Transcript Regulatory Reform and Trade Liberalization in Financial

The Role of Finance in Fostering
Sustainable Growth
Presentation for the
TÜSİAD-KOÇ UNIVERSITY ECONOMIC RESEARCH FORUM
INTERNATIONAL CONFERENCE ON
SUSTAINABLE GROWTH STRATEGIES FOR TURKEY
FRIDAY, 17 JUNE, 2005-ISTANBUL
By Stijn Claessens
Professor of International Finance, University of Amsterdam,
Senior Adviser, Operations and Policy Department, Financial
Sector Vice-Presidency, The World Bank
Structure of Presentation
• Finance and growth: the evidence
• What makes for financial sector development?
• Special issues for middle-income countries?
• What does changing world of finance imply?
• Why do countries not reform?
Finance and growth
• Financial system is important for growth. Much
evidence finance matters for real sector growth,
productivity, investment, cost of capital, etc.
– At the firm, sector and economy level
– Especially for SMEs and the emergence of new firms
– Specific channels shown, also using experiments
• Some questions remain, however
– On causality, missing/omitted variables
• Only recently evidence on the links between finance
and poverty
Finance and growth
Growth and financial development
Naïve and model-based relationship
Average GDP growth 19608
895
Acerage GDP growth 1960-95
6
6
Naive
4
4
Actual
Model
2
2
Model
Naive
0
0
-2
-2
-4
-4
0
0
1
2
3
4
4
Private credit as percentage of GDP
2
Private credit as % GDP (log)
5
6
6
Finance and firms/SMEs
• While large SME sector characteristic of successful
economies, SMEs do not “cause” growth, nor do SMEs
alleviate poverty or decrease income inequality
• Rather overall business environment–ease of firm entry
and exit, sound property rights, and proper contract
enforcement– influences economic growth
• Finance, however, accelerates growth by removing
constraints on small firms, more so than for large firms
• Finance allows firms to operate on a larger scale and
encourages more efficient asset allocation. Financial and
institutional development helps leveling the playing field
Finance and the poor
• Finance helps growth and growth helps poverty reduction.
Finance helps poverty through growth
• Finance can help distribute opportunities fairer (the more
concentrated income, the higher poverty)
• Cross-country studies:
– Beck, Demirgüç-Kunt and Levine 2004: controlling for reverse
causality: financial development => less income inequality
– Clarke, Xu, Zou, 2002: inequality decreases as finance develops
– Honohan 2004: financial depth explains poverty (less than $1 or
$2). But, microfinance penetration no special effects on poverty
Inequality declines as finance develops
Finance and volatility
• Evidence that better developed financial systems
share risks better, are more stable, less prone to crisis
– Evidence at household, firm, sector and economy level.
– Specific channels been shown, also using experiments,
e.g., allowing for (interstate, international) diversification,
introduction of new hedging tools
– Finance importantly relaxes credit constraints with shocks
• Some questions remain, however
– On causality, missing/omitted variables, what is volatility?
– Some evidence quantity of finance alone can add risks
Finance and volatility
What drives financial sector
development?
Financial development has been shown to depend on:
1. Good property rights and laws combined with a
judicial system that enforce those
2. Access to credible information on borrowers and
consumers and on financial intermediaries
3. Proper regulation and supervision of financial
intermediaries and markets
4. A competitive/contestable market structure
Finance and fundamentals
• Importance of effective legal system for financial market
development, external financing, dividend patterns, growth,
firm valuation, etc.
– Well documented for equity and creditor rights (La Porta
et al., Levine et al., Rajan and Zingales, etc.)
– Includes a well functioning judicial system
• Structure (bank versus markets) matters less than having the
right fundamentals (Demirguc-Kunt & Levine). Banks
complement securities markets, in corporate governance role
Creditor rights, rule of law and depth
of the financial system
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
1
2
3
Creditor Rights * Rule of Law
4
Shareholder protection, rule of law
and capital market development
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Stock markets and banks
complement in growth
High banking
development
4
3
Per capita growth,
1976-93
2
Low banking
development
1
0
Illiquid
Liquid
Initial stock market liquidity
Source: Demirgüç-Kunt and Levine, 1996.
Finance and fundamentals
• Information is essential
– Quality of accounting/auditing and credit bureaus key
components of informational infrastructures
• Regulation and supervision requires balance between
market discipline and government role.
– Without checks and balances, too much power in the
hand of supervisors retards financial development and
creates risks
• Contestability in financial system key
– Entry (of foreign banks) have helped stability, efficiency
and access while state-owned banks have hindered
Foreign banks can help in
financial sector development
• Borrower’s perceptions across 36 countries
– Financing obstacles lower in countries with high
levels of foreign bank penetration
– Strong evidence that even small enterprises benefit
and no evidence they are harmed by foreign banks
– Channel is both competition and direct provision of
financial services by foreign banks
• Latin America study
– Foreign banks with small local presence do not
appear to lend much to small businesses
– But large foreign banks in many cases surpass large
domestic banks
Financial sector development and
macro/fiscal and real sectors
• Financial sector development depends on stable macroeconomic environment and little crowding out
– Moderate, positive real interest rates
– Low fiscal deficits to avoid banks holding only government paper
• Financial services input for real sector and vice-versa.
Scope for vicious and virtuous relationships. Development
and effectiveness of financial and real sector depends on
many similar factors, yet still separate finance reform
– Additional positive effect of finance on growth
– Financial sector represent allocation of control rights,
link to political economy of reform in general
Current finance research questions
•
How do financial systems evolve?
•
How to tailor financial sector development
approaches to country circumstances?
•
What are special issues for emerging markets?
•
What does changing world (of finance) imply?
•
Implications for public policy
•
What drives (financial sector) reform?
How do financial systems evolve?
• Are certain financial market structures more
attractive at some levels of development?
– More concentrated banking systems more attractive at
lower levels of development?
– How does the balance between banks and markets
preferably change as countries develop?
– When to develop non-bank financial markets, e.g., bond
markets, securitized markets?
• How to classify countries’ financial systems,
market versus bank or horizontal versus vertical?
What does it imply for financial development?
How to tailor approaches to countries?
• Consistency of reform rather than speed is key
• Many country-specific requirements and tradeoffs
– E.g., degree of competition and access to financing relate
differently when information more obscure
• Limits to what government/regulation can achieve
– Much evidence that government is poor regulator, e.g.,
more power does harm if checks and balances missing;
minimally paid supervisors unlikely to resist corruption;
securities markets: private better than public oversight
– Regulations to vary. Are all standards good? Core 25,
Basle II, IOSCO, etc., will not always work
What are special issues
for emerging markets?
• Finance based on the same principles and finance
industries undergoing similar changes as ROW
• Countries generally benefit from reform and lib.
– Institutional weaknesses more severe, limits benefits
– Can lead to crises, especially when integrating. Causes
of crises shift, however, tools to predict may fail
– No fixed, a-priori pre-conditions for successful reform
– Often deeper causes: political economy, moral hazard,
low pay, corruption, etc. Rebalance government role
• Issues of size and special nature of banks and
safety net: need to consider government capacity
Many financial systems are small
Size of financial system (M2, billion of dollars)
log scale
10000
1000
100
10
1
0.1
0.01
167 countries
Deposit insurance rapidly expanded
Cumulative frequency of explicit DI systems
established
80
60
40
20
0
1934
1962
1966
1969
1974
Source:Kane, World Bank,
2000.
1977
1980
1983
1985
1987
1989
1993
1995
1997
1999
What does changing world imply?
• Financial services are changing rapidly
– Globalization: capital flows, cross-border financial
services, listing in financial centers, foreign bank entry
– Deregulation: within markets, geographic, including
cross-border, across markets and products
– Technology: advances in information, particularly
internet and increased remote delivery
• Factors are changing financial services industries
structures and altering forms of provision
– Banks and finance becoming less special; increasingly
more substitutes available; more remote delivery
possible; local markets less relevant; lines between
products and financial institutions blurring
What does changing world imply?
• Nature of the firm altering
– Intangibles, new economy, network-type assets more
important for production and productivity
• Investments to be financed changing
– Investors invest in “ideas”, rather than fixed assets
– Ideas need more protection for investors
• Implications for financial sector
–
–
–
–
Fewer fixed assets: makes debt more difficult
Higher risk: requires other financing structures
More VC-type and more equity markets as VC to exit
Greater importance of corporate governance
Implications for public policies
• Revisit “enabling environment” for finance
– Greater emphasis on property rights (laws and
enforcement), information infrastructure, etc.
– Do not expect market, but neither government to solve
all problems: focus on core role of government
– Revisit current prudential and institutional-oriented
approaches implied by standards and reduce safety net
– More need for consumer/investor protection as
financial services become more like other products
– Revisit tools/approaches used for managing risks
Revisit especially competition policy
• More active competition policy possible/needed
– Finance and banks particularly less special
• New paradigm to be developed and applied
– To go beyond institutional and functional approaches;
to be both global and horizontal and sector-specific.
– Approach to resemble other network industries
• Countries can benefit from committing to procompetitive framework
– Credibility more at a premium, competition policy
authorities weaker, political economy more adverse
– WTO, FTA-type of arrangements help (more)
Why do countries not reform?
• Countries do not adopt most efficient institutions
– Institutional change in general slow, although some
transition economies, crisis countries are exceptions
• In many dimensions unclear whether globalization will
allow for convergence in effective institutions
– Financial markets are subject to global competition, yet
very imperfect convergence and at high costs
– Firms and markets can adapt to weaker environments,
but alternative mechanisms have limits and costs
In general institutions are rigid
• Institutions and rules are rigid and path dependent
– Best example is legal origin which has long-lasting
effects, from colonization centuries ago to today
• Property rights not only institutional difference, though
– Regulation of labor markets, ease of entry for new
firms; restraints on executive, degree of democratic
institutions, degree of corruption; quality of regulation
• Institutions are highly correlated. Suggests deeper factors
– Settler’s mortality; social capital; natural factor
endowments; physical environment; ethic
heterogeneity; culture; religion; others?
What drives institutional
(financial sector) reform?
• Institutions are quite stable and by some measure can
explain level of development.
• What still triggers changes? How do institutions evolve and
in turn affect (financial sector) development?
– When do countries reform? What is the role of real
sector changes? How does competition—real,
financial—affect legal and financial systems?
– Is there a channel from ownership to reform? Any
benefits of certain privatization models?
– Why does it often take a crisis? Are crises blessings in
disguise? What is role of political economy?
Can financial crises spur reform?
• Are financial and real sector crises blessing in disguise?
Do political changes cause crises and thus reform, in
financial sector especially? What type of crises “work”
best: growth or financial crises? What measures enacted
in crises actually stuck and made a difference?
• Are financial crises (only) cause for international financial
institutions to get busy with financial sector? Is finance a
too long term investment?
• Has the link between finance and poverty not made
clearly? Has the link to inequality and lack of access not
been shown sufficiently?
How can other reforms support
financial reform?
• If financial sector reform is difficult, are there other,
indirect ways to get desired outcomes?
• Competition—openness to trade, capital flows, entry in
financial and corporate sectors, ability of corporations to
list in other markets—affects systems in two ways
– Competition can deliver functional convergence, but in
what areas? Can corporations “hire” corporate
governance by cross listing in foreign markets? Are
foreign-owned banks a substitute or complement?
– Competition can overcome/weaken political economy
constraints. More generally, real sector reform interacts
with financial sector reform
Can ownership changes
provide political support?
• Need for middle-class to push for and support reform,
including financial sector reform
• Can degree of general public ownership (directly) affect
incentives to push for some reforms?
• Channel from ownership to reform. When ownership,
control and political economy structures not change,
reforms not deep enough and insiders hijack reforms. With
extensive ownership changes, reform more likely deeper
• Benefits of certain privatization strategies. With large stateownership, after crisis/transition, certain ownership
distribution encourage reforms
Ownership concentration and
institutional development