Working Paper Series no. 221: On the Role of a Stock Market: A Study of France, Germany, and thez Euro Area

Abstract

What factors cause banks to lend to the private sector in a bank-based financial system like the ones in place in Europe? In this paper we compare a traditional demand oriented model to a non-traditional capital budgeting model of bank lending based on movements in the equity cost of capital for France, Germany, and the Euro area. Using non-nested hypothesis tests and omitted variables tests we find that we can reject the traditional demand oriented model of bank lending and fail to reject the capital budgeting model of bank lending for Monetary Financial Institutions in France and the Euro area. For Germany the evidence is mixed in that both models are rejected for Monetary Financial Institutions, but only the traditional demand oriented model is rejected for the commercial bank sector. Even though Europe may be a bank-based financial system, it appears the stock market plays a key role in the lending decisions of banks.

Robert Krainer
July 2008

Classification JEL : E3, E5, G2.

Keywords : Bank Loans, Stock Market, Non-nested Hypothesis Tests.