A key question in development economics is the relation between a country's financial system and its economic development. Historians such as Gerschenkron (1962) have sought to explain a perceived relation between the differences in the pattern of economic development between Britain and the Continental European economies and the differences between bank-based and market based financial systems. More recently, the differences in the relative performance of the Japanese and the US economies have led observers to conclude that bank-based and market-based financial systems may produce different growth patterns.
This view has been challenged by Laporta, Lopez de-Silanes, Shleifer and Vishny (LLSV) (1998, 1999), who argue that the legal system in a country is a primary determinant of the effectiveness of its financial system. An implication of this hypothesis is that the distinction between market-based and bank-based financial systems may not be of primary importance for policy.
In this paper we use firm-level data from a panel of forty countries to analyze how a country's legal and financial systems affect firms access to external finance to fund growth. For each country we predict a financial system based on the country's legal environment. We use our estimates to ask: Does the financial system have an effect independent of the legal system? Is the use of external financing different in market based and bank-based systems? Do the market-based and bank-based systems differ in the provision of long-term and short-term funds?
We find that the use of external financing by firms is positively related to the development of both the predicted banking system and the securities markets in each country. However, in our sample we do not find evidence that variations in the development of the financial system that are unrelated to the legal system affect access to external finance. In particular, we find no evidence that firms use external financing differently if they are in countries classified as bank-based or market-based, on the basis of the development of their banking sector relative to their securities markets.
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Funding Growth in Bank-Based and Market-Based Financial Systems: Evidence from Firm Level Data
