A number of countries that underwent heavy industrialization at approximately the same time developed very different financial systems. Although the countries of northwest continental Europe and North America all began large-scale industrialization in the early to mid-nineteenth century, for example, they developed financial systems quite distinct from one another. It remains unclear, as both a historical and an economic question, why the genesis and development of financial systems differed across countries that were, at first glance, relatively similar in their economic development.

Gerschenkron (1962) was among the first to attempt an explanation for the observed differences among financial systems that emerged over the latter half of the nineteenth century. His arguments hinged on economic factors as the crucial determinants of the particular form that financial systems took at that early phase of development. Gerschenkron hypothesized that a country’s stage of economic development and the particular national economic conditions dictated the sort of financial and banking systems that could take root. These sorts of theories held sway for several decades. More recently, however, a broader set of considerations has emerged in the literature on financial system design. Some argue that a country’s legal tradition factors critically into the type of financial organization that can arise and flourish. Others argue further that not only legal environment, but more proximally political environment, is significant or even crucial for determining the characteristics of financial systems. Each of these competing explanations has some intuitive merit for understanding the types of financial systems observed in today’s industrialized countries and their origins in the distant past. What is missing in the discussion, however, is a thorough examination of all three categories of theories for the birth and growth of particular financial systems across various industrialized countries. Moreover, the literature so far has turned up little or no quantitative evidence or tests of the theories in explaining or predicting outcomes. This chapter takes up these problems and sets the stage for a careful analysis of the consequences of financial system design in the following chapter.