Showing papers on "Financial sector development published in 1999"

Bank-based and market-based financial systems - cross-country comparisons

Abstract: What are the relative advantages and disadvantages of bank-based financial systems (as in Germany and Japan) and market-based financial systems (as in England and the United States). Does financial structure matter? In bank-based systems banks play a leading role in mobilizing savings, allocating capital, overseeing the investment decisions of corporate managers, and providing risk management vehicles. In market-based systems securities markets share center stage with banks in getting society's savings to firms, exerting corporate control, and easing risk management. The unresolved debate about whether markets or bank-based intermediaries are more effective at providing financial services hampers the formation of sound policy advice. The authors use newly collected data on a cross-section of roughly 150 countries to illustrate how financial systems differ around the world. They a) analyze how the size, activity, and efficiency of financial systems differ across different per capita income groups; b) define different indicators of financial structure and identify different patterns as countries become richer, and c) investigate legal, regulatory, and policy determinants of financial structure after controlling for per capita GDP. A clear pattern emerges: 1) Banks, other financial intermediaries, and stock markets all grow and become more active and efficient as countries become richer. As income grows, the financial sector develops. 2) In higher income countries, stock markets become more active and efficient than banks. Thus, financial systems tend to be more market based. 3) Countries with a common law tradition, strong protection for shareholder rights, good accounting standards, low levels of corruption, and no explicit deposit insurance tend to be more market-based, even after controlling for income. 4) Countries with a French civil law tradition, poor accounting standards, heavily restricted banking systems, and high inflation generally tend to have underdeveloped financial systems, even after controlling for income.

Banking Systems Around the Globe : Do Regulation and Ownership Affect the Performance and Stability?

Abstract: The authors report cross-country data on commercial bank regulation and ownership in more than 60 countries. They evaluate the links between different regulatory/ownership practices in those countries and both financial sector performance and banking system stability. They document substantial variation in response to these questions: Should it be public policy to limit the powers of commercial banks to engage in securities, insurance, and real estate activities? Should the mixing of banking and commerce be restricted by regulating commercial bank's ownership of non-financial firms and non-financial firms' ownership of commercial banks? Should states own commercial banks, or should those banks be privatized? They find: 1) There is no reliable statistical relationship between restrictions on commercial banks' ability to engage in securities, insurance, and real estate transactions and how well-developed the banking sector, how well-developed securities markets and non-bank financial intermediaries are, or the degree of industrial competition. Based on the evidence, it is difficult to argue confidently that restricting commercial banking activities benefits-or harms-the development of financial and securities markets or industrial competition. 2) There are no positive effects from mixing banking and commerce. 3) Countries that more tightly restrict and regulate the securities activities of commercial banks are substantially more likely to suffer a major banking crisis. Countries whose national regulations inhibit banks' ability to engage in securities underwriting, brokering, and dealing--and all aspects of the mutual fund business--tend to have more fragile financial systems. 4) The mixing of banking and commerce is associated with less financial stability. The evidence does not support admonitions to restrict the mixing of banking and commerce because mixing them will increase financial fragility. 5) On average, greater state ownership of banks tends to be associated with more poorly developed banks, nonbanks, and stock markets and more poorly functioning financial systems.

Finance and macroeconomic volatility

Abstract: Countries with more developed financial sectors, experience fewer fluctuations in real per capita output, consumption, and investment growth. But the manner in which the financial sector develops matters. The relative importance of banks in the financial system is important in explaining consumption, and investment volatility. The proportion of credit provided to the private sector, best explains volatility of consumption, and output. The authors generate their main results using fixed-effects estimates with panel data from seventy countries for the years 1956-98. Their general findings suggest that the risk management, and information processing provided by banks, maybe especially important in reducing consumption, and investment volatility. The simple availability of credit to the private sector, probably helps smooth consumption, and GDP.

The East Asia crisis and corporate finances : the untold micro story

Abstract: Explanations of the causes of the Asian crisis have focused on macroeconomic factors leading to the crisis. This paper offers a complementary corporate distress perspective linking the crisis to corporate finances. Key ratios for companies in various countries are presented in the paper. The global benchmarking imposes a consistent cross-border analysis of financial risk and performance, and sheds light on the crisis. The study provides a statistical review of the financial practices and performance of corporates in Asia: Hong Kong, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand benchmarked against financials of corporates in other countries: Latin America, and industrialized countries: France, Germany, Japan and USA. A thematic point that comes across in all the results of the corporate financial analysis is unsustainable rapid (and probably excessive) investment in fixed assets financed by excessive borrowing in some Asian countries- e.g., Indonesia, Korea and Thailand. The East Asian investment-spending spree resulted in poor profitability, reflected in low, and declining return on equity, and return on capital employed. It leads to the conclusion that at the core of the corporate crisis were financial excesses that violated prudent financial practices, and eventually lead to the inevitable financial distress we are witnessing. Therefore, the empirical findings presented in the paper lend credence to the view advanced by Krugman that crony capitalism was at the core of the crisis. Crony capitalism was manifested in supportive bad policies-e.g., implicit government guarantees, and poor banking supervision- that lead to poor credit allocation decisions in the banking dominated financial system. Preliminary findings suggest as well vast differences in Economic Value Added between countries- developing and developed alike. The conclusions from an economic value added approach indicate that in an era of increasing capital mobility, corporates are not adhering to global standards in creating shareholder value. The analysis leads to policy conclusions.

Measuring Financial Development in Sub-Saharan Africa

Abstract: This study introduces an index for measuring financial development and a set of six indices representing key characteristics of the financial systems in 38 sub-Saharan African countries. The results show that these countries have made good progress in improving and modernizing their financial systems during the last decade, particularly with regard to financial liberalization and the adoption of indirect instruments of monetary policy. In many countries, however, the range of financial products remains extremely limited, interest rate spreads are wide, capital adequacy ratios are insufficient, judicial loan recovery is a problem, and the share of nonperforming loans is large.

Financial regulation and performance : cross-country evidence

Abstract: Costly bank failures in the past two decades have focused attention on the need to find ways to improve the performance of different countries' financial systems. Belief is overwhelming that financial systems can be improved but there is little empirical evidence to support any specific advice about regulatory and supervisory reform. With scant cross-country comparisons of financial regulatory and supervisory systems, economists cannot decide how to correct incentives and moral hazard problems in developing economies--whether, for example, to require higher (and more narrowly defined) capital-to-asset ratios, to mandate stricter definition and disclosure of non-performing loans, to require that subordinated debt be issued, or to install world-class supervision. Proposed reforms usually involve changes in financial regulations and supervisory standards, but many pressing questions about reform remain unanswered. Making use of a new database, the authors come up with brief answers to three key questions: Do countries with relatively weak governments and bureaucratic systems impose harsher regulatory restrictions on bank activities? Yes. Do countries with more restrictive regulatory regimes have poorly functioning banking systems. No--or at least the evidence is mixed. Do countries with more restrictive regulatory systems have less probability of suffering a banking crisis? No. In fact, the reverse is true. In countries where banks' securities activities are restricted, the likelihood of a banking crisis is greater, other things being equal.

Stock Markets, Banks, and Growth : Correlation or Causality?

Abstract: The authors investigate the impact of stock markets and banks on economic growth using a panel data set for 1976-98 and applying recent generalized method of moments (GMM) techniques developed for dynamic panels. The authors illustrate econometrically the differences that emerge from different panel procedures. On balance, stock markets and banks positively influence economic growth--and these findings are not a result of biases induced by simulaneity, omitted variables, or inobserved country-specific effects.

New Firm Formation and Industry Growth : Does Having a Market- or Bank-Based System Matter?

Abstract: The authors find no evidence for the superiority of either market-based or bank-based financial systems for industries dependent on external financing. But they find overwhelming evidence that industries heavily dependent on external finance grow faster in economies with higher levels of financial development, and with better legal protection for outside investors - including strong creditor and shareholder rights and strong contract enforcement mechanisms. Financial development also stimulates the establishment of new firms, which is consistent with the Schumpeterian view of creative destruction. Financial development matters. That the financial system is bank-based on market-based offers little additional information.

Pension Reform and Financial Markets

Abstract: The question of the links between pension reform and financial markets has two aspects. One concerns the preconditions in terms of financial sector development for the successful implementation of pension reform, while the other refers to the long-term impact of pension reform on the development of financial markets. This paper argues that pension reform and the promotion of private pension funds requires a small core of sound, prudent and efficient financial institutions, such as banks and insurance companies, but does not depend on the prior existence of well-developed securities markets. Private pension funds and insurance companies are likely to have a beneficial impact on financial market development once they reach critical mass and provided they operate in a conducive regulatory environment.

Impediments to the development and efficiency of financial intermediation in Brazil

Abstract: Reforms to improve both the level and the efficiency of financial inter-mediation in Brazil should be high on Brazilian policymakers' agendas, because of the financial sector's importance to economic growth. This means that Brazil must also improve the legal and regulatory environment in which its financial institutions operate. Brazil is weak in important components of such creditors, the enforcement of contracts, and the sharing of credit information among intermediaries. Recent reforms, such as the extension of alienacao fiduciaria to housing, the introduction of cedula de credito bancario, the legal separation of principal and interest, and improvements in credit information system, are useful steps in strengthening the framework. But more is needed. Reforms that will significantly increase the level and efficiency of financial inter-mediation, and have a positive impact on economic growth include: 1) A more efficient judicial sector and better enforcement of contracts. 2) Stronger rights for secured and unsecured creditors. 3) Stronger accounting standards and practices, to improve the quality of information available about borrowers. 4) The development of a legal and regulatory framework that facilitates the exchange among financial institutions of both negative and positive information about borrowers.

Credit policies : lessons from East Asia

Abstract: Directed credit programs were a major tool of development in the 1960s and 1970s. In the 1980s, their usefulness was reconsidered. Experience in most countries showed that they stimulated capital-intensive projects, that preferential funds were often (mis)used for nonpriority purposes, that a decline in financial discipline led to low repayment rates, and that budget deficits swelled. Moreover, the programs were hard to remove. But Japan and other East Asian countries have long touted the merits of focused, well-managed directed credit programs, saying they are warranted when there is a significant discrepancy between private and social benefits, when invesment risk is too high on certain projects, and when information problems discourage lending to small and medium-size firms. The assumption underlying policy-based assistance and other forms of industrial assistance (such as lower taxes) is that the main constraint on new or expanding enterprises is limited to access to credit. The authors give an overview of credit policies in East Asian countries (China, Japan, and the Republic of Korea) as well as India, and summarize what these countries have learned about directed credit programs. Among the lessons: 1) Credit programs must small, narrowly focused, and of limited duration (with clear sunset provisions); 2) subsidies must be low to minimize distortion of incentives as well as the tax on financial intermediation that all such programs entail; 3) credit programs must be financed by long-term funds to prevent inflation and macroeconomic instability, recourse to central bank credit should be avoided except in the very early stages of development when the central bank's assistance can help jump-start economic growth; 4) they should aim at achieving positive externalities (or avoiding negative ones), any help to declining industries should include plans for their timely phaseout; 5) they should promote industrialization and export orientation in a competitive private sector with internationaly competitive operations; 6) they should be part of a credible vision of economic development that promotes growth with equity and should involve a long-term strategy to develop a sound financial system; 7) policy based loans should be channeled through well-capitalized, administratively capable financial institutions, professionally managed by autonomous managers; 8) they should be based on clear, objective, easily monitored criteria; 9) programs should aim for a good repayment record and few losses; and 10) they should be supported by effective mechanisms for communication and consultation between the public and private sectors, including the collection and dissemination of basic market information.

Contractual savings for housing : How suitable are they for transitional economies?

Abstract: Problems of developing specialized financial services for housing are acute in socialist economies in transition. Contractual savings for housing (CSH) are often advocated in Central and Eastern European countries as a primary solution. CSH systems were indeed used successfully in Europe for reconstruction after World War II. The issue today is what role CSH can play under very different financial conditions in latecomer countries that want to develop competitive and flexible financial systems capable of successfully integrating with the global financial markets. Problems of developing financial services for housing are acute in transitional socialist economies. Lea and Renaud examine contractual savings for housing (CSH), which are often advocated as a primary solution, especially in Central and Eastern European countries. A CSH instrument links a phase of contractual savings remunerated at below-market rate to the promise of a housing loan at a rate also fixed below market at the time the contract is signed. This contract can contain a variety of options. CSH were used very successfully in Europe after World War II. The issue today is not whether such specialized instruments can work. They clearly can under low inflation. The issue is whether CSH systems are advisable today in latecomer countries with vastly different financial technology and financial policy environments. Lea and Renaud focus on two influential CSH systems: the closed German Bauspar system and the open French epargne-logement. In a closed CSH system, access to a housing loan is based on queuing: a loan can be made only if funds are available in the specialist institution. In an open system, the saver can legally call his or her loan at contract maturity, regardless of the liquidity conditions in the CSH system. From the perspective of households, CSH contracts facilitate the accumulation of equity and offer the prospect of a low-interest loan. They promote savings discipline and provide a concrete goal that many households find important. But CSH instruments leave the objective of providing a primary loan unmet. In addition, even moderate inflation quickly leads to very low loan-to-value ratios for CSH loans and a large financing gap for housing purchases. From the perspective of financial institutions, CSH can help overcome the severe information asymmetries they face in transitional socialist economies, where there are no retail financial markets, no credit bureaus, and problematic income reporting. CSH are very effective in screening, monitoring, and establishing the reputation of steady savers as future borrowers, and they are good at lowering credit risks. With their saving periods of four to five years, CSH also help bridge the gap between long-term loans and short-term deposits. Finally, CSH can be an important commercial tool for developing cross-lending activities. But CSH can be risky. When the interest rate on outstanding contracts is low compared with current market rates, holders of mature contracts will want to call their loans. And new savers will be reluctant to sign on at very low contract rates. Eliminating this liquidity risk with a closed CSH system erodes the attractiveness of CSH. From the perspective of government, a CSH instrument can work in a noninflationary environment, yet a CSH system would have no justification in fully developed and competitive financial markets today. CSH instruments can play a useful but not a dominant role in housing finance. After stabilization, they can provide additionality, overcome information constraints on financial contracts, and contribute to higher financial savings rates. CSH instruments are best used to finance home improvements. They can also be used as part of a social policy to reach targeted social groups. This paper - a product of the Financial Sector Development Department - is part of a larger effort in the department to develop sustainable housing finance in transition economies.

The Latvian banking crisis : lessons learned

Abstract: Lessons from Latvia's banking crisis can be applied in other transition economies. In the spring of 1995, Latvia experienced the largest banking crisis in the former Soviet Union to date, involving the loss of about 40 percent of the banking system's assets and liabilities. Fleming and Talley outline the Latvian authorities' strategy for developing the banking system and identify how and why it unraveled. They discuss the World Bank's role and the lessons to be learned from the crisis, including the following: Banking systems are exposed to stress in several major ways. Enterprises - the main borrowers - become subject to hard budget constraints (are cut off from government funds) and are privatized. Inflation declines so enterprises can't rely on rapidly increasing revenues to service bank debts. Economic reform tends to produce banking systems that are mainly privately owned - making them vulnerable to withdrawals, as the public does not assume that failing banks will be bailed out. The government must protect against this vulnerability by establishing a proper legal framework for banking, developing effective bank supervision and regulation, and implementing solid accounting, disclosure, and auditing standards. It must also develop effective ways to handle problem banks and to close insolvent banks promptly. For banks in the state sector to be a source of strength to the banking system, they must have strong effective management and be relatively free from political influence. Outlier banks - those expanding assets very quickly or offering particularly high deposit rates - should be subject to intense supervision. Four things must be done to prevent fraud, incompetent management, and excessive risk-taking: Carefully screen those who want to get into banking; subject all banks to thorough, frequent onsite examinations and assign the best examiners to the largest banks; require annual audits of all banks by reputable auditing firms required to report significant irregularities to authorities; and act decisively when fraud or bank difficulties are detected or suspected. This paper - a product of the Enterprise and Financial Sector Development Division, Europe and Central Asia, Country Department IV - is part of a larger effort in the region to distill the lessons of the first five years of transition.

The role of trust in financial sector development

Abstract: In any economic environment where decisions are decentralized, agents consider the risk that others might unfairly exploit informational asymmetries to their own disadvantage. Incomplete results, especially, lies at the heart of financial transactions in which agents trade real claims for promises of future real claims. Agents thus need to invest considerable resources to assess the trustworthiness of others with whom they know they can interact only under conditions of limited and asymmetrically distributed information. Thinking of finance as the complex of institutions and instruments needed to reduce the cost of trading promises among anonymous individuals who do not fully trust each other, the author analyzes how incomplete trust shapes the transaction costs in trading assets, and how it affects resource allocation and pricing decisions from rational, forward-looking agents. His analysis leads to core propositions about the role of finance and financial efficiency in economic development. He recommends areas of financial sector reform in emerging economies aimed at improving the financial system's efficiency in dealing with incomplete trust. Among other things, the public sector can improve trust in finance by improving financial infrastructure, including legal systems, financial regulation, and security in payment and trading systems. But fundamental improvements in financial efficiency may best be gained by eliciting good conduct through market forces.

How deposit insurance affects financial depth : a cross-country analysis

Abstract: Should we expect deposit insurance to have a positive effect on development of the financial sector? All insurance pools individual risks: premiums are paid into a fund from which losses are met. In most circumstances, a residual claimant to the fund (typically a private insurance company) loses money when losses exceed premiums. Claimants that underprice risk tend to go bankrupt. With most deposit insurance, however, the residual claimant is a government agency with very different incentives. If the premiums paid by member banks cannot cover current fund expenditures, the taxpayer makes up the shortfall. Facing little threat of insolvency, there is less incentive for administrative agencies to price risk accurately. In the United States, researchers have found that the combination of increasing competition in banking services and underpriced deposit insurance led to riskier banking portfolios without commensurate increases in bank capital. Deposit insurance may facilitate risk-taking, with negative consequences for the health of the financial system. On the positive side, insurance may give depositors increased confidence in the formal financial sector -- which may decrease the likelihood of bank runs and increase financial depth. Indeed, simple bivariate correlations between explicit insurance and financial depth are positive. But when one also controls for income and inflation, that relationship disappears -- in fact, the partial correlation between changes in subsequent financial depth and the adoption of explicit insurance is negative (and quite pronounced). Counterintuitive though it may be, that stylized fact may be partially explained by the political and economic factors that motivated the decision to establish an explicit scheme. The circumstances surrounding decisions about deposit insurance are associated with different movements in subsequent financial depth. Adopting explicit deposit insurance to counteract instability in the financial sector does not appear to solve the problem. The typical reaction to that type of decision has been negative, at least with regard to financial depth in the three years after the program's inception. Adopting explicit deposit insurance when government credibility and institutional development were high appears to have had a positive effect on financial depth.

Reforming pensions in Zambia : an analysis of existing schemes and options for reform

Abstract: All of Zambia's pension schemes are deficient in design, financing, and administration. This report urges that Zambia restructure its social protection system to complement its new economic strategy. That restructuring must address such basic problems as macroeconomic fluctuations and an unstable financial sector; high inflation rates and politically-motivated low-yield investments and loans; income ceilings irregularly adjusted for inflation; overgenerous public sector pension benefits; and inadequate management of pension fund operations. In the short and medium term, the objectives should be to settle outstanding pension claims, revise early retirement provisions and investment policies, and improve capabilities for administering statutory pension funds. In the long term the objectives should be to convert the Zambia National Provident Fund (ZNPF) into a modest basic pension scheme for private sector employees, and subsequently integrate civil servants and public sector employees into that scheme; establish regulatory provisions to develop and supervise private pension funds; and establish an administrative mechanism to review social protection policy and to supervise and coordinate its application by all agencies.

Policy-based finance, financial regulation, and financial sector development in Japan

Abstract: The authors state the Japanese government's role in creating a macroeconomic and financial environment conducive to rapid industrialization went beyond maintaining price stability. The government created a stable but segmented and tightly regulated financial system that favored the financing of industry over other sectors of economic activity. Lending practices, the direction of policy based finnance, and the structure of Japan's financial system changed over time, but one thing stayed constant: the authorities'vision. Some observers maintain that Japanese policies - emphasizing the development of internationally competitive industries - retarded economic growth. And government policies were not the only or even the most important factor in Japan's success. One key to success was government agencies'close cooperation with the private sector, and the government's reliance on privately owned and managed corporations to achieve government-favored industrial goals. Japan's financial system was quite different from Anglo-American and continental European financial systems. The authors discuss some characteristics of the Japanese system in the high growth era: 1) the preponderent role of indirect finance; 2) the"overloan"position of large commercial banks; 3) the"overborrowing"of industrial companies; 4) artificially low interest rates; 5) the segmentation and fragmentation of the financial system; 6) the underdevelopment of securities markets and institutional investors; 7) the key role played by the main bank system; 8) the relations between banks and industry; 9) the different roles debt and equity played in the Japanese system; 10) the role large conglomerate groups, especially general trading companies, played in channeling funds to small firms at the industrial periphery; and 11) the role of policy-based financial institutions. These features evolved in the context of high savings rates and an accumulation of assets, mobilized mostly through deposit institutions, including the postal savings system, and transformed into short- and long-term and risky loans through commercial and long-term credit banks as well as specialized government financial institutions. Are hard work and good management the secrets of Japan's success? Hard work may be as much a symptom as a cause of economic success. But good management has unquestionably been a key to Japan's economic success. Whether Japan's approach is better than others is more difficult to answer. Japan may have overtaken several European countries butwas still lagging behind the US and a few European countries in per capita income expressed in purchasing power parity terms. And although the Japanese approach played a significant part in promoting industrialization and accelerating economic growth during the period of reconstruction and high growth, it also entailed significant long-term costs - in terms of poor-quality housing and other urban infrastructure. And the excesses of the 1980s and Japan's current economic recession undermine claims about its ability to continuously outperform other countries.

Partners for development: new roles for government and private sector in the Middle East and North Africa.

Abstract: There is a growing consensus that the time has come for governments and private sector leaders of the middle East and North Africa to forge a new partnership for development. The question is: what kind of partnership should the two parties seek in order to ensure sustainable economic development? This report comprises some of the presentations attempting to address this question at the second Mediterranean Development Forum conference held in Marrakech, Morocco, on September 3-6, 1998. The papers deal with four key facets of the government-private sector interface: the business environment, privatization, infrastructure, and two activities that induce transaction costs--tax administration and government procurement. Three themes guide much of the analysis. First, sustainable development requires the participation of government and the private sector but without the commitments of both, the private sector will not invest up to its potential and government will not be able to create new jobs and more goods and services. Second, the region is following the world-wide trend of government disengagement from directly providing goods and services and from market interventions but the policy and institutional environment do not fully support an efficient private sector. Third, the details of government-public partnerships when worked out will determine the usefulness of the new public-private partnerships to society.

Financial development and industrial capital accumulation

Abstract: There may be a compelling discontinuity to financial sector development in that banks need to be supported early in development but need to be weakened later - at the expense of bank rents - to foster further development The important question for policy is when and how to generate and manage this discontinuity so that it is not forced on society by costly and traumatic events such as bank failures In an economy where decisions are decentralized and made under conditions of uncertainty, the financial system can be seen as the complex of institutions, infrastructure, and instruments that society adopts to minimize the costs of trading promises when agents have incomplete trust and limited information Building on a microeconomic general equilibrium model that portrays such fundamental financial functions, Bossone shows that, in line with recent empirical evidence, the development of financial infrastructure stimulates greater and more efficient capital accumulation He also shows that economies with more developed financial infrastructure can more easily absorb exogenous shocks to output The results call for addressing a crucial issue in the sequencing of reform in the financial sector: early in development, banks provide essential financial infrastructure services as part of their exclusive relationships with borrowers Further economic development requires that such services be provided extrinsically to the bank-borrower relationship, clearly at the expense of bank rents There may be a compelling discontinuity to financial sector development in that banks need to be supported early in development but to be weakened later - at the expense of bank rents - to foster further development The important question for policy is when and how to generate and manage this discontinuity so that it is not forced on society by costly and traumatic events such as bank failures This paper - a product of the Financial Economics Unit, Financial Sector Practice Department - is part of a larger effort in the department to study the links between financial sector and economic development and improve financial sector reform policies

The role of non-bank financial intermediaries (with particular reference to Egypt)

Abstract: Non-bank financial intermediaries (NBFIs) comprise a mixed bag of institutions, ranging from leasing, factoring, and venture capital companies to various types of contractual savings and institutional investors (pension funds, insurance companies, and mutual funds). The common characteristic of these institutions is that they mobilize savings and facilitate the financing of different activities, but they do not accept deposits from the public. NBFIs play an important dual role in the financial system. They complement the role of commercial banks by filling gaps in their range of services. But they also compete with commercial banks and force them to be more efficient and responsive to the needs of their customers. Most NBFIs are also actively involved in the securities markets and in the mobilization and allocation of long-term financial resources. The state of development of NBFIs is usually a good indicator of the state of development of the financial system. The author focuses on contractual savings institutions, namely pension funds and life insurance companies, that are by far the most important NBFIs. He also offers a brief review of the role and growth of other NBFIs, such as leasing and factoring companies, as well as venture capital companies and mutual funds. The author covers developments in selected countries in different regions of the world. He also examines the recent growth of NBFIs, especially contractual savings institutions and securities markets, in Egypt. He discusses the necessary regulatory and other policy reforms for promoting NBFIs--in particular, the openness to international markets and foreign presence that is essential for the transfer of skills and technologies.

The real impact of financial shocks : evidence from the Republic of Korea

Abstract: To what extent did tightening monetary policy magnify the East Asian crisis through its adverse effects on credit supply? In the Republic of Korea, interest rate spreads, which capture credit channel effects, influence economic activity, and these effects are disproportionately larger for small and medium-size enterprises. So policymakers who neglect credit channel effects might be overkilling the economy and altogether overlooking the disproportionate effects of monetary and financial shocks on some sectors. The debates surrounding the recent East Asian crisis have focused not only on causes but also on policy actions in the wake of the initial shock. This has raised questions about the relationship between monetary policy and market confidence. Specifically, would rising interest rates bolster or depress market confidence? To answer this question requires assessing whether, and to what extent, monetary and financial shocks are magnified through the economy via the credit channel. Domac and Ferri focus on the Republic of Korea - a particularly good case for testing credit channel effects - with two objectives: - To ascertain whether and to what extent interest rate spreads could help predict subsequent fluctuations in real economic activity. - To test whether small and medium-size enterprises suffer more than other businesses do from the adverse effects of the credit channel. The authors' empirical findings support the hypothesis that spreads that capture credit channel effects do indeed influence economic activity. Specifically, spreads contain significant information for predicting the future course of industrial production. The effect is, as one might have assumed, disproportionately larger for small and medium-size enterprises. Thus policymakers, in Korea and elsewhere, who neglect credit channel effects might be overkilling the economy and altogether overlooking the disproportionate effects of monetary and financial shocks on various segments of the economy. This paper - a product of the Poverty Reduction and Economic Management Sector Unit and the Financial Sector Development Sector Unit, East Asia and Pacific Region - is part of a larger effort in the region to analyze the patterns and consequences of the East Asian crisis, with particular reference to the link between the real and financial sectors. The authors may be contacted at idomac@worldbank.org or gferri@worldbank.org.

Measuring services trade liberalization and its impact on economic growth : an illustration

Abstract: The authors explain how the output growth effect from liberalizing the service sectors differs from the effect from liberalizing trade in goods. They also suggest using a policy-based rather than outcome-based measure of the openness of a country's service regime. They construct such openness measures for two key service sectors' basic telecommunications and financial services. Finally, the authors provide some econometric evidence--relatively strong for the financial sector and less strong, but nevertheless statistically significant, for the telecommunications sector--that openness in services influences long-run growth performance. Their estimates suggest that growth rates in countries with fully open telecommunications and financial services sectors are up to 1.5 percentage points higher than those in other countries.

Uncertainty, financial development and economic growth : an empirical analysis

Abstract: This paper examines whether financial sector development may partly undo growth-reducing effects of policy uncertainty. By performing a cross-country growth regression for the 1970-1995 period I find evidence that countries with a more developed financial sector are better able to nullify the negative effects of policy uncertainty on per capita economic growth. For countries with a very well developed financial sector, it may even be the case that an increase in policy uncertainty positively affects per capita economic growth. This clearly indicates the relevance of financial sector development.

Financial sector adjustment lending : a mid-course analysis

Abstract: Nearly 100 countries have experienced bank insolvencies in the past 20 years. Weakness in the financial sectors of many countries is reflected in the size of the insolvencies -in many cases, the cost of bailout exceeded 15 percent of GDP- and the fact that these crises often recur. Because a strong financial sector is important for economic growth, the World Bank has increasingly granted loans with conditions attached to achieve specific financial sector reforms. The Bank often employs financial sector adjustment loans (FSALs) or, in poorer countries, credits (FSACs). FSALs are generally more comprehensive than other types of interventions and tend to concentrate on the reform areas most closely linked to the operations of deposit banks. Since 1990, their main focus has shifted from improving prudential regulations and correcting interest rate distortions to privatizing and recapitalizing banks. The author examines whether 1) initial conditions in a recipient country explain a substantial amount of the variation in intervention outcomes (as measured by post-intervention financial deepening) and 2) whether the changing nature of interventions has had implications for their success. He finds that: 1) the decline in post-intervention performance since 1990 cannot be attributed solely toinitial macroeconomic and financial sector conditions in the recipient country. 2) When initial macroeconomic and financial sector conditions were controlled for, certain types of reform, especially those dealing with prudential regulations, were associated with relatively large increases in the ration of money supply (M2) to GDP. Those dealing with recapitalization have also been relatively successful, especially when they also tackled prudential regulation or banking supervision. Those that focused on supervision did not, on average, substantially outperform those that did not, on average, focus on supervision. And reform focused on bank privatization was associated with much less financial deepening three years after the intervention. 3) In addition to reform aimed at institutional strengthening, the reform environment itself had a substantial impact on intervention outcomes. Financial deepening was positively associated with macroeconomic stability (low inflation) and an initially underdeveloped financial sector. 4) As the Bank's operational directives suggest, some macroeconomic stability is important for the success of financial sector interventions, especialy those that incorporate interest rate liberalization. While it may be best to move more aggressively on financial reform when macroeconomic circumstances are favorable,"visible"reform (such as privatization or interest rate deregulation) should be slowed down rather than abandoned in less fortunate circumstances. By contrast, less visible institution-building efforts should be continued regardless of macroeconomic conditions.

Was the Credit Channel a Key Monetary Transmission Mechanism following the Recent Financial Crisis in the Republic of Korea

Abstract: A marked decline in bank lending after the recent financial crisis in the Republic of Korea amplified the real effects of the tightened monetary policy implemented in response to the crisis. A substantial excess demand for bank loans in the wake of the crisis was caused essentially by a capital-induced bank credit crunch rather than by a weak demand for loans. This finding reveals compelling evidence of the importance of the credit channel after the crisis. Kim investigates whether the credit channel is a key monetary transmission mechanism in the Republic of Korea, especially after its recent financial crisis. To identify the existence of a distinctive credit channel (especially the bank lending channel), he applies two empirical tests to both aggregate financial data and disaggregated bank balance sheet data. As a more definitive analysis of the role of the credit channel, he estimates a disequilibrium model of the bank loan market, specifying separate loan demand and supply equations to characterize the credit crunch and identify its intensity in the wake of the crisis. He finds convincing evidence of the importance of the credit channel in the aftermath of the crisis. Bank lending plays a significant independent role in amplifying the real effects of the tightened monetary policy implemented in response to the crisis. There is strong evidence to suggest a substantial excess demand for bank loans following the crisis. This excess demand was caused by a sharp decline in loan supply largely attributable to pervasive and stringent bank capital regulation (a capital-induced bank credit crunch), rather than by weak demand for loans. This paper - a product of the Financial Sector Development Unit, East Asia and Pacific Sector Units - was presented at the international conference on Exchange Rate Stability and Currency Board Economics on November 18-29, 1998, in Hong Kong. The author may be contacted at hkim8@worldbank.org.

Payment systems in Latin America : a tale of two countries - Colombia and El Salvador

Abstract: Payment systems include all the paper (including cash) and electronic systems a country uses to exchange financial value to discharge obligations. Financial markets rely on promptness and certainty of payment and settlement for borrowing and investing. Consumers want convenience, choice (of payment options), privacy, and low cost. Inefficiencies in payment systems cause a drag on the national economy. The authors compare trends and areas for improvement in payment systems in Colombia and El Salvador, two countries that differ in size, volume of check-based transactions, and national issues. Check standards have developed slowly in both countries, which has retarded automation, particularly in Colombia, where the volume of checks handled makes manual processing unmanageable. Both countries need stronger leadership from central banks and bankers associations; incentives to adopt common check standards; streamlined check sorting and encoding, microfilming, and manual data processing; alternative (especially credit-based) payment mechanisms and private check-processing bureaus; and settlement of stock exchange transactions through several banks, rather than one bank. The countries differ in important ways: 1) it will be easier to reach economies of scale in check processing in Colombia (which has too many local clearinghouses) than in El Salvador (which has too few). Both countries need a more balanced approach; 2) same day payments are possible in Colombia; payments in El Salvador are next day, at best; 3) financial markets are less mature in El Salvador and may not need to be as sophisticated as markets in other countries; and 4) Colombia has yet to create effective disincentives for writing checks against insufficient funds. Both countries must take certain actions to develop a system for electronic payment and the settlement of payments at the central bank: 1) draft new laws and regulations; 2) provide more systematic data collection and analysis of payment flows; 3) undertake more risk analysis and prevention in the central banks and supervisory agencies, and draft contingency plans for major failures; 4) reexamine the dual roles of the central banks and other government agencies in operating and supervising payment systems; 5) review check-clearing pricing policies; and 6) analyze the economics of automating check processing.

Re-engineering insurance supervision

Abstract: The insurance industry is underdeveloped in many of the world's emerging markets and transition economies, sometimes because of restrictive regulations or inadequate supervision of insurance companies. Many countries are considering reforming regulation of their insurance systems and strengthening supervision. The author's analysis is designed to help them choose the program of regulation and supervision that best fits their circumstances. He draws on experience in industrial countries that have examined the reasons financial institutions failed. He concludes that the old approach to supervising the financial sector--covering a broad range of issues and devoting considerable energy to verifying data--must be replaced by a more focused approach that targets insurer solvency by getting supervisors to pay attention to management performance and business strategy. Financial supervisors in jurisdictions that have updated their systems with this approach in mind now see their main task as gauging the financial risk or risk profile of each company and allocating most of their resources to the higher-risk situations. In doing so, their objective will be to understand a firm's business strategy, to assess the firm management's competence and appetite for risk, and to assess the firm's outlook and financial viability. The author highlights the special role played in supervision by industry specialists such as the auditors and actuaries who support insurance companies. He identifies the priorities needed in the reform of insurance supervision and suggests steps needed for change--and helpful ways for officials to organize. He discusses not only issues associated with the supervision of solvency and financial strength but ways to protect consumers.

Before main banks : a selective historical overview of Japan's prewar financialsystem

Abstract: Among lessons learned from Japan's prewar financial system: Business conglomerates that did not remain dependent on government patronage were more successful than others in making the transition to a modern industrial economy. And banks that made a conscious effort to reduce their dependence on central bank credit were more successful than those that did not. The postwar experience of the Japanese banking system has received considerable attention recently partly because conditions in defeated Japan in 1945 (including high inflation and the need to switch from a military to a civilian economy) are similar to those in transition economies today. Policymakers in transition economies can learn a good deal from the experiences of Japan's postwar financial system but should remember that Japan also experienced extraordinary industrial growth and financial institution building in the late nineteenth and early twentieth centuries. Lessons to be learned from that experience include the following: ° Business conglomerates that did not continue to depend on government patronage were more successful than others in making the transition to a modern industrial economy. ° Banks that made a conscious effort to reduce their dependence on central bank credit were more successful than those that did not. ° The establishment of procedures for punishing defaulting borrowers helped the development of the payments system. ° Limits on the amount of lending to related parties appear to have contributed to financial stability (and could have contributed more if the newer zaibatsu had been as prudent as the older ones). ° Bank bailouts without accompanying reform (such as those the Bank of Japan undertook in 1920 and 1922) probably increased the likelihood of a more serious crisis, such as that of 1927. ° Capital standards - the minimum capital requirements established in the 1927 law - were a viable means of encouraging bank consolidation and more prudent lending. ° The public financial system served as a buffer when the banking sector was downsized. This paper - a joint product of the Finance and Private Sector Development Division, Policy Research Department, and the Financial Sector Development Department - was presented at a Bank seminar, Financial History: Lessons of the Past for Reformers of the Present, and is a chapter in a forthcoming volume, Reforming Finance: Some Lessons from History, edited by Gerard Caprio, Jr. and Dimitri Vittas.

Frontiers public-private interface in East Asia's infrastructure

Abstract: Governments and the private sector agree that the progress of private infrastructure in East Asia has been unacceptably slow. The region's total infrastructure needs for the next decade are estimated by the World Bank at $1.2 trillion to $1.5 trillion1-needs which can only be met with the help of private initiative and finance. Yet despite significant private activity in telecommunications and power generation and, to a lesser extent, in toll roads, the share of private capital at risk in infrastructure investment has been less than 10 percent in the past few years. The conference sought to identify common ground that would enable substantial private investment while addressing public concerns about due process in the award of contracts and the achievement of broader societal goals. The private-sector and government representatives agreed that moving forward depends on strong, high-level government commitment to increasing the role of the private sector in infrastructure development. They further concluded that achieving this goal requires a clear policy and institutional framework to ensure the efficient allocation of resources across sectors and projects, timely and credible contracting, and cost effective services responsive to the needs of consumers. The core elements of a framework for private infrastructure delivery are: (a) sectoral pricing reform; (b) introduction of competition among service providers and, where appropriate and feasible, direct competition by suppliers for final consumers, allowing feedback on consumer preferences and direct assumption of commercial risks; (c) transparent and competitive contracting processes; (d) credible legal and regulatory structures; and (e) clear definition and assignment of risks.