Does Traditional Finance Perpetuate Financial Inequality?

Mainstream financial institutions such as brokerage firms, banks, and insurance providers form the crux of the traditional financial system. The traditional financial system depends upon central institutions that regulate trading, lending, and managing assets and financial instruments. However, some flaws of traditional finance lead to financial inequality. Wherever traditional financial systems predominate, financial inequality widens. Therefore, it is necessary to understand how traditional financial systems cause this equality and how decentralized finance can offer much-needed respite.

Role of Traditional Finance in Financial Exclusion

Traditional finance is a monopoly of governments, central banks, and other financial institutions. This is the role traditional finance plays in perpetuating financial inequality and causing financial exclusion.

Financial Exclusion of Underprivileged Groups.

Traditional finance like banks often are unwilling to provide proper financial services to unbanked and underprivileged sections of society. The population either has no or little access to banking. They are regularly denied access to financial credit, insurance, and savings. Consequently, financial exclusion becomes the norm as there is less or no financial consultation for the underprivileged groups. For example, in a large country like India, nearly 11 percent of the adults are unbanked. Therefore, financial exclusion leads to poverty and keeps economic inequality intact.

Centralized Planning

Centralized planning is the most noticeable feature of all traditional financial systems. The central banks in various countries known by different names issue fiat currencies and have the legal power to eliminate any other competing currency in their territory. Therefore, centralized systems are a kind of monopoly. This monopoly is under the control of elites and is the very antithesis of a free market system. Thus, it invariably leads to inequality as the elite continue to grow richer but the poor continue to live in the margins. Some argue that centralized planning is like a restrictive force as it snatches away financial innovation and perpetuates inequality.

Currency Devaluation

Financial freedom is not just about becoming self-sufficient in finance. It also implies having adequate savings to combat financial emergencies. Unfortunately, many earning people in the world are not financially free because they just do not have enough savings to sustain themselves without a proper source of income. Traditional finance is largely responsible for this crisis as it keeps on printing fiat money which does not have any intrinsic value after 1971. As a result, price instability and economic inflation erode the savings of people and make them less valuable with each passing year. Therefore, even after earning money, traditional agencies devalue it periodically and render it less useful to combat inflation.

Wealth Concentration

Wealth concentration causes enormous levels of financial inequality. Traditional finance reliant upon fiat currencies continues to benefit individuals who are rich by systematically excluding financial opportunities for the unprivileged. Sometimes, the road to financial freedom is structurally so difficult that most people do not have the means to achieve it. There are several instances where banks have waived off loans of rich corporations but do not show laxity while recovering loans from unprivileged individuals. 

Volatility

Traditional financial institutions are taking steps to combat or reduce volatility but its reliance on fiat currencies also causes volatility. Excessive volatility not only causes economic exigencies but also causes financial inequality. The central banks often make errors while deciding the quantity of currency. This leads to price instability and restricts financial freedom by pushing millions of people to live life on a “paycheck to paycheck” basis without substantial savings and insurance facilities.

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Bottom Line

Traditional finance may have its set of advantages. However, it is an undeniable fact that it perpetuates financial inequality. The structure of traditional finance needs urgent reforms otherwise it will continue to stifle financial freedom and cause economic problems. Financial equality can therefore become a reality only if it reduces income inequality and combats volatility. Decentralized finance has the potential to break free the monopoly of these institutions and grant financial freedom to the financially excluded.