Overview of Financial Development Issues

1. Overview of Financial Development Issues Thorsten Beck World Bank

2. Outline • Goal of the development assessment • Analytical/research underpinning • Conducting the development assessment • Linking functional and institutional approaches • Typical components • Characteristic messages

3. Functions of financial markets • Ease the exchange of goods and services • Payment services • Mobilize and pool savings • Savings services • Produce information ex ante about possible investments and allocate capital • Credit services • Monitor investments and exert corporate governance after providing finance • Facilitate the trading, diversification and management of risk

4. Financial institutions and markets • Financial intermediaries • Collect savings and intermediate in the form of debt, collect proprietary information about debtors and monitor them directly • Financial markets • Attract savings in the form of debt or equity instruments to provide resources for firms; information collection and dissemination through price mechanism • Contractual savings and insurance • Mobilize savings through contingent contracts, offer risk management services, provide investment resources in different forms (institutional investors)

5. Goal of development assessment • Benchmark provision (quantity, quality and cost) of the key financial functions and services that support growth • Identify obstacles to efficient provision • Recommend policy actions

6. Finance helps foster growth…

7. … and alleviate poverty

8. Benchmarking • Available quantification covers both quantitative measures of performance… (e.g. depth, activity, reach, cost and price efficiency) • …and some qualitative indicators of infrastructures (e.g. on legal, regulatory and informational infrastructures) • … and more recently, some quantification of penetration • More on this later

9. Quantitative Data • Financial depth of financial institutions and markets • M2 to GDP • Private Credit to GDP • Efficiency of service provision • Interest spreads • Market liquidity

10. Qualitative Data on Infrastructures • Legal • Creditor protection; bankruptcy; corporate governance… • Informational • Accounting & auditing / transparency • Credit & property registries • Transaction technology • Payments and settlements • Government • Including regulatory “style” • Ownership

11. Typical Obstacles • Gaps in the financial infrastructure • legal, information and regulatory systems (soft) • transactional technology (incl payments & settlements; communications generally (harder) • Flaws in regulatory or tax policy • (including competition policy) • Deeper governance issues impeding policy-making • (esp. favoring incumbents over newcomers).

12. Issues in the development assessment (1) • Market Infrastructure for Access • Collateral and bankruptcy laws; competent and impartial courts; • Information infrastructure (e.g. credit registry, accounting and auditing, rating agencies) • Payments: is the system competitive & reasonable in cost? • Monopoly Power and Related Distortions • Detecting evidence of market power • (e.g. use of cross-country regressions) • Positive and negative policy to limit damage • Permissive entry and legislative environment • Minimum scale issues and globalization

13. Issues in the development assessment (2) • Special Institutions for Access • E.g. development banks, microfinance • Issues include subsidies, incentives, burdensome regulation • The Demand Side • Assessing unmet needs of corporates & households (not easy - data deficiencies, including for cross-country benchmarking)

14. Issues in the development assessment (3) • Other cross-cutting aspects of policy environment • Taxation/subsidization of intermediation • Distorting or inhibiting subsectors or key instruments • Missing products/markets • E.g. leasing/factoring, why missing: underlying laws, regulations, tax? • Cross-sectoral competition aspects • E.g. banking vs. NBFIs; banking vs. securities markets • Damaging side-effects of over-heavy prudential rules

15. The methodological challenge: functions versus silos • Statistics, regulation and market performance remains segmented along lines defined by institutional/organizational form (“silos”). • Though cross-cutting infrastructures are also central. • But development aspects need to be analyzed and reported along functional lines.

16. Combining the perspectives(of functions and sectoral silos) The development assessment has two phases: • Information gathering phase • Including infrastructural and sectoral • Analytical and reporting phase • Evidence to be distilled by mission leaders using functional perspective

17. Information gathering phase • Infrastructural reviews • Sectoral reviews (industry & regulation) • The demand side • Missing markets & other cross-cutting issues

18. Infrastructural reviews • Legal • Creditor protection; bankruptcy; corporate governance; competent & impartial courts… • Informational • Accounting & auditing / transparency • Credit & property registries; rating agencies • Transaction technology • Payments and settlements • Government • Including regulatory “style” • Ownership

19. b) Sectoral reviews (examples) • Banking etc. (also devt. banks, mortgage finance & other specialized institutions & MFIs) • Including competitiveness, ownership, efficiency, entry, unneeded regulatory impediments (e.g. on microfinance)… • Insurance and contractual savings • Including public pension funds • E.g. market penetration, product range, asset portfolio • Securities markets • E.g. liquidity, transactions costs, scale, linkage to ROW

20. c) The demand side • Corporate sector assessment • Infer unmet service needs from their financing patterns etc. • Households • Reach of mainstream and microfinance (including credit cooperatives etc)

21. 2. Analytical and reporting phase Delivering the message: • Describe the functional gaps • E.g. lack of term finance; no venture capital; high intermediation costs; limited access; nascent insurance industry… • Pinpoint the source(s) of the gaps and deficiencies • Propose strategic approach to solution • highlighting cross-sectoral aspects

22. Development versus stability? • Usually mutually supportive • (An insolvent banking system cannot provide the needed service) • Occasionally conflicting • “Belt-and-braces” approach may damage effectiveness of banks without helping safety • Example: Powerful bank supervisors might help stability, but are also associated with higher corruption in lending