Banking, financial intermediation and corporate finance

Abstract

Introduction What is the role of banks and other intermediaries in the provision of finance to industry? More generally, how do financial institutions affect the allocation of funds for investment and the evolution of production possibilities in an economy? Until very recently, questions of this type received little attention from economic theory. Theoretical work on finance tended to rely rather heavily on the Walrasian paradigm of ‘perfect’, i.e. anonymous, frictionless markets. Within this paradigm, there is no room for a comparative analysis of different institutions because one specific set of institutions, namely the Walrasian market system, is a priori taken as given. Reliance on the Walrasian paradigm with its given set of frictionless markets involves an implicit presumption that comparative institutional analysis can be neglected – say because as a first approximation all potentially interesting institutions achieve roughly the same outcome as a Walrasian market system. In contrast, the role of institutions in the provision of finance to industry is of great interest to economic historians and development economists. Historians observe that financial systems differ significantly across countries and across periods, so the question arises how these differences between financial systems affected the functioning of the different economies. In certain countries such as Germany, large banks seem to have played a prominent role in the industrial expansion of the late nineteenth century. In other countries such as Britain, banks do not seem to have played such a role. Did the prominence of the large banks in Germany make a positive contribution to economic growth? Does the difference between financial systems explain some of the difference between Germany and British growth rates in the late nineteenth century?