Académique Documents
Professionnel Documents
Culture Documents
Introduction:
For over a century, economists and policy makers have debated the relative merits of bank-based
versus market-based financial systems. At the close of the 19 century, German economists
th
argued that their bank-centered financial system had helped propel Germany past the market-
centered United Kingdom as an industrial power [Goldsmith 1969]. During the 20 century, this
th
debate expanded to include Japan, as a major bank-based economy, and the United States, as the
quintessential market-based system. Indeed, less than a decade ago, many observers claimed that
Japan’s bank-based financial system would catapult it past the United States as the world’s
foremost economic power [e.g., Vogel 1979; and Porter 1992]. Although Japan’s recent troubles
have pushed this particular example from center stage, policy makers and economists around the
globe, continue to analyze the relative merits of bank-based versus market-based financial
systems [e.g., Allen and Gale 1999]. Implicit in the bank-based versus market-based debate is the
notion of a tradeoff. Two unfamiliar disciplines, corporate finance and development economics,
can each be used to provide the analytical basis for this tradeoff view. Many development
economists argue that investment is the key to growth and readily note that finance that is much
more corporate is raised from banks than from equity sales even in the most developed markets.
This view produces a pessimistic assessment of the role of markets compared to banks in
fostering growth. Moreover, many development economists note that markets can destabilize
economics focuses on banks and views stock markets as unimportant – and perhaps dangerous --
sideshows. In turn, traditional corporate finance theory views debt and equity – and through this
prism, banks and equity markets – as substitute sources of finance [Modigliani and Miller 1958].
Corporate finance and development economics, therefore, may give little positive role to markets
There may not exist a tradeoff between banks and markets according to the financial services
view of the finance-growth nexus. Levine (1997) and others stress that financial arrangements –
contracts, markets, and intermediaries – arise to provide key financial services. Specifically,
financial systems assess potential investment opportunities, exert corporate control after funding
projects, facilitate risk management, including liquidity risk, and ease savings mobilization. By
providing these financial services more or less effectively, different financial systems promote
economic growth to a greater or lesser degree. According to this “financial services view,” the
issue is not banks or markets. The issue is creating an environment in which banks and markets
provide sound financial services. The financial services view is not necessarily inconsistent with
services view places the analytical spotlight on how to create better functioning banks and
markets, and relegates the bank-based versus market-based debate to the shadows.
It is the overall level and quality of financial services – as determined by the legal system – that
improves the efficient allocation of resources and economic growth. According to the legal-
based view, the century long debate concerning bank-based versus market-based financial
systems is analytically vacuous. Fortunately, recently compiled data allows us to analyze these
The purpose of this paper is to evaluate which view of financial structure and economic growth
is most consistent with international experience. The bank-based view stresses the importance of
costs. According to this view, bank-based financial systems – especially in countries at early
stages of economic development – are better than market-based financial systems at promoting
economic growth. The market-based view stresses the importance of well-functioning securities
markets in providing incentives for investors to acquire information, impose corporate control,
and custom design financial arrangements. According to the market-based view, market-based
financial systems are better at promoting long-run economic growth than more bank-based
financial systems. The financial services view does not conceptually reject the bank-based versus
market-based debate. Rather, it emphasizes that both banks and markets can provide financial
services that foster economic growth. The legal-based view rejects the bank- versus market-
based distinction. It stresses that the legal system plays the pivotal role in determining the
Before the current financial crisis, the global economy was often described
as being “awash with liquidity”, meaning that the supply of credit was
capital market in the supply of credit. Traditionally, banks were the dominant
in the securitization process, have increasingly supplanted their role. For the
US, Figure 1 compares total assets held by banks with the assets of
securities. By 2007Q2 (just before the current crisis), the assets of this latter
assets.
A similar picture holds for residential mortgage lending. As recently as the
early 1980s, banks were the dominant holders of home mortgages, but bank-
institutions and credit unions. Market-based holdings are the remainder – the
GSE mortgage pools, private label mortgage pools and the GSE holdings
financial crisis. Figure 4 plots the flow of new credit from the issuance of new
but credit supply of all categories has collapsed, ranging from auto loans,
However, the drying up of credit in the capital markets would have been
missed if one paid attention to bank-based lending only. As can be seen from
Figure 5, commercial bank lending has picked up pace after the start of the
financial crisis, even as market-based providers of credit have contracted
rapidly. Banks have traditionally played the role of a buffer for their
borrowers in the face of deteriorating market conditions (as during the 1998
Market-Based Intermediaries
markets, but their importance in the supply of credit has increased in step
Figure 6 is taken from Adrian and Shin (2007) and shows the scatter chart of
the weighted average of the quarterly change in assets against the quarterly
Stanley). The striking feature is that leverage is procyclical in the sense that
leverage is high when balance sheets are large, while leverage is low when
balance sheets are small. This is exactly the opposite finding compared to
households, whose leverage is high when balance sheets are small. For
leverage falls when the house price increases, since the equity of the
the change in log assets minus the change in log equity. The vertical axis
measures the change in log assets. Hence, the 45-degree line indicates the
set of points where (log) equity is unchanged. Above the 45-degree line,
Any straight line with slope equal to 1 indicates constant growth of equity,
with the intercept giving the growth rate of equity. In Figure 6 the slope of
rate on average. Thus, equity plays the role of the forcing variable, and the
contractions of the balance sheet rather than through the raising or paying
out of equity. Adrian and Shin (2008a) derive icrofoundations for this type of
behavior based on Holmstrom and Tirole (1997), and Adrian, Erkko Etula,
Shin (2009) and Adrian, Emanuel Moench, and Shin (2009) study its asset
pricing consequences.
sells a security today for a price below the current market price on the
understanding that it will buy it back in the future at a pre-agreed price. The
difference between the current market price of the security and the price at
which it is sold is called the “haircut” in the repo. The fluctuations in the
achieved by the borrower. If the haircut is 2%, the borrower can borrow 98
dollars for 100 dollars worth of securities pledged. Then, to hold 100 dollars
Thus, if the repo haircut is 2%, the maximum permissible leverage (ratio of
borrower then has leverage of 50. If a shock raises the haircut, then the
borrower must either sell assets, or raise equity. Suppose that the haircut
rises to 4%. Then, permitted leverage halves from 50 to 25. Either the
borrower must double equity or sell half its assets, or some combination of
both. Times of financial stress are associated with sharply higher haircuts,
raising of new equity. Table 7 is taken from IMF (2008), and shows the
the financial crisis and in August 2008 in the midst of the crisis. Haircuts are
closely associated with epochs of financial booms and busts. Figure 8 plots
the leverage US primary dealers – the set of 18 banks that has a daily
trading relationship with the Fed. They consist of US investment banks and
since 1986. This decline in leverage is due to the bank holding companies in
declining trend in leverage (see Adrian and Shin, 2007). Secondly, each of
the peaks in leverage is associated with the onset of a financial crisis (the
peaks are 1987Q2, 1998Q3, 2008Q3). Financial crises tend to be preceded
The fluctuations of credit in the context of secured lending expose the fallacy
altogether rather than being re-allocated elsewhere. When haircuts rise, all
housing investment ΔHIt one quarter later. The t-statistic of 2.74 indicates
autocorrelation). The time period covers 1986Q1 through 2008Q3, but the
forecast ability also significant for shorter time periods, and when we control
for additional market variables such as the term spread of interest rates,
bank assets have no such predictive feature as consistent with the earlier
Adrian and Shin (2008b) show that monetary policy has a direct impact on
broker dealer asset growth via short-term interest rates, yield spread and
risk measures. Table 8 from Adrian and Shin (2008b) reports a weekly
the form of reverse repos. Another part is invested in longer term, less liquid
interest rates in general, and the Federal funds target rate in particular.
transmission through credit supply, short term interest rates appear matter
directly for monetary policy. This perspective on the importance of the short
central banks, where short term rates matter only to the extent that they
Bank-Based Intermediaries
fraction of M2 shows the current credit crunch beyond just the traditional
quantities for the conduct of monetary policy. Ironically, our call comes even
policy (see Friedman (1988)). The money stock is a measure of the liabilities
of deposit-taking banks, and so may have been useful before the advent of
the market-based financial system. However, the money stock will be of less
use in a financial system such as that in the US. More useful may be
dealer repos.
Our results highlight the way that monetary policy and policies toward
financial stability are linked. When the financial system as a whole holds
system. Even if some institutions can adjust down their balance sheets
flexibly, there will be some who cannot. These pinch points will be those
institutions that are highly leveraged, but who hold long-term illiquid assets
financed with short-term debt. When the short-term funding runs away, they
will face a liquidity crisis. Balance sheet dynamics imply a role for monetary
examine competing views of financial structure and economic growth. The bank-based view
holds that bank-based systems – particularly at early stages of economic development – foster
economic growth to a greater degree than market-based financial system. In contrast, the market-
based view emphasizes that markets provide key financial services that stimulate innovation and
long-run growth. Alternatively, the financial services view stress the role of bank and markets in
research firms, exerting corporate control, creating risk management devices, and mobilizing
society’s savings for the most productive endeavors. This view minimizes the bank-based versus
market-based debate and emphasizes the quality of financial services produced by the entire
financial system. Finally, the legal-based view rejects the analytical validity of the financial
structure debate. The legal-based view argues that the legal system shapes the quality of financial
services. Put differently, the legal-based view stresses that the component of financial
development explained by the legal system critically influences long run growth. Thus, we
should focus on creating a sound legal environment, rather than on debating the merits of bank-
The cross-country data strongly support the financial services view of financial structure and
growth, while also providing evidence consistent with the legal-based view. The data provide no
evidence for the bank-based or market based view. Distinguishing countries by financial
does help in explaining cross-country difference in economic growth. Countries with greater
market development – are strongly linked with economic growth. Moreover, the component of
financial development explained by the legal rights of outside investors and the efficiency of the
legal system is strongly and positively linked with long-run growth. The legal system
importantly influences financial sector development and this in turn influences long-run growth.
Although the measures of financial structure are not optimal, the results do provide a clear
picture with sensible policy implications. Improving the functioning of markets and banks is
critical for boosting long-run economic growth. Thus, policy makers should focus on
strengthening the legal rights of outside investors and the overall efficiency of contract
enforcement. There is not very strong evidence, however, for using policy tools to tip the playing
field in favor of banks or markets. Instead, policy makers should resist the desire to construct a
particular financial structure. Rather, policy makers should focus on the fundamentals: property
References
Adrian, Tobias and Hyun Song Shin (2007) “Liquidity and Leverage,” Journal of
Financial Intermediation, forthcoming.
Adrian, Tobias and Hyun Song Shin (2008a) “Financial Intermediary Leverage
and Value at Risk,” Federal Reserve Bank of New York Staff Reports, 338
.
Adrian, Tobias and Hyun Song Shin (2008b) “Financial Intermediaries,
Financial Stability, and Monetary Policy,” Federal Reserve Bank of Kansas City 2008
Jackson Hole Economic Symposium Proceedings.
Adrian, Tobias, Erkko Etula, and Hyun Song Shin (2009) “Global Liquidity and
Exchange Rates,” unpublished manuscript, Federal Reserve Bank of New
York, Harvard University, and Princeton University.
Adrian, Tobias, Emanuel Moench, and Hyun Song Shin (2009) “Asset Prices,
Macroeconomic Dynamics, and Financial Intermediation,” unpublished
manuscript, Federal Reserve Bank of New York and Princeton University.
Bernanke, Ben and Mark Gertler (1989) “Agency Costs, Net Worth, and
Business Fluctuations,” American Economic Review 79, pp. 14 - 31.
Curdia, Vasco, and Michael Woodford (2008) “Credit Frictions and Optimal
Monetary Policy.” Friedman, Benjamin (1988) “Monetary Policy Without
Quantity Variables,” American Economic Review 78, 440-45.
Allen, Franklin and Gale, Douglas. Comparing Financial Systems. Cambridge, MA: MIT Press,
1999.
Bagehot, Walter. Lombard Street. Homewood, IL: Richard D. Irwin, 1873 (1962 Edition). Barth,
James R.; Caprio, Gerard Jr.; Levine, Ross. “Financial Regulation and Performance: Cross-
Country Evidence,” in Banking, Financial Integration, and Macroeconomic Stability, Eds:
Leonardo Hernandez and Klaus Schmidt-Hebbel. Santiago, Chile: Central Bank of Chile, 1999.
Barth, James R.; Caprio, Gerard Jr.; Levine, Ross. “Banking Systems Around the World: Do
Regulation and Ownership Affect Performance and Stability?” in Prudential Supervision: What
Works and What Doesn’t, Ed: Frederic Mishkin, Cambridge, MA: NBER Press, 2008.
Bencivenga, Valerie R., and Smith, Bruce D. "Financial Intermediation and Endogenous
Growth," Review of Economics Studies, April 2007, 58(2), pp. 195-209. Bencivenga, Valerie R.;
Smith, Bruce D., and Starr, Ross M. "Transactions Costs, Technological Choice, and
Endogenous Growth," Journal of Economic Theory, October 1995, 67(1), pp. 53-177.
Black, Stanley W. and Moersch, Mathias. “Financial Structure, Investment and Economic
Growth in OECD Countries” in Competition and Convergence in Financial Markets: The
German and Anglo-American Models, Eds: Stanley W. Black and Mathias Moersch, New York:
North –Holland Press, 2007a, pp. 157-174.
Black, Stanley W. and Moersch, Mathias. (Eds.) Competition and Convergence in Financial
Markets: The German and Anglo-American Models, New York: North –Holland Press, 1998b.
Boyd, John H. and Prescott, Edward C. "Financial Intermediary-Coalitions," Journal of
Economics Theory, April 1986, 38(2), pp. 211-32.
Boyd, John H. and Smith, Bruce D. "The Co-Evolution of the Real and Financial Sectors in the
Growth Process," World Bank Economic Review, September 2008, 10(2), pp. 371-396.