The Role of Financial Institutions in the Context of Economic Development

Abstract

The financial sector plays an important role in the context of economic development. However, the role that financial institutions played in developed countries was very different from the one they play in developing countries. In developed countries financial institutions largely emerged within the process of industrialization. The process of industrialization increased the demand for finance, and many entrepreneurs recognized that there was an opportunity to make a profit from the intermediation between savers and investors or between lenders and borrowers, and this led to the growth of varieties of financial institutions. Thus there was a mutual feedback between the two, arising from mutual benefit.¹ In developing countries the process of industrialization was not a natural process of transition from a backward state to an advanced industrial state; instead it relied on the respective governments’ deliberate attempts to reach such a state. Thus there is very little scope, if any, to make profit from engaging in financial intermediation. Yet the financial institutions had a very important role to play in fostering the process of industrialization via the coordination between savers and investors.