The Financial System Capacities of India and China

Abstract

The extraordinary performance of China and India's economies raises questions about the traditional measures of the size and depth of financial systems. While banks and markets have played a limited role in providing funds for corporate sectors and supporting economic growth in these two countries, non-state, non-listed firms, relying mostly on internal and alternative financing channels, have been growing faster than the state and listed sectors and contributing much of the growth. The alternative financing channels, excluded in the traditional measures of financial systems, operate outside legal institutions and are backed by alternative mechanisms such as reputation, relationships, and trust. We define the capacity of a financial system to be the total funding available for all corporate sectors in an economy. Our findings from China and India demonstrate that alternative finance can significantly expand the financial system capacity and promote growth at the firm level and economy wide.

Keywords: China, India, financial system capacity, banks, markets, alternative finance

JEL Classification: O5, K0, G0