Financial systems across “developed economies”: convergence or path dependence?

Research in Economics (1997) 51, 303–331

Financial systems across “developed economies”: convergence or path dependence? MAGDA BIANCO, ANDREA GERALI, and RICCARDO MASSARO Servizio Studi, Banca d’Italia, Via Nazionale 91, 00184 Roma, Italy Summary The accumulating evidence of a positive relationship between financial development and economic growth is associated with wide differences across the structure of financial systems of developed countries. In absence of a fully developed theoretical account of these two stylized facts, in the paper we present a comparison of six developed countries’ financial systems, based on their historical evolution and their current characteristics as emerge from the analysis of financial accounts. The analysis suggests that convergence across financial systems is still limited and major changes are under way in one of the countries considered only. This suggests that the different systems represent different equilibria leading to similar patterns of growth and that financial arrangements are complementary to non-financial features of the economy.  1997 Academic Press Limited J.E.L. Classification: G21, G22, G23, G32, N20. Keywords: Financial systems, financial accounts.

1. Introduction Why are financial regulations so different across countries? Does it really matter for growth? Are there signs of convergence across the various systems or rather these differences persist? Empirically, there seems to be an accumulating evidence of a positive connection between the size of financial systems and economic growth, at least at the very aggregate level.† If we try to qualify this relationship, however, by looking at the details of the financial systems involved, we also observe a striking diversity across developed countries in term of their financial arrangements, instruments and institutions. These two stylized facts are difficult to reconcile within a unitary framework, the latter indicating that † See, for all, De Gregorio and Guidotti (1992), King and Levine (1993a, 1993b, 1993c), Galetovic (1994), Rajan and Zingales (1996). 1090–9443/97/030303+29 $25.00/0/re970043

 1997 Academic Press Limited

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growth occurred in a set of countries seemingly independently of the nature of their financial structures, and the former suggesting instead a link between growth and, at least, the degree of financial development. The existing theory does not offer a coherent view of the relevant channels through which the degree or the nature of development of a financial system might affect growth. Instead, the recent contributions on financial markets and intermediation seem to suggest that different systems are more efficient under some circumstances and/or in some respects but not others, and that this induces effects on growth which are not distinguishable. The theoretical point, here, is that there can be multiple equilibria in this context, so that different financial arrangements might be complementary to certain non-financial features of the economy and lead to similar patterns of growth, with an apparent “irrelevance” of the financial structure. If this is the case, then the irrelevance is only apparent and a crucial task for both theory and policy will be precisely that of identifying and understanding where these successful interactions between the organization of the financial systems and the structure of the productive sector lie, and in particular the incentives to innovate. We believe that a particularly useful way to approach this problem is to focus on the evolution of these systems, and not only on their differences in any particular time. The first reason for doing so is that the presence of complementarities and multiple equilibria means that the phenomena of path dependency will be important in understanding the current organization of financial systems. Hence, to the extent that we seek answers to the question regarding the observed variety of current arrangements, the analysis should also be pursued in a dynamic framework. A second reason is that following some case studies through time should enable the isolation of the numerous factors that intervened in shaping the incentives and the constraints under which each system evolved, and help to clarify some of the interactions and complementarities involved. In order to evaluate empirically the different experiences, one would like to compare detailed data on countries’ financial structures and organization, and for the reasons outlined above, to extend the analysis beyond the specific financial instruments available or the role of the intermediaries, to include the countries’ institutional characteristics and the productive sector structure. Here we take a less ambitious step and combine a quantitative analysis of the recent evolution (the last 15 years) of the financial systems of six developed countries, based mainly on their financial accounts, with a stylized account of the historical evolution of these systems. This approach, although somewhat eclectic and unconventional, may help to shed light on the convergence versus

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7 6 5 4 3 2 1 0 Italy Germany U.S.

–1 –2 –3

France U.K. Japan

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE A. GDP growth rates.

path-dependence debate on economic systems’ evolution. Even such a simple comparison shows how institutional elements affected the development of financial systems and at the same time the organization of firms and their corporate control. The strong complementarities between financial systems and industrial systems seem to indicate that path-dependency is important in explaining current structures and their possible evolution and may account for the fact that some arrangements work better in some systems than in others and cannot easily be exported. Given this multiplicity of equilibria it seems particularly useful to extend the sample normally used for the comparison (U.S. versus Germany, Anglo– Saxon versus Continental) to include more observations from other industrialized countries, which may have quite different financial organizations although, presumably, a similar growth pattern. The balance between having a wider sample and the objective of a case-study approach led us to the choice of six of the most developed countries: the U.K., the U.S., Japan, Germany, France and Italy. These countries have indeed achieved rather similar growth rates in recent times (Figure A). A historical account of the economic evolution of such a diversified set of countries is certainly beyond the scope of the present work. In the following we are only interested in identifying some factors that characterize the historical evolution of these systems and, at the same time, define the challenges and limitations faced by their respective financial systems. The paper is structured as follows. In the first section, we briefly survey the historical experiences of six developed countries (France, Germany, Italy, Japan, U.K. and U.S.) with the aim of showing some of the factors that underline the current organization of their

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financial systems and that explain their current differences and the interactions with other characteristics of the economies. The second part compares the recent development of the financial structures of these economies on the basis of the countries’ financial accounts. This analysis shows how past evolution of the systems still matters in explaining their current structures, even if some changes are under way that are reducing the constraints under which they originally evolved. Hence, the convergence across systems, if any, has been limited. Some extremely preliminary suggestions on the possible effects of different financial structures on some of the channels linking them to growth are discussed, such as the presence of financial constraints. However, the analysis of these links and more precise conclusions concerning the effects on growth, leading possibly to policy indications, need more detailed data on the characteristics of real and financial systems and a comparative analysis based on more micro evidence. Hence this has to be taken as a first step in a larger research project aimed at looking at interactions between financial systems, the productive sectors and the innovative activity. 2. A historical characterization In our view, the main factors involved in the shaping of the structure of the financial systems of developed countries are: (a) the period in which the process of industrialization started, (b) the role played by the state, (c) the degree of opposition to the concentration of economic and financial power, or in some cases, the occurrence of banking crises due to the involvement of banks with non-financial companies, (d) the willingness of central banks to guarantee liquidity to the banks and (e) the size of the internal market (Figure B).† In the British case, the characteristics of its early industrialization period are important to understand the tradition of relatively little involvement in the financing of industry by its banking and financial system, when compared, for example, to industrial bankers in Germany. When the process started, Britain was a very successful mercantilist and trading nation. The wealth accumulated in such activities was concentrated in the hands of rather few individuals, essentially merchants and bankers. Traditionally, the latter were not involved in commerce, and their role was limited to the provision of short-term funds to the former. Therefore, the subsequent industrialization period was characterized by a large availability of internal funds (coming from † For this interpretation see, among others, Gerschenkron (1962), Chandler (1990), De Long (1990).

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Period of industrialization

U.K.

U.S., J, G, I, F

Limited need for large amount finance or State intervention Specialization in light sectors Limited separation ownership/control

Role for large intermediaries Specialization in heavy sectors

Opposition to concentration of power/banking crises/external shock

G

U.S., I, F, J

No separation banks-industrial companies

Separation banks-industrial companies

J Role for informal links

IT, FR Role of State

U.S. Development of other instruments to guarantee growth and separation ownership/control

FIGURE B. Stylized aspects of historical evolution.

trade), which implied a limited need for the direct involvement of banks or the state in firms’ financing, and a specialization in “light”, small scale sectors (given also the limited size of the internal market), which again did not call for large firm sizes and hence external funds. This situation favoured the development of a structure characterized by the separation between banks and industrial firms, more oriented towards short-term finance and where separation between ownership and control of firms occurred only to a limited extent. The British state was not called to intervene to solve problems of economic decline or to channel resources into industry and the developing stock market specialized in government debt and overseas investment. This also meant that British firms remained under the control of their owners for a much longer period than in the U.S. and led to the absence of an extensive middle-management hierarchy.

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After the identification of the so-called “Macmillan gap” in firms’ financing in the 1930s, potentially important institutions were set up in the mid-1930s, but it was only after the war that a serious attempt was made to establish institutions which would devote themselves specifically to small industrial and commercial firm financing.† Only later did the growth of firms through mergers and acquisitions, induce separation between ownership and control and create the need for instruments to reduce the agency problem linked to it (take-overs, involvement of other financial intermediaries etc). Late joiner countries, including to different extents all the others we consider here, experienced a phase of early development similar to each other, characterized by a relevant role played by banks in collecting funds to finance emerging firms with long-term loans and equity and in performing an active role in their corporate governance. The need of a large amount of finance was also induced by the type of specialization that characterized late comers into “heavy”, large economies of scale sectors. In Germany and the U.S. the large amount of capital necessary first for the development of the railroad system and later for the growth of large size firms, was provided by investment banks in the U.S. and by the Grossbanken in Germany. In both countries family control of enterprises declined as a result of mergers between firms that increased their size. Often managers, educated in the prestigious technical schools of the two countries, took the place of the founders. These directors were assisted and monitored by financial intermediaries who also raised the necessary funds. Partners of merchant banks sat on company boards and guaranteed through their reputation a good management of the companies to the dispersed shareholders and creditors, unable to perform such monitoring.‡ The risks of conflict of interest between the lending

† These were the ICFC (Industrial and Commercial Finance Corporation) whose shareholders were English and Scottish banks and Bank of England and the FCI (Finance Corporation for Industry) which was devoted to small firms. In the mid-1970s another institution was set up, the Equity Capital for Industry, designed for small issuers. FCI and ECI developed the ability to monitor firms and by 1990 venture capital was being provided to around 700 companies. See Capie and Collins (1992), Roe (1994), Cox (1986), Hu (1976), Mowery (1992), Chandler (1990). ‡ Germany historically has had the longest tradition of sustained industrial banking. The banks formed in the 1850s, and later, had the predominant and explicit purpose of promoting industrial development, the primary sphere of activity being coal-mining, iron and steel making, electrical and general engineering, heavy chemicals. To promote industrial development they often had to help to take the lead in the setting up of joint-stock industrial companies, and often would also assume an active entrepreneurial role. See Hu (1976).

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activity and equity ownership were solved by means of banks’ reputation.† In Japan, banks were part of the zaibatsu organizations, which, before the Second World War were the largest firms in Japan and resembled the U.S. conglomerates in the 1960s but with family rather than public ownership. Similarly to that of other late joiner countries, Italian early development, at the end of last century, was based on heavy industry and was characterized by a strong State intervention. Mixed banks‡ owned stocks of the largest industrial groups, although without actually performing an active monitoring role and financed the development of these sectors. Also the French financial system had a tradition of industrial banking: the Cre´dit Mobilier (established in 1852) was one of the first examples of special banking industry. After the crisis that shook it in 1866–1867, however, the company declined.§ The different routes taken by these late comer countries afterwards have been affected by various factors. In the U.S., whose financial system appeared at the beginning of the 20th century to share many common elements, especially with the German one, the concentration of financial and industrial power induced a strong political opposition. The potential risks of collusion and conflict of interests were the object of many criticisms, leading to various Congress investigations and, in 1933, to the Glass–Steagall Act.¶ Hence, the strong opposition to the concentration of financial power led to the separation of commercial and investment banking and to the fragmentation of the financial system. The Act legislated a full separation between commercial and investment banks (banks could either take deposits and make loans or engage in the origination and distribution of corporate securities) and introduced federal deposit insurance, thus favouring small banks.∀ This led to the fragmentation of financial institutions and to a number of rules which effectively prevented them from systematically having influential blocks.†† The separation between ownership and control, which was ensured originally by investment banks, had to follow a different route and alternative instruments (more “market-based”, † See De Long (1990), Krozner and Rajan (1994), Ramirez (1995). ‡ Banca Commerciale Italiana and Credito Italiano, established in the 1880s with an important share of foreign stocks (mainly German), were the main ones. § See Levy-Leboyer and Lescure (1991). ¶ See Chandler (1990), De Long (1990). ∀ See Smith and Sylla (1993). †† Banks have been barred from owning stocks and operating nationally; mutual funds generally cannot own control blocks; insurers can put only a fragment of their investment portfolios into any one company’s stock, and for most of this century the big insurers were banned from owning any stock at all. Pension funds are less restricted but they are fragmented since securities rules have made it hard for them to operate jointly (see Roe, 1994).

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such as a better diffusion of information on companies, fiduciary duties and, later, take-overs) developed after a period of managerial control of companies. At the same time improved information had fostered more rapid democratization of the capital markets, through more direct investment by individuals and, recently, indirect individual participation through pension funds and mutual funds. On the other hand, in the German case, the absence of a strong opposition to the concentration of power† allowed the universal banking system to survive and guarantee the separation between ownership and control, together with the involvement of representatives of other interests (other companies, workers) in companies’ boards. Until recently, universal banks were not opposed and the stock market experienced a very limited development. Consequently, the role of the state was never pervasive in Germany. In Italy and France, the separation between commercial and investment banking followed the industrial banks’ crises generated by the excessive involvement in the industrial firms they were lending to (possibly due also to more limited capabilities in firms’ monitoring as compared to the banks in other countries). In France, after the crisis of Cre´dit Mobilier, the leading banks were the Cre´dit Lyonnaise and Socie´te´ Ge´ne´rale. Their difficulties in the 1880s led to the banks’ decision of limiting themselves to short-term loans. Despite the presence of other State sponsored institutions the financial system remained largely dominated by commercial deposit banks (like Credit Lyonnaise) and the Bourse which were not interested in long-term industrial risk and preferred overseas investment to domestic industry.‡ In both countries, contrary to the U.S. case, the separation was followed not by the development of market-based instruments, but rather by a large role for the state; a heavy state involvement substituted financial intermediaries, with the nationalization of a large part of the financial system and the separation between commercial and investment banking. In France during the Second World War the banks suffered from the collapse of the economy. The law of 13 June 1941 defined and regulated the banks and set up supervisory institutions. After 1945 the role of the state has been transformed: as in Japan, the financial system was transformed into a credit system with the State playing a major role in directing economic investment to sectors of industry. Only after 1966–1967 the distinction between investment banks and deposit banks was reduced. In the 1970s the greater liberalization of

† Until 1957, when the Law against Restraints of Competition was passed, in Germany there was no systematic competition policy. See Katzenbach (1990). ‡ See Cox (1986).

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the financial system reduced the role of the planning process.† However, in the 1980s further nationalizations of the banking and industrial sector were pursued and this time also investment banks were nationalized. Pressures were exerted on the banks to be more liberal in providing funds for ailing industries and long-term fixed interest rates were reintroduced. In Italy the slowing down of the boom in 1925–1926 and attempts by the Fascist government to stabilize the lira by adopting a parity of 90 lire to the British pound led to a crisis with deep repercussions on the banking sector. The mixed banks saw themselves blocked with a huge amount of industrial securities in their portfolios which they could not get rid of at reasonable prices in a stagnating capital market. The consequence was a liquidity and solvency crisis which broke out in 1930–1931‡ and which showed the problems in Italy of the close links between banks and firms; the limited development of the stock market and the connections across industrial groups made these difficulties particularly serious. The difficulties extended to whole industrial–financial groups, and led to the largest ownership transfer in Italy: all industrial securities held in the portfolios of two of the major banks were transferred to the newly established state holding companies. After this, the banks’ activity had to limit itself to short-term operations. In 1936 the promulgation of the Banking Law decreed a functional and geographical distribution of credit, creating several categories of banks. The former mixed banks and most other banks could operate only in the field of short-term, commercial banking. Medium and long-term credit had to be allocated by special institutes. The separation between banks and industrial firms was imposed, thus making the system similar to the American model. But the alternative path of developing the market was not followed and instead the state remained one of the main intermediaries in the system. After the Second World War, Mediobanca was founded with the aim of providing long-term credit to the industrial sector and was able to perform the role of the American merchant banks (or the German Grossbanken) for a set of large private groups. The strong presence of the state (which guaranteed sources of finance to firms, often without imposing any condition), the fact that firms were not willing to open to intermediary supervision and the diffusion of guarantees on loans, limited the development of other institutions with characteristics similar to Mediobanca among the special credit institutions.§ Only recently in both France and Italy the role of the State has decreased and the constraints to the banking activity have been † See Cox (1986). ‡ See Ciocca and Toniolo (1994). § See De Cecco and Ferri (1994).

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removed. In France in 1987 the government privatized a few banks (Socie´te´ Ge´ne´rale, Cre´dit Commercial de France, Suez, Paribas). Most of the new financial instruments have been created in the form and at the time chosen by the monetary authorities. 1978 is considered the starting point of the financial innovation process in France: in 1978 the Monory Act provided tax incentives for the development of the stock market; in 1979 mutual funds were created; in 1983 the Delors Act created new financial instruments for the capitalization of nationalized or private firms and a secondary stock market was created; in 1985 commercial paper was introduced; in 1986 financial futures market were introduced, then option markets and future contracts on a stock index.† In Italy, only recently have new types of financial intermediaries started to develop, after reforms in the security law. In 1992 it was decided that state-owned banks should be privatized, and at the end of the year the implementation of the Second Directive of the European Community removed the limits to stock ownership for banks. Finally, in Japan, the limit for banks to own stocks in industrial companies was imposed after the war by the American government, with the aim of reducing the concentration of economic power. In 1948 orders from the Supreme Commander of Allied Powers imposed the destruction of the old corporate system with directives to break up the zaibatsu, to distribute their stocks and to prohibit bank ownership of big blocks of stocks. Also in the case of Japan, this led to the involvement of the state, which stepped into the gap left in the relationship between finance and industry by the dismantling of the zaibatsu.‡ The new engine of economic growth, the MITI (Ministry of International Trade and Industry) induced the privately owned commercial banks to provide long-term loans to large firms and industrial sectors that were chosen as the driving forces of the Japanese economy.§ Contrary to the two other countries, however, the banks’ involvement in non-financial companies was maintained, or rather emerged again in the newly formed keiretsu, even if through more informal channels as compared to the zaibatsu, since fears of Japanese domestic instability led to the decision not to pursue full fragmentation. This allowed closer relationships between finance and industry. During the following decades, stocks moved from individuals to banks and insurers and cross-ownership bound finance and industry together.¶ † See de Boissieu (1990), Peyrard (1992). ‡ See Cargill and Royama (1992), Cox (1986). § The mechanism adopted was the strengthening of the state’s control over the provision and price of credit (see Cox, 1986). ¶ See Roe (1994).

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This extremely stylized account shows how the different systems have solved financing and growth needs of firms in alternative ways. All of them are experiencing in the last period changes in their financial structures and corporate governance systems, partly due to a wider degree of international financial markets integration, with larger possibilities for firms to finance themselves abroad. The questions are, on the one side, whether this is leading to some forms of convergence or the past development of countries is still affecting their structure, and on the other side, as we discussed above, which are the advantages and drawbacks of each system in terms of their long-term growth. In the following section we offer some preliminary evidence on these issues by looking more closely at the recent evolution of these countries’ financial systems. 3. The recent evolution of six financial systems In what follows we offer a more thorough quantitative comparison of the recent evolution of the financial systems of the six countries and offer some evidence on their degree of convergence. From this evidence we might in turn derive some conclusion on the issue of whether we are actually observing different equilibria and whether competition across systems is affecting these equilibria, even if we do not have comparable data on all the “dimensions” of the systems that we would like to consider. The information used are OECD financial accounts, integrated with other sources. These data have significant drawbacks, in that they are extremely aggregated and not always perfectly comparable.† However, they appear to be a natural starting point for a comparative analysis since they are more comparable than the micro data available, both in terms of their coverage and in terms of definition of the variables. Hence, they allow a more detailed description of financial systems than has been presented elsewhere and which only concentrated on firms’ financial structure.‡ The period we consider here is 1980–1994. The information available shows that the convergence across systems, if any, has been rather limited. The evolution of the last 15 years has not changed the main characteristics of the six countries and the traditional distinction between market-based and bank-based countries, even if it has to be qualified, still † In order to obtain the most meaningful comparisons we have aggregated some sectors and made some adjustments (see the Appendix for the details). In particular data for Italy had to be reconstructed for the years before 1989; data for U.K. stocks had to be aggregated from other sources since they are not provided in OECD financial accounts. ‡ See Mayer (1990), Corbett and Jenkinson (1994), Browne (1994).

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2.5 Italy Germany U.S.

2

France U.K. Japan

1.5

1

0.5

0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE C. Financial interrelations ratio (financial assets/tangible assets).

survives. However, we also show how France and Italy represent peculiar cases in that in the last 15 years the first has come closer to the market-based systems, while for Italy the state has crowded out other intermediaries. This might be taken as evidence that it is rather difficult to move from one equilibrium to another and that competition across different systems is not inducing convergence, at least so far. 3.1.

AGGREGATE INDICATORS

A traditional indicator to measure the relative size of an economy’s financial structure is its Financial Interrelation Ratio (FIR), i.e. the ratio of total financial to tangible assets.† The analysis of this indicator over the last 15 years shows a sensible growth for some of the countries (Figure C). In particular, it has shown in the last 15 years an intense growth for France (from 0·37 to 1·18), the U.S. (from 0·81 to 1·65) and the U.K. (from 1·35 to 2·50), lower for Germany (from 0·80 to 1·16), Japan (from 0·82 to 1·18), and Italy (from 0·63 to 0·99) and a relative convergence for France, Germany, Japan and Italy, with the U.K. and U.S. at much higher levels. As we shall see in what follows, the degree of financial deepening of an economy reflects mainly the development of financial institutions, but also households’ propensity to save and the financial choices of firms. † This indicator was first proposed by Goldsmith in his classical analyses on financial systems (see Goldsmith, 1969, 1985).

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However, as we said, this indicator is too aggregate to provide useful insights on the structure of the financial systems. Hence, we shall in turn analyse some more detailed variables describing with greater precision the channels that might affect growth, through the financial system. We shall consider, in turn, the various sectors of the economy, starting with the one that provides funds to the others. We shall try to keep separate the two dimensions of comparisons, cross-sectional and over time, which both provide interesting insights. Different kind of factors appear to be at work at the different levels of choice. Among these the type of pension system affects the allocation of wealth across sectors as does its accumulation; the level of government debt and the taxation system might affect the allocation of wealth between the real and financial component and the allocation of financial wealth of investors across instruments. Again specific regulations (regarding especially financial intermediaries) affect their choices of financial instruments.† 3.2.

HOUSEHOLDS’ PORTFOLIOS

If we consider the accumulated stocks of financial wealth in terms of disposable income (Figure D), we observe a clear distinction between countries with large households’ financial assets (U.K., U.S., Japan) and the others. This appears to be partly related to the countries’ pension systems: where social security covers a lower amount of pension payments (as in the U.S. and U.K.‡) and financial assets held by households (in particular pension funds and life insurances) are higher. However, approximately the same grouping (with France as an exception) emerges when households’ liabilities are considered. In these countries intermediaries offering mortgages provide households with instruments for intertemporal transfer of funds, while in Italy and Germany households need to rely to a greater extent on “informal” financial markets to invest in the housing market, which leads to an extremely low level of households’ liabilities. If we consider in detail the instruments held by households † We have not discussed so far the role of legal systems which have recently been widely analysed as responsible for the degree of investor protection and, possibly as a consequence, for the amount of external finance available to firms. See La Porta et al. (1996a, 1996b). For what concerns the countries we are considering, they have widely different legal systems: the United States and United Kingdom have a common law tradition, Italy and France a civil code of French tradition and Germany and Japan what has been defined as a civil code of German tradition. ‡ See Davis (1995).

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4

3.5

Italy Germany U.S.

France U.K. Japan

3

2.5

2

1.5

1

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE D. Households financial assets/disposable income.

70

60

50

40

30

20

10

Italy Germany U.S.

France U.K. Japan

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE E.1. Households financial assets (deposits) (percentages on total financial assets).

(Figure E), we observe that a grouping emerges. At the beginning of the 1980s, on the one side we have Japan, Germany, Italy and France, where deposits accounted for the bulk (more than 50%) of financial assets; in these countries banks collected most of households’ assets; on the other side in the U.K. and U.S. deposits were high (approximately 30% of total assets) but other financial assets† were equally important (more than 30%). Other financial † Including assets held in pension funds, insurance companies, mutual funds, etc.

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35 30

Italy Germany U.S.

France U.K. Japan

25 20 15 10 5 0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE E.2. Households financial assets (securities other than shares) (percentages on total financial assets).

50 45 40

Italy Germany U.S.

France U.K. Japan

35 30 25 20 15 10 5 0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE E.3. Households financial assets (shares) (percentages on total financial assets).

institutions (pension funds, insurance companies, investment companies), provided households with a way to invest their assets. Shares and participations in companies represented a relevant part of financial assets only in Italy and the U.S., albeit with the major difference that in the U.S. the shares were mainly listed, whereas in Italy they were mainly unlisted. This description seems to confirm the traditional distinction between bank-based systems, characterized by a more concentrated

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70 60

Italy Germany U.S.

France U.K. Japan

50 40 30 20 10 0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE E.4. Households financial assets (other financial assets) (percentages on total financial assets).

and less competitive structure, and other systems, more fragmented and competitive, even if with some qualifications concerning the relevance of shares in Italy. This last characteristic is related to the ownership structure of the companies with a limited amount of separation between ownership and control and a large diffusion of family control of companies. The evolution over the last 15 years suggests that in all countries there have been changes. Firstly, a common trend has emerged in the reduction of deposits in households’ portfolios and the growth of “other financial assets” (their weight has in general at least doubled in the period†), i.e. an increase in investors’ sophistication and in the investments’ horizon, with a reduction in their liquidity. Secondly, households’ holdings in France and Italy have shown different behaviours: in France the major reforms that have been introduced since the beginning of the 1980s for the development of the stock market and at the same time the introduction of the privatization program have induced a substantial growth of shares held directly by households; in Italy the reduction in deposits is mainly explained by the increase in state securities (short- and long-term). Over the period, the growth of government deficit has absorbed a large share of households’ financial assets. This implies that the large amount of net financial assets held by Italian households is only partially available to the private productive sector. The recent evolution suggests that historical patterns of evolution still matter in terms of allocation of households’ financial † They are mainly life insurances in Germany, France and Japan, pension funds in the U.K. and U.S., life insurances and mutual funds in Italy.

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1.05 1 0.95 0.9 0.85 0.8 0.75 0.7 0.65 0.6 0.55 0.5

Italy Germany U.S.

France U.K. Japan

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE F. Financial intermediation ratio.

assets: the distinction between bank-based and market-based (or better institutional-investor-based) economies still holds and in the Italian case, the state still plays a substantial role. However, some regulatory changes are under way, possibly induced by a stronger competition in international capital markets, which, when consistently pursued, can successfully change some of these patterns.

3.3.

THE ROLE OF INTERMEDIATION

An aggregate measure of the importance of financial intermediaries is given by the financial intermediation ratio (Figure F), the ratio between financial assets of intermediaries and financial assets of domestic non financial sectors and the foreign sector. At the beginning of the 1980s the ratio was rather similar across countries with Italy at the lowest level. In the last 15 years the financial intermediation ratio has been rather stable around the values 0·8–0·9 for a group of countries, and has instead strongly reduced for France and Italy, suggesting, for these two countries, a process of disintermediation. Again, this hides different characteristics of the systems. On the one side we had a larger weight of banks’ financial assets for the U.K., France and, to a lesser extent, Germany and Italy (Figure

320 3

2.5

M. BIANCO, A. GERALI AND R. MASSARO Italy Germany U.S. France U.K.

Japan

2

1.5

1

0.5

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE G. Monetary institutions’ financial assets. 3 2.5

Italy Germany U.S.

France U.K. Japan

2 1.5 1 0.5 0

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

FIGURE H. Other financial institutions’ financial assets/GDP.

G) and on the other side a greater weight of other financial institutions† in Japan, the U.K. and U.S. (Figure H). If we take into account that “other financial institutions” in Japan include cooperative and other credit institutions‡ and that nearly 50% of the banks’ financial assets in the U.K. consist of loans to the rest of the world,§ we find a rather clear grouping of countries: in France, Germany, Japan and Italy banks held the largest share of † Including insurance companies, pension funds, mutual funds, investment companies. ‡ 70% of their financial liabilities are in fact represented by deposits. § And hence the financial assets used by the domestic system are only slightly higher than those of U.S. banks.

FINANCIAL SYSTEMS ACROSS “DEVELOPED ECONOMIES”

321

financial assets whereas in the U.K. and U.S. other financial institutions did. In the last 15 years, although other financial institutions grew faster than banks in virtually all six countries, this did not produce a change in the country groupings in terms of the most important financial intermediaries. However, the growth of other financial institutions has implied a change, even if slow, in the kind of involvement and financing of firms with respect to the past; while for banks, except in Germany and Japan, it was mainly based on loans, other financial institutions typically invest a larger amount of their assets in shares (see Table 1). Also in countries characterized by regulatory or de facto separation between banks and industry, this has induced a change in the relationships of financial intermediaries with corporate governance, with a slowly evolving shift towards larger involvement of financial institutions in firms’ equity. Italy and France nonetheless showed some distinctive features. In both countries there was a process of financial disintermediation: the fall in the Italian ratio was almost entirely due to the substitution of bank deposits with public sector securities in households’ portfolios; that in the French ratio, due to the development of the stock market and the subsequent privatization, resulted in an increase in the proportion of shares held directly by households. So far we have quantified some of the relevant changes in financial structures witnessed over the last 15 years, which appear to be consistent with past development of the various countries: those characterized (at least until recently) by the separation between banks and non-financial companies are allowing other intermediaries to grow; those without such separation see a further growth of banks; finally those characterized in the past by strong state involvement have experienced a different but still substantial role for the State in the financial sector. Only France seems to show substantial changes with a significant reduction in the role of the state and an increase of other financial institutions. Before analysing the flow of resources to firms, in order to fully characterize the financial systems we need to introduce some further qualifications concerning the other sectors providers or users of funds; the state and the foreign sector. The weight of the latter is extremely important in the U.K.; its financial assets over GDP are 2·08 and financial liabilities 2·10 compared to values well below 1 for all other countries. Its relevance is linked to the deposits of the foreign sector in British banks, on the one side, and to foreign securities and bonds owned by British residents on the other side. This role of U.K. banks has characterized, as we discussed above, all their evolution. In the other countries the assets held by the foreign sector have approximately doubled in the period considered. They represent approximately 10% of all

30·58 13·67 5·12 28·63 21·80 7·19 4·83 4·92 2·39 2·35

France Monetary institutions Other financial institutions

Germany Monetary institutions Other financial institutions

U.K.† Monetary institutions Other financial institutions

U.S. Monetary institutions Other financial institutions

Japan Monetary institutions Other financial institutions 2·15 3·93

4·18 3·20

15·86 10·71

6·36 35·83

30·50 1·32

17·08 4·82

1994

22·28 21·14

22·96 35·05

2·59 41·04

12·04 23·01

4·20 47·16

28·57 34·01

1980

14·76 24·71

28·47 38·63

1·99 48·07

20·42 15·57

10·25 70·88

25·56 50·00

1994

Securities

† For Italy, the first year available is 1982, for the U.K. is 1981.

24·62 35·83

1980

Cash and deposits

67·44 69·49

65·18 32·16

73·61 14·93

79·44 42·76

57·90 3·46

40·01 15·40

1980

73·82 51·46

52·83 28·15

72·57 2·80

67·77 20·83

52·62 5·22

49·85 22·28

1994

Loans

Financial assets of financial institutions (percentages on total financial assets)

Italy† Monetary institutions Other financial institutions

TABLE 1

7·19 6·34

4·48 23·36

1·56 28·56

1·76 5·60

1·82 35·71

0·98 14·58

1980

8·52 9·99

7·26 26·36

8·87 21·49

4·65 27·77

5·42 22·57

1·90 21·27

1994

Shares

0·70 0·68

2·55 4·51

0·44 8·29

1·64 0·00

5·49 0·00

5·82 0·17

1980

0·75 9·90

7·26 3·66

0·71 16·93

0·80 0·00

1·21 0·00

5·61 1·64

1994

Other

322 M. BIANCO, A. GERALI AND R. MASSARO

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323

100

Percent

80

60

40

20

0

1982 1994 1980 1994 1980 1994 1981 1994 1980 1994 1980 1994 Italy France Germany U.K. U.S. Japan Deposits Shares Loans Other Securities other than shares

FIGURE I. Non-financial companies liabilities (percentages).

financial assets in Italy, France and Germany and around 5% in the U.S. and Japan. The limited weight of the foreign sector until recently might be one of the reasons for the fact that we do not observe a large degree of convergence across financial systems yet. For what concerns the state, while in almost all countries it is generally a net user of resources, Italy shows the highest value of government liabilities compared to GDP. These values, accumulated over the 1980s, have obviously had an effect on other sectors’ financing and have resulted in extremely low liabilities of the private non-financial sector as compared to all other countries and, at the same time, in a lower level of financial deepening.

3.4.

FIRMS’ FINANCING

Finally, we aim to discuss the impact of these structures on firms’ financing and on their allocation of control. Also for what concerns firms’ financing in 1980 we observed a clear division of the six countries into different groups: the first included Germany and Japan, where the bulk of financing was in the form of bank debt; the second comprised the U.K. and the U.S., where shares and bonds, issued mostly by listed companies, accounted for the lion’s share; and the third, France and Italy, where the ratio of bank debt to (unlisted) equity was close to one and the contribution of bonds negligible (Figure I).

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Changes were similar in all countries over the 15 years considered, with a reduction in the importance of bank debt and an increase in that of bonds, except in Italy. Again there was a major shift in France, where the composition of non-financial enterprises’ liabilities in 1994 became comparable to those of the U.S. and U.K. Nonetheless, there continues to be a clear divide between these three countries and Germany and Japan, where bank debt is still the main source of financing. Flow of funds data allows direct comparison of the sources of finance with the investments of firms. What emerges confirms to some extent what has been already observed elsewhere,† that retentions appear to be the main source of funds for firms’ investment, both among gross sources of funds and, obviously even more, as a net source. However, there appear to be differences across countries in their values: retentions are particularly high in the U.S., U.K. and Japan, when evaluated in terms of gross sources (Table 2). Also in terms of net sources, the distinction persists. In the U.K. and U.S. retentions always contribute for at least 90% of investment expenditures. Again, since the mid-1980s, France has come closer to the Anglo–Saxon model under this respect. Japan, Germany and Italy have instead lower levels of the ratio of retentions to investments. Loans are generally the second source of finance, and at the beginning of the 1980s were more important in Italy, Germany, France and Japan both on a gross and on a net basis. During the last 15 years, however, their importance has decreased everywhere except in Germany, and recently provided a negative contribution to investment in France and the U.S. The stable importance of capital transfers in Italy and Germany‡ over the period is remarkable, reflecting the role that the State still plays in firms’ financing there. For what concerns market sources, securities other than shares are relevant in the U.S., both on a gross and on a net basis, and, starting in the 1980s, also in France and Japan. In Italy they represent a negative net source of finance for investments. Finally, new equity is an important source of finance in rare cases. In France it is particularly high on a gross basis, but more modest (even if still relatively high) on a net basis.§ It is a negative source, in the period considered, for the U.S., Germany and, except recently, for the U.K. Only in Italy and Japan does it represent a sizeable source. The importance of retentions in the U.K. and U.S. and, recently, † See Mayer (1990), Corbett and Jenkinson (1994). ‡ Even if in Germany they are partly overestimated due to the accounting system of the housing sector. § This difference is linked to the phenomenon of cross shareholdings.

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TABLE 2 Firms’ sources of funds (percentages on the total) 1980–1984 Gross Italy Retentions Capital transfers Securities other than shares Loans New equity Others France Retentions Capital transfers Securities other than shares Loans New equity Others Germany Retentions Capital transfers Securities other than shares Loans New equity Others U.K. Retentions Capital transfers Securities other than shares Loans New equity Others U.S.A. Retentions Capital transfers Securities other than shares Loans New equity Others Japan Retentions Capital transfers Securities other than shares Loans New equity Others

Net

1985–1989 Gross

Net

1990–1994 Gross

Net

38·5 5·4 2·9

48·7 6·8 −1·4

53·5 6·5 1·5

68·4 8·3 −8·6

48·5 7·6 0·6

57·7 9·1 −3·2

35·6 9·3 8·3

44·6 5·4 −4·1

26·1 7·4 5·0

32·7 1·4 −2·3

26·6 8·6 8·1

27·6 6·2 2·6

41·6 1·4 5·0

58·6 2·0 5·5

51·9 2·1 6·4

81·8 3·2 1·0

57·5 3·9 4·9

91·3 6·2 4·5

36·0 39·8 11·6 4·5 2·0 −10·4

18·1 17·7 1·4

13·4 5·6 −5·1

5·5 20·4 3·1

−4·8 1·7 1·1

42·0 16·5 0·4

50·3 19·7 −1·4

55·9 15·1 1·2

67·6 18·3 0·1

44·9 12·3 6·6

57·3 15·7 3·5

35·3 1·4 4·3

35·7 −0·2 −4·2

22·6 2·3 3·0

21·5 1·7 −9·2

31·5 2·1 2·7

30·0 −2·6 −4·0

67·0 1·0 2·8

98·6 1·5 0·9

48·1 0·0 0·3

77·4 −0·6 −2·2

58·9 0·0 6·8

75·3 −0·3 7·5

20·1 15·9 7·6 −0·5 1·4 −16·4

36·8 52·6 15·2 −3·5 0·0 −23·8

15·6 20·8 17·0 10·2 0·2 −13·5

71·8 — 10·8

72·0 — 15·5

87·6 — 17·4

89·3 — 9·9

102·9 — 8·2

25·8 29·7 −14·6 −20·1 1·3 −14·9

−1·2 0·4 1·8

−0·5 −7·7 −2·9

72·6 2·4 10·5

62·1 2·8 5·9

67·8 3·1 5·2

34·1 51·7 5·2 4·2 4·8 −41·4

27·5 1·8 −0·2

30·0 2·9 −9·1

86·1 — 9·8

28·7 31·1 −13·7 −20·3 2·4 −6·6 54·1 2·6 3·2

71·5 3·4 0·6

37·1 49·0 3·7 3·7 −0·7 −28·2

47·8 1·6 6·6

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France, might be interpreted as a preliminary sign of the existence of stronger financial constraints for Anglo–Saxon countries and appears in line with some micro-evidence on firms’ financial constraints in various countries† which seems to suggest that in the U.K. they are stronger than in other bank-based European countries and that they are in general lower for companies with close banking relationships. As Sussman (1994) suggests, however, this evidence may simply be driven by the amount of investment of the various countries. If what matters is instead the short-run dynamic, it might be that in some countries loans bridge the gap between retentions and investments when necessary. Hence we compare the correlation between retentions and investment with that between investment and the sum of retentions and loans; if loans reduce the constraints the first correlation should be lower than the second. In the period considered for Germany and Japan the correlation increases when we include also loans (from 0·91 to 0·98 in Germany and from 0·84 to 0·91 in Japan), while it decreases for the U.S. (from 0·88 to 0·76), suggesting that in the first two countries bank loans perform the role of reducing financial constraints while in the U.S. this is not the case. The other countries are, however, more difficult to classify: France seems to be closer to the U.S., in that the correlation decreases even if only slightly (from 0·92 to 0·90) and Italy appears under this respect closer to the bank-based systems, since the correlation increases but remains relatively low (from 0·80 to 0·84). The U.K., however, turns out to be similar to Germany and Japan since the correlation increases when we include loans (from 0·75 to 0·86). On this point more micro-evidence is needed. In evaluating the efficiency of different systems in financing investments, it is customary to consider the degree to which a financial structure favours long-term investments, mainly through ex-ante, interim and ex-post monitoring. What is not taken into account is the dynamic problem of the allocation of control. In the German and Japanese systems, where long-term relationship between firms and banks may favour a longer-term horizon for investments (a role which recently seems to be performed also by some categories of institutional investors in the U.K. and the U.S.), the more limited reallocation of control might imply a lower dynamic efficiency, due to a reduced entry of new agents on this market. Under this respect the intermediaries “banks” may be less efficient in the long run. Again, we need more micro-evidence on a comparable basis.

† See Bond et al. (1994), Hoshi et al. (1990).

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4. Conclusions The relationship between finance and growth is the result of possibly complex links going through the real economy structure and its institutional characteristics. This implies that history matters in the evaluation and analysis of current financial systems. Presented here is a survey of the essential elements of the recent evolution of some developed systems. It shows how, for some of the most developed economies, the characteristics of financial systems in terms of the weight of different financial intermediaries, the modes of raising funds and of firms’ financing in the last 15 years are rather stable and show limited signs of convergence. This, in the light of their rather similar growth patterns in the same period, seems to confirm that the different organizations represent different, possibly equally efficient, equilibria. The next step is to establish, both at the theoretical and at the empirical level, a relationship between the financial structure of the systems and their industrial structure and institutional characteristics which would allow the evaluation of the advantages and limits of each type of financial systems. Here we only offer some suggestions concerning the role of financial systems in reducing financial constraints. However, their capacity in ensuring an efficient allocation of control of companies and the incentives they provide for long-term investments and innovative activity should be explored. A greater availability of comparable data on these issues still represents a major obstacle.

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Mowery, D.G. (1992). Finance and corporate evolution in five industrialized economies, 1900–1950. Industrial and Corporate Change, 1, 1–36. OECD (1992). OECD Financial Statistics, Methodological Supplement, 1991–92. Paris. Peyrard, J. (1993). The French Financial System. In F. Dreyfus, J. Morizet, M. Peyrard, Eds. France and EC Membership Evaluated. London: Pinter Publishers. Rajan, R. & Zingales, L. (1996). Financial Dependence and Growth. mimeo, University of Chicago. Ramirez, C.D. (1995). Did J.P. Morgan men add liquidity? Corporate investment, cash flow, and financial structure at the turn of the twentieth century. Journal of Finance, 50, 2, 661–678. Roe, M. (1994). Strong Managers, Weak Owners. Princeton: Princeton University Press. Smith, G. & Sylla, R. (1993). The transformation of financial capitalism: An essay on the history of American capital markets. Financial Markets, Institutions & Instruments, 2, 2. Statistische Bundesamt (1994). Statistische Jahrbuch fu¨r die Bundesrepublik Deutschland. Sussman, O. (1994). Investment and banking: Some international comparisons. Oxford Review of Economic Policy, 10, 79–93.

Acknowledgements We would like to thank E. Berglo¨f, T. Guinnane, O. Sussman and participants to the conference on “Financial Institutions and Economic Growth: the Long-Run Perspective” for extremely useful comments, V. Di Giacinto and C. Ortenzi for excellent research assistance and Mme Blond of INSEE and Mr Heinelt of Bundesbank for providing us with some data. The usual disclaimer applies.

Appendix 1—The data SOURCES

Financial accounts data are diffused by OECD for France, Japan, U.S., Germany.† The outstanding stocks for the U.K. were obtained by aggregating the statistics published by the Central Statistical Office in a way to make them comparable with the OECD data. Data for Italy are derived from a new data set. The approach used has been that of implementing the new methodology of financial accounts, adopted since 1989, with the sources existing until 1988. As the older sources did not contain the full detail to implement the new methodology, some estimates were necessary.

† See OECD (1992).

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INSTITUTIONAL SECTORS

The data on 12 institutional sectors published by the OECD for the countries we consider are not homogeneous, both because of the institutional characteristics of the countries and because of country specific methodologies. To obtain sufficiently comparable data it was necessary to consider only two subsectors for financial institutions (Central bank and other monetary institutions; insurance companies and other financial institutions) and the sector general government as a whole. Households and non-financial enterprises have two different definitions: (a) France, U.K. and Japan include among households non-corporate enterprises; (b) Italy, Germany and U.S. include among non-financial enterprises both corporate and non-corporate enterprises. These differences are dealt with the use of real aggregates that refer, wherever possible, to the same definition of the sector.

FINANCIAL INSTRUMENTS

In order to have more homogeneous data some integrations have been made on shares and commercial credits. Shares as liabilities of non-financial enterprises are not published in the OECD data for the U.S. The OECD data have been supplemented with national data on shares. Equity in non-corporate enterprises has been excluded from financial assets of households as they are not available for other countries. For Japan the data on shares published by the Economic Planning Agency have been used, because they refer to an aggregate that is larger than that of quoted corporations. Commercial credits are only those with respect to the rest of the world, allocated to non-financial enterprises.

CONSOLIDATION

In Italy, France and U.K. a few sectors are consolidated, with limited effects. In Japan deposits and loans within banks and other financial institutions are consolidated. In the U.S. shortterm inter-bank deposits and shares of non-financial enterprises are consolidated. In Germany all sectors are consolidated except for transactions referring to shares and bonds.

TANGIBLE ASSETS AND OTHER REAL AGGREGATES

In constructing data on tangible assets particular attention has been devoted to obtain data comparable to those used by Goldsmith

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(1985). Therefore we used data including consumer durables. Where this information was not available, they have been estimated on the basis of other external information or on the basis of the values presented in Goldsmith (1985). For France, data at constant prices are taken from “Comptes et indicateurs e´conomiques, Rapport sur les comptes de la Nation”, published by INSEE. Data at current prices were obtained by applying the housing price index (INSEE, Annuaire statistique de la France). Data for consumer durables, not available, were estimated on the basis of Goldsmith (1985). For Germany, data from Statistische Bundesamt, “Statistische Jahrbuch fu¨r die Bundesrepublik”, were used. They are not particularly detailed on sectors and type of goods, which had to be estimated. For the U.S., data from the Board of Governors of the Federal Reserve System, Balance Sheets, were used. They do not include data on public administration tangible assets, which were estimated. For the U.K., detailed data are available from the Central Statistical Office, United Kingdom National Accounts. For Japan, detailed data are available from EPA, Annual report on national accounts. Data on GDP were taken from IMF publications. Data on disposable income and value added were taken from OECD, National Accounts.