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.
