[2] The five key functions of a financial system in a country are: (i) information production ex ante about possible investments and capital allocation; (ii) monitoring investments and the exercise of corporate governance after providing financing; (iii) facilitation of the trading, diversification, and management of risk; (iv) mobilization and pooling of savings; and (v) promoting the exchange of goods and services.
[7] Financial sector development also assists the growth of small and medium-sized enterprises (SMEs) by giving them with access to finance.
SMEs are typically labor-intensive and create more jobs than large firms, which contributes significantly to economic development in emerging economies.
[8] The crisis has challenged conventional thinking in financial sector policies and sparked debate on how best to achieve sustainable development.
Acemoglu, Johnson and Robinson emphasize the importance of the distribution of political power in shaping the differing paths of financial sector development in the United States and Mexico in the 19th and early 20th century.
As a result, "the central government granted monopoly rights to banks" [9] which enabled them to "raise revenue and redistribute rents to political supporters.
Rajan and Zingales focus on the power of interest groups to explain cross-sectional and time-series variation in financial sector development.
Cross border capital flows limit the government's ability to direct credit and give out subsidies to these firms is restricted.
In this model, increased trade and capital flows are an exogenous shock that can change the incentives of the economic elite.
Empirical work done so far is usually based on standard quantitative indicators available for a longer time period for a broad range of countries.