Bank-based System Research Articles

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.

A Novel Multicarrier Signal Transmission System Over Multipath Channel of Low-Voltage Power Line

As the technique of orthogonal frequency-division multiplexing (OFDM) has the ability to overcome the effect of multipath and to obtain high spectral efficiency of the communication channel, it is generally considered as one of the most effective methods to realize the high-speed digital communication system over the low-voltage powerline. This paper proposes a novel OFDM method, in which the cosine carriers of the conventional OFDM system are replaced with the orthonormal wavelets. A quantitative index used to measure the multipath interference, including the intersymbol interference (ISI) and the interchannel interference (ICI), is induced with a filter bank-based multicarrier transmission system model. The effectiveness of the proposed OFDM over the conventional OFDM in reducing both the ISI and the ICI is verified on a model obtained from the measurements of a practical low-voltage powerline communication channel.

Inequality, Industrialization and Financial Structure

We introduce monitored bank loans and non-monitored tradeable securities as sources of external finance for firms in a dynamic general equilibrium model. Due to frictions arising from moral hazard, access to credit and each type of financial instrument are determined by the wealth distribution. We study the depth of credit markets (financial development) and conditions under which the financial system relies more on either type of external finance (financial structure). Initial inequality is shown to determine financial development, with high inequality preventing developed systems from emerging. A more equitable income distribution as well as larger capital requirements of industry tend to promote a bank-based system. Investment risk promotes a greater reliance on non-monitored sources, while institutional parameters affect the financial structure in intuitively plausible ways. The model's predictions are consistent with historical and recent development experience.

Are performances of banks and firms linked? And if so, why?

Employing data sets from 46 countries, this paper identifies a significant positive relationship between the performance of the financial sector and the non-financial ones in the presence of a growth rate in the GDP and in inflation rates. To account for this relationship, we initially put forth four hypotheses. Results show that “bank concentration” (the first hypothesis) considerably strengthens the relationship but that the “protection of the creditor” (the second hypothesis) weakens it slightly. Noteworthy is that “restrictions on banks engaged in non-banking activities” (the third hypothesis) and the “bank-based system” (the fourth hypothesis) do not have any influence on the relationship, whatsoever.

Bank-Based Versus Market-Based Financial Systems: A Growth-Theoretic Analysis

We study bank-based and market-based financial systems in an endogenous growth model. Lending to firms is fraught with moral hazard as owner-managers may reduce investment profitability to enjoy private benefits. Bank monitoring partially resolves the agency problem, while market-finance is more hands-off. A bank-based or market-based system emerges from firm-financing choices. It is not possible to say unequivocally which of the two systems is better for growth. The growth rate depends, crucially, on the efficiency of financial and legal institutions. But a bank-based system outperforms a market-based one along other dimensions. Investment and per capita income are higher, and income inequality lower, under a bank-based system. Bank-based systems are more conducive for broad-based industrialization. A temporary income redistribution, under both financial systems, results in permanent improvement in per capita income as well as income distribution.

The market for corporate control in a bank-based economy: a governance device?

This study examines whether changes in ultimate firm ownership (control) play a disciplinary role in a bank-based economy. We focus on Germany as the prototype of a bank-based system. We find that poor performance makes a change in control more likely; this suggests a disciplinary role. Tight shareholder control acts as a substitute for control changes, strong creditor control as a complement. Following a change in control, management turnover increases, but not as a consequence of poor performance, and performance does not improve significantly. These findings are inconsistent with a disciplinary role of the market for corporate control in bank-based Germany.

Financial Architecture and Economic Performance: International Evidence

The paper examines the relation between the architecture of an economy's financial system—its degree of market orientation—and economic performance in the real sector. I find that while market-based systems outperform bank-based systems among countries with developed financial sectors, bank-based systems fare better among countries with underdeveloped financial sectors. Countries dominated by small firms grow faster in bank-based systems and those dominated by larger firms in market-based systems. The findings suggest that recent trends in financial development policies that indiscriminately prescribe market-oriented financial-system architecture to emerging and transition economies might be misguided because suitable financial architecture, in and of itself, could be a source of value. Journal of Economic Literature Classification Numbers: G1, G21, O1, 04.

Financial Architecture and Economic Performance: International Evidence

The paper examines the relation between the architecture of an economy's financial system-its degree of market orientation-and economic performance in the real sector. I find that while market-based systems outperform bank-based systems among countries with developed financial sectors, bank-based systems fare better among countries with underdeveloped financial sectors. Countries dominated by small firms grow faster in bank-based systems and those dominated by larger firms in market-based systems. The findings suggest that recent trends in financial development policies that indiscriminately prescribe market-oriented financial-system-architecture to emerging and transition economies might be misguided because suitable financial architecture, in and of itself, could be a source of value.

Reorganization Law and Dilution Threats in Different Financial Systems

In a market-based financial system, credit is held by dispersed creditors, and out-of-court renegotiation of debt is more likely to fail because of hold-out problems; in a bank-based system, out-of-court renegotiation stands good chances to succeed. Since out-of-court renegotiation is a substitute for court-supervised reorganization, the design of a reorganization law cannot abstract from the financial system. Chapter 11-style renegotiation is shown to benefit public debt firms and to be harmful for private debt firms; the overall effect depends on the financial system, but is likely to be positive only in a market-based system. The case for a reorganization law is weakened if dilution threats like exit consents are taken into account: such a law is then in most cases undesirable. Legislation, however, which jointly introduces a reorganization law while facilitating the use of dilution threats will improve welfare in a market-based system, but reduce welfare in a bank-based system. Thus, the paper identifies a new determinant in the debate over optimal bankruptcy codes, which is how easily dilution threats can be deployed.

Relationship Lending within a Bank-Based System: Evidence from European Small Business Data

We investigate relationship lending using detailed contract information from nearly 18,000 bank loans to small Belgian firms operating within the continental European bank-based system. Specifically, we investigate the impact of different measures of relationship strength on price and nonprice terms of the loan contract. We test for the possibility of rent shifting by banks. The evidence shows two opposing effects. On the one hand, the loan rate increases with the duration of a bank–firm relationship. On the other hand, the scope of a relationship, defined as the purchase of other information-sensitive products from a bank, decreases the loan's interest rate substantially. Relationship duration and scope thus have opposite effects on loan rates, with the latter being more important. We also find that the collateral requirement is decreasing in the duration of the relationship and increasing in its scope. Journal of Economic Literature Classification Numbers: G21, G32.

Optimal Bankruptcy Laws Across Different Economic Systems

We model fundamental differences across economic systems and propose optimal bankruptcy laws. We show that creditor-debtor relationships in a given economy are affected by the ability of creditors to obtain information about fundamentals and the managers' ability to strategically use their private information. An optimal bankruptcy law utilizes creditors' information while minimizing managers' use of strategic information. Our proposed laws for a developed bank-based system like Germany include a creditor chapter only, for a developed market-based system like the United States include both a creditor chapter and a debtor chapter, and for an underdeveloped system include both a creditor chapter and a debtor chapter that gives the manager more protection than in a market-based system. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Optimal Bankruptcy Laws Across Different Economic Systems

We model fundamental differences across economic systems and propose optimal bankruptcy laws. We show that creditors-debtors relationships in a given economy are affected by the ability of creditors to obtain information about fundamentals and the managers' ability to strategically use their private information. An optimal bankruptcy law utilizes creditors' information, while minimizing managers' use of strategic information. Our proposed laws for a developed bank-based system like Germany includes a creditor chapter only for a developed market-based system like the U.S.A. includes both a creditor chapter and a debtor chapter, and for an under-developed system includes both a creditor chapter and a debtor chapter that gives the manager more protection than in a market-based system.

Is relationship lending special? Evidence from credit-file data in Germany

The German financial market is often characterized as a bank-based system with strong bank–customer relationships. The corresponding notion of a housebank is closely related to the theoretical idea of relationship lending. It is the objective of this paper to provide a direct comparison between housebanks and “normal” banks as to their credit policy. Therefore, we analyze a new data set, representing a random sample of borrowers drawn from the credit portfolios of five leading German banks over a period of five years. We use credit-file data rather than industry survey data and, thus, focus the analysis on information that is directly related to actual credit decisions. In particular, we use bank-internal borrower rating data to evaluate borrower quality, and the bank’s own assessment of its housebank status to control for information-intensive relationships. The major results of our study support the view that housebanks are able to establish a distinct behavioral pattern consistent with the idea of long-term commitment. We find that housebanks do provide liquidity insurance in situations of unexpected deterioration of borrower ratings. With respect to loan pricing, we find no evidence for intra- or intertemporal price differentiation related to housebanking.

Emerging stock markets, portfolio capital flows and long-term economie growth: Micro and macroeconomic perspectives

The paper examines two major components of financial liberalization, stock market development and portfolio capital flows in the context of less developed countries. The paper considers microeconomic and macroeconomic perspectives on their implications for long-term development and economic growth. It concentrates on: 1. (a) the role of stock markets in financing corporate growth; 2. (b) the implications of stock market volatility for resource allocation and productive efficiency; and 3. (c) the interactions between the foreign exchange and stock markets in the context of economic shocks. Its policy recommendations are that LDCs should promote bank-based systems, influence the scale and composition of capital inflows, and prevent a market for corporate control from emerging.

Banks, finance and investment in Germany: A review article

Recently, there has been a flurry of activity in both the financial and political science literature discussing the possible merits of the German bank-based system over the market-based model of firm capital investment and financing. The debate in question can be characterized by "orthodox" and "revisionist" views, which seek to determine the importance of alternative institutional settings on the link between the real and financial decisions of the firm. The orthodox view holds that bank-based systems are better at overcoming asymmetrical information and principal-agent problems arising when ownership and control of firms are separated. The market-based model of firm investment finance, such as that which exists in the U.S. and the U.K. it is argued, often results in informational and incentive problems which lead to an increase in the external costs of investment finance to the firm. If the banks from which the firms borrow have less information about the firm than the