Financial structure and income inequality

Summary

Focus

This paper investigates the link between an economy's financial structure (that is, the mix of bank- vs market-provided funds) and income inequality.

Contribution

Using data for 97 advanced and emerging market economies over 1989-2012, we try to answer four questions: Does financial development affect inequality? Does the financial structure (the mix of bank- and market-provided funds) change the relationship between finance and inequality? Is the relationship non-linear (with sign change at a certain threshold)? And does any non-linearity differ for bank-provided finance and market-provided finance?

Findings

The results show that the relationship between financial development and income inequality is not linear. Up to a point, more finance reduces income inequality. Beyond that point, inequality rises if finance is expanded through market-based financing, but not when finance grows via bank lending. These findings agree with a well established literature indicating that deeper financial systems help reduce poverty and inequality in developing countries, but also with recent evidence of rising inequality in some financially advanced economies.

Abstract

This paper empirically investigates the link between financial structure and income inequality. Using data for a panel of 97 economies over the period 1989-2012, we find that the relationship is not monotonic. Up to a point, more finance reduces income inequality. Beyond that point, inequality rises if finance is expanded via market-based financing, while it does not when finance grows via bank lending. These findings concur with a well-established literature indicating that deeper financial systems help reduce poverty and inequality in developing countries, but also with recent evidence of rising inequality in various financially advanced economies.

JEL classification: G10, G21, O15, D63

Keywords: inequality, finance, banks, financial markets