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Banks versus Bonds: A Simple Theory of Comparative Financial Institutions

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Abstract

We use a simple, graphical moral hazard model to compare monitored bank lending versus non-monitored bond issues as sources of external funds for industry. We contrast the conditions that theoretically favor each system, such as the size and number of firms, with conditions prevailing when these financial systems were developed during the British and German Industrial Revolutions. Then, to address the question why different systems have persisted, we embed the model in an entry game in which firm size and number are endogenous. We show that multiple equilibria can exist if financiers take the industrial structure as given and vice versa. Finally, we compare these equilibria in welfare terms.

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  • Sandeep Baliga & Ben Polak, 1995. "Banks versus Bonds: A Simple Theory of Comparative Financial Institutions," Cowles Foundation Discussion Papers 1100, Cowles Foundation for Research in Economics, Yale University.
    • Handle: RePEc:cwl:cwldpp:1100
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    File URL: https://cowles.yale.edu/sites/default/files/files/pub/d11/d1100.pdf
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    Cited by:

    1. Al-Jarhi, Mabid Ali M. M., 2016. "An Economic Theory of Islamic Finance Regulation," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 24, pages 1-44.
    2. Sandeep Baliga & Ben Polak, 1998. "Banks Versus Bonds: the Emergence and Persistence of Two Financial Systems," Discussion Papers 1221, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

    More about this item

    JEL classification:

    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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