Financial Intermediaries, Markets, and Growth

In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. The authors' model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. They show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. They also show the optimal mix of two structurally very similar economies can be very different.