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On the Stability of Different Financial Systems

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Author Info
Falko Fecht (Deutsche Bundesbank,)

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Abstract

An economy in which deposit-taking banks of a Diamond and Dybvig style and a financial market coexist is modeled in a simple framework closely related to Diamond (1997). Solely depending on the fraction of naïve households who cannot efficiently invest directly in the cor-porate sector, two different types of financial systems emerge. With the fraction comparatively low, the evolving financial system can be interpreted as market-oriented, whereas a high frac-tion brings about a bank-dominated financial system. In market-oriented systems, banks only provide naïve households with access to efficient investments; in bank-dominated systems, banks' deposit contracts also offer some degree of liquidity insurance. Consequently, com-pared to market-oriented financial systems, the household sector in bank-dominated financial systems holds a larger portfolio fraction in deposits and a smaller part in direct investments. Analyzing the resilience of the different financial systems to various types of shocks shows that moderately bank-dominated (or hybrid) financial systems are particularly fragile, because only in these systems do fire sales of assets by distressed banks cause a deterioration in asset prices that also precipitates other banks into crisis. (JEL: D52, E44, G10, G21) Copyright (c) 2004 by the European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 2 (2004)
Issue (Month): 6 (December)
Pages: 969-1014
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Handle: RePEc:tpr:jeurec:v:2:y:2004:i:6:p:969-1014

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Alexandra Lai, 2002. "Modelling Financial Instability: A Survey of the Literature," Working Papers 02-12, Bank of Canada. [Downloadable!]
  2. Schmidt, Reinhard H. & Hackethal, Andreas & Tyrell, Marcel, 1999. "Disintermediation and the Role of Banks in Europe: An International Comparison," Journal of Financial Intermediation, Elsevier, vol. 8(1-2), pages 36-67, January. [Downloadable!] (restricted)
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  3. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December. [Downloadable!] (restricted)
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  4. Diamond, Douglas W, 1997. "Liquidity, Banks, and Markets," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 928-56, October.
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  5. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  6. X. Freixas & B. Parigi & J-C. Rochet, 2000. "Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank," DNB Staff Reports (discontinued) 47, Netherlands Central Bank. [Downloadable!]
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  7. Douglas W. Diamond & Raghuram G. Rajan, 2001. "Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 287-327, April. [Downloadable!] (restricted)
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  8. Franklin Allen & Douglas Gale, 1994. "A welfare comparison of intermediaries and financial markets in Germany and the U.S," Working Papers 95-3, Federal Reserve Bank of Philadelphia.
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  9. Franklin Allen & Douglas Gale, 2001. "Comparative Financial Systems: A Survey," Center for Financial Institutions Working Papers 01-15, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  10. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  11. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements. [Downloadable!]
  12. Aghion, Philippe & Bolton, Patrick & Dewatripont, Mathias, 2000. "Contagious bank failures in a free banking system," European Economic Review, Elsevier, vol. 44(4-6), pages 713-718, May. [Downloadable!] (restricted)
  13. Rajan, Raghuram G & Zingales, Luigi, 2003. "Banks and Markets: the Changing Character of European Finance," CEPR Discussion Papers 3865, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ralf Bebenroth & Diemo Dietrich & Uwe Vollmer, 2009. "Bank regulation and supervision in bank-dominated financial systems: a comparison between Japan and Germany," European Journal of Law and Economics, Springer, vol. 27(2), pages 177-209, April. [Downloadable!] (restricted)
  2. Falko Fecht & Antoine Martin, 2005. "Banks, markets, and efficiency," Staff Reports 210, Federal Reserve Bank of New York. [Downloadable!]
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  3. von Furstenberg, George M., 2004. "The Contribution of Rapid Financial Development to Asymmetric Growth of Manufacturing Industries : Common Claims vs. Evidence for Poland," Discussion Paper Series 1: Economic Studies 2004,34, Deutsche Bundesbank, Research Centre. [Downloadable!]
  4. Tharavanij, Piyapas, 2007. "Capital Market and Business Cycle Volatility," MPRA Paper 4952, University Library of Munich, Germany, revised 07 Oct 2007. [Downloadable!]
  5. Christina E. Bannier & Falko Fecht & Marcel Tyrell, 2008. "Open-End Real Estate Funds in Germany - Genesis and Crisis," Working Paper Series: Finance and Accounting 165, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
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  6. Falko Fecht & Kevin X.D. Huang & Antoine Martin, 2007. "Financial Intermediaries, Markets, and Growth," Working Papers 0714, Department of Economics, Vanderbilt University. [Downloadable!]
    Other versions:
  7. Piyapas Tharavanij, 2007. "Capital Market, Severity Of Business Cycle, And Probability Of An Economic Downturn," Monash Economics Working Papers 32/07, Monash University, Department of Economics. [Downloadable!]
  8. Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2009. "Outside and Inside Liquidity," NBER Working Papers 14867, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Fecht, Falko & Grüner, Hans Peter & Hartmann, Philipp, 2008. "Financial integration, specialization and systemic risk," Discussion Paper Series 1: Economic Studies 2008,23, Deutsche Bundesbank, Research Centre. [Downloadable!]
  10. Piyapas Tharavanij, 2007. "Capital Market And Business Cycle Volatility," Monash Economics Working Papers 33/07, Monash University, Department of Economics. [Downloadable!]
  11. Tharavanij, Piyapas, 2007. "Capital Market, Severity of Business Cycle, and Probability of an Economic Downturn," MPRA Paper 4953, University Library of Munich, Germany, revised 07 Oct 2007. [Downloadable!]
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