Advertisement

Banking sector functions and coordination

Part of the Contributions to Economics book series (CE)

Abstract

Since the seminal works of McKinnon (1973) and Shaw (1973), there has been a considerable body of literature covering the topic of financial liberalization and the importance of the financial sector for the overall economy. A recurring recommendation in these studies is that the direct involvement of the government in the banking sector should be reduced in order to allow the sector to perform its functions better.

Keywords

Interest Rate Banking System Financial Development Banking Sector Real Interest Rate 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. 1.
    The literature frequently mentions further functions of the banking system such as exercising corporate control or risk management (see for example Levine (1997), p. 691). These services of the banking system however have to be seen in connection to the allocation function and are therefore not explicitly discussed.Google Scholar
  2. 2.
    See Allen and Gale (2000), p. 3; Jaffe and Levonian (2001), p. 163, Lane (1994), p. 233; Megginson (2005), p. 1932; Quispe-Agnoli and McQuerry (2001), p. 2; Shirai (2002c), p. 4; World Bank (2001), p. 313. Theoretically, both banks and securities markets can provide the mobilization and allocation function. In the case of transition and developing countries, however, the banking system will play the dominant role because capital markets lack sufficient depth and banks provide better protection of small investors. See Berglof and Bolton (2002), p. 92; Lane (1994), p. 233; Quispe-Agnoli and McQuerry (2001), p. 2.Google Scholar
  3. 3.
    See, for example, the studies by de Gregorio and Guidotti (1995), King and Levine (1993), Levine (1997) or Wachtel (2001) that do not focus on the effect of the payment system.Google Scholar
  4. 4.
    Total domestic savings in a closed economy is the sum of the savings from households, enterprises and the state. For the mobilization of resources, savings from households are the most relevant, since in most cases the state produces negative savings (i.e. budget deficits) and enterprises often use their savings (i.e. retained earnings) as a source of internal financing. See Schmidt-Hebbel and Serven (1997), p. 56; World Bank (1989), p. 28f.Google Scholar
  5. 5.
    These functions can in theory also be performed by the informal financial sector. However, the informal sector lacks the legal enforcement mechanisms of the formal banking sector, and so a close bond between borrower and lender is necessary. This in turn restricts the reach and reduces the overall economic benefits of the informal sector. See Krahnen and Schmidt (1994), pp. 36–38 for an overview of the characteristics of the informal financial sector.Google Scholar
  6. 6.
    See Achleitner (2000), p. 24f.; Levine (1997), p. 698f.; Wachtel (2003), p. 35.Google Scholar
  7. 7.
    See Achleitner (2000), p. 25; Wachtel (2003), p. 35.Google Scholar
  8. 8.
    See Achleitner (2000), p. 26; Wachtel (2003), p. 35.Google Scholar
  9. 9.
    See Achleitner (2000), pp. 24–26; Wachtel (2001), p. 339.Google Scholar
  10. 10.
    See Deckert (1996), p. 25f.Google Scholar
  11. 11.
    See Stiglitz and Weiss (1981), p. 408f.Google Scholar
  12. 12.
    See Balassa (1990), p. 59; Loayza and Ranciere (2006), p. 1052; Lynch (1996), p. 5.Google Scholar
  13. 13.
    Only those predictions relevant to the functions of the banking sector are discussed here. For a complete overview, see Mankiw (1995), p. 277.Google Scholar
  14. 14.
    See Mankiw (1995), p. 277.Google Scholar
  15. 15.
    See Auerbach and Siddiki (2004), p. 234; Organization for Economic Cooperation and Development (2003), p. 5.Google Scholar
  16. 16.
    See Mankiw (1995), p. 296f.; Romer (1994), p. 3.Google Scholar
  17. 17.
    See Auerbach and Siddiki (2004), p. 234; Greenwood and Jovanovic (1990), p. 1078f.; Lane (1994), p. 234; Levine (1997), p. 691; Romer (1986), p. 1003; Roubini and Sala-i-Martin (1992), p. 5.Google Scholar
  18. 18.
    See Beck (2006), p. 13; Denizer, Desai and Gueorguiev (1998), p. 2; Shleifer (1998), p. 133f.Google Scholar
  19. 19.
    See Megginson (2005), p. 1933.Google Scholar
  20. 20.
    Public goods are an extreme case of external effects since nobody can be excluded from their consumption. An individual will thus not be willing to pay for them. See Schmidt (1999), p. 38.Google Scholar
  21. 21.
    See Aschinger (2001), p. 64f.; Besley (1994), p. 29; Döring (2003), p. 97; Fees (1997), p. 639; Feld and Kirchgässner (2003), p. 260; Mishkin (1996), p. 30f.; Schmidt (1999), pp. 36–40; Sheshinski and López-Calva (1999), p. 5.Google Scholar
  22. 22.
    See Aschinger (2001), p. 66. As pointed out by Diamond and Dybvig (1983), the loans a bank hands out are illiquid — they are longer-term commitments that cannot be readily called if a bank needs cash for withdrawals. While liquidity transformation is one of the main purposes of banks, it also makes them vulnerable to bank runs since they only hold a fraction of their assets in cash. See Diamond and Dybvig (1983), p. 403.Google Scholar
  23. 23.
    See Stiglitz and Weiss (1981), p. 393f.Google Scholar
  24. 24.
    See Arestis, Nissanke and Stein (2003), p. 6; Yeyati, Micco and Panizza (2004), pp. 6–9.Google Scholar
  25. 25.
    See Ahrens (1998), p. 24f.; Stiglitz and Bhattacharya (1999), p. 96; Stiglitz (2004), p. 21; Wachtel (2001), p. 354. A more in-depth discussion of market failures and their effect on the liberalization of the banking sector follows in section 6.3.3.Google Scholar
  26. 26.
    See Gerschenkron (1962), p. 22.Google Scholar
  27. 27.
    See Denizer, Desai and Gueorguiev (1998), p. 5; La Porta, Lopez de Silanes and Schleifer (2002), p. 267; Megginson (2005), p. 1933; Yeyati, Micco and Panizza (2004), p. 8.Google Scholar
  28. 28.
    See Arun and Turner (2002c), p. 93.Google Scholar
  29. 29.
    See La Porta, Lopez de Silanes and Schleifer (2002), p. 266f.Google Scholar
  30. 30.
    See Denizer, Desai and Gueorguiev (1998), p. 2; Giovanni and de Melo (1993), p. 954. These instruments are discussed in more detail in section 4.2.2. China is a prime example for the use of banks to achieve political goals. Since the Chinese government was neither prepared to let large state-owned enterprise fail nor to provide further direct subsidies, the state-owned banks had to extend loans to keep these firms in operation. See Broadman (2001), p. 17; Lardy (1998), p. 38.Google Scholar
  31. 31.
    See Schmidt (1999), p. 41.Google Scholar
  32. 32.
    See Megginson (2005), p. 1933.Google Scholar
  33. 33.
    See La Porta, Lopez de Silanes and Schleifer (2002), p. 266f.Google Scholar
  34. 34.
    See Wachtel (2001), p. 336.Google Scholar
  35. 35.
    Shaw (1973), p. 3.Google Scholar
  36. 36.
    See Demetriades and Luintel (1997), pp. 311–314; Denizer, Desai and Gueorguiev (1998), p. 3 and p. 10f.; Joshi and Little (1997), p. 112 and p. 125.Google Scholar
  37. 37.
    See Demetriades and Luintel (1997), p. 314.Google Scholar
  38. 38.
    See Ganesan (2003), p. 14; Shirai (2002c), p. 18; Stiglitz (1994), p. 42.Google Scholar
  39. 39.
    See Caprio, Hanson and Honohan (2001), p. 5f.; Denizer, Desai and Gueorguiev (1998), p. 3; Giovanni and de Melo (1993), p. 954.Google Scholar
  40. 40.
    See Honohan (1997), p. 7 and p. 11.Google Scholar
  41. 41.
    See Shirai (2002c), pp. 19–21.Google Scholar
  42. 42.
    See Roubini and Sala-i-Martin (1992), p. 7.Google Scholar
  43. 43.
    See Arestis and Demetriades (1997), p. 793; Denizer, Desai and Gueorguiev (1998), p. 2; Stiglitz (1994), pp. 39–42. Lower financing costs will all else equal increase profits, which will through higher retained earnings increase equity.Google Scholar
  44. 44.
    See Park (2004), p. 35; Rodrik (1995), p. 56 and p. 74; Rodrik (2004), p. 6. Another example for successful involvement in the financial sector is Japan, where in the 1950s and 1960s the government was actively involved in pricing and allocating credit. See Arestis and Demetriades (1997), p. 791.Google Scholar
  45. 45.
    See Deckert (1996), p. 11.Google Scholar
  46. 46.
    McKinnon (1973) defines a fragmented economy as one where “[...] firms and households are so isolated that they face different effective prices for land, labor, capital, and produced commodities and do not have access to the same technologies.” McKinnon (1973), p. 5.Google Scholar
  47. 47.
    See King and Levine (1993), p. 718; McKinnon (1973), p. 68f.; Shaw (1973), p.3.Google Scholar
  48. 48.
    See McKinnon (1973), p. 68f and p. 73; Shaw (1973), p. 85f.Google Scholar
  49. 49.
    See McKinnon (1973), pp. 71–77; Shaw (1973), pp. 81–87.Google Scholar
  50. 50.
    See Auerbach and Siddiki (2004), p. 248f.Google Scholar
  51. 51.
    Adapted from Auerbach and Siddiki (2004), p. 248.Google Scholar
  52. 52.
    See Shaw (1973), p. 85f.Google Scholar
  53. 53.
    See Fry (1997), p. 755; McKinnon (1991), p. 11f. McKinnon and Shaw reach similar conclusions with different explanations. While McKinnon introduces the complementarity hypothesis between money and real capital, Shaw uses the debt intermediation view. See McKinnon (1973), p. 3; Shaw (1973), p. 47f.Google Scholar
  54. 54.
    See Balassa (1990), p. 58f.; Das (2003), p. 346; Deckert (1996), p. 13; Gemech and Struthers (2003), p. 3; McKinnon (1973), pp. 59–61; Shaw (1973), pp. 81–86. Figure 10 showed that despite an increase of the interest rate, the volume of loans should increase.Google Scholar
  55. 55.
    See Demetriades and Luintel (2001), p. 461; Stiglitz (1994), p. 39.Google Scholar
  56. 56.
    The size of this tax can be substantial, as a study by Giovanni and de Melo (1993) found. The average revenue from financial repression across a sample of 24 countries was equivalent to about two percent of GDP or nine percent of total government revenue. See Giovanni and de Melo (1993), p. 962.Google Scholar
  57. 57.
    See Schmidt-Hebbel and Serven (2002), p. 12.Google Scholar
  58. 58.
    See Bandiera et al. (2000), p. 239 and p. 257. The composition of the index is discussed in section 6.3.2.Google Scholar
  59. 59.
    See Nair (2005), p. 18.Google Scholar
  60. 60.
    Browning and Lusardi (1996) provide a comprehensive overview and discussion of saving motives. Modigliani and Cao (2004) try to explain the level of Chinese saving by the life-cycle hypothesis. They argue that the two main drivers of the saving rate in China are income growth and demographic changes caused by the one-child policy. See Modigliani and Cao (2004), pp. 165–168.Google Scholar
  61. 61.
    See Laeven (2003), p. 5 and p. 25. The financial liberalization index used by Laeven is described in section 6.3.2.Google Scholar
  62. 62.
    See Galindo, Schiantarelli and Weiss (2003), p. 25. The efficiency of capital allocation is measured by the sales per unit of capital and the operating profits per unit of capital. Financial liberalization is measured by two dummy variables. The first is a summary variable that includes interest rate deregulation, reduction of entry barriers, reduction of reserve requirements, reduction of credit controls, privatization of state banks, and strengthening of prudential regulations. The second is a dummy variable that is set to one in the year after the removal of the main restrictions on interest rates and credit allocation. See Galindo, Schiantarelli and Weiss (2003), p. 7 and p. 13f.Google Scholar
  63. 63.
    See Abiad, Oomes and Ueda (2004), p. 27.Google Scholar
  64. 64.
    See Guha-Khasnobis and Bhaduri (2000), p. 345.Google Scholar
  65. 65.
    See Misra (2003), p. 161 and p. 175.Google Scholar
  66. 66.
    See King and Levine (1993), p. 718.Google Scholar
  67. 67.
    See Arestis et al. (2002), pp. 110–112; Levine (1997), p. 691; Mavrotas and Kelly (1999), p. 4; Shan and Morris (2002), p. 156. The relationship may also work in the other direction: more repressive policies may impede financial development, which in turn may negatively affect capital accumulation and capital efficiency.Google Scholar
  68. 68.
    Author’s presentation based on Levine (1997), p. 691 and Shan and Morris (2002), p. 156.Google Scholar
  69. 69.
    See Arestis et al. (2002), p. 119.Google Scholar
  70. 70.
    See King and Levine (1993), p. 719f.Google Scholar
  71. 71.
    See Roubini and Sala-i-Martin (1992), pp. 25–27.Google Scholar
  72. 72.
    See Rajan and Zingales (1998), pp. 559–561.Google Scholar
  73. 73.
    See de Gregorio and Guidotti (1995), p. 445.Google Scholar
  74. 74.
    See Calderón and Liu (2003), p. 323 and p. 331.Google Scholar
  75. 75.
    See Sylla (2000), p. 2.Google Scholar
  76. 76.
    See Ram (1999), p. 168f.Google Scholar
  77. 77.
    See Demetriades and Hussein (1996), p. 395 and p. 406.Google Scholar
  78. 78.
    See Shan and Morris (2002), p. 153f. and p. 166.Google Scholar
  79. 79.
    See Bhattacharya and Sivasubramanian (2003), p. 929. The results should be interpreted with caution: M3 is not always regarded as a reliable indicator for financial development as it is influenced by factors other than financial depth. See de Gregorio and Guidotti (1995), p. 438.Google Scholar
  80. 80.
    See Bell and Rosseau (2001), pp. 153–155 and p. 173. It is important to note that Bell and Rosseau (2001) do not investigate alternative policies, so it is not possible to make conclusions about the effects of different policy regimes on economic growth. See Bell and Rosseau (2001), p. 155.Google Scholar
  81. 81.
    See Aziz and Duenwald (2002), p. 11.Google Scholar
  82. 82.
    See Boyreau-Debray (2003), p. 20.Google Scholar
  83. 83.
    See Chang (2002), p. 872. Granger causality tests are described in more detail in section 7.2.2.2.Google Scholar
  84. 84.
    It is also worth remembering that “finance cannot create opportunities. It only makes it easier to exploit them [...].” Rajan and Zingales (2003b), p. 112.Google Scholar
  85. 85.
    See Ataullah, Cockerill and Hang (2004), p. 1916; Galindo, Micco and Ordonez (2002), p. 7f.; Humphrey and Pulley (1997), p. 91.Google Scholar
  86. 86.
    See Jayaratna and Strahan (1996), p. 641f.Google Scholar
  87. 87.
    See Bonaccorsi di Patti and Hardy (2005), p. 2402.Google Scholar
  88. 88.
    See Ataullah, Cockerill and Hang (2004), p. 1924.Google Scholar
  89. 89.
    See Ganesan (2001), p. 36.Google Scholar
  90. 90.
    See Bhaumik and Dimova (2004), p. 177.Google Scholar
  91. 91.
    See Kumbhakar and Sarkar (2003), p. 405 and p. 421.Google Scholar
  92. 93.
    Diaz-Alejandro (1985), p. 17.Google Scholar
  93. 94.
    See Diaz-Alejandro (1985), p. 1f.Google Scholar
  94. 95.
    See Kaminsky and Reinhart (1999), p. 479f.Google Scholar
  95. 96.
    See Caprio and Klingebiel (1997), p. 9.Google Scholar
  96. 97.
    See Demirgüc-Kunt and Detragiache (1998), p. 6f.Google Scholar
  97. 98.
    See Eichengreen and Arteta (2002), p. 67.Google Scholar
  98. 99.
    See Blejer (1999), p. 388; Caprio and Klingebiel (1997), p. 4.Google Scholar
  99. 100.
    See Barton, Newell and Wilson (2003), p. 58f.Google Scholar
  100. 101.
    See Blejer (1999), p. 387f.; Caprio, Hanson and Honohan (2001), p. 16; Eichengreen and Arteta (2002), p. 72; Kaminsky and Reinhart (1999), p. 496; McKinnon and Pill (1997), pp. 191–193; Mehrez and Kaufmann (2000), p. 2f.Google Scholar
  101. 102.
    See Demirgüc-Kunt and Detragiache (1998), p. 5; Loayza and Ranciere (2006), p. 1069; World Bank (2005), p. 182.Google Scholar
  102. 103.
    See Fry (1997), p. 768; King and Levine (1993), p. 734f.; Wachtel (2001), pp. 357–359.Google Scholar
  103. 104.
    See Deckert (1996), p. 3; Fry (1997), p. 768f.; Wachtel (2001), p. 357.Google Scholar

Copyright information

© Physica-Verlag Heidelberg 2008

Personalised recommendations