Financial structure matters for economic growth

Financial structure matters for economic growth

Financial structure matters for economic growth

There is an unresolved debate over whether banks or markets are better at providing financial services and stimulating economic growth. Recent studies showing that neither bank-based nor market-based systems are particularly linked with growth, and they fail to take account of different national experiences.

Research from CardiffUniversity and the University of Cambridge, in the UK, and the WorldIntellectual Property Organisation, in Switzerland, examines the links betweenfinancial structure and economic growth in fourteen countries at varying stagesof development: Argentina, Brazil, Chile, Greece, India, Indonesia, Jordan,South Korea, Malaysia, Mexico, Philippines, Portugal, Thailand and Venezuela.

Financial structure refers tothe mix of financial institutions, markets and instruments that channel savingsand other funds to businesses and other borrowers. In a bank-based system,banks play the key role in channelling funds to businesses. In a market-basedsystem, capital markets – including the stock and bond markets – are the moreimportant source of funds.

Some studies have shown thatas countries get richer, stock markets develop and become more efficient thanbanks at channelling funds. So, many developed countries have market-basedfinancial systems, while many low- and middle-income countries have bank-basedsystems.

There is a long-runningdebate over whether bank-based or market-based systems are better for economic growthand development. For example, some early work on this subject highlighted thekey role of banks in industrialisation in Germany and Japan. However, otherwork has claimed that the market-based systems in the UK and USA are moreefficient.

More recently, a number of studieshave argued that neither banks nor markets are better: both are important andcan complement each other. According to these studies, the type of financialstructure has no influence on economic growth.

However, the current researchshows that these studies miss important differences in country experiences andso give misleading results. This is because of the research methods used,including panel data approaches which pool information on different countries.

To address these problems,the research uses different methods – including country-by-country time seriesanalyses – to examine the relationship between financial structure and economicgrowth. The results take account of differences between countries, such asdifferent production structures and levels of banking, financial and capitalmarket development.

Key findings of the researchinclude:

  • In most of thecountries studied, financial structure does influence economic growth.
  • Market-basedsystems appear to be better for growth than bank-based systems.
  • The relationshipbetween financial structure and growth varies greatly from country to country.
  • So research intothis relationship needs to take account of different national experiences.
  • There is onlylimited evidence that as countries become richer, market-based systems becomemore important.
  • There is alsoonly limited evidence that the influence of financial development on growthreduces as countries become richer.

The findings differ fromthose of previous studies because of the different research methods used. Andunlike some of the previous studies, the research shows that financialstructure does matter for economic growth.