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Contributions from
the Column
Studies and reports
India: Debate on GM cotton
Argentina: Trading old bonds for new
Women’s rights: Under attack from neo-conservatives
Banks serve poorest countries best
China: Market economy and dictatorship still co-exist
04/2005 |
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[ Financial markets ]
Banks serve poorest countries best
Economists have long debated whether financial markets based on banks or stock exchanges are more conducive to development. It is obvious, of course, that, for an economy to grow, efficient access to capital is important. It is less clear, however, which kind of institution is best suited to provide it. Moreover, empirical studies have supported both bank- and stock market-based approaches.
That both systems are viable does not mean that the choice does not matter. At a seminar organised by KfW development bank in cooperation with the German Development Ministry’s academic advisory board, Eva Terberger of Heidelberg University came up with a theoretical argument in favour of opting for banks in the case of particularly poor countries. Her starting point was that markets, in general, suffer from asymmetric information. Not all participants are fully aware of all relevant data which leads to inefficiencies. This is exacerbated by unreliable institutions of accounting and reporting. The less trustworthy information systems and procedures are, the more frictions are to be expected on the markets.
The performance of stock exchanges particularly depends on legal reporting obligations for companies. It also depends on the strict enforcement of such laws. Therefore, banks can be expected to be more efficient in countries with weak institutions. While unreliable data will make operations difficult for stock market investors, banks can independently monitor the performance of those they give loans to. Banking activities are more based on personal relations and trust and, consequently, depend less on the overall quality of governance.
On the other hand, legal regulations determine what kind of financial system will evolve in any given country. If they focus on protecting the rights of those who lend assets to others, they enhance the standing of banks. If, on the other hand, the law is aimed at ruling out insider trading and stressing the property rights of share holders, it will inherently promote the growth of stock markets. For development to succeed, it is important to draft coherent policies that take account of these insights. As an economy expands over the longer run, however, it will need viable rules for both banks and stock markets. All advanced nations have financial systems that benefit from both pillars, which, after all, do not serve identical functions. (dem)
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