Financial deepening is a term used by

economist An economist is a professional and practitioner in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...

s to refer to increasing provision of financial services. It can refer both a wider choice of services and better access for different socioeconomic groups. Financial deepening can have an effect on both individuals' and societies' economic situations.

Features

The following are examples of different forms of financial deepening. Provision for the

unbanked The unbanked are adults who do not have their own bank accounts. Along with the underbanked, they may rely on alternative financial services for their financial needs, where these are available. Causes Some reasons a person might not have a bank ...

and

underbanked The underbanked is a characteristic describing people or organizations who do not (or volunteer to not) have sufficient access to mainstream financial services and products typically offered by retail banks and thus often deprived of banking servic ...

in a society. Development of financial markets. Development of financial institutions and increasing the diversity in financial instruments. One of the key features of financial deepening is that it accelerates economic growth through the expansion of access to those who do not have adequate finance themselves. Typically, in an underdeveloped financial system, it is the incumbents who have better access to financial services through relationship banking. Moreover, incumbents also finance their growth through internal resource generation. Thus, in an underdeveloped financial system, growth is constrained to the expansion potential of incumbents. In mature financial systems on the other hand, financial institutions develop appraisal techniques, and information gathering and sharing mechanisms, which then enable banks to even finance those activities or firms that are at the margin, thereby leading to their growth-inducing productive activities in addition to the incumbents. The assumption is that the availability of external finance to budding entrepreneurs and small firms enables new entrepreneurship, while also providing competition to incumbents and consequently encouraging entrepreneurship and productivity. However, research indicates that widely available formal finance can produce informal intermediation, an unintended form of entrepreneurship. Hence, maintaining a sceptical approach when researching the effectiveness of initiatives is advisable.

Macroeconomics

Financial deepening can have a

macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...

effect for a country. Financial deepening generally can increase the ratio of

money supply In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circul ...

to GDP or some price index. It can have the effect of increasing

liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liq ...

. Having access to money can provide more opportunities for investment and growth. A developed financial system broadens access to funds; conversely, in an underdeveloped financial system, access to funds is limited and people are constrained by the availability of their own funds and have to resort to high cost informal sources such as money lenders. Lower the availability of funds and higher their cost, fewer would be the economic activities that can be financed and hence lower the resulting economic growth. Promoting well-managed financial deepening in low-income countries (LICs) can enhance resilience and capacity to cope with shocks, improve macroeconomic policy effectiveness, and support solid and durable inclusive growth. Financial deepening and macro-stability has been identified as a priority area in the years ahead for the Fund, as reflected in its Financial Surveillance Strategy paper. Managing Volatility and Supporting Low-income Country Growth Enhancing macro-economic policy effectiveness Shallow financial systems limit fiscal, monetary, and exchange rate policy choices; hamper macroeconomic policy transmission; and impede opportunities for hedging or diversifying risk. This is of particular concern because LICs are vulnerable to external shocks, such as sharp swings in commodity prices and fluctuations in external financing. Limited policy space and instruments to mitigate the ensuing macroeconomic volatility often translate into large growth and welfare costs for these countries.

Economic growth

The association between economic growth and financial deepening has been a wide-ranging subject of experiential research. The practical evidence suggests that there is a significant positive relationship between financial development and economic growth. Many economists support the theory that financial development spurs economic growth. Theoretically, financial development creates enabling conditions for growth through either a supply-leading (financial development spurs growth) or a demand-following (growth generates demand for financial products) channel. A large body of empirical research supports the view that development of the financial system contributes to economic growth. Empirical evidence consistently emphasises the nexus between finance and growth, though the issue of direction of causality is more difficult to determine. At the cross-country level, evidence indicates that various measures of financial development (including assets of the financial intermediaries, liquid liabilities of financial institutions, domestic credit to private sector, stock and bond market capitalisation) are robustly and positively related to economic growth. Other studies establish a positive relationship between financial development and growth at the industry level. Some supporters of the view that internal factors determine growth ( endogenous growth theory) nevertheless assign a special role to finance. Financial systems in

developing countries A developing country is a sovereign state with a lesser developed industrial base and a lower Human Development Index (HDI) relative to other countries. However, this definition is not universally agreed upon. There is also no clear agreem ...

became inclusive in the twenty first century. However, they are still undiversified and small.

Personal finance

Financial deepening can play an important role in reducing risk and vulnerability for disadvantaged groups, and increasing the ability of individuals and households to access basic services like health and education. This can have direct impact on

poverty reduction Poverty reduction, poverty relief, or poverty alleviation, is a set of measures, both economic and humanitarian, that are intended to permanently lift people out of poverty. Measures, like those promoted by Henry George in his economics cl ...

Limitations

In developing countries policy and exogenous influences determine whether financial deepening achieves optimum results.

Country specific experience

India

The All-India Debt and Investment Survey (AIDIS), 2002 raised concerns about

financial inclusion Financial inclusion is defined as the availability and equality of opportunities to access financial services. It refers to a process by which individuals and businesses can access appropriate, affordable, and timely financial products and service ...

, it may have reduced since 1990. After the

green revolution The Green Revolution, also known as the Third Agricultural Revolution, was a period of technology transfer initiatives that saw greatly increased crop yields and agricultural production. These changes in agriculture began in developed countrie ...

focus has been on financing crop loans connected largely with food grains. The

Reserve Bank of India The Reserve Bank of India, chiefly known as RBI, is India's central bank and regulatory body responsible for regulation of the Indian banking system. It is under the ownership of Ministry of Finance, Government of India. It is responsible f ...

views the provision of banking to the poor as a viable business opportunity. It notes that costs and benefit exercises need to be attempted by the banks to make financial inclusion congruent with their business models.