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Financial Sector

Enlarging the Contracting Space: Collateral Menus, Access to Credit, and Economic Activity

Mauricio Larrain's picture

One of the main obstacles that firms in developing countries face is lack of access to credit. A key factor that restricts access is insufficient collateral. Interestingly, banks in less-developed countries usually lend only against real estate; they rarely lend against other assets such as machinery, equipment, or inventory. The problem is that assets such as machines and equipment often account for most of the capital stock of small and medium-size firms. In this context, these assets become “dead capital”: they lose their debt capacity and only serve as inputs in the firms’ production processes.

While it’s true that machines and equipment are less redeployable than real estate, banks in developed countries do lend against these types of assets. In a recent study with Murillo Campello, we argue that the root of the problem lies in weak collateral laws. The law makes a clear distinction between two types of assets: immovable assets (e.g., real estate) and movable assets (e.g., machinery and equipment). Developing countries have weak collateral laws regarding movable assets, which makes its very difficult to pledge these assets as collateral. This shrinks the contracting space, since the menu of collateral becomes smaller, which limits access to credit. Moreover, since movable assets lose debt capacity, firms under-invest in technologies intensive in movable assets.

Shifting regulation of digital financial services: from enabling to fostering competition

Ignacio Mas's picture

Branchless banking and mobile solutions in developing countries tend to be dominated by very few large (mostly telco) players, focus narrowly on the payment function of money that calls for a national footprint, elicit relatively infrequent usage from the majority of customers, and exhibit low levels of service innovation. There are few examples globally of what I call an intensive model: smaller players making the business economics work by driving much greater usage from a much smaller customer base.

Tackling financial inclusion — that is, making financial services truly a mass-market offering — will require more, and more diverse, players contributing variously their resources, inventiveness and goodwill. We need more players jumping in: to create more competitive tensions and force more service and business model differentiation, but also because in most markets the usual path to scale is through specialization.

How are Financial Capability and Financial Access Linked? Insights from Colombia and Mexico

Miriam Bruhn's picture

Access to formal financial services has been expanding in recent years.  But as people start to use these services for the first time, it has become clear that the challenge is not only providing access to financial services, but also ensuring that people have the behaviors and attitudes to use financial products responsibly and to their advantage. If not, increased access to finance could potentially lead to over-indebtedness and even financial crises.

Two recent nationwide surveys of 1,526 adults in Colombia and of 2,022 adults in Mexico measure financial capability to provide insights on how people manage their finances. The term “financial capability” refers to a broader concept than financial literacy or knowledge alone. It covers a number of different behaviors and attitudes related to participation in financial decisions, planning and monitoring the use of money, and balancing income and expenses to make ends meet.

The financial capability surveys find for example that, in Mexico, many make financial plans, but far fewer adhere to them. Seventy percent of those surveyed say they budget, but just one-third reported consistently adhering to a budget. Similarly, just 18 percent knew how much they spent last week. In Colombia, while 94 percent of adults reported budgeting how income would be spent, less than a quarter of those surveyed actively monitored spending or had precise knowledge of how much is available for daily expenses.

Islamic Finance: A Quest for Publically Available Bank-level Data

Amin Mohseni-Cheraghlou's picture

Attend a seminar or read a report on Islamic finance and chances are you will come across a figure between $1 trillion and $1.6 trillion, referring to the estimated size of the global Islamic assets. While these aggregate global figures are frequently mentioned, publically available bank-level data have been much harder to come by.

Considering the rapid growth of Islamic finance, its growing popularity in both Muslim and non-Muslim countries, and its emerging role in global financial industry, especially after the recent global financial crisis, it is imperative to have up-to-date and reliable bank-level data on  Islamic financial institutions from around the globe.

To date, there is a surprising lack of publically available, consistent and up-to-date data on the size of Islamic assets on a bank-by-bank basis. In fairness, some subscription-based datasets, such Bureau Van Dijk’s Bankscope, do include annual financial data on some of the world’s leading Islamic financial institutions. Bank-level data are also compiled by The Banker’s Top Islamic Financial Institutions Report and Ernst & Young’s World Islamic Banking Competitiveness Report, but these are not publically available and require subscription premiums, making it difficult for many researchers and experts to access. As a result, data on Islamic financial institutions are associated with some level of opaqueness, creating obstacles and challenges for empirical research on Islamic finance.

Deposit Insurance and the Global Financial Crisis

Asli Demirgüç-Kunt's picture

How does deposit insurance affect bank stability?  This is a question that has been around for a while but has come up again after the global financial crisis.  In response to the crisis, a number of countries substantially increased the coverage of their safety nets in order to restore market confidence and to avert potential contagious runs on their banking sectors.  Critiques worry that such actions are likely to further undermine market discipline, causing more instability down the line. My earlier research on this issue suggests that on average deposit insurance can exacerbate moral hazard problems in bank lending, making systems more fragile.  In other words, particularly in institutionally under-developed countries, banks have a tendency to exploit the availability of insured deposits and increase their risk, making the financial system more crises prone.  This is ironic since deposit insurance is supposed to make the systems more stable, not less.

But what if the impact of deposit insurance on stability varies depending on the economic conditions? Does deposit insurance help stabilize banking systems by enhancing depositor confidence during turbulent times?

Financial Inclusion for Financial Stability: Improving Access to Deposits and Bank Resilience in Sync

Martin Melecky's picture

From 2006 to 2009, growth of bank deposits dropped by over 12 percentage points globally. The most affected by the 2008 global crisis were upper middle income countries that experienced a drop of 15 percentage points on average. Individual countries such as Azerbaijan, Botswana, Iceland, and Montenegro switched from deposit growth of 58 percent, 31 percent, 57 percent, and 94 percent in 2007 to deposit declines (or a complete stop in deposit growth) of -2 percent, 1 percent, -1 percent, -8 percent in 2009, respectively.

In times of financial stress, depositors get anxious, can run on banks, and withdraw their deposits (Diamond and Dybvig, 1983). Large depositors are usually the first ones to run (Huang and Ratnovski, 2011). By the law of large numbers, correlated deposit withdrawals could be mitigated if bank deposits are more diversified. Greater diversification of deposits could be achieved by enabling a broader access to and use of bank deposits, i.e. involving a greater share of adult population in the use of bank deposits (financial inclusion). Based on this assumption, broader financial inclusion in bank deposits could significantly improve resilience of banking sector funding and thus overall financial stability (Cull et al., 2012).

Islamic Finance and Financial Inclusion: A Case for Poverty Reduction in the Middle East and North Africa?

Amin Mohseni-Cheraghlou's picture

The Middle East and North Africa (MENA) region is home to about 70 million of the world’s poor (living on less than two dollars per day) and 20 million of the world’s extremely poor (living on less than US$1.25 per day). According to a recent Gallup survey, 95 percent of the adults residing in MENA define themselves as religiously observant. The combination of these two facts has produced a growing interest in Islamic finance as a possible tool for reducing poverty through financial inclusion among the region’s religiously conscious Muslim population (see Mohieldin et al. 2011).

Uneven access to financial services and instruments that are compliant with Shari’ah, or Islamic law, could be one of the contributing reasons for the low number of bank accounts in the MENA region. A mere 18 percent of adults (above the age of 15) have accounts in formal financial institutions, the lowest in the world (Figure 1). There is ample evidence that, if done correctly, increasing access to and the use of various financial services can help both reduce poverty and its severity (for example see Burgess and Pande 2005 and Beck, Demirgüç-Kunt and Levine 2007 among many). With no access to financial services, many of the poor in MENA will continue to be trapped in poverty with little to no chance of escaping it in the foreseeable future.

Could leveraging Public Credit Registries’ information improve supervision and regulation of financial systems?

Jane Hwang's picture

“You never want a serious crisis to go to waste.”
Rahm Emanuel, former White House Chief of Staff

Looking in the rearview mirror, the recent U.S. subprime crisis seemed to be precipitated by a cauldron of events which were embedded in the fundamental problem that credit risk management was compromised on various levels. Naturally with a few years of hindsight, academics, economists, regulators, and supervisors have all wondered how the crisis could have been adverted or at least mitigated.

In this light, the existence of information data gaps and the importance of complete, accurate and timely credit information in the financial system have become more poignant. As a result of accelerated financial innovation, the banks offered new, but opaque, vehicles for investment. This made it difficult to assess risk levels and the true extent of credit leverage. Thus, as financial institutions began to develop and issue more convoluted instruments, credit risk management became more imprecise and at times erroneous. Without proper regulatory oversight and amid highly liquid credit markets (i.e. high demand for CDOs, ABSs, etc.), it further enabled banks to loosen their lending policies and thus continue to take riskier positions. As this occurred, banking supervisors and regulators often lacked the appropriate information to readily monitor the developments unfolding in the marketplace.

Financial Stability Reports: What Are They Good For?

Martin Cihak's picture

Words, words, words: do they matter in finance? And, more to the point, do reports on financial stability have an impact on, say, financial stability? New research suggests that the answer is a qualified “yes”: such reports can actually have a positive link with financial stability, if they are done well. Reports that are written clearly, are consistent over time, and cover the key risks to stability are associated with more stable financial systems.

Publishing reports on financial stability has been a rapidly growing industry, with more and more central banks and other agencies around the world now publishing such reports. As of early 2012, around 80 such reports are being issued on a regular basis (Figure 1). The stated aim of most of these reports is to point out key risks and vulnerabilities to policy makers, market participants, and the public at large, and thereby ultimately helping to limit financial instability.

Figure 1. The number of countries that publish financial stability reports


Source: Čihák, Muñoz, Teh Sharifuddin, and Tintchev (2012).

New Paper on Financial Regulation Recognized by ICFR and Financial Times

Asli Demirgüç-Kunt's picture

More than three years after the onset of the global financial crisis, a plethora of regulatory reforms are being put in place. The Basel Committee has prepared new capital and liquidity requirements, and the Financial Stability Board has kicked off an impressive agenda of reform. But implementation has been far from straightforward, and domestic priorities have often been in conflict with attempts at regulatory convergence. Against this background, the International Centre for Financial Regulation (ICFR) and the Financial Times invited submissions for a research prize in financial regulation, calling for essays that would consider “what good regulation should look like”.

The call resulted in an interesting set of ten top-rated essays. One of them is a new paper that we co-authored with R. Barry Johnston, based on some of the background work for the World Bank’s upcoming 2013 Global Financial Development Report. In our piece (which of course represents only our views and not necessarily those of the World Bank), we answer the organizers’ question by saying that “good regulation needs to fix the broken incentives.” Or, to paraphrase a 1990s campaign slogan, “it’s the incentives, stupid.”

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