Capital Markets and Economic Growth - Long-Term Trends and Policy Challenges


Published: 01 March 2014

The following is an online summary of this particular AIMA paper



The financial crisis of 2008 threw into sharp relief the weaknesses of the banking sector, prompting massive state bail-outs and decisive supervisory action by G20 nations: banks have been forced to reduce the size of their balance sheets and build up stronger capital buffers, with a view to ensuring that they are better able to withstand any future shock.

But this leaves policymakers across the globe with a dilemma. How do they ensure that building a more stable, resilient financial system does not come at the expense of economic growth? New rules have required banks to scale back the amount of money that they lend, which in turn means that firms − particularly small and medium enterprises (SMEs) − are less able to access the capital that they desperately need to be able to invest in and grow their business.

This has led to increasing interest on the part of policymakers in the role that market finance − sometimes referred to as part of the ‘shadow banking’ system − could play in terms of filling the lending gap and allowing firms to access the capital that they need for growth.

In its simplest form, market finance is based on a model whereby businesses are able to raise capital from investors by issuing shares and bonds − by accessing capital markets. In some regions, like North America, capital markets already dominate, contributing more to the supply of finance than the banking sector. In other regions, such as Asia, the primary source of capital is banks, with capital markets playing a more peripheral role.

Europe is an interesting region to consider, because it is characterised by differences between countries in terms of the balance between market-finance and bank-based lending. We at AIMA were keen to explore these differences, to see whether this could provide broader insights into global financial structure and its future evolution. Specifically, what do differences in the balance between bank lending and capital markets mean for economic growth? Do capital markets offer a source of finance that has positive spill-over effects on the economy?

AIMA asked two leading academics in this field, Christoph Kaserer and Marc Steffen Rapp, to explore these questions, resulting in the publication of the study ‘Capital Markets and Economic Growth − Long-term trends and policy challenges’.

The study’s key finding is that the balance between market finance and bank lending does matter and that overreliance on banks comes at a cost in terms of reduced economic growth. The study estimates that growing capital markets by one-third could fuel a long-term real growth rate in per capita GDP of around 20 percent.

The study also highlights the positive role that hedge funds can play, using their expertise and willingness to create positive governance changes in the firms in which they invest. Hedge funds are also important providers of liquidity, risk management and price discovery in capital markets.

The study goes on to explore how policymakers could build a policy programme that aims to support the development of capital markets and tap into their underexploited growth potential − a vision that AIMA strongly endorses. Ultimately, embracing the financing possibilities associated with capital markets can help to ensure that the global economy is on a sure footing for future growth.

Jack Inglis