Banking and Real Economic Activity

Abstract

This chapter reviews insights about how the banking system affects real economic performance. After arguing that the causality debate—the high-level question of whether the characteristics of a banking system have causal consequences for the real economy—has essentially been settled, we evaluate the specific channels through which banking activity may exert real effects. We focus on the rich empirical literature spawned by the theoretically ambiguous impact of greater banking competition, which has found concentration of the banking system to be a significant determinant of the structure and health of non-financial industries. We also discuss how, after the 2007–9 financial crisis, there has been revitalized interest in modeling the role that financial intermediaries play in amplifying aggregate shocks and initiating crises. We conclude by noting the importance of accounting for the changing institutional, structural, and technological properties of the financial sector in understanding the interplay between financial and real activity.