The Depth of the Financial System: A Comparison of Developed and Less Developed Countries

This paper summarizes the arguments and counterarguments within the scientific discussion on the issue of how countries' income levels are related to the depth of their financial system. The main purpose of the research is to determine whether high-income countries have deeper financial systems when compared to other countries. We also examine whether high-income OECD member countries have a deeper financial system when compared to high-income non-OECD member countries. Our contribution is threefold: First, our study has a wider scope than most of the previous studies (i.e. 203 countries in total). Second, we examine both the impact of OECD membership and the actual income level on “depth”. The OECD members and the non-members differ in terms of their cultures, their resources and their infrastructure, therefore we expect differences between their financial systems. Third, our study goes deeper than most of the previous studies (i.e. we examine twenty different variables on “depth”). The examination of several variables on “depth” allows us to see the dimensions in which one group of countries perform better than the other group. While one group can perform better in certain dimensions of “depth”, the other group can perform better in other dimensions of “depth”. In our empirical analyses, we find that high-income countries tend to have a deeper financial system (in all measures except for “Central bank assets to GDP (%)”) when compared to other countries. When we compare high-income OECD-member countries to high-income non-OECD-member countries, we find that OECD-member countries tend to have a deeper financial system (in most measures). Interestingly, with respect to two measures, non-OECD-member countries have better “depth” measures. These two measures are “Stock market total value traded to GDP (%)” and “Gross portfolio debt assets to GDP (%)”. Overall, our results indicate that when an economic or financial crisis is expected, middle and low-income countries will be more vulnerable when compared to high-income countries, because in most aspects, their markets are not as deep. On the other hand, high-income countries will be more vulnerable if their Central bank needs to use their assets to protect their system. Similarly, non-OECD members will be more vulnerable when compared to OECD-member countries, because in most aspects, their markets are not as deep. On the other hand, OECD-member countries are weaker with regard to the depth of their stock markets and the amount of debt securities held in investment portfolios. Therefore, we can conclude that a country's income level and OECD-membership should help determine the precautions that policymakers need to take if a crisis is on the horizon.