Rethinking Financial Deepening: Stability and Growth in Emerging Markets

TLDR

The global financial crisis highlighted the dangers of rapid financial deepening, showing that when deepening outpaces supervisory capacity it can trigger excessive risk‑taking and instability. This note reexamines financial deepening to identify lessons for emerging markets drawn from advanced economies. The study finds that while financial deepening yields substantial growth and stability gains for most emerging markets, limits on size and speed exist, and regulatory reforms that promote depth also enhance stability, so better regulation expands development and stability prospects.

Abstract

The global financial crisis experience shone a spotlight on the dangers of financial systems that have grown too big too fast. This note reexamines financial deepening, focusing on what emerging markets can learn from the advanced economy experience. It finds that gains for growth and stability from financial deepening remain large for most emerging markets, but there are limits on size and speed. When financial deepening outpaces the strength of the supervisory framework, it leads to excessive risk taking and instability. Encouragingly, the set of regulatory reforms that promote financial depth is essentially the same as those that contribute to greater stability. Better regulation—not necessarily more regulation—thus leads to greater possibilities both for development and stability.