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1. Introduction
The link between financial development and economic growth has received considerable attention in recent literature. Numerous studies have studied this relationship at both the theoretical and empirical levels. At a basic level, they have tried to find the answer, whether financial development leads to improved growth performance or vice versa. Other studies have focused on identifying the channels of transmission between financial intermediation and growth. Despite several attempts to empirically investigate the relationship between financial development and economic growth, very few studies have addressed the causal relationship between financial development and income inequality on the one hand and financial development and inequality reduction on the other. The theoretical predictions of the effects of financial development on income inequality are still unresolved.
It is generally accepted that strong financial growth can offer more development and progress of an economy. A financial system, which is inherently strong, functionally diverse and displays efficiency, is essential for national objectives of fostering a market-driven productive and competitive economy. Subsequently this will promote higher level of investment and economic growth with its depth and coverage. Policies directed toward enacting a strong and vibrant financial sector growth through two channels. First, these policies make credit cheaper, make best available tool cater to financial need and requirements of various participants and segment of the society, boost entrepreneurial activities, generates employment opportunities and enhance the welfare of the poor. Second, the availability of credit at cheaper cost can provide crucial support to the financially weaker families by allowing them to invest in health, education and improve life of their children and create and enhance human capital formation of the economy which in turn will improve the income distribution of the economy.
This study takes into the case of Indian economy to explore the relationship of financial development with income inequality. The Indian economy, a latecomer to economic reforms and liberalization, joined the club in the 1990s in the wake of a severe external balance crisis. Financial sector reforms were also introduced as a part of the economic reform programs. Consequently, interest rates were gradually liberalized, and reserve and liquidity ratios were reduced significantly. These reforms were designed to promote greater efficiency in the economy through promotion of competition. These reforms are documented...