“Bank-based versus Market-based Financial Systems: A Growth-theoretic Analysis” by Tridip RAY
Hong Kong University of Science and Technology
University of Oregon
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 endogenously evolves depending upon 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 as well as per capita GDP are higher under a bank-based system, and income inequality lower. Bank-based systems are more conducive for broad-based industrialization. A temporary income redistribution, under both financial systems, results in permanent improvements in per capita GDP and income distribution.