Revisiting the impact of finance on growth: Can the United Kingdom benefit from further financial development?

Abstract

There has been a large debate in the literature on the impact of financial development on economic growth, with some recent publications establishing a non-linear relationship between the two variables. Recently, the results of the Brexit vote have created the fear of a reduction in the size of the British financial sector. This paper questions whether the non-linear relationship between financial development and economic growth exists and locates the optimal level of financial development for the United Kingdom. We find that the relationship between financial development and economic growth is non-linear, and that banking crises impair the effect of financial development on growth. The United Kingdom scores beyond the optimal theoretical level, meaning that it has exhausted the benefits brought by its large financial sector. Additionally, we find that differences in regulatory and legal systems affect a country’s optimal level of financial development in times of banking crises.