Financial nexus: Efficiency and soundness in banking and capital markets

• We analyse the financial nexus between banks and capital markets.
• We use a model to test our hypotheses for a data sample of 63 countries.
• We find large banks are abler to control and transfer various types of risks.
• We find that capital markets development contribute to banks' soundness.
• Results are sensitive to the tail of banking sector and economic development.

Based on a modified version of the model used in Corvoisier and Gropp (2002) and De Guevara et al. (2005), we argue that banks' soundness, the structural characteristics and efficiency of the banking sector along with the development of the capital markets constitute a financial nexus. For a data set of 63 developed and developing countries, we find evidences that efficiency significantly modulates the linkages between concentration and soundness. We also find that capital markets' development supports a stable evolution in banking sector. For the relationship between capital markets and soundness, our findings appear to be robust for various measures of the considered variables as well as for different estimation techniques. Regarding the impact of the concentration upon soundness, the results obtained display a certain sensitivity about the way concentration is measured.