Optimal Financial Structure and Economic Growth in Emerging Markets

This study endeavors to determine the optimal bank–market mixtures of different countries and their effects on economic activity. We particularly examine emerging markets, following the view that optimal financial structures differ according to different levels of economic development. Our findings show that development in economic activity has a negative impact on financial structure ratio. As economies grow, the financial structure ratio decreases, i.e., the financial system becomes more market based. We also document a negative relationship between countries’ economic growth and the financial structure gap, which suggests that deviation of a country’s actual financial structure from the estimated optimal financial structure leads to lower levels of economic output. We believe that our findings will have policy implications for developing countries that are seeking to improve their financial systems.