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Has Financial Development Made the World Riskier?

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Author Info
Raghuram G. Rajan

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Abstract

Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behavior makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11728.

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Date of creation: Nov 2005
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Handle: RePEc:nbr:nberwo:11728

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Find related papers by JEL classification:
G0 - Financial Economics - - General
G1 - Financial Economics - - General Financial Markets
G2 - Financial Economics - - Financial Institutions and Services
G3 - Financial Economics - - Corporate Finance and Governance

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