Market Friendly Roles for the Visible Hand?

1. Market Friendly Roles for the Visible Hand? Public Banks in Latin America: Myths and Realities IADB Conference February 25, 2005 Augusto de la Torre Sergio Schmukler

2. Structure of Presentation • Development policy, financial policy, development banks • Interventionist state • Laissez-faire state • Pro-market activist state • Development banks and pro-market activism • NAFIN – market for receivables-based finance • FIRA – structured finance • Questions for future research

3. 1.a. Interventionist State • Development policy • Strategic or socially important sectors (SMEs, agriculture, low-income housing) are underdeveloped and will not take off by themselves • Protection (temporary) and investment by government is needed • Financial sector policy • Widespread market failures – markets will not finance take-off • Government should mobilize and allocate finance to these sectors • Public banks • A policy vehicle/instrument that is functional in this context • Although not necessary – selective allocation of credit also done via regulation of private banks • Administered interest rates, earmarked investments, quantitative ceilings

4. 1.b. Laissez-Faire State • Development policy • Development is hampered by heavy-handed government intervention • Let markets breath and work (openness, privatization) and focus on strengthening “enabling” environment (rule of law, property rights) • Financial sector policy • State interventionism leads to financial repression • Liberalize financial markets and shift focus to prudential oversight • Improve contractual environment (creditor and minority shareholder rights, contract enforcement, accounting/disclosure, credit bureaus) • Public banks • They become de-contextualized • Privatize or liquidate public banks (at least move to 2nd tier) • Public banks in search of new identity

5. 1.c. Pro-Market Activist State • Development policy • Links between reforms and development are elusive and studies of growth determinants give little policy guidance • Igniting growth and sustaining growth are different things • But problems (poverty, low growth, inequality) are pressing • Be heterodox, identify the binding constraint to mitigate second best • Financial sector policy • Degree of financial development disappointing despite reforms • Segmentation in access to finance particularly troublesome • The focus on “enabling” and “contractual” environment is insufficient • Deep implications of path dependent institutional change • Go back to basics, readjust expectations, and be creative • Explore market-friendly roles for the visible hand

6. 1.c. Pro-Market Activism & Public Banks • New roles for existing public banks – “smart” interventions • Share risk (e.g., through partial guarantees) • Pool risk and group otherwise atomized borrowers • Facilitate achievement of economies of scale to lower costs • Encourage adoption of technological and financial innovation • Solve coordination failures, aligning incentives of stakeholders • Players • Non-financial private sector (e.g., large buyers, suppliers) • Private banks • Capital markets (domestic and international) • Type of activities • Selected interventions (focus is not on organization that intervenes) • Tailored to specific needs and institutional settings

7. 2.a. Innovative Public Banking – NAFIN The Problem • SMEs with limited or no access to working capital from banks • SMEs thus forced to grant credit (30-90 days) to their clients, many of which are big and reputable • Receivables not perceived as good collateral • Lack of reliable registry system for receivables • Ample room for double-pledging or forging of receivables • No effective way to “bridge” part of the problem by taking advantage of creditworthiness of issuers of receivables

8. 2.a. Innovative Public Banking – NAFIN The Solution • Leapfrogging: creation of internet-based market for the discounting of accounts receivable (SME working capital) • Around 300,000 SMEs plus most large buyers and open to all banks • Most transactions are “reverse factoring” – SMEs discount their post-delivery receivables • Banks take risk exposure to reputable buyers, without recourse • Protocol to deal with defective deliveries w/o unwinding transaction • System ensures integrity and transparency • Authenticity of receivables, standardization, custody, legality of electronic contract, property rights transfer, settlement, etc. • Incipient market for discounting of pre-delivery orders • Banks take risk exposure to SME – agency problems bigger • System allows SMEs to build reputation (record of reliable delivery)

9. 2.b. Innovative Public Banking – FIRA • Innovating beyond traditional 2nd tier lending • Examples: • Interest rate swaps with international markets – result in long-term, fixed-rate, local currency loans to small producers • Structured finance involving Cargill, sugar mills, small sugar producers, and banks – results in inventory financing • Structured finance involving shrimp exporting firm, feed suppliers, shrimp producers, and institutional investors – results in stable, affordable working capital financing

10. 3. Questions for Research • Is there a clear value added to pro-market activist interventions by the public sector? • Will the private sector do it by itself? If not, why? • If there is a role for visible hand interventions, what is it? • Lender (1st or 2nd tier)? Risk sharer? Coordinator? • How to ensure professionalism, transparency, and accountability in interventions, given complexity of schemes? • How to minimize unintended consequences of second-best? • Governments may be distracted away from the first-best solutions • Given path dependence, second best solutions may lead to traps that are difficult to exit

11. 3. Questions for Research • Can idiosyncratic experiences lead to more general policy guidelines? • What are the key features that make these interventions work? • Can they be replicated to other sectors and other countries? • To what extent can we separate the organization (e.g., development bank) from the instrument? • Even if experiences are replicable, should government create organizational capacities where they do not exist?

12. END