could lengthen the life of the production cycle. a steady rise in the wealth of nations required a large injection of capital. 3 without access to credit, such large upfront payments of production resources simply would not have been possible. without credit, production processes are constrained to an economically inefficient scale. 4 the opportunity to borrow against future income streams reduced the constraints on the ability of entrepreneurs to invest in bigger machines and larger premises. today, access to external funding is no less important. it has the potential to spur economic innovation and allows production facilities to be operated efficiently through standing credit lines. access to credit is not only important for businesses. students can receive a loan in expectation of the higher income that they are likely to earn later in their lives. student loans permit the enjoyment of the benefits of a higher education at a time in life when income is low. credit makes promising projects possible – whether they are embodied in physical capital or in better education. for a similar classification of functions see levine ( 2005 ). see pollins ( 1954 ) or hudson ( 2002 ). see hicks ( 1969 ). see e. g. sirri and tufano ( 1995 ). the provision of screening and monitoring services is the second key function of finance. specialised screening of the quality of borrowers is an effective remedy against the problem of adverse selection in credit markets. financial intermediaries acquire, process and evaluate information about potential borrowers. in doing so, they help reduce the large costs that we – as individuals – would face if lending of savings were not intermediated. likewise, banks are more effective at monitoring the behaviour of borrowers after funds have been allocated. they can thereby reduce the costs associated with moral hazard – a situation in which asymmetric information can lead borrowers to take action that erodes the value of the loan. stock markets can also perform this duty. influential research literature claims that liquid stock markets help foster corporate governance and hence reduce moral hazard. 5 the basic intuition is straightforward. if managerial compensation is directly linked to stock market performance, either through contracts or stock ownership, managers have an incentive to select and implement actions that increase shareholder wealth. the transformation and management of risk – the third key function of financial institutions in modern societies – became the focus of attention during the recent financial crisis. i will turn to the dark side of this function later. for now, let me stress the potential value of risk management. financial markets provide savers with a large array of

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