The development and structure of financial systems

Firms raise external finance via monitored bank loans and non-monitored borrowing in a dynamic general equilibrium model. Access to credit and each type of financing depend on the wealth distribution due to moral hazard. We study the depth of credit markets (financial development) and conditions under which the financial system relies more on either type of external finance (financial structure). Initial inequality, investment size and institutional factors determine the level of financial development, while financial structure is shaped by the investment technology and legal and financial institutions. The model's predictions are consistent with historical and recent development experience.