University of Maryland
Department of Economics
• Financial System as Respiratory/Circulatory system.
• Financial policy is much broader than “monetary policy.”
• Financial policy determines the structure, size, and
operation of financial sector.
• Early Development Economics gave little thought to the
role of the financial sector in development, but the
importance of sector apparent from country to country
and through time, especially given globalization and
exchange rate complications.
• Many catastrophic losses of income and redistribution of
income occur through problems in financial system and
its markets. Financial and monetary analysis for LDCs is
a field about 25 years old.
• Latin American Debt Crisis 1982-1988
• Savings and Loan Crisis 1988 – 1994
• ERM meltdown 1992
• Mexico 1994
• Asian Financial Crisis & offshoots 1997-99
• Stock Price Bubble 1997 – 2001
• Property Price Bubble 2004 - ???
• Myriads of domestic banking crises.
• Developing a fully-functional and efficient financial
system is one of the fundamental challenges for any
• McKinnon and Shaw set theoretical basis for new
thinking: Money and Capital in Economic Development
Major Components of Financial System
• Central Banks - monetary policy and supervision
• Formal Credit Institutions -- banks, insurance,
pension funds, investment banks
• Commercial Banking System – heavily regulated
• NGO or PVO credit, cooperatives (microcredit)
• Informal Credit Institutions: Money-lenders (curb
mkt), relatives, local banks
• Equity (Stock) markets – usually national
• Bond markets – often global
Functions of Financial System
• Money – medium of exchange, store of value, unit of account.
Monetization Ratio -- proportion of goods & services
purchased with money.
• Financial intermediation -- borrowing (liabilities) and lending
(assets) money for a profit
- channel savings to investors,
- savings endowments do not corres