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September 2015

Firms’ use of long-term finance: why, how, and what to do about it?

Miriam Bruhn's picture

This post is part of a series highlighting the key findings of the Global Financial Development Report 2015 | 2016: Long-Term Finance. You can view all the posts in the series at gfdr2015.

The first part of Chapter 2 of the 2015 Global Financial Development Report examines the use of long-term finance from the firm’s perspective. It draws on theoretical and empirical studies to ask why firms would want to use long-term finance and how this use affects their performance. It also relies on the most recent data and evidence to show how use of long-term finance varies across countries and discusses what governments can do to promote the use of long-term finance by firms. Here are the main messages regarding firms’ use of long-term finance:

Firms tend to match the maturity of their assets and liabilities, and thus they often use long-term debt to make long-term investments, such as purchases of fixed assets or equipment. Long-term finance also offers protection from credit supply shocks and having to refinance in bad times. But not all firms need long-term finance. For example, firms with good growth opportunities may prefer short-term debt since they may want to refinance their debt frequently to obtain better loan terms after they have experienced a positive shock.

Understanding the use of long-term finance

Maria Soledad Martinez Peria's picture

This blog post is part of a series highlighting the key findings of the Global Financial Development Report 2015 | 2016: Long-Term Finance. You can view all the posts in the series at http://blogs.worldbank.org/allaboutfinance/category/tags/gfdr2015.

Long-term finance—defined here as any source of funding with maturity exceeding at least one year—can contribute to economic growth and shared prosperity in multiple ways. Most importantly, it reduces firms’ exposure to rollover risks, enabling them to undertake longer-term fixed investments and it allows households to smooth income over their life cycle and to benefit from higher long-term returns on their savings.

But how are we to think about the actual use of long-term finance by firms and households?  Chapter 1 of the 2015 Global Financial Development Report presents a conceptual framework for understanding the use of long-term finance summarized in Figure 1 below. In essence, the use of long-term finance can be best understood as a risk-sharing problem between providers and users of finance. Long-term finance shifts risk to the providers because they have to bear the fluctuations in the probability of default and the loss in the event of default, along with other changing conditions in financial markets, such as interest rate risk. In contrast, short-term finance shifts risk to users because it forces them to roll over financing constantly. Therefore, long-term finance may not always be optimal. Providers and users will decide how they share the risk involved in financing at different maturities, depending on their needs.

Hot off the Press: The Global Financial Development Report 2015/2016 on Long-Term Finance

Asli Demirgüç-Kunt's picture

GFDR 2015 Book CoverIn recent years, long-term finance has increasingly attracted interest from policy makers, researchers, and other financial sector stakeholders. Policymakers are often concerned when they see limited use of long-term finance in their countries since limited availability may adversely affect growth and welfare.  These concerns were further heightened after the global financial crisis since availability of long-term finance was perceived to be reduced following the crisis, adversely affecting the performance of small and medium enterprises and widening financing gaps for investment.

In fact, ensuring more and better long-term finance has become one of the priorities for the post 2015-Agenda (United Nations 2013). Concerns about the detrimental development effects of a potentially constrained supply of long-term finance have been voiced in the Group of Twenty (G-20) meetings and by the Group of Thirty and ensuring more and better long-term finance is one of the priorities for the post 2015-Agenda (United Nations 2013). This year’s Global Financial Development Report (GFDR), the third in the series, is a synthesis of recent and ongoing research aiming to identify those policies that work to promote long-term finance and those that do not, as well as areas where more evidence is still needed.