Financial System Components - Substitutes or Complements?

Abstract

Prior studies have examined the development of the financial system and its impact on economic growth, but little has been said about the relationship between its four major components: banking, the stock market, the bond market (private and public bond) and insurance (life and nonlife). Using a dynamic panel of 106 countries over the period 1980-2007, we use the GMM (generalized-method-of-moments) system estimator to observe the pair-wise relationships between these components. Our findings show a high level of interdependence. When evaluated at the average level of each component’s development, the majority of the pair-wise relationships reveal that one component will act as a substitute for the other. This should be taken into consideration for policies relating to growth in the financial sector.