Transcript The Role of the Financial Sector

II Foro Estados Unidos-Unión
Europea de la Fundación
Euroamérica
The role of financial system in
economic and social
development
Miami Dade College, Wolfson Campus
Jose Juan Ruiz, 2014, May 15th & 16th
Bancos circa 1934: … the ephor of the exchange economy.
The banker...has become the capitalist par
excellence. He stands between those who wish to
form new combinations and the possessors of
productive means. He is essentially a
phenomenon of development, though only when
no central authority directs the social process. He
makes possible the carrying out of new
combinations, authorizes people in name of
society as it were, to form them. He is the ephor
of the exchange economy.
He claimed he had set himself three goals in life: to
be the greatest economist in the world, to be the
best horseman in all of Austria and the greatest
lover in all of Vienna
J.A. Schumpeter, The Theory of Economic
Development (1934)
Bancos circa 2014: If a change would cost the financial sector, say, one billion a year (…) it
just means that there is an extra billion for the other sectors
The literature indicates that some tasks of the
financial sector are beneficial, some attributes of
financial institutions matter, and others matter
less so or not at all. (…)
Without doubt, various proposed changes in
regulation will be costly for the financial sector
and make it more difficult for the sector to perform
some activities.
But that is not necessarily a bad thing.
If a change would cost the financial sector, say, one
billion a year but does not affect the total amount
being produced, then it just means that there is an
extra billion for the other sectors.
Wouter den Haan, 24 October 2011, http://www.voxeu.org/article/why-do-weneed-financial-sector
Quien se ha quemado con leche... ve una vaca y llora
https://www.imf.org/external/pubs/ft/fandd/2004/09/pdf/carstens.pdf
Back to the era of ‘the ephor of the exchange economy”
Epur si muove: Productivity Growth and Financial sector development are
closely correlated
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
LAC: Low levels financial intermediation , even controlling for GDP per
capita
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
LAC : Real Convergence falters due to to low TFP growth
50
40
GDP per capita
Factor accumuation
TFP
30
20
10
0
-10
-20
-30
-40
-50
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
LAC growth is back to “Normal ”
Source: WEO, IMF. April 2014
…and there are high downside risks
Source: WEO, IMF. April 2014
Relative Low Growth and Middle Class Expectations
“’Reduzimos drasticamente a pobreza ea desigualdade.
Conquistas são importantes, mas é completamente natural
que os jovens, especialmente aqueles que tem coisas que
seus pais nunca tiveram, como mais "
Back to the era of ‘the ephor of the exchange economy”
The Role of the Financial Sector: Why do we need to do more?
•
If small credit markets resulted from low demand for investable funds due to limited investment opportunities,
the financial sector would not be a bottleneck to economic development.
•
However, there is evidence that small credit markets in Latin American countries are also due to distortions and
bottlenecks in the supply of credit, which explains high and heterogeneous lending rates. At about 8 percent, the
Region has average real lending rates which are much higher than those of most developing regions (only subSaharan Africa has higher average lending rates). Interest rates are especially high for small firms. High lending
rates tend to be associated with credit rationing cutting off supply at low levels of credit.
•
Beck et al. (2000) estimations suggest that an increase in financial development that had brought Latin America’s
financial depth from its 1965-2003 average of 31 percent of GDP to the East Asian average of 70 percent of GDP
would increase the Region’s annual average productivity growth by 1 percentage point, corresponding to a 60
percent reduction in the difference between average productivity growth in the two regions.
•
Besides stimulating growth, well-working financial markets can reduce income inequality and promote social
mobility. In countries with poorly developed financial markets, initial wealth is more important than
entrepreneurial talent and potentially productive projects may not be implemented because of lack of financing.
Financial markets that reallocate capital from less to more productive firms can jointly increase productivity and,
by limiting the economic power of the elites, “democratize” market economies (Rajan and Zingales, 2003).
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
Rethinking Productive Development
Sound Policies and Institutions for Economic Transformation
Rethinking
Productive Development
Sound Policies and Institutions for Economic Transformation
Urgent need for growth policies

Most successful growth experiences around the world are associated with active productive
development policies (PDPs)

Low and slow productivity in the region calls for fresh policy action to break stagnation:
– Macro stabilization and structural market reforms not enough
– Industrial policy of the past misguided

Countries are quite actively searching for PDP solutions
– Not always with analytical clarity
– They spend important resources, not always well
– Multilaterals also dedicate sizable resources to support them
There is a great variety of PDPs …

Matching grants for business innovation projects

Reduction of number of days to start a business

Incubation services for start-ups

Training to close the skills gap for mining industry

Cluster development policies

Provision of cold storage facilities for fresh flowers

Opening offices abroad for export promotion

Tax exemptions for tourism

Strategic policies to attract medical devices sector
How to make sense of this diversity?

We need a conceptual framework to think about PDPs

We emphasize two dimensions
o
Scope of the interventions (horizontal or vertical).
o Type of interventions: public goods / public inputs, or market interventions (subsidies,
tax exemptions, protection).

These two dimensions define a 2x2 matrix which we find useful, because every quadrant
raises different public policy considerations.
How to make sense of this diversity?
H
Public
inputs
Market
interventions
V
To provide public inputs that favor certain sectors.
May involve collective inputs that can financed by the
private sector. State may be needed to help solve
coordination problems. Public-private interaction is
key
Reduce number of days to start a
business
Interventions that stimulate certain activities (not
sectors). What market failures do we seek to address?
Not all of these policies are justified. Instruments
need to be designed so as to target the type of
activities that do generate them and to address
market failures as precisely as possible
R&D subsidies, job training subsidies, subsidies for
investment in capital equipment.
Phytosanitary control
Cold storage for fresh flowers
Strategic bets in specific sectors. Under certain
conditions –for example, coordination failures in
sectors with competitive potential-- may be justified
on a temporary basis
Tax exemptions for tourism
Bringing sterilization Equipment
to Costa Rica
Best matches, not best practices

Prevailing practice in institutional and policy reform is to identify “best practices” and
adopt them

Problem 1: policies not applied in a vacuum, but in specific contexts rich in behavioral
norms and tacit “working rules”

Problem 2: countries differ with regards to existing capabilities

Rather than “best practices”, countries should focus on “best matches” between
policies and capabilities, taking institutional context into account.

Policies beyond existing capabilities may be best left for the future (once capabilities
are developed)
Back to the era of ‘the ephor of the exchange economy”
The Role of the Financial Sector: Why do we need to do more?
•
Market Failures and the Rationale for Interventions
•
•
•
•
Intertemporal contracts can only exist in the presence of a proper institutional set-up and a well-working legal system that
can enforce contracts promptly and at a low cost.
Market failures associated with the presence of asymmetric information and the costs associated with collecting and
managing information.
Easier financial conditions for high social return projects whose benefits are external to the contracting parties and therefore
not valued by the market.
Financial Policies: How and where to intervene
•
Public Inputs can improve productivity through better access to finance include setting transparent and enforceable ground
rules for supervision and regulation of financial markets, lowering barriers to entry in financial markets, reducing
asymmetries that distort the allocation of capital or lead to credit rationing, and establishing (or improving) the legal basis for
credit bureaus, secured transactions, land registries, registries of moveable property, and bankruptcy laws. The ability to
pledge collateral is key and problems related to the lack of pledgeable collateral are amplified by insolvency laws that do not
establish clear priority rights and do not allow for quick restructuring of going concerns in the case of default.
•
Market interventions are policies that attempt to counteract market failures by altering the market conditions under which
financing can be obtained. Some of these policies are hybrid, blending public and private participation. Contractual
arrangements in which a third party guarantees the repayment of a specific loan can be effective instruments for promoting
access to credit for constrained firms and sectors. Multilateral reciprocal guarantee schemes (MGS) are cooperative
arrangements in which certain partners (participating members) receive and offer guarantees, while other partners
(sponsoring members) only offer guarantees.
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
The Role of the Financial Sector: Why do we need to do more?
•
Public credit guarantees can directly reach credit constrained firms whose realization of high returns investments is frustrated by
lack of creditworthiness.
•
Cheap funding of commercial banks by second-tier development banks is a method to induce financial institutions to reduce their
lending rates without explicitly affecting the risk of the loan.
•
Both guarantees and funding presumably have (implicit or explicit) fiscal costs if they are conducted at below-market prices.
Guarantees are better suited for tackling credit constraints, and are particularly efficient when private banks are excessively risk
averse and the guarantor has superior enforcement capacity or information on collateral value. Cheap funding is ideal for targeting
firms that generate positive spillovers but do not face tight credit constraints impeding borrowing, so that once the cost capital is
low enough to match their private returns, investment will naturally follow at the appropriate scale.
Special policies for small firms?
•
Some of the market failures previously reviewed hurt SMEs with more intensity and would thus justify special care for SMEs.
•
For example, the range of assets that can be effectively used as collateral is particularly important to equity scarce SMEs and it could
be expanded by developing registries of movable collateral that allow lenders to track what assets have been pledged and on what
terms (IDB, 2010).
•
Recent changes in banking practices and regulation may also have had a negative effect on SMEs' ability to access credit (OECD,
2012), such as Basel II regulation increasing collateral requirements for SMEs.
•
Banking regulations that unduly penalize SMEs ought to be reviewed, and in fact, access to credit for SMEs may be facilitated by the
implementation of Basel III which, by classifying loans to SMEs as retail banking, reduces their risk weight (OECD, 2012).
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
The Role of the Financial Sector: Why do we need to do more?
•
However, is there a case for special policies for SMEs beyond the generic justifications reviewed above?
•
The fact that SMEs face more problems in accessing credit markets does not necessarily justify SME-specific
interventions.
Aside from social objectives, it is difficult to make a case for special policies for SMEs on productivity grounds
based on this argument.
Higher intermediation cost per unit lent is a real cost associated with operating small firms, a real cost to an
economy based on small firms.
Necessary financial intermediation costs are part of the productivity equation, and on this count SMEs are on
average less productive than large firms (IDB, 2010), and therefore promotional policies that target small and
medium enterprises may reduce overall productivity.
Special policies for SMEs could be justified if credit constraints prevent productive firms from achieving critical
mass to grow on their own.
However, it is not clear how relevant this case is in practice. Alternatively, a more fruitful policy approach may be
to focus on new and young firms rather than small firms in general. Fledgling firms are more likely to be trapped
in a credit constraint impeding their development to reach critical mass or even their emergence in the market.
•
•
•
•
•
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
Back to the era of ‘the ephor of the exchange economy”
The Role of the Financial Sector: The Experiences
Relaxing collateral constraints through factoring
•One way to access credit beyond available collateral is to sell accounts receivable to a factoring company.
• “Cadenas Productivas” (Productive Chains), a program put in place by the Mexican state-owned development
bank Nacional Financiera (Nafin), is a successful example of a policy that creates the legal and logistic framework to
facilitate factoring services to SMEs by creating “chains” between large buyers, including the government, and small
suppliers. By using receivables from large creditworthy buyers to obtain cash, small suppliers implicitly enlarge their
collateral (they “borrow” collateral from large, creditworthy firms), and in this way can effectively reduce their credit
risk. Nafin provides the financial infrastructure for the program, a public input, ensuring competition among the
lenders enrolled in the program giving national reach to regional banks. Nafin also acts as a second-tier bank and
refinances the participating financial institutions. Furthermore, Nafin encourages the participation of large buyers in
the program and provides training for SMEs enrolled in it. Importantly, Cadenas Productivas required critical public
inputs of supporting laws which allow secure and legally binding factoring transactions.
•As of December 2012, Cadenas Productivas covered 550 large buyers, more than 100,000 small and medium firms,
and more than 50 domestic lenders. Since the inception of the program in September 2001, Nafin has brokered more
than 17 million transactions amounting to more than USD 131 billion in financing.
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
The Role of the Financial Sector: The Experiences
Credit guarantees
Credit Guarantee programs “crowd in" the private sector. By providing a partial guarantee, the risk of lending by the financial institution is
reduced and this allows currently credit constrained firms to obtain more credit, effectively expanding collateral.
Partial credit guarantees are potentially effective and efficient instruments to counteract other market failures: By increasing the number
of firms with access to credit, a credit guarantee program creates credit histories and also expands the available information for lenders
to estimate and asses firms’ ability and willingness to pay. More accurate credit scores can be developed. A partial credit guarantee
program can have demonstration and learning-by-doing effects as their expertise for SME lending improves.
Using average rates for Latin America, for every one dollar of fiscal contribution a guarantee program generates 7.3 (the effective
leverage rate) dollars of credit to their target markets. However, these guarantee schemes generate contingent liabilities, whose size
depends on how the program design establishes incentives for prudent risk analysis for guaranteed loans. The lower the coverage, the
greater the financial risk assumed by the financial intermediary and, therefore, the greater the incentive for safe loans..
The Chilean FOGAPE (Fondo de Garantía para el Pequeño Empresario) program, administered by Banco Estado (a state-owned
commercial bank), has an innovative way to balance achieve increased market participation. Rather than setting a fixed coverage rate
and guarantee fee, these parameters are flexible. First, access to guarantees is auctioned in such a way that financial institutions bidding
lower coverage levels obtain larger quotas of guaranteed amounts. The maximum coverage rate allowed is 80% but the average rate on
the portfolio obtained with this bidding process is currently 65%. Moreover, in order to ensure that the resulting risks are internalized,
under the FOGAPE program, when the past due rate of the portfolio of a financial institution exceeds an established ceiling, the
guarantee fee on its whole portfolio is increased in line with its quality deterioration. These mechanisms are factors that have
contributed to the FOGAPE scheme’s success in terms of both high levels of credit additionality as well as strong and sound financial
performance. Furthermore, the average firm with a guarantee had both higher profits and sales compared to similar non-participating
firms (Larrain and Quiroz, 2006)
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
The Role of the Financial Sector: The Experiences
Combining credit with non-financial services (NFS)
•Credit programs are sometimes needed as a complement of the provision of NFS addressing market failures. For example, services that
reduce information asymmetries, thereby altering the perception of risk associated with financing certain operations, would strengthen
the need for credit. Clusters and value chains represent forms of industrial organization where financial services may also usefully
accompany the provision of non-financial services. A proper analysis of a cluster and its firms requires a full understanding of the market,
the interrelation with suppliers and clients, production and market cycles, the relevance of a firm within a chain, their associative
capacity, etc. This is costly information. Public policies to ensure cluster financing imply additional credit risk evaluation whose cost may
need to be defrayed.
•A good example of this type of public intervention is the San Juan Province productive development Program in Argentina, which
includes both financing and technical assistance components to support eleven identified value chains for a total amount of $53 million.
These value chains represented 76% of the province’s exports and were responsible for 32% of the local economy. The program was
coordinated by an agency created with the specific purpose (Agencia San Juan de Desarrollo de Inversiones) of facilitating the publicprivate linkages needed to alleviate the market failures preventing the financing of productive investments. Financing was funded
through the Central Bank of Argentina operating as a second tier institution providing medium and long term financing. The funds were
auctioned among private and public banks through a transparent process and beneficiaries of the program increased sales and exports by
69% and 29% more than comparable non participant firms in the province.
•The experiences of partnership between agencies of innovation promotion and banks in Argentina and Colombia offer another
example of synergy. Because of lack of technical expertise, banks may be unable to evaluate investment projects by firms that are
interested in improving their technology. In these cases, banks delegate the task of carrying out the analysis of the technological risk
involved in projects to public agencies (Rivas, et al 2010). The challenge for public policy for synergy to emerge is to make sure that these
services are structured as to support the need of the financial intermediary to learn about the firm’s capacity of repayment.
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
The Role of the Financial Sector: The Experiences
Subsidized lending
•Targeted subsidies to finance investments in energy efficiency (EE) and in the production of electricity from renewable primary sources
can correct spillovers associated with pollution and CO2 emissions. EE has indirect social returns, which range from the local
environment, workers’ health, lower aggregate costs associated with national energy intensity and balance of payments resilience in the
case of energy-importing countries to global climate effects.
•Development Banks can play a strategic role in overcoming barriers to finance EE and to capture their positive spillovers. For example, in
order to address these barriers, BANCOLDEX developed a pilot program targeting the country’s fast-growing hotel and hospital/clinic
industries with a US$10 million Clean Technology Fund (CTF) loan to provide investment financing and technical cooperation.
•The program provides:
• (i) an insurance policy to ensure the energy savings that the EE projects will deliver to the borrower (issued on the basis of a
standardized Energy Performance contract, to be monitored and certified by a third-party technical expert), in order to address
creditor and investor risks;
• and (ii) a concessional financing line to enhance local demand for credit for green technologies and increase the participation
of EE service providers.
•BANCOLDEX is coordinating these instruments and supporting commercial local financial institutions (first tier) and other market
participants in structuring, financing, monitoring, and evaluating projects. Over time, the program may be replicated and expanded to
other sectors– including factories, businesses, schools and universities, among others.
Crespi, Gustavo, Eduardo Fernández-Arias, and Ernesto Stein, eds. Forthcoming. Rethinking Productive Development: Sound Policies and
Institutions for Economic Transformation. Development in the Americas Series. New York: Palgrave Macmillan and Washington, DC: Inter-American
Development Bank.
Thank you!!
HH
BP
PI
VV
Quadrant MI / H
IM
MI

Interventions that stimulate certain activities (not sectors).

Examples: R&D subsidies, job training subsidies, subsidies for investment in
capital equipment.

The key question in this quadrant is: “what market failures do we seek to
address?” Not all of these policies are justified.
– R&D vs. investment subsidies

One should not assume “automatic” externalities.
– Some types of R&D may generate more spillovers than others.

Instruments need to be designed so as to target the type of activities that do
generate them and to address market failures as precisely as possible.
HH
BP
PI
VV
Quadrant PI / V
IM
MI

Should the State provide public inputs that favor certain sectors?

Yes! most public inputs have differential effects on sectors
– phytosanitary control important for fruits and vegetables, not for garments.

May involve collective inputs that can financed by the private sector; State may be needed to
help solve coordination problems.

Typically addressed within cluster development programs

How to decide which sectors to work with?

How does the State identify their PI needs?
– Public-private interaction is key. But how to structure it?
– How should State organize itself to deliver needed PIs?
– Requires cooperation across different public agencies
•HH
•BP
PI
•VV
Quadrant MI / V
•IM
MI

Most controversial. Lends itself to favoritism and rent-seeking.

Includes interventions with different objectives

Protect declining sectors, or sectors with no latent comparative advantage, but strong lobby
capabilities (should be discouraged!)
– Example: rice protection in Costa Rica

Strategic bets in specific sectors. Under certain conditions –for example, coordination failures
in sectors with competitive potential-- may be justified on a temporary basis.
– Example: tourism in Costa Rica (subsidies to several actors in the sector needed to
coordinate investments)