Are the Increased Size and Profits Share of Finance in the Economy Justified?

Finance is used to intermediate savings between retail savers and borrowers. The size of finance (in terms of jobs, value added and profits) is normally expected to evolve in line with the size of intermediation of savings carried out between lenders and borrowers. If intermediating savings becomes riskier for financial intermediaries (with respect to default and liquidity risks), one also expects profit margins demanded by finance to rise. We will study this relationship between size and role of finance in the United States and the euro zone.

The increase in the size of finance (up 50% between 1995 and 2011 in the United States and 25% in the euro zone) is easily accounted for by the similar increase in the size of the activity of intermediating savings. The growth in the relative profitability of finance in comparison with other sectors (33% over the same period for both economies) can also be explained by the rise in borrowers’ default risk premia. The high level of finance’s relative profitability in comparison with other activities cannot of course be explained only by changes in the size and risk of financial intermediation. However, the similarity between the weight of finance and the size of savings and intermediated assets is striking.