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Financial Sector

Crisis Recovery and the Role of Credit: Do Phoenix Miracles Exist?

Asli Demirgüç-Kunt's picture

One of the most hotly debated policy questions with respect to the 2008 global crisis is how to stimulate business recovery. Because the crisis started in and severely affected the financial sector, the conventional assumption is that the recovery of the financial sector is a precondition to recovery in the corporate sector. While this conjecture appears reasonable, some have challenged it, pointing to numerous crises across the world in recent years in which real sector recovery preceded that of the financial sector. Of particular interest are episodes characterized by Calvo et al. (2006) as Systemic Sudden Stops (3S episodes) where output declines are associated with sharp declines in the liquidity of a country’s financial sector. Subsequent credit-less recoveries—in which external credit collapses with output but fails to recover as output bounces back to full recovery—have been termed “Phoenix Miracles.”

Empirically, 3S episodes offer an unusual natural experiment since they provide an opportunity to observe how firms are affected in economies which have been subjected to a financial shock that precedes or is contemporaneous with a recession. To date there has been little evidence at the firm-level on how corporations respond to crises in general. In a recent paper, my co-authors Meghana Ayyagari, Vojislav Maksimovic and I use a database of listed firms in emerging markets to analyze the recovery process after a financing crisis. We try to see if recovery of the financial sector precedes or occurs at the same time as the recovery in output of the corporate sector. In other words, we ask: Do firms experience Phoenix Miracles where their sales recover without a recovery in external credit? We then compare and contrast the experience of emerging market firms to that of US firms during the 2008 US financial crisis and investigate if the recent US recovery process qualifies as a Phoenix Miracle.

How to Deepen Financial Systems in Africa: All financial sector policy is local

Thorsten Beck's picture

Editor’s Note: This is the fifth and final contribution in a series of posts that preview the findings of the forthcoming Financing Africa: Through the Crisis and Beyond regional flagship report, a comprehensive review documenting current and new trends in Africa’s financial sectors and taking into account Africa’s many different experiences. The report was prepared by the African Development Bank, the German Federal Ministry for Economic Cooperation and Development and the World Bank. In this post, the authors argue that all financial sector reform has to start locally, taking into account political constraints, but also aiming to create a constituency for financial sector reform.

What has the recent crisis taught us about the role of finance in the growth process of countries? The global crisis and the ensuing Great Recession have put in doubt the paradigm that financial deepening is good for growth under any circumstance. For students of financial systems, the bright (growth-enhancing) and dark (instability) sides of financial development go hand in hand. The same mechanism through which finance helps growth also makes finance susceptible to shocks and, ultimately, fragility.

Lengthening Financial Contracts in Africa

Thorsten Beck's picture

Editor’s Note: This is the third in a series of posts that preview the findings of the forthcoming Financing Africa: Through the Crisis and Beyond regional flagship report, a comprehensive review documenting current and new trends in Africa’s financial sectors and taking into account Africa’s many different experiences. The report was prepared by the African Development Bank, the German Federal Ministry for Economic Cooperation and Development and the World Bank. In this post, the authors focus on the challenges and opportunities in providing long-term finance for enterprises, households and governments. Long-term finance is a critical element for financial systems to fulfill their growth-enhancing role.

Despite recent encouraging innovations in banks, contractual savings institutions, and the capital market, we find that lengthening financial contracts remains a challenge for financial systems across Africa. Figure 1 illustrates the short-term nature of African banking; more than 80% of deposits are sight deposits or with a maturity of less than one year and less than 50% percent of loans have a maturity of more than one year. Providers of long-term finance that are well developed in the industrialized world, such as insurance companies, pension and equity funds and venture capitalists are small in most African countries and inefficient in their operation. This goes hand in hand with a limited supply of long-term equity and debt instruments across the continent.

Is Infrastructure Capital Productive?

From a theoretical and empirical standpoint, the contribution of infrastructure capital to aggregate productivity and output has been extensively researched. Public capital has been modeled as an additional input in Ramsey-type exogenous growth models and in endogenous models as well. On the empirical front, the literature has witnessed a proliferation of research over the last 20 years following Aschauer’s (1989) seminal paper on the effects of public infrastructure capital on US total factor productivity. His finding of excessively high returns to infrastructure, however, has not held up. Subsequent research using a large variety of data and more robust econometric techniques has yielded widely contrasting empirical results. For instance, Bom and Ligthart (2008) find that estimates of the output elasticity of public capital range from -0.175 to +0.917 in a wide set of empirical research for industrial countries.

Financing Africa: Through the Crisis and Beyond

Thorsten Beck's picture

In mid-September, the African Development Bank, the German Federal Ministry for Economic Cooperation and Development and the World Bank will launch Financing Africa: Through the Crisis and Beyond , a comprehensive review documenting current and new trends in Africa’s financial sector and taking into account Africa’s many different experiences. During the coming weeks and leading up to the formal launch of the book in Ethiopia on September 15, we will give a sneak peek of the book’s main findings and recommendations. In this first post, we’ll summarize our main messages.

Bank Competition and Stability: Cross-Country Heterogeneity

Thorsten Beck's picture

In a recent Economist debate, Franklin Allen and I discussed the relationship between competition and stability. In the debate I argued that it is not so much the degree of competition in the banking market but rather bank regulation and supervision that drives bank fragility. In a recent paper with Olivier de Jonghe and Glenn Schepens, we now combine these two areas and test whether the regulatory and supervisory framework influences the competition-stability relationship. And we indeed find several dimensions of the market, regulatory and institutional framework that influences the degree to which competition harms or helps bank fragility.

But let us first review what theory tells us about the competition-stability link, and then examine how this relationship might vary with certain country features.

When Credit is More Than Just Financing: The Case of Trade Credit Contracts

Leora Klapper's picture

As most manufacturers around the world can attest, trade credit is an important source of external financing for firms of all sizes. Suppliers—some of whom may be small or credit constrained—generally offer working capital financing to their buyers, reported as accounts receivables (e.g. McMillan and Woodruff, 1999). Research has also demonstrated that trade credit can act as a substitute for bank credit during periods of monetary tightening or financial crisis (see, for example, Love et al., 2007).

Trade credit, however, is not used for financing purposes alone. Trade credit, it has been argued, is a way for a supplier to engage in price discrimination, giving favored or more powerful clients longer terms (see, for example, Giannetti, Burkart, and Ellingsen, 2011). Furthermore, trade credit may simply be customary in an industry, with this particular custom driven by economic rationales such as allowing buyers time to assess the quality of the supplied goods (Lee and Stowe, 1993).

How a Mere Fingerprint Can Boost Loan Repayment Threefold

Xavier Gine's picture

If I told you that people respond to incentives you’d probably think I’m stating the obvious. But if I told you that a simple intervention raised the repayment rate among risky borrowers by more than threefold, you’d perhaps be more surprised.

Malawi—like many other Sub-Saharan African countries—suffers from limited access to formal credit, especially in rural areas. Part of the problem is that the typical microfinance loan is not well suited for agriculture. For example, lenders cannot schedule frequent repayments because farmers receive cash flows only after the harvest, several months after the loan is taken. Similarly, all farmers need cash at the same time to purchase inputs, so allowing some farmers to borrow only after others have repaid their loans would mean that some farmers would end up receiving credit when they do not need it.

Which Households Use Banks? And Does Bank Privatization Make a Difference?

Thorsten Beck's picture

Access to banking services is viewed as a key determinant of economic well-being for households, especially in low-income countries. Savings and credit products make it easier for households to align income and expenditure patterns across time, to insure themselves against income and expenditure shocks, as well as to undertake investments in human or physical capital. Up to now, however, there is little cross-country evidence which documents how the use of financial services differs across households and, in particular, how cross-country variation in the structure of the financial sector affects the types of households which are banked. In a recent paper with Martin Brown, we use survey data from 28 transition economies and Turkey to:

  1. document the use of formal banking services (bank accounts, bank cards and mortgages) across these 29 countries in 2006 and 2010,
  2. relate this use to an array of household characteristics,
  3. gauge the relationship between changes in bank ownership and the financial infrastructure (deposit insurance and creditor protection) over time within a country and changes in the use of banking services, and
  4. assess how cross-country variation in bank ownership structures, deposit insurance and creditor protection affect the composition of the banked population.

Unexploited Gains from International Diversification: Patterns of Portfolio Holdings around the World

Sergio Schmukler's picture

The increase in global financial integration over the last twenty years has been remarkable, and U.S. institutional investors have been significant participants in this growth. Given standard economic theory, one would expect to see greater international diversification accompanying the expansion of global investment opportunities. To date, however, evidence on how investors actually allocate their portfolios around the world and what determines it is still limited.

In a joint paper with Roberto Rigobon, we aim to fill the gap in the literature by constructing a unique micro dataset of asset-level portfolios for a group of important institutional investors, namely US mutual funds with international investments. To shed light on the drivers of globalization and investment across countries, we explore the structure of mutual fund families. We make within-family comparisons of the behavior of “specialized funds,” which can invest only in certain countries or regions, and “global funds,” which can invest anywhere in the world and thus have access to a larger set of instruments (more firms from more countries).