The role of nonbank intermediation in a financially repressed economy (theory and evidence based on the Korean economy, 1972--1994)

Abstract

In existing economic literature on finance and economy, it is argued and generally accepted that financial intermediation contributes to economic growth though the contending argument is that financial development is simply a result of economic growth. However, studies on the contribution of financial intermediation of nonbanks (as opposed to banks) to economic growth are relatively scant and too general to clarify the mechanism through which nonbank financial intermediation might help economy to expand and develop. The focus of this study is on whether nonbank financial intermediation contributed to economic growth in the case of Korea where the share of nonbank financial intermediation increased from around 20% in 1970 to more than 60% in the early 1990's. This study is particularly interesting in light of the fact that rapid economic growth in Korea was accompanied by a concomitant increase in the share of nonbank financial intermediation. As a precursor to the empirical analysis, this study shows theoretically that financial intermediation of nonbanks subject to lesser liquidity control is complementary to, rather substitutional for, that of banks. Further, it is shown by optimizing a two-period dynamic model that under certain conditions nonbank intermediation increases an economy's savings mobilization and contributes to the economic growth. For empirical analysis, we used the annual data from 1972 to 1994 which can be considered as a financially repressed period. The empirical results are all consistent with the theoretically expected: nonbanks are complementary to banks in financial intermediation, increased the savings mobilization, and in the end contributed to the economic growth of the Korean economy during the sample period. Further, the estimated allocative efficiencies of nonbanks are almost in phase with business cycles, which may well be interpreted as consistent with the proposition that nonbanks financial intermediation made a significant contribution to Korea's economic growth.