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Financial Sector

A Better Way to Benchmark Financial Sector Development

Erik Feyen's picture

 I. The problem of comparing apples and oranges

Comparison of countries lies at the heart of assessing financial sector performance. In doing so, analysts often simply compare financial sector indicators such as credit to the private sector as a percentage of GDP for a given country to a regional average or a set of "representative" countries.

However, such comparisons are only accurate to the extent that the selected benchmark is appropriate. In practice, countries often differ substantially in terms of structural factors that affect financial development. Thus, a simple comparison can lead to inaccurate conclusions.

Figure 1 below displays a simplified example that demonstrates the core of the issue. It shows dots that represent countries with different “structural factors” (e.g. population density) plotted against their “financial development”, i.e. the extent to which the financial sector fosters economic growth via better risk sharing and more productive investments. The figure shows that in terms of financial development, Country B is better than Country A in an absolute sense.

Prospects for Recovery in Eastern Europe

Ryan Hahn's picture

According to a new paper by World Bank economists Paulo Correa and Mariana Iootty, the recovery won't look pretty. The financial crisis and concomitant global economic crisis have had a disproportionately harsh impact on young and innovative firms in Eastern Europe, and this does not bode well for future growth prospects.

A few weeks ago, our corner of the World Bank hosted an event where Correa and Iootty presented their findings. (This was the first in a new series called FPD Academy that will highlight excellent new analytical work on financial and private sector development.) Video of the event appears below the jump. The presentation itself starts at 4:30 and runs to 27:30. A discussant provides remarks immediately after the presentation, and a Q&A follows. 

Deals vs. Rules: Capturing Regulatory Burdens

Mary Hallward-Driemeier's picture

The costs of excessive regulatory burdens can stifle incentives for firms to innovate, invest and grow. In recent years, aid agencies and developing countries have been stepping up efforts  to reduce numerous and lengthy regulatory procedures. However, the focus on aggregate measures of regulatory burden for a country and relying on measures of formal requirements misses a lot of the action.

The World Bank has interviewed over 100,000 entrepreneurs and senior managers in over 100 countries as part of its Enterprise Surveys project. Among the measures collected is the de facto time it takes businesses to complete various interactions with the government (e.g., the time to get goods through customs, get a construction permit, or get an operating license). In the chart below, each vertical line represents a country, and the length of the line represents the distribution of time for firms to clear goods through customs. The first thing to notice is just how much variation there is – within individual countries. There are favored firms for whom it takes a couple of days to obtain permits or clear customs – and disfavored firms, for whom the wait can be weeks or even months. The variation within most countries is considerably larger than the differences in averages across countries.

Job Creation and the Global Financial Crisis

David McKenzie's picture

Each new jobs report in the U.S. reignites the debate about whether the government is succeeding in stemming job losses and doing enough to help stimulate the creation of new jobs.

The U.S. has been far from alone in pursuing active labor market policies during the crisis. In a new note, David Robalino and I take stock of what labor market interventions countries have put in place during the recent crisis and summarize what we know about their effectiveness to date, as well as discuss the emerging issues countries are facing as they adapt these policies to a recovery period.

What Will Economic Recovery Look Like in Eastern Europe?

Paulo Correa's picture

Editor's Note: The following post was contributed by Paulo Correa, Lead Economist for Private Sector Development in the Europe and Central Asia Region of the World Bank.

International debate on the financial crisis has shifted attention to the potential drivers of the future economic recovery. The countries of Eastern Europe were hit hard by the global financial crisis, after having long enjoyed abundant international financing and large inflows of foreign direct investment that brought them high rates of growth, mainly through the expansion of domestic consumption. With the slowing of international trade and the indefinite tightening of financial conditions, sustained economic recovery will depend to a greater extent on productivity gains and growth in exports. 

Two important sources of expansion in firms’ productivity are learning and R&D. Economic research tells us that, depending on size and survival rate, younger firms tend to grow faster than older firms. Because the learning process presents diminishing returns, younger firms, which are in the early phases of learning, will learn faster and thus achieve higher productivity gains than older firms. Innovative firms are expected to grow faster too – R&D tends to enhance firm-productivity, while innovation leads to better sales performance and a higher likelihood of exporting.

The Pitfalls of Financial Regulatory Reform

Ryan Hahn's picture

On May 25 we invited Professor Charles Calomiris of Columbia University to come speak at the World Bank as part of our FPD Chief Economist Talk series. Professor Calomiris discussed the on-going process of regulatory reform, particularly in the U.S., and was, to put it mildly, less than sanguine about the legislation that is currently making its way through the U.S. Congress. Watch a video of his talk (below the jump). The talk itself runs about 46 minutes, and a Q&A session follows.

Impact Assessment Meets the Market

David McKenzie's picture

Rigorous impact evaluations are one of the most important tools we have for understanding “what works” in development. Impact evaluations compare the outcomes of a program or policy against an explicit counterfactual of what would have happened without the program or policy. This kind of evaluation has been gaining more recognition recently, particularly since Esther Duflo, a professor at MIT and a pioneer in this field, received the prestigious John Bates Clark Award. But her work and that of others in the field has focused primarily on health and education. That is starting to change, with finance and private sector development finally getting their due.

In a recent overview paper, I examine why impact evaluations have been slow to occur in the areas of finance and private sector development, and provide examples of successful cases where it has occurred. I suggest key barriers to their use, including (1) a lack of experience with these methods by operational staff working in these fields; and (2) a perception that many of the policies being implemented are not amenable to evaluation.

Bank Competition and Access to Finance

Asli Demirgüç-Kunt's picture

In a recent blog post, I talked about whether there are trade-offs between bank competition and financial stability.  But what about access to finance?  What does competition imply for access?

Theory supplies conflicting predictions, as usual.  According to standard economic theory, a banking system characterized by market power delivers a lower supply of funds to firms at higher cost; hence greater competition improves access.  However, several theoretical contributions have shown that when we take into account problems of information asymmetry, this relationship may not hold.  For example, banks with greater market power can have more of an incentive to establish long-term relationships with young firms and extend financing since the banks can share in future profits.  In competitive banking markets, however, borrower-specific information may become more dispersed and loan screening less effective, leading to higher interest rates. Indeed, while it has been shown that concentration may reduce the total amount of loanable funds, it may also increase the incentives to screen borrowers, thereby increasing the efficiency of lending.  However, all these models also assume a developed economy, with a high degree of enforcement of contracts and developed institutional environments in general. This is obviously not the case for most of the countries where the Bank works.

An Autopsy of the Financial System - The Movie Edition

Ryan Hahn's picture

As promised, here is the video of Professor Ross Levine's presentation at the World Bank on April 28 on the theme of An Autopsy of the Financial System: Suicide, Accident, or Negligent Homicide. For background information on the event, please see Professor Levine's earlier post.