Stock Market and Bank Regulation

Topics: Economics, Investment, Economic growth Pages: 14 (4310 words) Published: September 21, 2011
QUESTION: Compare and contrast how the stock market and banks promote economic growth; and provide a critique of their functions in the development of the economy

INTRODUCTION The main aim of the paper is to compare and contrast how the stock market and the Banks promote economic growth and it provides a critique of their functions in transitional economies. Every country depends on its economy for its growth. For a country to be stable, its economy has to be stable. Banks and stock market contribute to a great extent to the economic growth of every country where it provides firms with opportunity to get funds thus encouraging more investment from the firms. At the same time they give information on the ways resources should be allocated. The development of a financially sound, market-oriented banking system is always considered to be fundamental to a flourishing transition. Arguably, it is important to macroeconomic stability and to positive long-term growth prospects. As documented, bank intermediation in transition economies continues to be stunted after a decade or addition of reform, mainly where advancement in banking reforms is inadequate. The banking system profitability still stands to be unimpressive, after the effect of inflation on valid profitability is taken into account.

When we consider the balance between return and risk provided by the stock markets in transition economies, the developing countries and industrialized market economies have provided a higher favorable balance between risk and return during the earlier four years than the transition economies as a group. The price-to-book-value ratios are lesser in the transition group as compared to developing countries. It is obvious that firms that are flourishing in investing their capital together with their borrowings will likely have sturdy prospects for earning growth and will get reduced discount rates used in their future earnings.

Considering the modern economy, banks and stock markets represent a key component of the financial system. Even though they may execute dissimilar functions in the economic development process, their distinctiveness is barely emphasized within the framework of economic growth. The analysis by King and Levine (1993) cannot differentiate between the functions of stock markets and banks. As per the physical accumulation, banks and stock markets offer sources of external financing for firms. In terms of the role of resource allocation, stock markets and banks generate information to direct the allocation of resources. They vary only by means of transmitting information. Stock markets information is enclosed in equity prices, while loan managers collect that in banks.

Dow and Gorton (1995) conveyed a model analysis that if the major function of the stock market is to signal information for monitoring, evaluation and financing, banks may be similarly efficient at proficient resource allocation. Even though some papers had analyzed the effect of stock market on social welfare (Bresnahrah, Milgrom, and Paul (1992), has connected empirically stock markets and economic growth on volume or investment productivity.

Another perception on the connection involving financial development and economic growth is based on savings, investments, financial markets and growth. The analysis is that financial markets will increase savings, investment and hence the growth rates. The stock market is considered to promote savings by offering households with an extra instrument which may meet their liquidity need and risk preferences. Considering the well-developed capital market, share ownership gives individuals fairly liquid ways of sharing risk in investment projects. There is also substantial proof on the level to which these markets are playing a function in distributing capital to the corporate sector and the useful effects for the rest of the economy. Though the...

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