Role of Stock Market and Banking System in Promoting Economic Growth Assignment

Role of Stock Market and Banking System in Promoting Economic Growth and Ensuring Financial Stability - Assignment Example In the given project different theoretical factors will be discussed to understand how banks and stock exchange influences the economic growth of a nation. After conducting the required literature review, some case studies will be discussed to critically verify the role of banks and stock market. On the basis of this research final conclusion will be drawn. Literature review Walter Bagehot (1873) and Joseph Schumpeter (1912) emphasised on role of banking system in economy growth and productive investment in a nation. However, there are economists like Robert E. Lucas (1988) who stated that â€Å"the economists have badly over-stressed the role of financial system† (Levine & Zervos, 1998, p.1). Similarly Joan Robinson (1952) also critically pointed out that banks respond passively to the economic growth. No doubt these critics were not wrong but one cannot deny the role of banks in economic growth. To have a healthy economic growth, it is quite essential for a nation to maintai n different businesses and industries operating in a harmonised manner. Bank acts as an intermediary that facilities fast and secure flow of capital within the domestic market as well as in international market. A healthy and well developed banking system is one of the core factors which are taken into consideration by foreign investors while making investment in a country. To attract foreign investment in a country, the government provides special changes in the monitory policy. Cameron (1972), pointed out that banks should vigorously search for ideal funds that can be used, mobilised and circulated in the economy. To attract the investors, high interest rate on deposits is a good tool, as that will attract more saving (Badun, 2008, p.122).... This paper outlines the crucial role of banks and stock markets in promoting growth and development in the modern world. After conducting the required literature review, the case study, pertaining to a global financial crisis, is discussed to critically verify the role of banks and stock market. The root cause of financial crisis was the loose monitory policy followed by the financial institutes of developed country like US and UK. The main aim of the banks was to provide easy loans at comparative lower rates. As soon as this strategy was introduced, the flow of capital increased and the liquidity position went high. Though the global economy was performing well but on the side the credit growth in the balance sheet of financial institutions also increased Banks paid less attention towards risk associated with loans at sub-prime rate. They used highly complex hybrid debt instruments without developing a proper method to analyse the risks. The policy of extensive use of sub-prime rates resulted into a bubble that burst in 2007. The poor condition of many banks created a state of liquidity crisis in the international stock market. Till mid of 2007, the stock market of US and UK was too bullish. People had ample capital to invest and thus liquidity was high. The failure of the banking system along with decline in the stock market performance created a state of harsh liquidity crisis in international market. The result was economic crisis in developed countries followed by fall in economic growth in developing nations.