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Additional info for Annual World Bank Conference on Development in Latin America and the Caribbean, 1998: banks and capital markets : sound financial systems for the 21st century : proceedings of a conference held in San Salvador, El Salvador
Because the ratio of loans to net worth is very large, even small changes in net worth can have a large impact on loans. Parenthetically, not only has modern finance emphasized the relative importance of this credit channel, it has actually challenged the validity of the older "money" channel, as an increasingly large fraction of money bears interest, as the ratio of transactions involved in exchanges of assets to those related to income generating activities has increased, as it has been recognized that this relationship itself changes dramatically over time and over the cycle, and as new developments in financial markets make an increasingly large fraction of transactions not dependent on money, as conventionally defined.
With debt, a company gets the full benefit of the upside realization of the risk, while the marginal cost of bad realizations is limited. In contrast, the risk incentives are more aligned with equity. Despite these advantages, in most countries equity is a trivial source of new finance, and net issuance of equity has actually been negative in the United States and United Kingdom over the past decades. While equity markets are a relatively more important source of finance in many emerging economies, they are still much smaller than bank finance or retained earnings.
It has also been shown that increases in capital requirements are an inefficient substitute for the franchise value that is lost as a result of ful liberalization; Pareto efficiency requires the use of both instruments, even in banking systems without deposit insurance (Hellman, Murdock, and Stiglitz 1997). This analysis is but one example of a general principle: Government intervention can help improve the performance of financial markets. One could go further: There are virtually no examples of successful financial markets in which governments do not play an important role.