Bank-based Financial System Research Articles

Does Economic Structure Determine Financial Structure?

Differences in countries financial structure are prevailing despite the global converegence of the economies. In countries such as Germany or Spain the financial system is dominated by banks, whereares in the U.S. or the U.K. financial system capital markets is predominated. In our paper we investigate the relation between the structure of the real economy and country's financial system. We consider whether the development of the real economic structure determine the evolution of the financial system structure. Using both pooled FGLS regression and panel EC2SLS techniques we find that economies dominated by physical-asset-intensive firms tend to have a bank-based financial system. Conversely, countries with knowledge based industries and intangible-asset-intensive firms tend to have a market-based financial system. Our results suggests that financial structures develop and prevail in response to the financial needs of firms, hence to the characteristics of the real economy.

Myths and Truths: The 'Law and Finance Theory' Revisited

The law and finance theory predicts that the common law system provides the best basis for financial development and economic growth, followed by Scandinavian and German origin civil law and finally French origin civil law. Referring to a number of sceptical views, this paper argues that the theory faces an identification problem, since the majority of common law countries have a market-based financial system, whereas the majority of civil law countries have a bank-based financial system. Moreover, there are plausible alternative hypotheses to explain the quality of the financial system; but that they cannot rule out that the theory refers to a relevant link between the legal tradition and financial development. Finally it is argued that the corner stone of the law and finance theory is the proposition that different legal traditions imply different degrees of investor protection. It is demonstrated that a few minor, but sensible modifications in aggregating the original indicator set produce results that are different from those reported so far and contradictory to the theory's ranking of the four major legal families in terms of investor protection. Accordingly, the validity of the theory's investor protection measures for international comparisons, the supremacy of the common law legacy in protecting investors and, consequently, the validity of legal origin variables to instrument for financial development, have to be regarded as myths rather than truths.

Changes in Germany's Bank-Based Financial System: implications for corporate governance

Throughout the 20th century, banks have dominated Germany's financial system and also played a key role in corporate governance. Recently, however, a number of efforts have been made to increase the role of markets within this bank-based financial system, including regulatory innovations and a reform of the pension system. This article finds that, despite these changes, there are a surprising number of continuities in the structure of the financial system. The German financial system can therefore still be characterised as bank-based. Furthermore, banks have only partially withdrawn from the stakeholder system of corporate governance, and to some extent been replaced by insurance companies. An explanation for these continuities is advanced which emphasises stability in household investment behaviour and in patterns of company sector demand for finance.

The Transition from Banks to Markets in the German and Japanese Financial Systems

One of the key features of both the German and Japanese postwar political economies is a bank-based financial system. In the 1980s bank-based systems were widely perceived to be superior to market-based systems like the US and UK in their ability to provide long-term patient capital to industry. Since the early 1990s, however, the bank-based financial systems in both Japan and Germany have faced serious challenges, to the extent that their fundamental viability vis-a-vis market-based systems is being questioned. This paper assesses the potential paths of development for these bank-based systems and argues that change in the two countries is poorly captured by the convergence-divergence dichotomy. The first point made is that an examination of changes in financial systems should start with an analysis of the societal foundations of bank-based systems. Bank-based systems rest not just on a set of financial regulatory practices but also on the institutions and behavior of the household, corporate and public sectors as savers and investors. The second point made in this paper is that, although public policy choices are often presented in terms of a stark dichotomy between liberal and non-liberal modes of regulation (the former associated with market-based systems, the latter with bank-based systems), in fact both Germany and Japan are struggling to find a successful combination or hybrid of the two types of financial regulation. A third and final point is that banks play important (if diminished) roles even in market-based systems. The ultimate form that the coexistence of banks and markets will take in Japan and Germany depends on the creativity and efforts of policymakers and the banks themselves. Those interested in institutional design should try to preserve a viable banking system for SMEs and the household sector while simultaneously promoting stable capital markets for larger companies and high-tech start-ups.

Small business owner-managers as latent informal investors in Japan: Evidence from a country with a bank-based financial system

Start-up support by small business owner-managers looks extremely promising for the formation of a pool of latent informal investors in countries like Japan with a bank-based financial system and small-scale informal investing. First, small business owner-managers have superior potential in regard to the hands-on capacity to provide management know-how. Second, there are a large number of small businesses in Japan. Third, small businesses exist not only in financial centres and new venture clustering areas, but also in all regional areas. This paper demonstrates the activities of small business owner-managers acting as financial and non-financial supporters of business start-ups in Japan, by using two data sets both surveyed in 1999 by the National Life Finance Corporation. The empirical results showed that owner-managers who are younger, from larger small businesses, or who had received support when their own businesses were starting tended to provide start-up support. It was shown that there was a clear tendency to provide financial support to business types 'different' from the managers' own businesses. One way of increasing the pool of informal investors would be to attract managers in various positions to make informal investments and expand their businesses and entrepreneurial skills.

Changes in Germany's Bank-Based Financial System: A Varieties of Capitalism Perspective

Throughout the 20th century Germany's financial system has been dominated by banks. Recently, however, a number of efforts have been made to increase the role of markets within this bank-based financial system, including regulatory innovations, changes in corporate governance, and a reform of the pension system. This paper finds that, despite these changes, there are a surprising number of continuities in the structure of the financial system. The German financial system can therefore still be characterized as bank-based. An explanation for this based on the Varieties of Capitalism viewpoint is advanced, which emphasizes complementarities and continuities in household savings and investment behavior and in patterns of company sector demand for finance.

The Relationship between Stock Prices, House Prices and Consumption in OECD Countries

Abstract This paper analyzes the relationship between stock prices, house prices and consumption using data for 16 OECD countries. The panel data analysis suggests that the long-run responsiveness of consumption to permanent changes in stock prices is higher for countries with a market-based financial system than for countries with a bank-based financial system. Splitting the sample into the 1980s and 1990s further shows an increased sensitivity in the 1990's of consumption to permanent changes in stock prices for both countries with bank-based financial systems as well as countries with market-based financial systems. The relationship between changes in consumption and changes in house prices is positive for the second sample period across all specifications and financial systems.

Lead-lag Structure between the R&D Investments and Market Values

This study investigates the lead-lag structure between the R&D investments and market values in countries with different financial systems. The purpose of the study is to examine whether the leading period market values are stronger associated with R&D investments in countries with market-based financial system than in countries with bank-based financial system. We also investigate whether these differences disappear when the lagging period market values are associated with R&D investments. The study applies the method by Collins and Kothari (1989) who point out the importance of taking into account the lead-lag structure between the earnings and returns when measuring the returns-earnings association. The results indicate that leading period market values are stronger associated with R&D investments in countries with market-based financial system than in countries with bank-based financial system. Finally we report that R&D expenditures are reflected in the firms' market values and market value changes several years after which indicate the long-term nature of R&D investments.

Market- vs. bank-based financial systems: Do rights and regulations really matter?

In some countries, banks are firms' key source of financing. In others, firms look mainly to financial markets to meet their financial needs. Why should this be so? This paper provides an explanation tied to legal traditions. Civil-law courts are less effective than their common-law counterparts in resolving conflicts because they have less flexibility in interpreting the laws and creating new rules. Banks emerge in these economies as primary contract enforcers, leading to bank-oriented financial systems. Furthermore, because common-law courts enforce laws effectively, providing them with more detailed creditor and shareholder protection laws has a greater impact on the development of financial markets compared with civil-law systems.

Optimal Lender of Last Resort Policy in Different Financial Systems

In a framework closely related to Diamond and Rajan (J Polit Econ 109:287–327, 2011) we characterize different financial systems and analyze the welfare implications of different central bank policies in these financial systems. We show that in case of a large negative liquidity shock, liquidity demand has lower interest rate elasticity in a bank-based financial system than in a market oriented financial system. Market interventions, i.e. non-standard monetary policy measures to inject liquidity need to be much larger in a bank-based financial system in order to bring down interest rates to sustainable levels. Therefore, in financial systems with rather illiquid assets an individual liquidity assistance might be welfare improving, while in market oriented financial systems, with rather liquid assets in the banks’ balance sheets, liquidity assistance provided freely to the market at a penalty rate is likely to be efficient. While the costs of individual support might not be worthwhile in a market oriented financial system in which deadweight losses of market based support are small, in a bank based system the deadweight losses of unconventional monetary policy are large and thus individual support more efficient.

The Genesis of Venture Capital - Lessons from the German Experience

Why does venture capital work in some countries but not in others? This clinical study of the first German venture capital firm examines the difficulties of creating a venture capital market in a bank-based financial system. The analysis identifies the problem of creating appropriate governance structures to protect investor returns. It exposes the difficulties of established banks - not to mention government - to devise venture investment strategies. It identifies the availability of high quality entrepreneurs as a critical complement. And it provides a reinterpretation of the hypothesis of Black and Gilson (1997), arguing that the existence of an active stock market is a necessary, but by no means sufficient condition for the development of venture capital.

Funding growth in bank-based and market-based financial systems: evidence from firm-level data

The authors investigate whether firms' access to external financing, to fund growth differs between market-based, and bank-based financial systems. Using firm-level data for forty countries, they compute the proportion of firms in each country that relies on external finance, and examine how that proportion differs across financial systems. They find that the development of a country's legal system predicts access to external finance, and that stock markets, and the banking system have different effects on access to external markets. The development of securities markets is related more to the availability of long-term financing, whereas the development of the banking sector is related more to the availability of short-term financing. They find no evidence, however, that firms' access to external financing is predicted by an index of the development of stock markets, relative to the development of the banking system.

Is financial liberalization good for developing nations? The case of South Korea in the 1990s

Korea's state-led, bank-based, and closed financial system helped generate its impressive development record from 1961 until the 1997 crisis. However, an ill-conceived liberalization process in the early 1990s eventuated in an IMF takeover in late 1997. Post-crisis neoliberal restructuring, which moved Korea towards a globally open, capital market-based financial system, has thus far failed to generate a sustainable economic recovery. It threatens to significantly lower Korea's long-term rate of capital accumulation. Korea would be well advised to reject neoliberalism, and adopt a modernized and radically democratized version of the traditional model, incorporating a state-led bank-based financial system with capital controls.

Industry growth and capital allocation:

Are market-based or bank-based financial systems better at financing the expansion of industries that depend heavily on external finance, facilitating the formation of new establishments, and improving the efficiency of capital allocation across industries? We find evidence for neither the market-based nor the bank-based hypothesis. While legal system efficiency and overall financial development boost industry growth, new establishment formation, and efficient capital allocation, having a bank-based or market-based system per se does not seem to matter much.

Fostering Capital Markets in a Bank-based Financial System: A Review of Major Conceptual Issues

The paper presents a review of major conceptual issues as a framework in which to conceptualize the rationales and strategies for fostering capital markets in a largely bank-based financial system. As elsewhere in the developing world, the relative underdevelopment of capital markets in developing Asia can be attributed to inadequate market and legal infrastructure, which, in the presence of informational problems, raises the cost of external finance. In such an environment, bank finance is often a less costly means of external finance because it can minimize informational problems by establishing a long-term monitoring relationship with borrowers. On the other hand, the benefits of capital market finance rise with economic development, which tends to increase the complexity and dispersion of information held in the economy. Price signals provided by market finance can lead to a better allocation of resources by allowing better investment and saving decisions. With the passage of time, an equity market will become particularly beneficial as a means of financing new and complex economic activities, as equity finance does not require fixed assets and can better reward risk taking activities. The paper concludes by discussing several conceptual issues that are important in designing an optimal financial structure.

The Impact of Changes in Stock Prices and House Priceson Consumption in OECD Countries

This paper quantifies the different impact of stock and house prices on consumption using data for 16 OECD countries. The analysis finds that the long-run impact of an increase in stock prices and house prices is in general higher in countries with a market-based financial system. The sensitivity of consumption to changes in stock wealth is about twice as large as the sensitivity to changes in housing wealth. Splitting the sample into the 1980s and 1990s shows that both countries with a market-based financial system and countries with a bank-based financial system moved toward a higher degree of responsiveness of consumption to changes in stock prices and house prices.

Is financial liberalization good for developing nations?: The case of South Korea in the 1990s

Korea’s state-led, bank-based, and closed financial system helped generate its impressive development record from 1961 until the 1997 crisis. However, an ill-conceived liberalization process in the early 1990s eventuated in an IMF takeover in late 1997. Post-crisis neoliberal restructuring, which moved Korea towards a globally open, capital market-based financial system, has thus far failed to generate a sustainable economic recovery. It threatens to significantly lower Korea’s long-term rate of capital accumulation. Korea would be well advised to reject neoliberalism, and adopt a modernized and radically democratized version of the traditional model, incorporating a state-led bank-based financial system with capital controls.

The Impact of Changes in Stock Prices and House Prices on Consumption in OECD Countries

This paper quantifies the different impact of stock and house prices on consumption using data for 16 OECD countries. The analysis finds that the long-run impact of an increase in stock prices and house prices is in general higher in countries with a market-based financial system. The sensitivity of consumption to changes in stock wealth is about twice as large as the sensitivity to changes in housing wealth. Splitting the sample into the 1980s and 1990s shows that both countries with a market-based financial system and countries with a bank-based financial system moved toward a higher degree of responsiveness of consumption to changes in stock prices and house prices.

Do lending relationships matter?: Evidence from bank survey data in Germany

Strong lending relationships between banks and small and medium-sized enterprises (SMEs) play a key role in the bank-based financial system of Germany. So far, they have been mainly described by the notion of a housebank and transactional features of long-term bank–customer relationships. In contrast, the present paper also considers interactional variables, which try to measure social relations between loan officer and firm manager. Using bank survey data, the relationship and interaction variables prove to affect loan prices, collateral requirements and credit availability.

Frankfurt's Neuer Markt and the IPO explosion: is Germany on the road to Silicon Valley?

Germany's bank-based financial system has been generally perceived as good at providing long-term debt finance to traditional industry but poor at supplying equity capital to high-tech start-ups. In 1997 a special segment of the Frankfurt stock exchange, the Neuer Markt , was founded to improve the supply of high-risk equity capital in Germany. The subsequent listing of over 300 companies on the Neuer Markt , many of them in technology-intensive sectors, has led to speculation that Germany is rapidly closing the gap with the US, the world leader in high technology. Contrary to this view, this article suggests that these companies have more in common with traditional German small and medium-sized companies (SMEs) than with the Silicon Valley model of governance and innovation.