What is the Appropriate Size of the Banking System?

Abstract

To measure the size of the banking system, a country’s banking assets divided by the country’s gross domestic product (GDP) is commonly applied as a yardstick. But is the banking assets to GDP ratio an appropriate yardstick? This paper shows that comparing a country’s banking sector only by using that country’s GDP does not capture the whole story as countries have distinctive financial needs. In particular, countries differ with regard to the number and size of multinational enterprises. In a cross-country empirical study, we find a statistically significant relationship between the presence of large banks and the presence of multinationals, after controlling for the size of the country. We therefore suggest using an additional yardstick, which compares the size of large banks to the size of multinationals in a country.