Question

a. Discuss the difference between a bank-based and a market-based financial system, and state whether the financial systems of developing countries are generally characterised as bank-based or market-based. Does the structure of the financial system affect the nature of financial relationships?

b. Describe the typologies of private capital flows and the rationale for the existence of a ‘hierarchy’ of private capital flows to developing countries.

Answer 1

a. Discuss the difference between a bank-based and a market-based financial system, and state whether the financial systems of developing countries are generally characterised as bank-based or market-based.

In Bank-based financial system, banks play a major role in savings mobilisation, risk management and controlling corporate sector in the economy. In Market-based financial system, securities market also share the role along with banks in attracting savings to companies, risk management and corporate control.

Does the structure of the financial system affect the nature of financial relationships?

Yes, the structure of the financial system affects the nature of financial relationship. Market based financial system facilitate better income distribution and bank based financial system helps to reduce the inequality in the developing countries. In countries where market based financial system exists, the stock market will be active. Such financial system increases the GDP of the country.

b. Describe the typologies of private capital flows and the rationale for the existence of a ‘hierarchy’ of private capital flows to developing countries.

Private capital flows include foreign direct investment and portfolio investment. These are very important for developing countries to develop. Sector wise private cash flow control must be formed in developing countries. It must be through the hierarchy of cash flows. Low income developing countries must be well equipped to analyse these cash flows. Investment promotion authoroties should ensure this.