Summary: What are the relative advantages and disadvantages of bank-based financial systems (as in Germany and Japan) and market-based financial systems (as in England and the United States). Does financial structure matter? In bank-based systems banks play a leading role in mobilizing savings, allocating capital, overseeing the investment decisions of corporate managers, and providing risk management vehicles. In market-based systems securities markets share center stage with banks in getting society's savings to firms, exerting corporate control, and easing risk management. The unresolved debate about whether markets or bank-based intermediaries are more effective at providing financial services hampers the formation of sound policy advice. The authors use newly collected data on a cross-section of roughly 150 countries to illustrate how financial systems differ around the world. They a) analyze how the size, activity, and efficiency of financial systems differ across different per capita income groups; b) define different indicators of financial structure and identify different patterns as countries become richer, and c) investigate legal, regulatory, and policy determinants of financial structure after controlling for per capita GDP. A clear pattern emerges: 1) Banks, other financial intermediaries, and stock markets all grow and become more active and efficient as countries become richer. As income grows, the financial sector develops. 2) In higher income countries, stock markets become more active and efficient than banks. Thus, financial systems tend to be more market based. 3) Countries with a common law tradition, strong protection for shareholder rights, good accounting standards, low levels of corruption, and no explicit deposit insurance tend to be more market-based, even after controlling for income. 4) Countries with a French civil law tradition, poor accounting standards, heavily restricted banking systems, and high inflation generally tend to have underdeveloped financial systems, even after controlling for income.
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