Bank-based & Market-based Financial Systems and Financial Stability: Perspectives on the European Capital Markets Union

Line Diemer Wulff

Student thesis: Master thesis


The Capital Markets Union was initiated in 2015 by the European commission with the aim to
“broaden the sources of financing in Europe towards nonbanking financing by giving a stronger role to capital markets” (The European Commission, 2015a, p. 14). In the words of literature, the Capital Markets Union is pushing Europe’s financial structure from a bank-based towards are more market-based one.
Through a generally deductive approach, this paper aims to extend the academic discussion where it left off and by doing so supporting the Capital Markets Union debate regarding whether market-based financing leads to a greater degree of financial stability. This is done by investigating whether a bank-based or a market-based financial structure leads to more financial stability. So forth literature investigates the efficiency of each of the two financial structures in the intermediation of savings to investments and the effect of financial structure on growth. Only a subset of literature has touched upon financial structures’ effect on financial stability and no common conclusion on this topic has been found to date.
In order to determine how bank-based and market-based systems affect financial stability, this paper applies the old bank-market dichotomy in econometrically analyzing whether a bank-market ratio affects financial stability, the latter proxied by The European Central Banks’ Composite Indicator of Systemic Stress and the St. Louis Financial Stress Index. An unbalanced panel of 17 countries, including USA and 16 European countries, ranging from 2002-2013 is modelled using panel data with fixed effects. In line with literature a subset of control variables are added to capture other variances affecting the dependent variable.
While the results of the paper does not suggest that either market-based or bank-based systems are in general more associated with financial stress, the results suggest that market- based structures seem to provide a greater degree of financial stability during financial crises compared to bank-based. Thus, after all, from a financial stability point of view, the results obtained seem to indicate that market-based structures seem advantageous. Even though the results are subject to several data and methodology consequences, such as limited sample size, it raises fundamental questions to existing literature, provides support to the Capital Market Union and provides a point of departure for further research.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2017
Number of pages91