5 In this setting, the poor, who have no formal collateral, or small enterprises that would be more likely to recruit the poor, would find it difficult to reap the benefits of a larger financial sector. Financial development would thus favor the rich and increase income inequality if not accompanied by reforms to deal with information problems (Banerjee and Newman, 1993; Galor and Zeira, 1993; Piketty, 1997).

Alternatively, loan providers could invest in gathering additional information on projects that would lead to a better perception of the probability of success for a given project (Devinney, 1986; Singh, 1994, 1997). In this regard, a number of authors have argued that banks would be better placed than markets in alleviating these informational problems. For instance, Diamond (1984), Boot and Thakor (1997), Boyd and Prescott (1986), and Ramakrishnan and Thakor (1984) stress the critical role banks play in easing information asymmetries and thereby improving resource allocation. Furthermore, banks frequently establish close, longterm relations with firms and ease cash-flow constraints on existing firm expansion with positive ramifications on economic growth (Hoshi et al., 1991). By contrast, markets have been argued not to produce the same improvements (Bhide, 1993; Stiglitz, 1985). Stiglitz (1985), for instance, argues that well-developed markets quickly and publicly reveal information, which reduces the incentives for individual investors to acquire information.

The importance of a market-based versus bank-based financial system may depend on existing institutions. According to this view, economies will benefit from becoming more market-based only as their institutional framework strengthens (Levine, 2002). Gerschenkron (1962), Boyd and Smith (1998), and Rajan and Zingales (1999) stress that banks can more effectively force firms to honor their contracts than atomistic markets and would thus be especially important in countries at early stages of development and with weak contract enforcement capabilities.

As institutions in countries mature, the exchange of information becomes more efficient, reducing the cost of screening borrowers. In advanced countries, databases centralizing information on borrowers are often established by the private sector or maintained by central banks. These registries collect information on the standing of borrowers in the financial system and make it available to lenders. The system improves transparency, rewarding good borrowers and increasing the cost of default. Detragiache et al. (2005), Djankov et al. (2005), McDonald and Schumacher (2007), and Singh et al. (2009) all show that information-sharing is associated with greater financial development.

The law and finance literature has stressed the importance of legal institutions (especially those protecting private property rights) in explaining international differences in financial development. Where legal systems enforce private property rights, support private contracts, and protect the legal rights of investors, lenders tend to be more willing to finance firms —in other words, stronger creditor rights tend to promote financial development (see Acemoglu and Johnson, 2005, Cottarelli et al., 2003, Dehesa et al., 2007, McDonald and Schumacher, 2007, Singh et al., 2009, and Tressel and Detragiache, 2008).

Hence, theoretically, given a certain level of institutional development, banks may have an advantage in dealing with information asymmetries compared to markets. If this is true, a bank-based financial system would be able to either provide better access to credit to poor