Theoretical Approaches to the Understanding of Financial Institutions (Pols 219)

Introduction 

Financial institutions did not emerge by accident; their existence and roles in the economy can be explained through different theoretical perspectives. Two major theoretical approaches used to explain the emergence, functions, and control of financial institutions are the Classical Liberalist (Free Market) approach and the Marxist approach. These approaches differ mainly on the issue of ownership, control, and whose interests financial institutions serve.

1. Classical Liberalist or Free Market Approach

Leading scholars like Adam Smith and David Ricardo are among the major proponents of this theory. According to them, financial institutions are essential for economic growth and national development.

Adam Smith 

This is because financial institutions provide credit to firms, governments, and individuals. This credit supports industrial development, increases production, promotes trade, and encourages investment in the economy.

They also help in:

• Mobilizing savings
• Facilitating investment
• Supporting business expansion
• Ensuring smooth circulation of money

However, it is important to note that in practice, central banks, not financial institutions generally, regulate money supply and help maintain price stability.

According to the liberalist school of thought, the stability created by financial institutions promotes domestic economic growth and strengthens a country's position in international economic and political relations.

2. Marxist Approach to Economy and Financial Institutions

Karl Marx 

The Marxist approach, associated with Karl Marx, views society as divided into two main classes:

• The bourgeoisie (the owners of capital and means of production)
• The proletariat (the workers who sell their labour)

In this system, the bourgeoisie are seen as the dominant and exploiting class, while the proletariat are the oppressed class.

According to the Marxist approach, financial institutions in a capitalist economy serve mainly the interests of the bourgeoisie. They help the dominant class to:

• Control capital
• Accumulate wealth
• Maintain economic dominance

Marxists argue that this leads to inequality and exploitation.

Therefore, Marxists believe that:

• The state should control the means of production and distribution
• Financial institutions should be regulated by the state
• Economic resources should be distributed based on need and capacity

The aim is to prevent exploitation and ensure fairness and equality in the economy.

Conclusion

In conclusion, the Classical Liberalist approach sees financial institutions as essential tools for economic growth, investment, and development through free market operations. On the other hand, the Marxist approach views financial institutions as instruments of class domination that should be controlled by the state to prevent exploitation. Both approaches provide important perspectives for understanding the role and impact of financial institutions in an economy.