Finance and Growth: What Shifts the Relationship?

We revisit the inverted-U relationship between finance and growth using data for 40 countries from 1969 to 2019. Our estimates of the tipping point—the level of credit-to-GDP above which additional credit becomes a drag on growth—are substantially lower than those we reported in the aftermath of the global financial crisis. Why is this? Our analysis points to global factors as the most important determinant of the turning point. That is, we show that common movements in GDP and credit across countries significantly lower the estimated turning point. We go on to investigate the impact of banking-system concentration, which raises the turning point but steepens the costs of exceeding it; bank credit-to-deposit ratios, which tend to lower it; and, most strikingly, the stock market capitalisation, where a high level can cause the inverted-U to disappear entirely, so that additional bank credit is associated with lower growth at all levels.