sustained for long, and has been falling since then. Is the pace at which India is growing in sync with the pace at which its dependence on banking sector is decreasing? Since bank credit has been falling, does the Indian financial sector have an alternative source of fund that could complement the banking sector? This financing gap has pushed for the need of promoting different financial institutions that could complement the banking sector and provide funds to the riskier section of the economy with different maturity profiles that banks are unable to provide.

The Micro, Small, and Medium Enterprises (MSME) sector in India contributes 45% of the industries’ output and 11.5% of the GDP. This sector has high growth prospects and could bring large revenues to the economy. However, only approximately 33% of this sector has access to bank or formal institutional financing. SIDBI (Small Industries Development Bank of India) has estimated the overall debt finance demand of the MSME to be Rs. 32, 50,000 crores of which merely 22% is financed through formal sector means. Moreover, 85% of those finances come from the banking sector (IFC report), clearly indicating that the niche sectors in India are dependent upon its banking sector.

Lastly, what drives financialization? Of late, regulatory bodies are placing emphasis on the regulatory environment of the financial infrastructure space in an economy. Central Banks in countries are pushing their banks to implement the Basel norms III structure. There are strict regulations on capital requirements for banks such as the capital adequacy ratio and periodic financial system risk assessments reports by the IMF. The idea about the “right place” stresses upon the legal environment which sheds light on the role of property rights, financial institution lending to smaller firms, and promoting a competitive and dynamic business sector.

The experience of developed economies with financialization urges me to take a step back and wonder how, if ever needed, the developing economies can do it in a systematic manner. A policy recommendation that I feel is the need of the hour is a committee like that of Basel Committee of Banking Supervision (BCBS) which would examine real and speculative investment of private companies separately from the banks, also tracking where their borrowing or surplus profit is flowing into.