Bank oriented System, Market oriented System

Economic literature makes a distinction between so-called ‘bank-oriented’ systems in which financial institutions are the predominant source of financing and a ‘market-oriented’ model whereby funds are raised primarily via the securities markets. In the former, banks are responsible for channelling funds from savers to borrowers, particularly non-financial corporates. By performing this intermediation role, banks constantly ‘monitor’ the borrowers on behalf of the deposit holders, a function which could not be conducted individually by each of those deposit holders or lenders.

In a market-oriented system, the companies are more inclined to issue securities (shares, bonds, etc.). Savers purchase these securities directly through distribution networks or banks. However, the key difference is the absence of any financial intermediary that alters the nature of the security issued.

Although both forms of financing coexist in all jurisdictions, countries differ in terms of the relative weight of each model. The synthetic proxies often used to determine the system bias include the stock of bank credit outstanding with the private sector and the market value of the securities equity shares and fixed income (bonds and notes)  issued by private enterprises. In order to facilitate a comparison between countries, these indicators are usually measured against the value of a country’s gross domestic product (GDP).

A comparison using those benchmarks confirms that the US is the most market-oriented system, while the banks dominate the financial systems in Europe. Specifically, the European banking system, measured by its volume of assets or their weight in GDP, is nearly three times the size of the US system. Conversely, the percentage of listed securities’ market values over GDP in the US is much higher. This can be partially attributed to the fact that the US system is more specialised in direct financing via the markets.

Bank-based vs Market-Based Economies

In countries such as Japan, France and Germany, where banks provide around 20% of the corporate financing, it is known that banks are making significant effort to develop a relationship banking culture, with long-term loans and preferential interest rates for clients with a ‘good history’. These economies can be called Bank-Based Economies.

There are also countries where the borrowing-lending activities take place through organized markets, such as London Stock Exchange, in the UK, or New York Stock Exchange in USA. These are known as Market-Based Economies. Although banks are present in these countries, they are highly competitive, the relationship with lenders and borrowers is purely limited to the transactions of granting loans or taking deposits and loans are usually granted on short-term.

The competition between the bank-based financial system and the market-based one is starting to lose terrain nowadays, due to globalization. The clear separation between the two types of financial systems is slowly fading, since banks have become active players on the organized markets. In addition, banks are constantly changing the way they are operating as financial intermediaries, moving from the ‘brick and mortar’ concept of bank towards an almost exclusive electronic presence.