Financial Nexus: Efficiency and Soundness in Banking and Capital Markets

Abstract

Based on a modified version of a model used in Corvoisier and Gropp (2002) and de Guevara et al (2005), we argue that banks’ soundness, the structural characteristics and efficiency of the banking sector and the development of the capital markets are forming a financial nexus. For a data set of 63 developed and developing countries, we find evidences that efficiency significantly modulates the linkages between concentration and soundness. We also find that capital markets’ development is supporting a stable evolution in banking sector. For the relationship between capital markets and soundness, our findings appear to be robust for various measures of the considered variables as well as for different estimation techniques. In what concerns the impact of the concentration upon soundness, the results obtained display a certain sensitivity regarding the way concentration is measured.

Keywords: bank concentration, efficiency and soundness; Z-scores, Lerner index; Arellano and Bover models, Two-Stages Quantile regression models

JEL Classification: G21; G28; L11