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Banks Versus Bonds: the Emergence and Persistence of Two Financial Systems

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  • Sandeep Baliga
  • Ben Polak

Abstract

We use a simple graphical moral hazard model to compare monitored (non-traded) bank loans versus traded (non-monitored) bonds as sources of external funds for industry. We contrast the conditions that theoretically favour each system, such as the size and number of firms, with conditions prevailing when these financial systems evolved during the British and German industrial revolutions. Then, to address why different systems have persisted, we consider a larger model with entry so that firm size and number are endogenous. We show that multiple equilibria can exist if financiers take the industrial structure as given and vice versa, and we compare these equilibria in welfare terms. Finally, we argue that with, if bilateral co-ordination is possible, Anglo-Saxon style finance systems can only persist if they are efficient, but an economy can get stuck in an inefficient German style system.

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1221.

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Date of creation: Jul 1998
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Handle: RePEc:nwu:cmsems:1221

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  1. Dewatripont, M & Maskin, E, 1995. "Credit and Efficiency in Centralized and Decentralized Economies," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 541-55, October.
  2. Charles W. Calomiris, 1998. "Universal Banking "American-Style"," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 154(1), pages 44-, March.
  3. Baker, George P, 1992. " Beatrice: A Study in the Creation and Destruction of Value," Journal of Finance, American Finance Association, vol. 47(3), pages 1081-119, July.
  4. Pollard, Sidney, 1964. "Fixed Capital in the Industrial Revolution in Britain," The Journal of Economic History, Cambridge University Press, vol. 24(03), pages 299-314, September.
  5. Richard Tilly, 1998. "Universal Banking in Historical Perspective," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 154(1), pages 7-, March.
  6. Fremdling, Rainer & Tilly, Richard, 1976. "German Banks, German Growth, and Econometric History," The Journal of Economic History, Cambridge University Press, vol. 36(02), pages 416-424, June.
  7. Fohlin, Caroline, 1997. "Universal banking networks in pre-war Germany: new evidence from company financial data," Research in Economics, Elsevier, vol. 51(3), pages 201-225, September.
  8. Allen, Franklin & Gale, Douglas, 1995. "A welfare comparison of intermediaries and financial markets in Germany and the US," European Economic Review, Elsevier, vol. 39(2), pages 179-209, February.
  9. Sandeep Baliga & Ben Polak, 1995. "Banks versus Bonds: A Simple Theory of Comparative Financial Institutions," Cowles Foundation Discussion Papers 1100, Cowles Foundation for Research in Economics, Yale University.
  10. Charles W. Calomiris & Carlos D. Ramirez, 1996. "The Role Of Financial Relationships In The History Of American Corporate Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(2), pages 52-73.
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