In a new paper, we address this question using detailed manufacturing census data from India. India offers an ideal laboratory for testing the role of institutions on firm lifecycle given the large persistent differences in institutions, business environment, and income across different regions. Specifically, we examine the relationship between plant size, age, and growth and ask: how does local financial development influence the size-age relationship? Are there differences in the size-age relationship across different industry characteristics and between the formal and informal manufacturing sector and does this vary with the extent of local financial development? Does the role of local financial development on firm lifecycle vary with major regulation changes in India such as financial liberalization, changes in labor regulation, and industry de-licensing?
Since the late 1990s, the importance of multinational banks has grown dramatically. Between 1999 and 2009 the average share of bank assets held by foreign banks in developing countries rose from 26 percent to 46 percent. The bulk of the pre-global crisis evidence analyzing the consequences of this significant transformation in bank ownership suggests that foreign bank participation brought many benefits to developing countries, especially in terms of bank competition and efficiency.
The recent global financial crisis, however, highlighted the role of multinational banks in the transmission of shocks across countries. Most of the research has focused on transmission through the lending channel – how foreign bank lending behaved during the crisis. A number of papers, including some before the recent global crisis, have documented that lending by foreign bank affiliates declines when parent banks’ financial conditions deteriorate.
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.
According to the most recent World Bank Enterprise Survey Data, firms in developing countries report that access to finance is the biggest obstacle for the growth of their operations. Across all regions, 17 percent of firms report that access to finance is the biggest obstacle. In some regions, access to finance is an even larger obstacle. For example, in Sub-Saharan Africa close to a quarter of the firms report access to finance to be the top obstacle.
An important impediment to firm financing is asymmetric information: a firm seeking to borrow from a lender in the credit market has better information about its financial state and its ability and willingness to repay the loan than the lender. Asymmetric information can lead borrowers less seriously intent on repaying loans to be more willing to seek out loans (adverse selection) and borrowers to use loaned funds in ways that are inconsistent with the interest of the lender (moral hazard). Seminal work by Stiglitz and Weiss (1981) shows that under asymmetric information the equilibrium interest rate is such that demand for credit exceeds supply - even borrowers willing to pay the market equilibrium interest rate are not able to get a loan (credit rationing).
Despite the common perception that institutional investors herd, it is difficult to identify the reasons for correlated trading. For example, managers might buy into or out of the same securities over some period due to correlated information, perhaps from analyzing the same indicator. Alternatively, a manager might infer private information from the prior trades of better-informed managers and trade in the same direction. Also, managers might disregard their own information and trade with the crowd due to the reputational risk of acting differently from other managers. Finally, managers might simply have correlated preferences over certain types of securities.
In a recent paper, I study correlated trading by Colombian pension fund managers in the presence of a peer-based underperformance penalty known as the Minimum Return Guarantee (MRG). The MRG resembles a reputational risk, in that the manager might be penalized for having lower returns than her peers. With the MRG, the risk is explicit as the manager will be penalized financially if returns are below the maximum allowed shortfall relative to the peer benchmark. The rationale for the MRG, which is a common piece of the regulation in defined contribution pension systems, is to discourage excessive risk taking by pension fund managers.
Financial inclusion initiatives are proliferating rapidly through domestic and global efforts like the Alliance for Financial Inclusion’s “Maya Declarations.” These efforts are materializing in regulatory improvements in issues ranging from mobile banking—allowing ever more innovation, to consumer protection to access to finance for SMEs. There regulations, however, may only prove effective if they take into account the incentives that providers and sales staff have to shroud prices and adjust their behavior to undermine transparency initiatives.
To assess the quality of information provided by sales staff and the suitability of the financial products offered the World Bank, CGAP and CONDUSEF (Mexico’s Financial Consumer Protection Agency) conducted an audit study of savings and credit products for low-income consumers. (The full results have been released in a working paper and accompanying policy note and infographic with key highlights) The research team trained low-income consumers in peri-urban Mexico City and Cuernavaca to visit a range of financial institutions, seeking consumers loans and savings product. By varying the shopper’s scripts along the debt to income, purpose for the savings, and whether they were “experienced” or “inexperienced” shoppers, the study revealed important insights.
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.
Remittances to Sub-Saharan Africa (SSA) have increased steadily in recent decades and are estimated to have reached about $32 billion in 2013. Though studies have shown that remittances can affect aggregate financial development in SSA — as measured by the share of deposits or M2 to GDP (Gupta et al. 2009), to my knowledge there is no evidence for this region on the impact of remittances on household financial inclusion defined as the use of financial services. This question is important because there is growing evidence that financial inclusion can have significant beneficial effects for households and individuals. In particular, the literature has found that providing individuals access to savings instruments increases savings, female empowerment, productive investment, and consumption. Furthermore, the topic of financial inclusion has gained importance among international bodies. In May 2013, the UN High-Level Panel presented the recommendations for post-2015 UN Development Goals, which included universal access to financial services as a critical enabler for job creation and equitable growth. In September 2013, the G20 reaffirmed its commitment to financial inclusion as part of its development agenda.
Cross-border banking has been an important part of Africa’s financial systems since colonial times. While it has long been dominated by European banks, its face has changed significantly over the past two decades. African banks have not only significantly increased their geographic footprint across the region (see Figure 1) but have also become economically significant beyond their home countries in a number of countries across Africa. As their banks have expanded across borders, South Africa, Nigeria, Morocco, and Kenya have emerged as the dominant regional financial centers (see Figure 2). Yet despite this increase in cross-border banking activity within Africa there has been a lack of comprehensive research and analysis on this topic. In a new policy report we try to fill this gap by documenting the growth of cross-border banking in Africa and assessing the risks and benefits of cross-border linkages as well current supervisory arrangements for cross-border supervisory coordination.
Figure 1: Cross-Border Expansion of African Financial Groups over Time,
In the wake of the global financial crisis, policy-makers’ attention has focused on lending to small and medium-sized enterprises (SMEs) as these were among the most affected firms when the credit cycle turned. SME finance has also attracted the attention of the G20 as it is seen as an important constraint on firm growth in developing, emerging and industrialized countries. Indeed, a joint report by IFC and McKinsey has pointed to a global SME financing gap of over 2 trillion USD (Stein, Goland and Schiff, 2010). Various initiatives, such as the SME Finance Challenge and the SME Finance Forum, have consequently been established to try to alleviate small firms’ funding constraints.