Comparative Business Systems

The Role of Financial Systems

Sverre Knutsen
Norwegian School of Management

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 Comparative financial systems

• Whitley:
• The financial system is among the key
institutional features structuring business
systems
• Financial systems vary on a number of
dimensions
– But the critical feature deals with the processes
by which capital is made available and priced

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 Comparative financial systems

• Whitley use the traditional dichotomy to

classify financial system:

– Capital-market-based financial systems

Vs.
– Credit-based financial systems

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 Comparative financial systems

• Characteristics of capital-market-based
financial systems:
• Mobilize and distribute capital through large and
liquid markets
• Financial claims are traded and priced through the
usual commodity-market process
• Short-termism is enhanced
• Only weak commitment to the growth of any single
firm
• A strong market for corporate control is encouraged

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 Comparative financial systems

• Characteristics of credit-based financial

systems
• Exhibit weak and fairly illiquid and thin capital
markets
• capital markets play only a minor role in mobilizing
and pricing investment funds
• Dominant institutions are either large, ‘universal’
banks (as in Germany) or a combination of
commercial banks and long-term credit banks co-
ordinated by state agencies and ministries, as in
France, Japan and some other countries

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 Comparative financial systems

• Banks and/or the state allocate capital through

administrative processes to particular sectors and
activities (such as export industries or the heavy
manufacturing sector)
• Interlocking and ‘Haus banks’
• This basic contrast between two major
kinds of financial systems has “strong
implications for firms and markets and is a
critical feature of the institutional context
of business systems”.
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 Comparative financial systems

• What do “strong implications” really mean?

• According to Whitley one effect of a credit-based
system is collaboration between economic actors
• Whitley is rather vague upon other, and more
decisive, possible consequences like for instance
economic performance
• Others have claimed that a credit-based financial
system is inherently superior, and that economic
performance can be enhanced by adopting the
superior system. Can this be proved?

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 Comparative financial systems

• How good is Whitley’s taxonomy?

• What about history? It seems like Whitley

has presented a kind of universal model for
the configuration of financial systems. But
are not financial systems subject to change?
These are the three main questions I
want to discuss further in this lecture.

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 Comparative financial systems

• How good is Whitley’s taxonomy and

when?
– How well do the bank-based – market-based
dichotomy describe, e.g. the Norwegian
financial system?
– What are the role of ‘big banks’?
– How significant/insignificant are US banks as
sources of external funds for nonfinancial
businesses?

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 Comparative financial systems

• The bank-based Norwegian financial

system
• The formative period: 1870 – 1913
• The banking system was a kind of hybrid between
universal (mixed) and specialized banking
• The banking system was a decentralized unit-bank
system (like USA, but distinguished from UK)
• The capital markets were relatively poor developed,
even in comparison with Sweden and Denmark
• The Norwegian system of credit institutions was not
backward

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Was the Norwegian financial system backward before 1913?
Varieties of financial institutions (number of types)
1880 1900 1910 1929
Norway 6 10 12 12
Denmark 7 9 9 12
Sweden 8 12 15 18
Italy 11 12 14 14
G.B. 14 16 17 23
USA 9 10 12 19
Canada 11 11 11 13
Median 9 11 12 14
Financial assets/GDP
1880 1900 1913 1929
Norway 107 136 166 241
Denmark 95 147 184 186
Sweden 89 123 136 138
Italy 36 61 97 95
G.B. 95 93 103 131
USA 49 86 91 129
Canada 43 87 101 101
India 2 4 7 11
Nigeria 6

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 Comparative financial systems

• Norway was one of the countries in the

European periphery that experienced what
Simon Kuznets labeled modern economic
growth
• It is thus a reasonable hypothesis to state
that the financial system was adequate to, or
at least it did not hamper Norwegian
economic growth

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 Comparative financial systems

• But what shaped the distinguished characteristics

of the Norwegian banking system?
– A combination of:
 History
 Institutional factors(legal system, unformal norms,
enforcement characteristics)
 Level of economic development
 Information problems

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 Comparative financial systems

• The Norwegian financial system 1955 –

80 developed to meet all the basic
characteristics in what Whitley classifies
as a credit-based financial system
– Actually the financial sector was transformed
to be an instrument to serve two purposes:
1. To control the aggregate credit volume as a tool
for stabilization policy
2. To be able to direct investment funds to political
prioritized sectors, projects and enterprises

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 Comparative financial systems

• This neo-mercantilist regime was based on:

• Administrative pricing of capital
• Credit rationing based on interest rates fixed below
a price that would have cleared the market
• Strict control on capital movements across the
border
• Reserve requirements and lending quotas
• Heavy regulated capital markets

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 Comparative financial systems

• What about ‘big banks’?

• Big banks was not a dominant feature of the
Norwegian banking system.
• What about Germany?
• The following data reveals that the role of
Big banks in German industrial finance is
exaggerated:

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 Bank lending in Germany to domestic non-bank enterprises and self-
employed persons by various categories of bank

1970 1980 1988

Commercial banks 36,3 25,9 28,7
Of which Big banks 16 10,5 12
Savings banks 32,3 36,9 34,9
Credit cooperatives 12,7 15,3 15,8
Mortgage banks 7,1 14,7 14,5
Banks with special functions 8,1 3,6 4
Postal savings banks 2,4 2,3 2,1
Misc. intermediaries 1,2 1,1 0

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 Comparative financial systems

• Are loans unimportant in financing US

firms compared with other countries?
• Data shows that loans were more important as
sources of external funds for nonfinancial
businesses in USA than in “credit-based” Germany
and Japan! (during the period 1970-85) (cfr.
Diagram)

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 Comparative financial systems

• A broader definition of financial structure is

needed
• Both Pakistan and Germany are classified as bank-
based systems. In Pakistan, however, banks cannot
perform the functions expected of a sophisticated
bank- based system, because they are not as well
developed as German banks.
• USA and the Philippines are both market-based
systems, but the markets in the Philippines are not as
effective at providing financial services

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 Comparative financial systems

• Thus,
– Looking at financial structure, we see that
Pakistan and the Philippines have more in
common with each other than their respective
bank-based and market-based counterparts.
– Hence, it is also necessary to distinguish among
economies with underdeveloped and developed
financial systems

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 Comparative financial systems

• Consequently,
• We should make use of a broader definition of
financial structure, than the Whitley dichotomy.
• This definition should comprise the whole financial
system – i.e. all the intermediaries and markets that
make up the system and how these elements are
configurated
• A better definition of financial structure:

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 Comparative financial systems

– ”a country’s finacial structure consists of infra-

structure, financial technology, institutions and
the rules of the game that define how financial
activity is organized at a point of time”
• The same function of a financial can be performed
by different institutions or according to different
rules.

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 Comparative financial systems

• Economic performance – does the financial

system make any difference?
• Whitley does not give any clear answer on this
crucial question
• An increasing number of historical as well as
economic studies have found that the overall level of
financial development is robustly linked with long-
run growth

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 Comparative financial systems

• Financial structure is not significantly related to

economic growth. There is no evidence that the
development of a market-based or bank-based
financial system per se affects access to financing of
firms
• Recent research suggest that it is the improving of
the overall financial system that is critical for
boosting financial development and hence economic
development
• The legal system seems to have significant impact
on finance and growth

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 Comparative financial systems

• Why has the idea of the financial structure

dichotomy and its importance for economic
growth gained so much influence?
• The roots: the rivalry between Germany as a rising
power after 1871 and UK. At the close of the 19th
century, German economists argued that their bank-
centered financial system had helped propel
Germany past the market-centered UK as an
industrial power

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 Comparative financial systems

• In the 1960s and 1970s several scholars (especially

sociologists) emphasized the relative merit of the
German bank-centered system vs. the British
market-oriented to explain Britain’s week growth
rates.
• This was followed up by scholars like John Zysman
in the late 1970s, early 1980s, to explain Japan’s
substantial growth relative to US economic
stagnation. ( Zysman’s Governments, markets and
growth is Whitley’s main reference on financial
structure)

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 Comparative financial systems

• Allen and Gale (2000) suggest on the other

hand that stock-market based economies are
the mot efficient in developing new
industries and promoting real GDP growth.
• Perhaps this view should be understood in context
of the neo-liberal shift taking place on an
international scale since the mid-1980s?

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