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Financial Sector

Building a Robust Case for Microsavings

Ignacio Mas's picture

Editor's Note: The following post was submitted jointly by Jake Kendall and Ignacio Mas of the Bill and Melinda Gates Foundation.

At the Financial Services for the Poor team at the Bill & Melinda Gates Foundation we have made a deliberate choice to focus on promoting savings (you can read about our strategy here). We think that saving in a formal, prudentially regulated financial institution is a basic option that everyone should have. Having a safe place to save allows people to manage what little they have more effectively and to self-fund life-improving or productivity-enhancing investments without paying the high interest rates associated with small loans. Accessing other people’s money through credit may not be right for everyone, but making the most out of your own income surely is. From a donor perspective, we need to move beyond microcredit and support the development of broader markets. In fact, too much focus on microcredit risks tilting the incentives of local financial intermediaries to funding their credit portfolio from external soft funds rather than via mobilizing local deposits.

As I go around the world talking up these issues, I am struck by how often I need to justify the value of savings for poor people intellectually. Sure, we should do more to demonstrate these benefits with actual data, and we are funding a bunch of studies in this regard. But why is the notion so counter-intuitive for many people? I would trace that to two misconceptions and two fears.

Bank Capital Regulations: Learning the Right Lessons from the Crisis

Asli Demirgüç-Kunt's picture

The recent financial crisis demonstrated that existing capital regulations—in design, implementation, or some combination of the two—were completely inadequate to prevent a panic in the financial sector. Needless to say, policymakers and pundits have been making widespread calls to reform bank regulation and supervision. But how best to redesign capital standards? Before joining the calls for reform, it’s important to look at how financial institutions performed through the crisis to see if we’re learning the right lessons from the crisis. Is capital regulation justified? What type of capital should banks hold to ensure that they can better withstand periods of stress? Should a simple leverage ratio be introduced to reduce regulatory arbitrage and improve transparency? These are some of the questions addressed in a recent paper I wrote with Enrica Detragiache and Ouarda Merrouche.

 

Since the first Basel capital accord in 1988, the prevailing approach to bank regulation has put capital front and center: banks that hold more capital should be better able to absorb losses with their own resources, without becoming insolvent or necessitating a bailout with public funds. In addition, by forcing bank owners to have some “skin in the game,” minimum capital requirements help counterbalance incentives for excessive risk-taking created by limited liability and amplified by deposit insurance and bailout expectations. However, many of the banks that were rescued in the latest turmoil appeared to be in compliance with minimum capital requirements shortly before and even during the crisis. In the ensuing debate over how to strengthen regulation, capital continues to play an important role. A consensus is being forged around a new set of capital standards (Basel III), with the goal of making capital requirements more stringent.  

Measuring Bank Competition: How Should We Do It?

Maria Soledad Martinez Peria's picture

Lack of competition in the banking sector has detrimental effects. Studies have found that it can result in higher prices for financial products and less access to finance, especially for smaller firms. Others have shown that it can lead to the entry of fewer new firms, less growth for younger firms, and delayed exit for older firms. Moreover, while a debate is still under way, new evidence suggests that lack of competition can undermine the stability of the banking sector, especially if some banks become too big to fail.

How to measure bank competition? In a recent paper Asli Demirgüç-Kunt and I propose a multipronged approach. While we apply this framework to Jordan, it can be used to analyze bank competition in any country. In fact, the approach developed in this paper has been used to analyze competition in China, the Middle East and North Africa, and Russia.

The Most Effective Development Intervention We Have Evidence For?

David McKenzie's picture

Ask most people to name the most effective means of raising incomes of people in poor countries, and what would they say?

Microfinance? Perhaps not after the recent experimental assessments.

Deworming? It increased primary school participation and improved health, but in the short-term at least seems unlikely to raise household income.

Conditional cash transfers? This might be a popular answer, with evidence from a number of countries that they have increased household expenditure , schooling, and health outcomes. But even though Governments devote significant resources to such programs, the absolute annual increases in household income and expenditure are still at most US$20-40 per capita for participating households.

I bet that facilitating international migration is not very high up the list of interventions people think of. But it should be. In a new working paper, John Gibson and I evaluate the development impacts of New Zealand’s new seasonal worker program, the RSE. The figure below compares the per-capita income gain we estimate to those from microfinance, CCTs, and from my previous research giving grants of $100-200 to microenterprises. It is simply no contest!

Business Environment Reforms: Distinguishing Tokenism from the Real Thing

Inessa Love's picture

To promote the registration of new firms, many countries have been undertaking reforms to reduce the costs, days or procedures required to register a business. For example, the World Bank Doing Business report each year identifies the 10 most improved countries on the overall Doing Business index (comprised of 9 subindicators). One of these subindicators measures reforms related to starting a business, with 30-65 countries reforming in this area each year. A still unanswered question is whether some reforms are more important than others. A priori, it is not clear what magnitude of reduction in costs (or days or procedures) is necessary to create a significant impact on firm registration. In other words, what exactly constitutes a reform? Is a 20% reduction in the costs of registration sufficient, or is a 50% reduction necessary to get a substantial number of firms to register?

In a recent paper Leora Klapper and I empirically investigate the magnitude of reform required for a significant impact on the number of new registrations. We use a new dataset that is uniquely suited for this purpose: the World Bank Group Entrepreneurship Snapshots (WBGES), a cross-country, time-series panel dataset on the number of newly registered companies. We supplement it with data from Doing Business reports that contain the cost, time and procedures required for registration of new companies. Importantly, both datasets focus on limited liability companies. In an earlier paper, we used the same dataset to investigate the impact of the global financial crisis on new firm registrations

Did Yesterday’s Patterns of Colonial Exploitation Determine Today’s Patterns of Poverty?

Miriam Bruhn's picture

Several economists have argued that cross-country differences in economic development today have their roots in the colonial era. For example, Engerman and Sokoloff (1997, 2002)—henceforth referred to as ES—argue that different types of economic activities that the colonizers engaged in led to different growth paths. They claim that the link between colonial activities and current-day levels of economic development is as follows. In many areas, colonial society was very unequal, giving political rights only to a few landowners, while repressing most of the population through slavery or forced labor. Consequently, institutions that developed during colonial times were designed to protect the rights of only a few. These institutions persist until today and constrain economic development. To give one example, many Latin American banking systems developed primarily to serve a wealthy elite, restricting access to finance for the rest of the population.

In a paper I recently co-authored with Francisco Gallego, we test empirically whether areas with different types of colonial activities do indeed have different levels of economic development today. We use within-country data for 345 regions in seventeen countries in the Americas to do this. We rely on within-country data because colonial activities varied considerably even within countries (for example, the northeast of Brazil grew sugar, while many states in central and southern Brazil had large cattle ranches). Moreover, in our sample, levels of development vary almost as widely within countries (between regions) as they do between countries.

The Global Financial Inclusion Indicators: An Important Step towards Measuring Access to Finance

Asli Demirgüç-Kunt's picture

How inclusive are financial systems around the world? What proportion of the population uses which financial services? Despite all the work we have done so far, most of the figures cited by experts in this field are still just estimates (see, for example, here and here). But this is about to change—in a big way.

To help us understand the scope and breadth of financial activity by individuals around the world, the Bill & Melinda Gates Foundation today announced an $11 million, 10-year grant to the World Bank’s Development Research Group to build a new publicly accessible database of Global Financial Inclusion Indicators. The ultimate goal of the project is to improve access to finance; achieving this goal requires reliably measuring financial inclusion in a consistent manner over a broad range of countries and over time to provide a solid foundation of data for researchers and policymakers. We will carry out three rounds of data collection, starting with Gallup, Inc’s 2011 Gallup World Poll, which will survey at least 1,000 people per country in 150 countries about their access and use of financial services.

Islamic Banking: Can it Save Us from Crises?

Asli Demirgüç-Kunt's picture

Pundits in the financial press have been asking an intriguing question: if too much debt and insufficient equity was partly responsible for the financial crisis, might Islamic banking be part of the solution? After all, Islamic principles require that financial transactions cannot include interest rate payments on debt, but rather have to rely on profit-loss risk-sharing arrangements (as in equity). For example, demand deposits that do not pay interest are fine, but savings deposits generally participate in the profits of the bank since these cannot accrue interest. Lending also generally follows a partnership model where the bank provides the resources and the client provides effort and expertise, and profits are shared at some agreed ratio. So can the heightened risk-sharing required by Sharia curb excess risk-taking by banks?

In practice Islamic scholars have also developed products that resemble those offered by conventional banks, replacing interest rate payments and discounting with fees and contingent payment structures. Nevertheless, Islamic banking still retains a strong element of equity participation. How does this affect bank risk-taking? Conceptually, the answer is not immediately clear. On the one hand, the equity-like nature of savings instruments may increase depositors’ incentives to monitor and discipline banks. On the other hand, if deposit instruments are equity-like, banks’ incentives to monitor and discipline borrowers may also be reduced since banks no longer face the threat of immediate withdrawal. Similarly, the equity-like nature of partnership loans can reduce the important discipline imposed on entrepreneurs by debt contracts.

The Challenges of Bankruptcy Reform

Leora Klapper's picture

The 2008 financial crisis precipitated a global economic downturn, credit crunch, and reduction in cross-border lending, trade finance, remittances, and foreign direct investment, which all adversely affected businesses around the world. The increase in the number of distressed firms has made policymakers more concerned about the effectiveness of existing bankruptcy regimes, including both the laws that address reorganization and liquidation, as well as improved enforcement of laws in court.

In a recent paper with Elena Cirmizi and Mahesh Uttamchandani, my co-authors and I summarize the theoretical and empirical literature on designing bankruptcy laws; discuss the challenges of introducing and implementing bankruptcy reforms; and present examples of the most recent reforms in this area from around the world. As policymakers use the current recession as an opportunity to engage in meaningful reform of the bankruptcy process, it is important to assess experiences from previous crises.

Reforming Global Finance: What is the G20 Missing?

Franklin Allen's picture

Editor's Note: Professor Franklin Allen came to the World Bank on October 27 to give an FPD Chief Economist Talk on the topic of Reforming Global Finance: What is the G20 Missing? Please see the FPD Chief Economist Talk page to download a copy of his presentation and watch a video of his Talk.

The recent financial crisis clearly had more than one cause. My view is that the most important one was a bubble in real estate prices, not only in the US but also in a number of other countries such as Spain and Ireland. It was the bursting of this bubble that has led to so many problems in the world economy. A significant part of this is a direct effect on the real economy rather than an effect transmitted through the financial system. For example, Spain had one of the best regulated banking systems and its banks did much better than in other countries. Yet with a doubling of its unemployment rate to 20 percent, its real economy has been devastated. In contrast countries like Germany that did not have a real estate bubble but had much larger drops in GDP have not suffered nearly as much. Germany's unemployment rate is now lower than at the start of the crisis.

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