Even if the financial sector is small relative to the real economy, it may be comprised of banks whose incentives are misaligned due to “too big to fail” considerations. This can lead to excessive risk-taking and inefficient credit growth and has inspired recent changes to regulation and prudential policy.
For example, Basel III includes a revised leverage ratio framework that has the goal of preventing banks from operating with excessive leverage. This should reduce the discrepancy between social and private returns in banking and limit the rents extracted by the financial sector. A similar role is envisaged for recent rules on liquidity coverage.