Banking and innovation: a review

ABSTRACT

We summarize the major findings of empirical studies that examine the effect of banking development on innovation and highlight their relative contributions to our understanding of the various roles the banking sector plays in determining innovation. We reassess the effect of banking development and innovation, extending the scope of analysis to more granular dimensions of innovation and to Asian economies where financial markets are less developed. We find that while theoretical implications are generally indefinite about the effect of banking development on innovation, empirical findings are less ambiguous given their distinct focus of sample firms and the underlying channels investigated. The development conditions of financial markets also matter in drawing implications for the effect of financial institutions on innovation. Specifically, when the stock market is relatively less developed, as in most Asian economies, banks play a significant role in financing and promoting innovation. Therefore, it seems plausible for policy makers in these regions to strengthen the development of the banking sector and to improve the depth of the credit market.In this survey, we will summarize the major findings of the empirical studies that examine the effect of banking development on innovation and highlight their relative contributions to our understanding.

Keywords:

• Banking
• Innovation
• Caiptal Market Incentives

Acknowledgement

Lin acknowledges the financial support from the National Natural Science Foundation of China (No. 72192841).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. This survey mainly focuses on the inputs (e.g. R&D, innovators, etc.) and outputs (e.g. patent, product, etc.) of innovation and thus does not review the effect of banking development on industrial organization related to creative destruction and entrepreneurship (e.g. Black and Strahan 2002; Kerr and Nanda 2009).

2. The banking deregulation in Italy mainly liberates inter-province banking restrictions. The two papers we surveyed (Herrera, Ana and Minetti 2007; Ayyagari, Demirgüç-Kunt, and Maksimovic 2011) have analyzed the effect on both public and private manufacturing firms in Italy.

3. The effective Stock/GDP ratio should be much lower than the value shown in the figure in the early years because most Asian economies started to develop their stock markets in the 1990s or later. However, credit markets have a much longer history in these economies.

Additional information

Notes on contributors

Chen Lin

Lin is Chair of Finance and Stelux Professor of Finance at the Faculty of Business and Economics, University of Hong Kong.

Sibo Liu

Liu is an Assistant Professor at the Department of Finance and Decision Sciences, Hong Kong Baptist University.

Lai Wei

Wei is an Associate Professor at the Faculty of Business, Lingnan University.