This then led to a push to develop securities markets at the national and regional levels. The 2008–09 crisis centred on the advanced economies then cast doubt on securities markets as efficient allocators of resources and on the efficacy of universal banks combining commercial and investment-banking functions. It is not infrequently asked whether China is going down this same dangerous road as it deregulates its financial markets, facilitating the rapid growth of its shadow banking system, and as it liberalises its capital account with the goal of internationalising the renminbi.
Recent work on the subject has the capacity to shed important light on the connections between financial development and growth and to usefully illuminate policy. In particular, the historical experience of four countries — Great Britain, the United States, Germany and Japan — and their juxtaposing systems highlights the controversy over the relative merits of market- and bank-based financial systems and provides a series of lessons for analysis and policy making in emerging economies today.
Most pioneering historians of industrialisation in Britain and the United States attached relatively little importance to the role of finance. Yet the recent literature paints both experiences in a different light. British finance was not underdeveloped because growth was slow; rather, growth was slow because finance was underdeveloped and, more than that, actively repressed. And the United States may have seen financial instability, but it also saw rapid financial development that played an important role in economic growth. Britain’s heavily market-based financial system was the product of the crown’s need to finance expensive wars. The Bank of England was created at the end of the 17th century to advance credit to the government and underwrite the bonds providing the finance. Competition for savings was limited, and while this heavy-handed regulation encouraged the development of the securities markets that would become the signature of the British financial system, it also hindered the development of the kind of banking system that would have helped to address the financial needs of the private sector.
As former British colonies, the banking systems of the new United States initially developed along similar lines but then diverged sharply. By the end of the 1780s there were still only four state-chartered banks in the new confederation, leaving the United States under-banked even by English standards. But after Alexander Hamilton engineered the creation of a federally chartered bank, the results were striking. With the development of a relatively well capitalised banking system came the development of more active and liquid securities markets, and investment in canals, railroads, and water- and steam-powered machinery followed as a consequence.
Germany, on the other hand, was later to industrialise than Britain. By the time it did, mechanisation and centralised power had spread from light industries to heavy industries, raising capital requirements and hence the need to mobilise savings. At the same time, Germany lacked securities markets that might have helped with that process. Hence the need for big banks capable of exploiting economies of scale and scope in mobilising savings, coordinating investment, monitoring borrowers, and providing entrepreneurial and management services — or so it is said.
In emerging Asia in particular, where late industrialisation is similarly the norm, the merits attributed to universal banking would seem to recommend its adoption. But in Germany, large universal banks servicing big industrial firms accounted for only a small fraction of the country’s total bank lending in the decades before 1913. The main contribution of universal banks was to organise and underwrite new share issues; they provided little long-term investment finance themselves. This is a reminder that banks tend to be part of a large and diverse financial ecosystem. Policy makers seeking to promote financial development would do well to foster this diversity rather than encouraging one financial form at the expense of others.
Japan’s economic development has traditionally been viewed in parallel with Germany’s. But, again, recent work sits uneasily with this view. The ratio of bank deposits to GDP was quite low in Japan in 1913 and again in the 1920s. On the other hand, the ratio of stock market capitalisation to GDP was relatively high in 1913. Securities markets, it would appear, played a larger role in Japanese industrialisation and banks a smaller one than suggested by qualitative accounts. Japanese finance took on its more modern form after the end of the post-World War I boom and the Great Earthquake in 1923 prompted the government to engineer bank mergers and impose more restrictive regulation. The issuance of financial securities not related to the war effort was also effectively suppressed during the 1930s. Japan thus emerged from World War II with a moribund securities market and a banking system dominated by a relatively small number of large institutions. Thus, we see in the Japanese case how banks and securities markets were not really alternatives to one another until policy made them so.
These historical examples carry a list of implications for analysis and policy in the current day.
History casts a long shadow. National financial structures today continue to reflect economic circumstances and policy decisions in the distant past.
It is possible for major events to shock the financial system out of its established equilibrium. But, historically, such shocks have been associated with wars and financial crises. One hopes that emerging markets will avoid both types of shocks. But this hope in turn suggests that discontinuous changes in financial structure and regulation are unlikely.
The close connection between government and finance is unavoidable. Government plays an essential role in creating the institutional framework and level playing field within which financial institutions and markets develop. At the same time, government regulation can hinder the development of an efficient financial structure suited to the needs of the economy.
The distinction between the Anglo-Saxon market-based system and bank-based financial systems à la Germany and Japan has been given more weight than it deserves. Banks and securities markets are complements, not substitutes.
The question for Asia is not banks or markets. The region needs both.
Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. This article digests a paper to be presented to the Thirty-Sixth Pacific Trade and Development Conference at the Hong Kong Monetary Authority in Hong Kong on Tuesday, 19 November.