Triphon Phumiwasana Milken Institute [email protected] Conference on Political Economic Indicators and International Economic Analysis:

Triphon PhumiwasanaTriphon PhumiwasanaMilken InstituteMilken Institute

[email protected]@milkeninstitute.org

Conference on Political Economic Indicators and Conference on Political Economic Indicators and International Economic Analysis:International Economic Analysis:

Measuring Quality and the Quality of MeasuresMeasuring Quality and the Quality of MeasuresOctober 12-13, 2007October 12-13, 2007

Diversified Financial Structure: Diversified Financial Structure: Implications for Economic Growth Implications for Economic Growth

and Stabilityand Stability

Why Study Financial Structure?Why Study Financial Structure?

““Diversity within the financial sector provides Diversity within the financial sector provides insurance against a financial problem turning into insurance against a financial problem turning into economy-wide distresseconomy-wide distress” ”

Alan Greenspan, 1999Alan Greenspan, 1999

““It is the financial services themselves that matter It is the financial services themselves that matter

more than the form of their delivery. … It is better more than the form of their delivery. … It is better to focus policies on development of a solid to focus policies on development of a solid infrastructure, rather than specific structuresinfrastructure, rather than specific structures.”.”

World Bank, 2001World Bank, 2001

MotivationMotivation

Increasing number of financial market reforms in Latin America and Asia, encompassing the stock, bond and derivative marketsLong economic downturns in major bank-based systems—Japan and GermanyEmpirical Evidence: Mixed

No cross-country relationship between financial structure and growth No cross-country relationship between financial structure and growth (Levine, 2002).(Levine, 2002).

Market-based systems outperform bank-based systems among developed Market-based systems outperform bank-based systems among developed countries, while bank-based systems outperform market-based systems countries, while bank-based systems outperform market-based systems among developing countries (Tadesse, 2002).among developing countries (Tadesse, 2002).

Bank-based systems promote long-run growth better than market-based Bank-based systems promote long-run growth better than market-based systems (Arestis et al, 2001)systems (Arestis et al, 2001)

Bank-based systems can reduce the impact of interest rate shocks. (Scharler, 2006)

Growing Number of ArticlesGrowing Number of Articles(Results from a Google Scholar Search)(Results from a Google Scholar Search)

 Year

Phrase Used in Search

Both“Bank-Based Financial System”

“Market-Based Financial System”

1997 4 6 2

1998 7 8 0

1999 9 17 2

2000 16 25 7

2001 22 27 10

2002 31 40 11

2003 41 48 16

2004 44 49 15

2005 55 42 10

2006 48 41 14

2007YTD 21 24 9

Selected Papers ReviewedSelected Papers ReviewedPinno, Karl and Apostolos Serletis (2007) “Financial structure and economic growth: the role of Pinno, Karl and Apostolos Serletis (2007) “Financial structure and economic growth: the role of heterogeneity,” heterogeneity,” Applied Financial Economics Applied Financial Economics

Chakraborty, Shankha and Tridip Ray (2006) “Bank-based versus Market-based Financial Systems: A Chakraborty, Shankha and Tridip Ray (2006) “Bank-based versus Market-based Financial Systems: A Growth-theoretic Analysis,” Growth-theoretic Analysis,” Journal of Monetary Economics.Journal of Monetary Economics.

Scharler, Johann (2006) “Do Bank-Based Financial Systems Reduce Macroeconomic Volatility by Smoothing Interest Rates?,” Austrian Central Bank Working Paper.

Vitols, Sigurt (2005) “ (2005) “Changes in Germany's Bank-Based Financial System: implications for corporate governance,” Journal of Corporate Governance.

O. Emre Ergungor (2004) “Market- vs. Bank-Based Financial Systems: Do Rights and Regulations Really O. Emre Ergungor (2004) “Market- vs. Bank-Based Financial Systems: Do Rights and Regulations Really Matter?,” Matter?,” Journal of Banking and Finance.Journal of Banking and Finance.

Levine, Ross (2002) “Bank-based Or Market-based Financial Systems: Which Is Better?,” Levine, Ross (2002) “Bank-based Or Market-based Financial Systems: Which Is Better?,” Journal of Journal of Financial IntermediationFinancial Intermediation..

Degryse, Hans and Patrick Van Cayseele (2000) “Relationship Lending within a Bank-Based System: Relationship Lending within a Bank-Based System: Evidence from European Small Business Data,” Evidence from European Small Business Data,” Journal of Financial IntermediationJournal of Financial Intermediation ..

Weinstein, David E, Yishay Yafeh (1998) “ “On the Costs of a Bank-Centered Financial System: Evidence from the Changing Main Bank Relations in Japan,” Journal of Finance.

Gertler, Mark (1998) “Financial Structure and Aggregate Economic Activity: An Overview,” Gertler, Mark (1998) “Financial Structure and Aggregate Economic Activity: An Overview,” Journal of Journal of Money, Credit and Banking.Money, Credit and Banking.

Measuring Financial StructureMeasuring Financial Structure

““Because financial structure is determined by a combination of financial Because financial structure is determined by a combination of financial instruments and financial institutions, several aspect must be taken into instruments and financial institutions, several aspect must be taken into account and given quantitative expression when ever possible. They are:account and given quantitative expression when ever possible. They are: the relation of total financial assets to total tangible assets; the relation of total financial assets to total tangible assets; the distribution of total financial assets and liabilities among various types of the distribution of total financial assets and liabilities among various types of financial instruments; financial instruments; and the position of financial assets and liabilities in the accounts of the and the position of financial assets and liabilities in the accounts of the various economic sectors. various economic sectors.

Each of these stock relations has a corresponding flow aspect, doubling the Each of these stock relations has a corresponding flow aspect, doubling the number of relation relevant for the study of financial structure”number of relation relevant for the study of financial structure”

Raymond Goldsmith Raymond Goldsmith Financial Structure and Development, Financial Structure and Development, 19691969

How to Define Financial Structure?How to Define Financial Structure?

Financial institutions vs. financial markets?Financial institutions vs. financial markets?

Banks vs. stock market? Banks vs. stock market?

Insurance companies? Bonds? Derivatives? Private Insurance companies? Bonds? Derivatives? Private equity? Hedge funds? Personal funding? Cooperative equity? Hedge funds? Personal funding? Cooperative banks? Microfinance?banks? Microfinance?

Domestic vs. cross-border funding?Domestic vs. cross-border funding?

Financial sector: Depth? Activity? Size? Efficiency?Financial sector: Depth? Activity? Size? Efficiency?

The composition of the source of funding of firms in The composition of the source of funding of firms in a country?a country?

Financial Intermediation and Financial Intermediation and DisintermediationDisintermediation

Source: Laurent Jacque, 2001

Bifurcated Intermediation

Pension Funds, Mutual Funds,

Insurance Co.'s

Financial Markets

Financial Intermediation 1. Commercial Banks 2. Insurance Companies,

Pension Funds, Venture Capitalists

Disintermediation 1. Equity 2. Debt

3. Commercial Paper

Brokerage Firms and Internet?

4. Hybrids

Households Firms

Debt, equity and private placement

Mostly debt

Currency and Deposits

12%

Bonds7%

Insurance, Investment Trusts and

Pension Funds46%

Other3%

Stocks and Equities

32%

Composition of Financial Assets Held By HouseholdsComposition of Financial Assets Held By HouseholdsJune 2007June 2007

Currency and Deposits

50%

Insurance, Investment Trusts and

Pension Funds31%

Other4%

Bonds3%

Stocks and Equities

12%

United States$44.3 Trillion

Japan$13.5 Trillion

Source: Bank of Japan

Data SourcesData Sources

Flow of funds: U.S., U.K., Japan, Germany, Malaysia, ChinaFlow of funds: U.S., U.K., Japan, Germany, Malaysia, China International Financial Statistics (bank)International Financial Statistics (bank) BankScope (bank data)BankScope (bank data) Bank for International Settlements (bond and derivative)Bank for International Settlements (bond and derivative) Global Stock Market Fact Book--S&P (stock by country)Global Stock Market Fact Book--S&P (stock by country) World Federation of Exchanges (stock by exchange)World Federation of Exchanges (stock by exchange) SwissRe (insurance)SwissRe (insurance) Bloomberg (stock by exchange, bond, derivative) Bloomberg (stock by exchange, bond, derivative) Thomson Financial (stock, bond and derivative)Thomson Financial (stock, bond and derivative) World Bank financial structure database 2007 (bank, stock, World Bank financial structure database 2007 (bank, stock,

bond, insurance) bond, insurance)

Simplified Version of Simplified Version of “Financial Structure”“Financial Structure”

Examine the two widely used channels which connect saving to investment

Classification of channels: market-based vs. bank-based systems

Most evidence shows that finance promotes growth, but do channels of finance matter?

Why Do Bank-Based SystemsWhy Do Bank-Based Systems Develop First? Develop First?

High initial cost to develop financial infrastructure for broader market development.

Banks lobby to keep out competitor.

Role of Market-Based SystemsRole of Market-Based Systems

Allow portfolio diversification for investors and widening the choice of finance for firms.

“Spare Tire”: At macro level, so long as both systems are not perfectly correlated, having two system may produce a more stable economy.

Factors Effecting Financial StructureFactors Effecting Financial Structure

Level of DevelopmentLevel of Development (Boyd and Smith, (Boyd and Smith, 1996; Gurley 1996; Gurley

and Shaw, 1955)and Shaw, 1955)

Legal OriginLegal Origin (La Porta et al,1998) (La Porta et al,1998)

Laws and RegulationsLaws and Regulations (Levine, 2002; World Bank, (Levine, 2002; World Bank,

2001))2001))

Demographics and Human CapitalDemographics and Human Capital (Black, 2002) (Black, 2002)

Common Measurements of Financial StructureCommon Measurements of Financial Structure

Activities:Activities: Bank Credit to Private Sector relative Bank Credit to Private Sector relative to Stock Market Traded Valueto Stock Market Traded Value

Size:Size: Bank Credit to Private Sector (some authors Bank Credit to Private Sector (some authors use Bank Assets) relative to Stock Market use Bank Assets) relative to Stock Market Capitalization Capitalization

Efficiency:Efficiency: Reciprocal of Bank Overhead Cost to Total Asset Multiplied by Stock Market Traded Value / GDP

Time and Regional Differences in Time and Regional Differences in

Financial Structure: ActivityFinancial Structure: Activity Bank Credit to Private Sector relative to Stock Market Traded Value

  80 - 84 85 - 89 90 - 94 95 - 99 00 - 04 2005

High Income 42.81 3.84 3.48 1.74 1.30 1.06

South Asia 11.91 15.59 4.68 2.05 0.95 0.49

Sub-Saharan Africa 23.13 23.02 18.00 5.36 3.21 2.52

Europe & Central Asia NA 42.22 6.96 3.31 3.17 2.72

Latin America & Caribbean 40.90 14.31 5.71 8.98 10.83 5.79

East Asia & Pacific

10.32

6.84

1.24

1.89

2.61

2.71

Middle East & North Africa

9.49

12.83

8.97

8.15

7.76

1.16

Time and Regional Differences in Time and Regional Differences in

Financial Structure: SizeFinancial Structure: Size Bank Credit to Private Sector relative to Stock Market Capitalization

  80 - 84 85 - 89 90 - 94 95 - 99 00 - 04 2005

High Income 14.75 1.56 1.49 1.08 1.02 0.92

South Asia 6.49 3.79 1.07 1.58 1.74 0.82

Sub-Saharan Africa 2.09 1.3 1.03 0.65 0.79 0.65

Europe & Central Asia

NA 4.67 3.88 1.92 1.46 1.38

Latin America & Caribbean

3.2 2.81 1.09 1.31 0.9 0.53

East Asia & Pacific 1.79 1.78 0.72 0.86 0.91 0.8

Middle East & North Africa

0.95 1.48 1.79 1.39 1.51 0.72

Time and Regional Differences in Time and Regional Differences in Financial Structure: EfficiencyFinancial Structure: Efficiency

Reciprocal of Bank Overhead Cost to Total Asset Multiplied by Stock Market Traded Value / GDP

  90 - 94 95 - 99 00 - 04 2005

High Income 184.57 78.88 47.50 38.34

South Asia 851.77 313.49 131.93 56.8

Sub-Saharan Africa 1,450.84 408.18 219.6 149.70

Europe & Central Asia 689.90 236.81 276.88 253.65

Latin America & Caribbean

330.73 499.09 466.95 375.13

East Asia & Pacific 86.08 117.36 192.68 214.31

Middle East & North Africa

1,173.26 846.36 692.94 103.52

Differences Among Emerging Markets Differences Among Emerging Markets Financial StructuresFinancial Structures

 2004 Activity Size Efficiency

Venezuela 58.62 2.60 14092.81

Philippines 3.74 0.75 247.61

Chile 3.63 0.54 143.06

Malaysia 2.69 0.72 184.20

Poland 2.62 0.95 398.54

Hungary 2.19 1.70 150.06

Mexico 2.13 0.54 276.74

Israel 1.81 1.00 87.69

Egypt 1.57 0.68 168.66

Indonesia 1.49 0.81 239.37

Differences Among Emerging Markets Differences Among Emerging Markets Financial StructuresFinancial Structures

 2004 Activity Size Efficiency

Brazil 1.49 0.57 66.94

Thailand 1.45 1.08 112.36

Argentina 1.13 0.34 141.2

Czech Republic 0.99 1.17 108.99

South Africa 0.96 0.38 22.62

Korea 0.95 1.59 41.56

Singapore 0.94 0.59 117.32

India 0.65 0.61 84.76

Hong Kong 0.55 0.27 18.13

Turkey 0.38 0.59 29.82

Pakistan 0.21 0.79 35.84

HypothesesHypotheses

H1: A market-based financial system has a

positive and significant impact on economic

growth

H2: A market-based financial system has a

negative and significant impact on the

stability of growth

WDI (209), IFS (168), S&P (114) Annual data: 1985-1999 5-year panel data

Financial structure changes over timeFinancial structure changes over time More degree of freedomMore degree of freedom Average business cycle is about 4-5 yearsAverage business cycle is about 4-5 years

114 countries in bivariate, 68 countries in multivariate, regressions

Separate developing and developed countries Robustness checkRobustness check Institutional differencesInstitutional differences

DataData

EstimationEstimation

itbittiit

itiititittiit

ZB

ερ'IγFBβ'XδαY

'

ˆ

Yit = Five-year average GDP GrowthXit = Control variables (Initial income, Government Expenditure, Trade and Schooling)Bit = Natural log of bank credit to private sector as a share of GDP

Fit = Financial structure (higher value indicates more bank-based system)Ii = Lack of Property rights, Corruption, Costly of Contract EnforcementZit = Instrumental variablesBit(hat) = estimated Bit

Time-Fixed Effects with Instrumental Variables:Time-Fixed Effects with Instrumental Variables:

Dependent Variable: Dependent Variable: Growth of Real GDP Per CapitaGrowth of Real GDP Per Capita

(1.10) (1.11) (1.12) (1.13) (1.14) (1.15) (1.16) (1.17) (1.18)LOG(BTCF) 0.129 -0.441 -0.204 -0.244 -0.496 -0.282 -0.322 -0.319

(0.83) (0.42) (0.71) (0.66) (0.34) (0.68) (0.52) (0.53)LOG(STR) 0.039 -0.217 -0.578** -0.785* -0.041 -0.823** -3.13 -0.885*** -0.28

(0.82) (0.25) (0.04) (0.06) (0.98) (0.04) (0.28) 0.00 (0.93)Adjusted R2 -0.01 0.35 0.47 0.46 0.44 0.49 0.48 0.63 0.62P_Value (F-Stat) 0.77 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Number of Observations 67 41 41 39 39 39 39 41 41Number of Countries 23 16 16 15 15 15 15 16 16

(1.19) (1.20) (1.21) (1.22) (1.23) (1.24) (1.25) (1.26) (1.27)LOG(BTCF) 2.509***3.698***2.793*** 2.536** 3.956***3.888***3.393***3.281***

0.00 0.00 0.00 (0.01) 0.00 0.00 (0.01) 0.00LOG(STR) -0.38** -0.235** -0.16 -0.072 -0.526 -0.18 -0.036 -0.147 -0.742

(0.02) (0.05) (0.26) (0.76) (0.34) (0.44) (0.92) (0.32) (0.25)Adjusted R2 0.04 0.24 0.26 0.24 0.23 0.27 0.26 0.28 0.28P_Value (F-Stat) 0.01 0.00 0.00 0.00 0.00 0.00 0.01 0.00 0.00Number of Observations 166 113 93 73 73 60 60 93 93Number of Countries 76 49 38 29 29 22 22 38 38

(1.01) (1.02) (1.03) (1.04) (1.05) (1.06) (1.07) (1.08) (1.09)LOG(BTCF) 1.777*** 1.764** 0.885 0.772 0.864 0.862 1.547** 1.505**

0.00 (0.02) (0.12) (0.17) (0.10) (0.11) (0.04) (0.04)LOG(STR) -0.315** -0.285** -0.31** -0.319* -1.004** -0.389** -0.322 -0.295** -0.634*

(0.01) (0.01) (0.03) (0.08) (0.02) (0.05) (0.18) (0.05) (0.08)Adjusted R2 0.04 0.15 0.12 0.11 0.12 0.12 0.11 0.14 0.14P-Value (F-Stat) 0.00 0.00 0.00 0.01 0.01 0.02 0.03 0.00 0.00Number of Observations 233 154 134 112 112 99 99 134 134Number of Countries 99 65 54 44 44 37 37 54 54

All Countries

Developed Countries

Developing Countries

Dependent Variable: Dependent Variable: Standard Deviation of Growth in Real GDP Per CapitaStandard Deviation of Growth in Real GDP Per Capita

(2.09) (2.10) (2.11) (2.12) (2.13) (2.14) (2.15) (2.16)LOG(BTCF) 0.096 0.265* 0.216 0.147 0.152 0.145 0.147

-0.52 -0.08 -0.19 -0.35 -0.31 -0.35 -0.36LOG(STR) 0.272***0.252*** 0.253** 0.839** 0.273*** -0.804 0.286*** 2.096*

0.00 0.00 (0.03) (0.03) (0.01) (0.23) 0.00 (0.09)Adjusted R2 0.23 0.61 0.70 0.71 0.69 0.70 0.66 0.66P_Value (F-Stat) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Number of Observations 67 41 39 39 39 39 41 41Number of Countries 23 16 16 15 15 15 16 16

(2.01) (2.02) (2.03) (2.04) (2.05) (2.06) (2.07) (2.08)LOG(BTCF) 0.009 -0.04 0.075 0.321 0.395 0.4 0.396

-0.98 -0.89 -0.81 -0.43 -0.32 -0.37 -0.38LOG(STR) 0.125 -0.051 -0.025 0.312 0.02 -0.397** -0.112 0.025

(0.27) (0.52) (0.82) (0.31) (0.87) (0.02) (0.22) (0.92)Adjusted R2 0.00 0.13 0.24 0.24 0.08 0.14 0.14 0.14P_Value (F-Stat) -0.17 0.00 0.00 0.00 0.02 0.00 0.00 0.00Number of Observations 232 165 132 132 107 107 164 164Number of Countries 99 72 55 55 41 41 71 71

All Countries

Developed Countries

Developing Countries

(2.17) (2.18) (2.19) (2.20) (2.21) (2.22) (2.23) (2.24)LOG(BTCF) 0.697 0.766 0.913 0.932 1.1 0.795 0.871

-0.24 -0.15 -0.14 -0.22 -0.15 -0.21 -0.17LOG(STR) -0.11 -0.247** -0.097 0.18 -0.003 -0.27 -0.255** -0.774*

(0.46) (0.03) (0.47) (0.67) (0.99) (0.16) (0.03) (0.07)Adjusted R2 0.00 0.16 0.20 0.20 0.04 0.05 0.16 0.17P_Value (F-Stat) -0.35 0.00 0.00 0.00 0.23 0.19 0.00 0.00Number of Observations 165 124 93 93 68 68 123 123Number of Countries 76 56 40 40 26 26 55 55

ConclusionsConclusions

Bank-based financial structures in general Bank-based financial structures in general have a negative impact on growth. The results have a negative impact on growth. The results are stronger for developed countries.are stronger for developed countries.

Evidence is inconclusive as to whether a Evidence is inconclusive as to whether a bank-based or market-based system is better bank-based or market-based system is better for growth for developing countries.for growth for developing countries.

ConclusionsConclusions

On average, evidence does not indicate that a bank-On average, evidence does not indicate that a bank-based system either lowers or increases volatility of based system either lowers or increases volatility of growthgrowth

Among developed countries, however, a bank-based Among developed countries, however, a bank-based system is positively associated with higher volatility of system is positively associated with higher volatility of growth.growth.

Some evidence exists, however, that for developing Some evidence exists, however, that for developing countries a bank-based system is negatively associated countries a bank-based system is negatively associated with volatility of growth.with volatility of growth.

Suggestions for Future ResearchSuggestions for Future Research Improve financial structure measurementsImprove financial structure measurements Examine whether government ownership of Examine whether government ownership of

banks affects the relationship between a bank-banks affects the relationship between a bank-based financial structure and growth.based financial structure and growth.

Examine the degree to which cross-border Examine the degree to which cross-border financing impacts the domestic structure, and financing impacts the domestic structure, and whether the inflow through each channel whether the inflow through each channel impacts economic growth differently.impacts economic growth differently.

Examine bond market development and Examine bond market development and growthgrowth