The role of the State, and that of public policy, in the development of the financial sector is
much debated. There is a considerable consensus about the role of the State in producing
the public goods of financial regulation. Beyond that, whether the State can play a role in
shaping the design of markets, or to what extent the State should do so, is questionable.
There appears to be a contradiction in having the State play a role in developing a competitive
market system that enables efficient capital allocation and risk sharing. But financial
market systems in developed and emerging markets have been known to be vulnerable to
capture by vested interests (Rajan and Zingales, 2003). Inefficient ways of organising markets,
such as floor trading or telephone markets, are associated with rents captured by the
insiders who dominate those markets. Thus there does appear to be a role for intervention
from the State to help financial market systems move towards a competitive outcome with
a lack of entry barriers and an absence of rents accruing to participants with concentrated
market power.
Of course, these problems can also be induced by malfunctioning state intervention. India
is a very interesting case study which helps us understand both the impact of State guided
financial sector development, with stories of success as well as failure.
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