Financial system architecture and the patterns of international trade

Countries differ in the extent to which their financial systems rely on banks or on financial markets. We offer a model featuring a complex relationship between countries’ financial system architecture and their comparative advantage. Countries with capital markets that are relatively more efficient than their banking systems gain comparative advantage in sectors with strong dependence on market finance. Moreover, countries specializing in sectors that depend on market finance develop their capital markets more than their banking systems. To empirically investigate these links, we construct a measure of sector bank dependence and establish a bi-directional relationship between countries’ comparative advantage and their financial systems architecture.