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Rev Fin 1997; 10:693-733
© 1997 the Society for Financial Studies

Article

Financial system architecture

AWA Boot and AV Thakorz
University of Amsterdam, The Netherlands
z Corresponding author at: University of Michigan Business School, 710 Tappan St., Ann Arbor, MI 48109-1234, USA

Abstract

This article builds a theory of financial system architecture. We ask: what is a financial market, what is a bank, and what determines the economic role of each? Starting with basic assumptions about primitives-the types of agents and the nature of informational asymmetries-we provide a theory that explains which agents coalesce to form banks and which trade in the capital market. It is shown that borrowers of higher observable qualities access the financial market. Moreover, a financial system in its infancy will be bank-dominated, and increased financial market sophistication diminishes bank lending.


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