Private Credit, Stock Market Development and Financial Structures

Abstract

This paper examines the empirical relation between private credit by banking institutions and capital market development under different financial structural characteristics. We find that in market based systems and countries with developed financial systems, an increase in bank credit impedes the development of capital markets. However, the result is opposite in bank based systems and countries with underdeveloped financial systems. Therefore, although at lower levels of economic and financial development, stock markets and banks act as complementarities, at higher levels of economic and financial development, they do not. The impact of increased credit flow on the liquidity in capital markets is also found to be pronounced in market based economies. Since we find that a market based system is not more effective than a bank based system at facilitating the development of the capital market, we argue that instead of promoting a shift toward a market based system, effort should be concentrated on developing a balanced financial structure.