The Economic Effects of ‘Excessive’ Financial Deepening

We study the causal implications of high levels of financial deepening for economic development and banking crises in a panel of countries over the past seven decades. We adopt a factor‐augmented heterogeneous difference‐in‐differences estimator and find, in contrast to the existing literature, that very high levels of financial development do not lead to lower long‐term economic growth or a higher likelihood of banking crises associated with ‘credit booms gone bust’ cycles or excessive capital inflows. We submit this null result to a battery of robustness checks adopting alternative specifications, alternative aggregate data for households vs. firms, and carrying out theory‐driven heterogeneity analysis.