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Notes on financial system development and political intervention

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  • Song. Fenghua
  • Thakor, Anjan

Abstract

The paper studies the impact of political intervention on a financial system that consists of banks and financial markets and develops over time. In this financial system, banks and markets exhibit three forms of interaction: they compete, they complement each other, and they co-evolve. Coevolution is generated by two new ingredients of financial system architecture relative to the existing theories: securitization and risk-sensitive bank capital. The authors show that securitization propagates banking advances to the financial market, permitting market evolution to be driven by bank evolution, and market advances are transmitted to banks through bank capital. Then they examine how politicians determine the nature of political intervention designed to expand credit availability. The authors find that political intervention in banking exhibits a U-shaped pattern, where it is most notable in the early stage of financial system development (through bank capital subsidy in exchange for state ownership of banks) and in the advanced stage (through direct lending regulation). Despite expanding credit access, political intervention results in an increase in financial system risk and does not contribute to financial system evolution. Numerous policy implications are drawn out.

Suggested Citation

  • Song. Fenghua & Thakor, Anjan, 2013. "Notes on financial system development and political intervention," Policy Research Working Paper Series 6350, The World Bank.
    • Handle: RePEc:wbk:wbrwps:6350
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    References listed on IDEAS

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    2. Ahamed, M. Mostak & Mallick, Sushanta, 2017. "Does regulatory forbearance matter for bank stability? Evidence from creditors’ perspective," Journal of Financial Stability, Elsevier, vol. 28(C), pages 163-180.
    3. Guangdong Xu, 2022. "From financial structure to economic growth: Theory, evidence and challenges," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 51(1), February.
    4. Molina Danielken & Roa Mónica, 2017. "The Effect of Bank Credit and the Trade Patterns of Colombian Exporters," Working Papers 2017-19, Banco de México.
    5. Mostak Ahamed, M. & Mallick, Sushanta K., 2017. "House of restructured assets: How do they affect bank risk in an emerging market?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 47(C), pages 1-14.
    6. Xu Guangdong, 2021. "Reassessing the Literature on the Relationship Between Financial Structure and Economic Growth," Review of Economics, De Gruyter, vol. 72(2), pages 149-182, August.
    7. Vinogradov, Dmitri & Makhlouf, Yousef, 2021. "Two faces of financial systems: Provision of services versus shock-smoothing," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).
    8. Claessens, Stijn, 2017. "Regulation and structural change in financial systems," CEPR Discussion Papers 11822, C.E.P.R. Discussion Papers.

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    Keywords

    Access to Finance; Banks&Banking Reform; Debt Markets; Bankruptcy and Resolution of Financial Distress; Financial Intermediation;
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