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Bank-based versus Market-based Financial Systems: A Growth-theoretic Analysis

  • Shankha Chakraborty

    ()

    (University of Oregon Economics Department)

  • Tridip Ray

    ()

    (Hong Kong University of Science & Technology Economics Department)

We study bank-based and market-based financial systems in an endogenous growth model. Lending to firms is fraught with moral hazard as owner-managers may reduce investment profitability to enjoy private benefits. Bank monitoring partially resolves the agency problem, while market-finance is more ‘hands-off’. A bank-based or market-based system emerges from firm financing choices. It is not possible to say unequivocally which of the two systems is better for growth. The growth rate depends, crucially, on the efficiency of financial and legal institutions. But a bank-based system outperforms a market-based one along other dimensions. Investment and per capita income are higher, and income inequality lower, under a bank-based system. Bank-based systems are more conducive for broad-based industrialization. A temporary income redistribution, under both financial systems, results in permanent improvement in per capita income as well as income distribution.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2003-6.

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Length: 39
Date of creation: 01 Feb 2003
Date of revision: 01 Feb 2002
Handle: RePEc:ore:uoecwp:2003-6
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