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Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft

The Open Access Publication Server of the ZBW – Leibniz Information Centre for Economics

Schmidt, Reinhard H.; Hryckiewicz, Aneta

Working Paper

Financial systems - importance, differences and

convergence

IMFS Working Paper Series, No. 4

Provided in Cooperation with:

Institute for Monetary and Financial Stability (IMFS), Goethe University

Frankfurt am Main Suggested Citation: Schmidt, Reinhard H.; Hryckiewicz, Aneta (2006) : Financial systems

- importance, differences and convergence, IMFS Working Paper Series, No. 4, http://nbnresolving.de/urn:nbn:de:hebis:30-70340

This Version is available at:

http://hdl.handle.net/10419/97758

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zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics Institute for Monetary and Financial Stability

REINHARD H. SCHMIDT

ANETA HRYCKIEWICZ

FINANCIAL SYSTEMS IMPORTANCE, DIFFERENCES AND CONVERGENCE

Institute for Monetary and Financial Stability

JOHANN WOLFGANG GOETHE-UNIVERSITÄT FRANKFURT AM MAIN

WORKING PAPER SERIES NO. 4 (2006)

PROF. DR. HELMUT SIEKMANN

INSTITUTE FOR MONETARY AND FINANCIAL STABILITY

PROFESSUR FÜR GELD-, WÄHRUNGS- UND NOTENBANKRECHT

JOHANN WOLFGANG GOETHE-UNIVERSITÄT

MERTONSTR. 17 60325 FRANKFURT AM MAIN

–  –  –

FINANCIAL SYSTEMS IMPORTANCE, DIFFERENCES AND CONVERGENCE

Institute for Monetary and Financial Stability

JOHANN WOLFGANG GOETHE-UNIVERSITÄT FRANKFURT AM MAIN

–  –  –

Financial Systems – Importance, Differences and Convergence** Abstract This paper provides an overview of conceptual issues and recent research findings concerning the structure and the role of financial systems and an introduction into the new research area of comparative financial systems.

The authors start by pointing out the importance of financial systems in general and then sketch different ways of describing and analysing national financial systems. They advocate using what they call a “systemic approach”. This approach focuses on the fit between the various elements that constitute any financial system as a major determinant of how well a given financial system performs its functions.

In its second part the paper discusses recent research concerning the relationships between financial sector development and general economic growth and development. The third part is dedicated to comparative financial systems. It first analyses the similarities and, more importantly, the differences of the financial systems of major industrialised countries and points out that these differences seem to remain in existence in spite of the current wave of liberalisation, deregulation and globalisation. This leads to the concluding discussion of what the systemic approach suggests with respect to the question of whether the financial systems of different countries are likely to converge to a common structure.

Key words: Financial sector, financial system, growth and development, convergence JEL classification: G32, G34, G38 * Reinhard H. Schmidt, the corresponding author, holds the Wilhelm Merton Chair of International Banking and Finance at the University of Frankfurt and is a member of the Institute for Monetary and Financial Stability at the University of Frankfurt. His email is Schmidt@finance.uni-frankfurt.de. Aneta Hryckiewicz is a research associate and a PhD candidate at the Finance Department at Frankfurt University.

** The paper is an extended version of the keynote address prepared for a FUNCAS Workshop on Comparative Financial Systems in Zaragoza, Oct. 17, 2006. A Spanish translation will be published in Papeles de economia Española.

I. Comparative Financial Systems as a New Field of Research and Policy





Since about 15 years, the notion has become more and more widely accepted that financial systems are an important field of public policy and of academic research. The underlying assumption behind this “discovery” is that in some sense the “quality” of a country’s financial system is important. This new conviction is reflected in the fact that policy makers have started to be concerned about improving the financial systems for which they have a certain responsibility. In the European Union almost all elements of the so-called financial sector action plan have recently been implemented. International organisations like the World Bank, the EBRD and the IMF have for quite some time spent a great deal of their effort and money on helping to improve the financial systems of countries on which they have some influence.

However, there are a number of problems coming with this “discovery” and the apparent consensus. One can summarize them by stating that it is not at all clear what it means to say that financial systems are important, why this statement should be true and relevant; and what policy implications it might have. What exactly is a financial system? What determines its quality? Are there any general standards for evaluating financial systems? For whom and for what are financial systems and their quality important? Is there a solid theoretical or empirical basis for the assumption that the quality of a financial system is indeed important? And what can policy makers do to improve a given financial system?

Most of the work by academics and practitioners on financial systems has taken empirical observations and practical problems as its starting point. Among other things, the frequency and severity of financial crises in the period after the demise of the fixed exchange regime of the Bretton Woods system spurred this interest. Another factor is that in many countries the financial system has undergone dramatic changes in recent years. There was a wave of liberalisation and deregulation of national financial systems in the 1970s and 1980s, followed by a wave of re-regulation in the next decades. Yet the economic, social and political consequences of these developments are difficult to assess on a general scale.

A comparative perspective is very fruitful for the study of the questions listed above. If one looks at different countries, one can easily see that their financial systems differ considerably.

This diversity has existed for a long time, and at least in some cases it has remained after the turbulences of the past decades and in spite of the possible pressure of growing international integration and competition to adopt what might be the single best financial system. This observation is obviously important for relevant policy efforts. Does it mean that some countries have good financial systems while others have not? And if this is the case, what prevents the countries with a bad financial system from adopting a better one? Or does it rather imply that what is a good financial system for one country may not be a good system for other countries? It is the purpose of this paper to provide a short survey of recent research concerning financial systems in general and the diversity of national financial systems in particular.

We start with an attempt to define what a financial system is and by looking at different ways of describing and analysing financial systems (section II). Then, in section III, we take a look at the existing theoretical and empirical arguments concerning the questions of why, for what and for whom financial systems may be important, before we embark on discussing differences between countries’ national financial systems in Section IV. The concluding section V is dedicated to the question of how financial systems develop over time and discusses whether one can expect that the financial systems of different countries are likely to converge towards what may be the best type of a financial system.

II. How to Define and Analyse a Financial System

1. Finance is more than capital For decades economists have disregarded finance as a genuine topic. Even when they used the term finance what they meant was almost always capital. The underlying concept of capital was that of real capital. Real capital is a stock of resources that can be applied as an input into future production allowing economic agents to use other resources more productively.

Machinery, roads or even accumulated knowledge are real capital in this sense, even if they are measured in monetary terms. Not finance but capital figures in conventional growth theories; and the transfer of capital to so-called developing countries and possibly to certain so-called target groups has been the dominant approach of development policy for decades.

Of course, capital in the sense of real capital is important for any economy. But finance is more than capital, and it is a different concept. It is concerned with how economic agents in a given society can and do make intertemporal choices, and with intertemporal relationships between economic units. Finance is about how economic agents carry over income and consumption opportunities from one time period to later time periods, that is, how they save or accumulate and hold wealth and how they invest; about how agents finance investments;

and how they deal with risk. Many of those who now say that finance is important refer to this concept, and that is why it should also shape the definition of the term financial system.

2. A financial system is more than the financial sector

Building on a broad concept of finance, the concept of a financial system is also broad. It covers the ways in which financial decisions1 are made, and can be made and implemented, and in which financial relationships are designed and implemented. The description of the financial system of a given country or region is contained in the answers to the questions of which opportunities the economic agents in this country or region have, and use, to accumulate wealth and to transfer income into the future, to fund investment projects and to manage risk. Thus, the conceptual starting points are financial decisions and activities of nonfinancial firms and households.

In most economies, many financial decisions and relationships of the households and the firms involve banks, capital markets, insurance companies and similar institutions in some way. In their totality, those institutions that specialise in providing financial services2 constitute the financial sector of the economy. Of course, the financial sector is a very important part of almost any financial system. But it should not be taken for the entire financial system. Only some 15 years ago, there were some parts of the so-called developing world and some formerly socialist countries in which almost no financial institutions existed or operated, and still people saved, invested, borrowed and dealt with risks in these countries and regions. Thus there can in principle even be financial systems almost without a financial sector. But also in advanced economies, many financial decisions and activities completely bypass the financial sector. Examples are real saving3, self-financing and self-insurance and informal and direct lending and borrowing relationships.

One can also illustrate the distinction between the concepts of the financial sector and the financial system by invoking the distinction between supply and demand. The financial sector only encompasses the supply of financial services while the financial system includes both supply and demand and the way in which supply and demand are matched. The broader concept suggests looking not only at the institutions of the financial sector but also at those decisions and relationships that give rise to a demand for the services of the financial sector as Financial decisions and financial relationships are those involving different points in time or different time periods.

The provision of loans and equity participation is one among several financial services; others are payment transfers, deposit taking and security transactions, just to name the most important ones.

Building a house or growing a tree or a hedge and even feeding the proverbial “savings pig”, that is, putting money into the “piggy bank”, and raising children are forms of real saving and investment that do not involve the financial sector. Incidentally, this explains why they are particularly wide-spread in countries whose financial sector is not well developed.

well as those that do not involve the financial sector at all. Especially if one analysed financial systems in a comparative perspective, it could be misleading if one overlooked self-financing of investment, real savings, self-insurance and direct financing and investment.



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