misallocation episodes are sufficiently frequent to merit including effective risk-reduction mechanisms for both the banking system and the non-bank financial sector including macro-prudential measures among the relevant supporting institutions.

# _Empirics and Issues_

The relative merits of bank-based/RBFS and market-based/ALFS have been the subject of extensive empirical work.

Historical case studies, notably assessments of industrialization in late 19<sup>th</sup> century Western Europe have importantly shaped the evolving debate. A popular view – dating back to Alexander Gerschenkron’s (1962) analysis – argues that Britain, with already well developed capital markets and a fairly extensive and differentiated banking system – including country, national and internationally focused banks - was able to rely on a diverse set of financial structures to fund industrialization, reaping the maximum benefits from the two-sided feedback loop between financial and real development. Conditions on the continent in this view were less propitious. Conditional on the starting point, the emerging financial structure centered on banks with deep ties to their customers was however seen as an effective arrangement for funding the catch-up process, with the German three pillar system centered on the large universal banks complemented by savings and co-operative banks focused on the small business sector gaining particular attention. More recent empirical work including comparative studies however qualifies some of the central tenets of this dichotomous view in terms of both features and measurable outcomes.<sup>7</sup> The case studies permitting in depth exploration of national idiosyncrasies are complemented<sup>8</sup> by a recent literature exploring the linkages for broad cross-country datasets<sup>9</sup> documenting a strong link between financial development and economic growth, but tending to find less robust evidence for conditional systemic links between financial system structure and performance. Context dependence, with both RBFS and ALFS better suited for some but not other sets of (partly time-varying) circumstances provides a possible interpretation (Rajan and Zingales (2002)). Under this view, the ability of the financial system structure to adjust to changing circumstances, and the extent to which policy measures can facilitate the adjustment is of obvious interest. The range of relevant determinants discussed in the literature ranges broadly from deep parameters largely outside the scope of policymaking to slowly changing features and specific factors – such as detailed provisions of bankruptcy rules or tax laws - amenable to intervention.<sup>10</sup> In considering these theories, the profound long run stability of overarching financial system structures (Fohlin (2000)) provides some support to views focusing on deep structural parameters, though persistence may also result from the combination of time varying factors and feedback loops.

> 7 See in particular Fohlin (1997,2000)) as well as the contributions in Forsyth and Verdier (eds. 2003).

> 8 See Levine (1997,2002) for integrated assessments of the literature.

> 9 See e.g. the studies in Demirgüç-Kunt and Levine (eds. 2001).

> 10 Largely invariant or slow changing factors include the structure of the legal system (La Porta et al. (1997, 2002)) and the interaction between political structures, financial system governance and financial system structure (Verdier (2002)).

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