© 2002 sverre knutsen - handelshøyskolen bi 1 comparative business systems the role of financial...

© 2002 Sverre Knutsen - Handelshøyskolen BI

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Comparative Business SystemsThe Role of Financial Systems

Sverre Knutsen

Norwegian School of Management


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Comparative financial systems

• Whitley:

• The financial system is among the key institutional features structuring business systems

• Financial systems vary on a number of dimensions– But the critical feature deals with the processes

by which capital is made available and priced


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• Whitley use the traditional dichotomy to classify financial system:

– Capital-market-based financial systems

Vs.– Credit-based financial systems


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• Characteristics of capital-market-based financial systems:

• Mobilize and distribute capital through large and liquid markets

• Financial claims are traded and priced through the usual commodity-market process

• Short-termism is enhanced

• Only weak commitment to the growth of any single firm

• A strong market for corporate control is encouraged


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• Characteristics of credit-based financial systems

• Exhibit weak and fairly illiquid and thin capital markets

• capital markets play only a minor role in mobilizing and pricing investment funds

• Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks co-ordinated by state agencies and ministries, as in France, Japan and some other countries


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• Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector)

• Interlocking and ‘Haus banks’

• This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”.


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• What do “strong implications” really mean?• According to Whitley one effect of a credit-based

system is collaboration between economic actors

• Whitley is rather vague upon other, and more decisive, possible consequences like for instance economic performance

• Others have claimed that a credit-based financial system is inherently superior, and that economic performance can be enhanced by adopting the superior system. Can this be proved?


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• How good is Whitley’s taxonomy?

• What about history? It seems like Whitley has presented a kind of universal model for the configuration of financial systems. But are not financial systems subject to change?

These are the three main questions I want to discuss further in this lecture.


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• How good is Whitley’s taxonomy and when?– How well do the bank-based – market-based

dichotomy describe, e.g. the Norwegian financial system?

– What are the role of ‘big banks’?– How significant/insignificant are US banks as

sources of external funds for nonfinancial businesses?


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• The bank-based Norwegian financial system

• The formative period: 1870 – 1913• The banking system was a kind of hybrid between

universal (mixed) and specialized banking• The banking system was a decentralized unit-bank

system (like USA, but distinguished from UK)• The capital markets were relatively poor developed,

even in comparison with Sweden and Denmark• The Norwegian system of credit institutions was not

backward


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Was the Norwegian financial system backward before 1913? Varieties of financial institutions (number of types)

1880 1900 1910 1929 Norway 6 10 12 12 Denmark 7 9 9 12 Sweden 8 12 15 18

Italy 11 12 14 14 G.B. 14 16 17 23 USA 9 10 12 19

Canada 11 11 11 13 Median 9 11 12 14

Financial assets/GDP 1880 1900 1913 1929

Norway 107 136 166 241 Denmark 95 147 184 186 Sweden 89 123 136 138

Italy 36 61 97 95 G.B. 95 93 103 131 USA 49 86 91 129

Canada 43 87 101 101 India 2 4 7 11

Nigeria 6


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• Norway was one of the countries in the European periphery that experienced what Simon Kuznets labeled modern economic growth

• It is thus a reasonable hypothesis to state that the financial system was adequate to, or at least it did not hamper Norwegian economic growth


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• But what shaped the distinguished characteristics of the Norwegian banking system?– A combination of:

History

Institutional factors(legal system, unformal norms, enforcement characteristics)

Level of economic development

Information problems


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• The Norwegian financial system 1955 – 80 developed to meet all the basic characteristics in what Whitley classifies as a credit-based financial system

– Actually the financial sector was transformed to be an instrument to serve two purposes:

1. To control the aggregate credit volume as a tool for stabilization policy

2. To be able to direct investment funds to political prioritized sectors, projects and enterprises


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• This neo-mercantilist regime was based on:• Administrative pricing of capital

• Credit rationing based on interest rates fixed below a price that would have cleared the market

• Strict control on capital movements across the border

• Reserve requirements and lending quotas

• Heavy regulated capital markets


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• What about ‘big banks’?• Big banks was not a dominant feature of the

Norwegian banking system.

• What about Germany?

• The following data reveals that the role of Big banks in German industrial finance is exaggerated:


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Bank lending in Germany to domestic non-bank enterprises and self-employed persons by various categories of bank

1970 1980 1988Commercial banks 36,3 25,9 28,7Of which Big banks 16 10,5 12Savings banks 32,3 36,9 34,9Credit cooperatives 12,7 15,3 15,8Mortgage banks 7,1 14,7 14,5Banks with special functions 8,1 3,6 4Postal savings banks 2,4 2,3 2,1Misc. intermediaries 1,2 1,1 0


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• Are loans unimportant in financing US firms compared with other countries?

• Data shows that loans were more important as sources of external funds for nonfinancial businesses in USA than in “credit-based” Germany and Japan! (during the period 1970-85) (cfr. Diagram)


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• A broader definition of financial structure is needed

• Both Pakistan and Germany are classified as bank-based systems. In Pakistan, however, banks cannot perform the functions expected of a sophisticated bank- based system, because they are not as well developed as German banks.

• USA and the Philippines are both market-based systems, but the markets in the Philippines are not as effective at providing financial services


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• Thus,– Looking at financial structure, we see that

Pakistan and the Philippines have more in common with each other than their respective bank-based and market-based counterparts.

– Hence, it is also necessary to distinguish among economies with underdeveloped and developed financial systems


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• Consequently,• We should make use of a broader definition of

financial structure, than the Whitley dichotomy.

• This definition should comprise the whole financial system – i.e. all the intermediaries and markets that make up the system and how these elements are configurated

• A better definition of financial structure:


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– ”a country’s finacial structure consists of infra-structure, financial technology, institutions and the rules of the game that define how financial activity is organized at a point of time”

• The same function of a financial can be performed by different institutions or according to different rules.


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• Economic performance – does the financial system make any difference?

• Whitley does not give any clear answer on this crucial question

• An increasing number of historical as well as economic studies have found that the overall level of financial development is robustly linked with long-run growth


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• Financial structure is not significantly related to economic growth. There is no evidence that the development of a market-based or bank-based financial system per se affects access to financing of firms

• Recent research suggest that it is the improving of the overall financial system that is critical for boosting financial development and hence economic development

• The legal system seems to have significant impact on finance and growth


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• Why has the idea of the financial structure dichotomy and its importance for economic growth gained so much influence?

• The roots: the rivalry between Germany as a rising power after 1871 and UK. At the close of the 19th century, German economists argued that their bank-centered financial system had helped propel Germany past the market-centered UK as an industrial power


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• In the 1960s and 1970s several scholars (especially sociologists) emphasized the relative merit of the German bank-centered system vs. the British market-oriented to explain Britain’s week growth rates.

• This was followed up by scholars like John Zysman in the late 1970s, early 1980s, to explain Japan’s substantial growth relative to US economic stagnation. ( Zysman’s Governments, markets and growth is Whitley’s main reference on financial structure)


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• Allen and Gale (2000) suggest on the other hand that stock-market based economies are the mot efficient in developing new industries and promoting real GDP growth.

• Perhaps this view should be understood in context of the neo-liberal shift taking place on an international scale since the mid-1980s?

© 2002 sverre knutsen - handelshøyskolen bi 1 comparative business systems the role of financial...

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