Economists all over the world are of the opinion that markets are the best system for allocating scarce resources. However, they do not seem to agree so much on what the nature of those markets should be? Countries like the United States, Japan, and France, etc. all do follow the market structure. However, there are glaring differences in the type of markets present in each of these countries.

In this article, we will have a closer look at the different types of financial systems as well as the comparison between them.

Why Do Different Financial Systems Exist?

Different financial systems exist because of the unique financial needs of different countries.

• For instance, in some countries, stock markets have a high degree of importance. However, in some other countries, there is more reliance on the market for government debt.

• Similarly, in some countries, the majority of the finance which the corporations use is raised by the banking sector. Therefore, the regulation of the banking system becomes more important in such countries

• Lastly, some countries rely on capital, which has been generated internally by savings. On the other hand, there are countries which rely on capital which has been invested by a foreign country. If a country relies on the latter, then the regulations relating to foreign investment become quite important.

Comparison between Different Financial Systems

The difference between financial systems can be best understood with the help of an example.

For instance, the United States and Germany are both developed countries. Ideally, their financial system should be quite similar, given that the needs of their economy are also quite similar. However, this is not reality. In fact, the financial systems in these countries are so different that they can be called polar opposites of one another.

The United States’ financial system is completely dependent upon the financial markets. The United States has some of the best securities markets in the world. When it comes to trading in stocks, bonds, and even derivatives, the American markets provide the most depth to investors. This is the reason why most of the capital raised in America is channelized through the stock markets.

Proponents of the stock market believe that it helps improve the efficiency in the American markets. This is because once a company is listed on the stock market, it becomes vulnerable to a hostile takeover.

If the current management is not managing the company efficiently, then there are specialized funds that will buy out the company, replace the management, and make a quick buck in the process. These hostile takeovers cannot happen if banks are the main source of funding for an organization.

The German stock markets aren’t central to its economy. Even though Germany is one of the most developed countries in the world, its stock market is not considered to be important from an international standpoint.

Instead, in the German financial system, most of the money is raised using bank loans! The German government prefers the banking system to the stock market. The reasons behind this are unknown. However, there is widespread speculation that banking credit is relatively easier to control, and hence, the Germans prefer the banking sector. Also, since banking securities are not traded openly on exchanges, the chances of an asset bubble are also less. As a result, Germans consider the banking system to be more robust.

However, the problem is that the German banking system is very concentrated. The three top banks viz. Deutsche Bank, Commerzbank, and Dresdner control more than three-quarters of the capital in the economy. This leads to multiple problems.

Firstly, this means that if the government can control these three banks, it can basically control the flow of capital in the entire economy. This is akin to centralized planning seen in communist countries and different as compared to the market system followed worldwide.

Also, since the capital is concentrated, so is the risk. If these three banks face a credit crisis, then the entire economy faces a credit crisis. This is what is happening in Germany as of now.

The German government made an unsuccessful attempt to merge Deutsche Bank and Commerzbank since both banks are facing economic issues.

On the other hand, the United States is known for promoting competition amongst its banks. The United States has many regional and national banks that have significant control over the market. In the United States, it is very difficult, if not impossible, for a small group of banks to control the entire market.

The United Kingdom has adopted the middle path when it comes to financial markets. The United Kingdom also has four major banks that control the entire banking sector viz. Barclays, Lloyds, NatWest, and Midland.

The United Kingdom also has efficient stock and bond markets. There is an equal allocation of capital between the banks and the securities markets.

The banking system in France is also more prominent as compared to its capital markets. Also, in France, the major banks are either owned or directly controlled by the government.

The bottom line is that there are several types of financial systems possible. In general, all institutions are present in almost every country. However, even though the type of institutions remains the same in each market, the relative importance of these institutions changes.