Aurora Borealis
1 November 2015 CFA Institute Journal Review

Financial Structure, Corporate Savings, and Current Account Imbalances (Digest Summary)

  1. Pamela G Yang, CFA, CPA, CGMA

A country’s financial structure has important implications for its current account imbalances. In financial systems that rely more on the capital market, corporate savings are significantly lower than in more bank-based financial systems. Small- and medium-sized enterprises in bank-based financial structures have difficulties accessing external finance and thus rely more on their own corporate savings.

What’s Inside?

The authors empirically explore the relationship between the structure of a country’s financial system and its current account balances. Capital market–based financial systems appear to produce lower corporate savings and larger current account deficits, whereas financial systems that rely more on bank savings tend to have higher corporate savings and higher current account surpluses or smaller deficits. In conclusion, the nature of a country’s financial system is a structural determinant of its current account balance, which is the difference between a country’s national savings and its national investment.

How Is This Research Useful to Practitioners?

Much research has been conducted on and devoted to the study of the implications of cross-country differences in financial sector characteristics for current accounts and international cash flows. The authors take this research one step further by connecting the financial system structure with a country’s corporate savings and current account balances. A comparison of two chronic current account deficit countries and two chronic current account surplus countries highlights the relationship.

A financial system that relies more on banks and less on the capital market presents more difficulties for small- and medium-sized enterprises (SMEs) in securing external financing. As a result, SMEs need to accumulate more savings on their own to finance further growth. Thanks to easier access to external funding, however, SMEs in a more capital market–based system tend to save less. Corporate savings as part of national savings is significantly affected by the country’s financial structure. Countries that rely relatively more on bank financing are likely to run higher current account surpluses or lower current account deficits, whereas countries that rely relatively more on the capital market are likely to run higher current account deficits or lower current account surpluses. This relationship indicates that such countries as the United States, whose capital market is more developed, tend to run a current account deficit.

This research is useful to practitioners in two ways. On the macro level, a country’s current account deficit or surplus is not a direct reflection of its financial health. On the micro level, the retained earnings balance of a company—especially an SME—may not be a fair indication of its future growth plan. Investors need to go further to make connections between a country’s financial structure and its current account balance and corporate savings.

How Did the Authors Conduct This Research?

The research is conducted via robust analysis in two parts: at the country level and at the firm level.

At the country level, the authors compile a panel of 66 countries for the period 1990–2007 obtained from the World Bank and the UN. The period is chosen to exclude the global financial crisis and to avoid irregularities. They first look at the bivariate correlation between the current account/GDP ratio and the financial structure. Next, creating a dynamic panel model using the data, they show how a country’s current account is linked to its financial structure. The authors further examine separate effects on corporate, household, and government savings and conclude that corporate savings makes the biggest difference in national savings. Finally, they conduct a rich set of robustness checks to address multiple concerns. The country-level study establishes a positive relationship between a relatively more developed capital market and a larger current account deficit.

At the firm level, the authors add more firm-level variables to measure firms’ perception of judiciary quality and corruption to reflect a country’s general institutional environment. In addition, they include such specific variables as firm total sales, age, growth, and type. Their regression analysis shows that the financial structure significantly affects firms’ reliance on retained earnings to finance their investment, especially for SMEs. Further cross-group comparisons also highlight the correlation; all of the results are consistent with the hypothesis and provide supplemental evidence.

Abstractor’s Viewpoint

The relationship between the financial structure and the current account imbalances is significant, but the authors go one step further by linking the corporate retained earnings with the capital market structure. What is even more interesting is that the authors find that the financial development does not demonstrate significant effects on the share of retained earnings. The authors provide additional insights and pathways in investment analysis.

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