This study introduces financial intermediaries into the Schumpeterian growth model developed by Aghion et al. (2005, Quarterly Journal of Economics, Vol. 120, pp. 173–222). They collect deposits from households, provide funds for entrepreneurial projects, and monitor the entrepreneurs. I consider an economy with moral hazard problems: entrepreneurs can hide the result of a successful innovation and thereby avoid repaying financial intermediaries if the latter do not monitor entrepreneurial performance. I analyze the effects of financial intermediaries' activities on technological progress and economic growth in such an economy. I show that financial intermediaries need to monitor entrepreneurs in an economy where the legal protection of creditors is not strong enough. Such monitoring can resolve the moral hazard problem; however, it does not always promote technological innovation, because it could increase the cost of entrepreneurial innovation and thus reduce the amount invested for innovation. I also examine how monitoring by financial intermediaries affects the welfare of individuals through the stringency of financial markets.

This paper describes the Danish mortgage system by comparing it with the UK mortgage system. The Danish mortgage system has attracted attention in the literature on the design of mortgage systems. It is a type of narrow banking model where mortgage loans are financed by specialised institutions that issue bonds with cash flows that match that of the mortgage loans. Thereby, the Danish mortgage system outsources many of the risks that are usually kept on the balance sheet of banks to bond investors. Measured in terms of four criteria, the Danish mortgage system performed better during the financial crisis than the UK mortgage system. However, both in Denmark and the UK, alignment of the mortgage and the pension systems could offer significant advantages.