99100 Long-Term Finance GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Long-Term Finance © 2015 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 18 17 16 15 This work is a product of the staff of The World Bank with external contributions. The findings, interpreta- tions, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Contents Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Abbreviations and Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 Conceptual Framework, Stylized Facts, and the Role of the Government . . . . . . . . . . . . 21 2 The Use of Long-Term Finance by Firms and Households: Determinants and Impact . . . 41 3 The Use of Markets for Long-Term Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 4 Banks and Nonbank Financial Institutions as Providers of Long-Term Finance . . . . . . . 107 Statistical Appendixes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 A Basic Data on Financial System Characteristics, 2011–13 . . . . . . . . . . . . . . . . . . . . . 149 B Key Aspects of Long-Term Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 Bibliography. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 v vi CONTENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOXES O.1 Main Messages of This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 O.2 Practitioners’ Views on Long-Term Finance: Global Financial Development Barometer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 O.3 The Role of Multilateral Development Banks in Mobilizing Long-Term Finance . . .12 O.4 Navigating This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 1.1 The Role of Infrastructure in Economic Development . . . . . . . . . . . . . . . . . . . . . . .23 1.2 A Conceptual Framework for Understanding the Use of Long-Term Finance . . . . . .25 1.3 Intermediaries and Markets for Long-Term Finance . . . . . . . . . . . . . . . . . . . . . . . . .26 1.4 Development Banks and Long-Term Finance: Two Different Approaches. . . . . . . . .36 1.5 Using Credit Guarantees to Reduce the Risk of Long-Term Lending . . . . . . . . . . . .38 2.1 Firms’ Long-Term Finance and Investment after the Global Financial Crisis. . . . . . .44 2.2 Did the Global Financial Crisis Affect Firms’ Leverage and Debt Maturity? . . . . . . .46 2.3 What Explains the Variation of Firm Debt Maturity across Countries? . . . . . . . . . .48 2.4 Contract Enforcement and Use of Long-Term Finance: Evidence from Debt Recovery Tribunals in India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50 2.5 The Impact of Credit Information Sharing on Loan Maturity . . . . . . . . . . . . . . . . . .50 2.6 Information Asymmetries and Use of Long-Term Debt in the United States . . . . . . .52 2.7 Short-Term Debt and Good Governance: Are They Substitutes or Complements? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55 2.8 Political Connections and Firms’ Use of Long-Term Debt in China . . . . . . . . . . . . .56 2.9 The Rise of the Annuity Market in Chile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 2.10 Sensitivity of Human Capital Investment to the Development of Credit Markets . . .60 2.11 Housing Booms and Busts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 2.12 Benchmarking Housing Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67 2.13 How do the Poor in Developing Countries Save? . . . . . . . . . . . . . . . . . . . . . . . . . . .69 2.14 Changing Gambling Behavior through Experiential Learning . . . . . . . . . . . . . . . . . .70 3.1 Finance and Growth in China and India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80 3.2 Infrastructure Finance and Public-Private Partnerships . . . . . . . . . . . . . . . . . . . . . . .85 3.3 Supporting Local Currency Market Development. . . . . . . . . . . . . . . . . . . . . . . . . . .91 3.4 Building Blocks for Domestic Corporate Bond Market Development . . . . . . . . . . . .93 3.5 Sukuk: An Alternative Financing Source . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 3.6 Macroeconomic Factors and Government Bond Markets in Developing Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98 4.1 The Correlates of Long-Term Bank Lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111 4.2 The Basel III Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113 4.3 What Drives Short-Termism in Chilean Mutual and Pension Funds? . . . . . . . . . . .117 4.4 Institutional Investors in Equity Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 4.5 International Financial Institutions and PE Investments in Developing Countries . .139 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 CONTENTS vii FIGURES BO.2.1 Views on Policies to Promote Long-Term Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 O.1 Firms’ Median Long-Term Debt-to-Asset Ratios by Country Income Group and Firm Size, 2004–11, Country-Level Median . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 O.2 Sources of External Finance for Purchases of Fixed Assets by Firm Size, 2006–14. . . . 7 O.3 Change in Leverage and Debt Maturity since the Global Financial Crisis by Country Income Group and Firm Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 O.4 The Relationship between Greater Financial Depth and Longer Debt Maturity by Country Income Group, 1999–2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 O.5 Average Loan Maturity in Credit Bureau Reformer and Nonreformer Countries, 2002–09 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 O.6 Firm Corporate Governance and Use of Short-Term Debt, 2003–08 . . . . . . . . . . . . . 16 O.7 Effects of Financial Education on Long-Term Borrowing . . . . . . . . . . . . . . . . . . . . . . 17 O.8 Maturity Structure of Chilean Institutional Investors . . . . . . . . . . . . . . . . . . . . . . . . . 19 1.1 Ratio of Firms’ Median Long-Term Debt to Total Debt by Country Income Group and Firm Size, 2004–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 1.2 Sources of External Financing for Fixed Asset Investment by Country Income Group and Firm Size, 2006–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 1.3 Outstanding Mortgage Debt by Country Income Group, 1980–2011 . . . . . . . . . . . . 29 1.4 Share of Population with an Outstanding Mortgage by Income and Country Income Group, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1.5 Maturity Structure of Bank Loans by Country Income Group, 2000–13 . . . . . . . . . . 30 1.6 Annual Issuance of Syndicated Loans and Average Maturity by Country Income Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 1.7 Capital Market Sizes by Country Income Group, 2000–11 . . . . . . . . . . . . . . . . . . . . 31 1.8 Maturity of Corporate Bond Issues by Country Income Group, 2000–13 . . . . . . . . . 31 1.9 Institutional Investor Assets by Country Income Group, 2000–11. . . . . . . . . . . . . . . 32 1.10 Private Equity across Income Groups, Average over 2008–13 . . . . . . . . . . . . . . . . . . 32 B2.1.1 Growth Rate of Credit, 2003–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 2.1 Percentage of Firms with Any Long-Term Liabilities by Country Income Group and Firm Size, 2004–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 2.2 Share of Fixed Asset Purchases Financed from External Sources by Country Income Group, 2006–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 2.3 Maturity of Loan or Line of Credit by Country Income Group, 2006–09 . . . . . . . . . 46 2.4 Share of Fixed Asset Purchases Financed through Internal and External Sources by Firm Size, 2006–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 B2.6.1 Debt Maturity of U.S. Publicly Listed Firms, 1976–2008. . . . . . . . . . . . . . . . . . . . . . 52 2.5 Share of Fixed Asset Purchases Financed from External Sources by Firm Size and Strength of Creditor Rights, 2006–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 B2.7.1 Firm Corporate Governance Reforms and Short-Term Debt . . . . . . . . . . . . . . . . . . . 55 B2.8.1 Use of Long-Term Debt by Chinese Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 viii CONTENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 B2.9.1 Fraction of Pensioners in Chile by Type of Retirement Product Selected . . . . . . . . . . 58 2.6 U.S. Treasury Yield Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 B2.11.1 Delinquency Rates on Real Estate Residential Loans at U.S. Commercial Banks, 1991–2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 2.7 Penetration and Size of Insurance Markets across Regions, 2000–08 . . . . . . . . . . . . 64 2.8 Volume of Life Insurance Premiums and Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 2.9 Frequency of Depth and Penetration of Mortgage Markets . . . . . . . . . . . . . . . . . . . . 65 2.10 Mortgage Depth and Typical First Mortgage Loan-to-Value Ratios at Origination . . 66 2.11 Relation of Mortgage Debt to Income and Inflation. . . . . . . . . . . . . . . . . . . . . . . . . . 66 B2.12.1 Housing Finance Gaps on Mortgage Penetration and Depth . . . . . . . . . . . . . . . . . . . 67 2.12 Adults with a Mortgage by Income and Region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 3.1 Total Amount Raised in Equity, Corporate Bond, and Syndicated Loan Markets, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 3.2 Average Number of Issuers per Year by Period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 3.3 Share and Maturity of Corporate Bonds Raised by Firm Sector and Country Income Group, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 3.4 Share and Maturity of Syndicated Loans Raised by Firm Sector and Country Income Group, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 3.5 Share and Average Maturity of Syndicated Loans Raised by Firm’s Primary Use of Proceeds and Country Income Group, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . 85 3.6 Average Maturity in Domestic Markets Compared with Continuous Measures of Domestic Financial Development by Country Income Group, 1991–2013 . . . . . . 89 3.7 Average Maturity of Corporate Bond and Syndicated Loan Issuances, 2000–13 . . . . 95 3.8 Total Amount Raised in Domestic and International Corporate Bond Markets by Nonfinancial Firms, 2000–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 3.9 Share Raised by the 10 Most Active Developing Countries in Domestic Corporate Bond Markets, 2008–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 3.10 Total Amount Raised in Corporate Bond Markets by Financial and Nonfinancial Companies, 2000–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 3.11 Total Amount Raised by Nonfinancial Firms in Domestic and International Syndicated Loan Markets, 2000–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 3.12 Total Amount Lent to Developing Countries through Syndicated Loan Markets by Lender Region, 2000–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 3.13 Syndicated Lending to Developing Countries for Project Finance, 2000–13 . . . . . . 102 4.1 Assets under Management of Nonbank Institutional Investors, 2001–13 . . . . . . . . 108 4.2 Average Share of Bank Loans by Length of Maturity and Country Income Group, 2005–12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 4.3 Share of International Bank Claims with Maturity above Two Years by Period and Country Income Group, 2005–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 B4.2.1 Basel III Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 4.4 Relative Shares of Defined Benefit and Defined Contribution Pension Fund Assets in Selected Countries, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 4.5 Differing Maturity Structures of Chilean Institutional Investors . . . . . . . . . . . . . . . 116 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 CONTENTS ix 4.6 Worldwide Total Net Assets Held by Mutual Funds by Degree of Development and Region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 B4.4.1 Trading Volume versus Institutional Concentration, 2000–11 . . . . . . . . . . . . . . . . . 120 4.7 Shares and Average Maturity of Investments of U.S. and U.K. Mutual Funds, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 4.8 Shares and Average Maturity of U.S. and U.K. Mutual Funds by Industry, 2013 . . . 122 4.9 Average Maturity by Country and Issuer Type, 2013 . . . . . . . . . . . . . . . . . . . . . . . . 123 4.10 Average Maturity of U.S. and U.K. Mutual Funds Compared with Outstanding Bonds by Country, 2013. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 4.11 Comparison of Average Maturity of U.S. and U.K. Mutual Funds to Domestic Mutual Funds, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 4.12 Targeted Asset Allocation of Selected Sovereign Wealth Funds . . . . . . . . . . . . . . . . 128 4.13 Private Equity Fund-Raising in Developing Countries by Region, 2001–13. . . . . . . 134 4.14 Private Equity Fund Types by Country Income Group, 2014 . . . . . . . . . . . . . . . . . . 136 MAPS A.1 Depth—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157 A.2 Access—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 A.3 Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 A.4 Stability—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 A.5 Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 A.6 Access—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 A.7 Efficiency—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 A.8 Stability—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 TABLES BO.2.1 Selected Results from the 2014 Financial Development Barometer . . . . . . . . . . . . . . .5 B2.2.1 Impact of the Global Financial Crisis on Firm Leverage, 2004–11 . . . . . . . . . . . . . .47 B2.3.1 Impact of Firms and Country Characteristics on Debt Maturity . . . . . . . . . . . . . . . .48 3.1 Average Annual Number of Issuing Firms, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . .79 3.2 Firm Characteristics by Country Income Group, 2003–11 . . . . . . . . . . . . . . . . . . . .81 3.3 Average Maturity of Corporate Bonds, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . .82 3.4 Average Maturity of Syndicated Loans, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . .83 3.5 Amount Raised per Year in Corporate Bond Markets by Market Location, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 3.6 Average Maturity of Domestic and International Corporate Bonds Issuances, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 3.7 Amount Raised per Year in Syndicated Loan Markets by Market Place, 1991–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90 4.1 Share of Bank Loans across Different Maturity Buckets . . . . . . . . . . . . . . . . . . . . .109 x CONTENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 B4.1.1 Estimations for the Share of Bank Loans with Original Maturity Greater than 1 Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111 B4.4.1 Stock Market Development and Institutional Investors, 2000–11 . . . . . . . . . . . . . .120 4.2 Sovereign Wealth Funds by Total Assets under Management, 2014. . . . . . . . . . . . .127 4.3 Percentage Share of Sovereign Wealth Fund Transactions by Level of Economic Development, 2010–13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130 4.4 Selected Sovereign Wealth Funds with a Domestic Investment Mandate, 2014 . . . .131 4.5 Types of Private Equity Funds and Investment Strategies . . . . . . . . . . . . . . . . . . . . .133 4.6 Private Equity Returns by Region, 2001–14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .138 A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 . . . . . .148 A.1.1 Depth—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157 A.1.2 Access—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 A.1.3 Efficiency—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 A.1.4 Stability—Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 A.1.5 Depth—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 A.1.6 Access—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 A.1.7 Efficiency—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 A.1.8 Stability—Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 B.1 Economies and Their Maturity Structure of Finance, 2013 . . . . . . . . . . . . . . . . . . .165 Foreword T he third Global Financial Develop- ment Report contributes to the ongoing debate on the role of long-term finance in sus- International Monetary Fund, the Organisa- tion for Economic Co-operation and Devel- opment, and the World Bank Group) in areas taining economic development and ensuring such as financial sector regulatory reforms, shared prosperity. It builds on the fi rst and the development of local currency bond mar- second reports, which respectively contrib- kets, and the role of institutional investors in uted to the debates on the role of the state in financing long-term investments. finance and on financial inclusion. Like these The Global Financial Development Report prior analyses, this report provides a nuanced, 2015/2016: Long-Term Finance offers new practical, and evidence-based approach to research and data that help fill gaps in the financial sector policy. knowledge on long-term finance and that con- Its recommendations come at a crucial tribute to the policy discussion on this devel- time, almost seven years after the global finan- opment issue. It provides stylized facts and cial crisis spread rapidly and broadly across examines both new and older evidence on the many advanced and developing countries. In use and provision of long-term finance and its recent years, international policy makers, in economic impact. particular the Group of Twenty (G-20), have Extending the maturity structure of finance voiced growing concerns about the potential is often considered to be at the core of sus- detrimental effects of a prolonged decline in tainable financial development. It would be a the supply of long-term funding by the inter- challenge to achieve high and sustainable rates national banking system. At the same time, of economic growth if countries fail to invest raising fixed investment, particularly in infra- in schools, roads, power generation, electric- structure, is increasingly seen as critical to sus- ity distribution, railways and other modes taining the level of economic growth needed of transport, and communications. Private to achieve the broader objectives of the post- sector construction of plants and investment 2015 Sustainable Development Goals. In in machinery and equipment are also impor- this context, the G-20 has endorsed various tant. Without long-term financial instru- policy initiatives involving international orga- ments, households would face great hurdles nizations (the Financial Stability Bureau, the to smoothing or raising income over their life GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 xi xii FOREWORD GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 cycle—for example by investing in housing or promote long-term finance. Typically, direct education—and may not benefit from higher interventions have not been successful where long-term returns on their savings. underlying problems remained. As a result, For many years, the World Bank Group governments and international bodies must has been engaged in activities related to focus on reforms that help overcome market delivering sustainable long-term finance failures and institutional weaknesses. They to developing countries. Prior attempts at must also improve risk and information shar- directly boosting the supply of long-term ing, and promote financial literacy and con- finance have not been free of controversy sumer protection. and have sometimes led to substantial costs We hope that this year’s Global Financial to taxpayers. In response, the World Bank’s Development Report will prove useful to a direct long-term lending was reduced in the wide range of stakeholders, including gov- 1990s and 2000s, and its other roles became ernments, international financial institutions, more prominent. nongovernmental organizations, think tanks, The report provides a careful review and academics, the private sector, donors, and the synthesis of recent and new research, iden- broader community. tifying those policies that work to promote long-term finance and those that do not; it Jim Yong Kim also notes where more research is needed. President It argues that there is no magic bullet to The World Bank Group Acknowledgments G lobal Financial Development 2015/ 2016: Long-Term Finance reflects the efforts of a broad and diverse group of the chapters include Martin Kanz (chapter 1), Colin Xu (chapter 2), and Tatiana Didier (chapter 3). Jeanne Verrier, Nan Zhou, and experts both inside and outside the World Amin Mohseni-Cheraghlou completed the Bank Group. The report was produced by the core team. Martin C ˇ ihák contributed to the World Bank Research Department in collabo- concept note. Inputs were received from Deniz ration with the Finance and Markets Global Anginer (chapter 2, box 2.7); Gunhild Berg, Practice, the Financial Institutions Group in Bilal Zia, and Haelim Park (chapter 2); Edu- the International Finance Corporation (IFC), ardo Engel, Ronald Fischer, and Alexander and the Multilateral Investment Guaran- Galetovic (chapter 3, box 3.2); Eva Hansen tee Agency (MIGA). Moreover, it includes (chapter 3, box 3.3); Zamir Iqbal (chapter 3, inputs from a wide range of units, including box 3.5); Catiana Garcia-Kilroy and Ander- the Development Economics Vice Presidency, son Caputo Silva (chapter 3, box 3.6), Julieta the Regional Vice Presidencies, the Macro- Picorelli (chapter 4, box 4.1); Pierre-Laurent economics and Fiscal Management Global Chatain (chapter 4, box 4.2); and Erik Feyen Practice, the Treasury, and the Publishing and and Subika Farazi (appendixes and Global Knowledge Division of the External and Cor- Financial Development Database). porate Relations Vice Presidency. Kaushik Basu, Chief Economist and Senior Aslı Demirgüç-Kunt was the report’s direc- Vice President; Mahmoud Mohieldin, Special tor. Thierry Tressel was the task manager of Envoy of the World Bank President; and Ber- the project. The main authors in charge of the trand Badre, Managing Director and World chapters were María Soledad Martínez Pería Bank Group Chief Financial Officer, provided (chapter 1); Miriam Bruhn and Claudia Ruiz overall guidance and valuable advice. Ortega (chapter 2); Juan Jose Cortina Lorente External advisors to the report included and Sergio Schmukler (chapter 3); and Martin Franklin Allen, Professor of Finance and Kanz, María Soledad Martínez Pería, Matias Economics at the Wharton School, Univer- Moretti, Alvaro Enrique Pedraza Morales, sity of Pennsylvania; Thorsten Beck, Profes- and Sergio Schmukler (chapter 4). Other sor of Banking and Finance, Cass Business authors who provided key contributions to School in London; Charles Calomiris, Henry GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 xiii xiv ACKNOWLEDGMENTS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Kaufman Professor of Financial Institutions, Inquiry into the Design of a Sustainable Columbia Business School; Stijn Claessens, Financial System. Senior Adviser, Federal Reserve Board; Oliv- In the World Bank–wide review of the ier Jeanne, Professor of Economics, Johns concept note and of the report, substantial Hopkins University and Senior Fellow at the comments were received from Loic Chiquier, Peterson Institute for International Econom- Roberto R. Rocha, Alison Harwood, and ics; Ross Levine, Willis H. Booth Chair in other staff of the units in the Finance and Banking and Finance, Haas School of Busi- Markets Global Practice (in particular, the ness; and Vojislav Maksimovic, William Financial Systems and Capital Markets and A. Longbrake Chair in Finance, Robert H. Nonbank Financial Institutions units); Ravi Smith School of Business at the University of Vish and Franciscus Johannes Linden (all Maryland. Multilateral Investment Guarantee Agency); The team received valuable peer review Ted Haoquan Chu and William C. Haworth and guidance from other staff members at (International Finance Corporation); Augusto the World Bank Group including Loic Chi- de la Torre, Steen Byskov, Alain Ize, and Edu- quier, Augusto de la Torre, Alain Ize, Roberto ardo Levy-Yeyati (all Latin America and the Rocha, Peer Stein, and Ravi Vish. Aart Kraay Carribean Region); Axel van Trotsenburg, reviewed the concept note and drafts of the Ulle Lohmus, Sudhir Shetty, and Nikola L. report for consistency and quality multiple Spatafora (all East Asia and Pacific Region); times. Cesar Calderon, Makhtar Diop, Arnaud Peer Stein and Matthew Gamser were the Dornel, Cedric Mousset, and Christopher key contacts at IFC, Gloria M. Grandolini at Juan Costain (all Africa Region); Shantay- the Finance and Markets Global Practice, and anan Devarajan and Pietro Calice (all Middle Ravi Vish at MIGA. The authors benefited East and North Africa Region); Hans Tim- from informal discussions and received valu- mer, Davide Salvatore Mare, Anna Bjerde, able suggestions and other contributions from John Pollner, Natalie Nicolaou, and David Hormoz Aghdaey, Irina Astrakhan, Dilek Michael Gould (all Europe and Central Aykut, Meghana Ayyagari, Arup Banerji, Asia Region); Philippe Le Houérou, Markus Patrick Blanchard, Markus K. Brunnermeier, Kitzmuller, Martin Rama, and Niraj Verma Ana Fiorella Carvajal, Gerardo Corrochano, (all South Asia Region); Reynaldo F. Pas- Mariano Cortes, Shantayanan Devarajan, tor, Alejandro Alcala Gerez, Susan Maslen, Shanthi Divakaran, Mark Dorfman, Arnaud Vikram Raghavan, Shirmila T. S. Rama- Dornel, Aurora Ferrari, Erik Feyen, Havard samy, Mariangeles Sabella, Anthony Toft, Halland, Alison Harwood, Martin Hommes, Vijay Srinivas Tata and Shirmila Ramasamy Anushe A. Khan, Anjali Kumar, Rodney Ross (all Legal Unit); Samuel K. E. Otoo, Mark Lester, Samuel Maimbo, Yira J. Mascaro, Roland Thomas, Pinki Chaudhuri, Jeffrey David McKenzie, Martin Melecky, Sebastian Lewis, Mick Riordan, and Carlos Cavalcanti Molineus, Cedric Mousset, Michel Noel, (all Macroeconomics and Fiscal Manage- Robert Palacios, Jorge Patiño, Harris Selod, ment Global Practice); Jacob Goldston, Car- Aksinya Sorokina, Fiona Stewart, Francesco los Silva-Jauregui, and Tara Vishwanath (all Strobbe, Markus Taussig, Anuradha Thakur, Poverty Global Practice); Joachim von Ams- Craig Thorburn, Hourn Thy, Marilou Uy, berg and Clara Ana Coutinho de Sousa (all Simon Walley, Ivan Zelenko, and Albert Zeu- Development Finance Unit); Marianne Fay, fack. Data contributions were received from Roy Parizat, Eduardo Ferreira, Habiba Gitay, Ibrahim Levent, Wendy Ven-dee Huang, Joshua Gallo, and Julie Rozenberg (all Cli- and Eung Ju Kim. The report also benefited mate Change Cross-Cutting Solutions Area from informal conversations with colleagues and Sustainable Development Vice Presi- at the International Monetary Fund and at dency); Scobey Leonardo Bravo, Mariano the United Nations Environment Program Cortes, Jack Glen, Anjali Kumar, and Andrew GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 ACKNOWLEDGMENTS xv Stone (all Independent Evaluation Group); Janice Tuten, and as well as the external edi- Laurence W. Carter and Xavier Cledan tor, Martha Gottron. Roula Yazigi assisted Mandri-Perrott (all Public Private Partern- the team with the website. The communica- ships Cross-Cutting Solutions Area); Myles tions team included Ryan Douglas Hahn, Brennan, Phillip Anderson, Daniela H. Phil Hay, Vamsee Kanchi, and Merrell Tuck- Klingebiel, and Colleen E. Keenan (all Trea- Primdahl. Excellent administrative assistance sury); Jaehyang So and Rahul Gupta (all was provided by Michelle Chester, Paulina Trust Funds and Partnerships); Ivan Rossi- Sintim-Aboagye, and Tourya Tourougui. gnol (Trade and Competition Global Prac- Liliana Longo and Eileen Monnin-Kirby pro- tice); Caren Grown and Benedicte Leroy De vided continuous support on budgetary issues. La Briere (all Gender Cross-Cutting Solutions Azita Amjadi, Colleen Burke, Liu Cui, Shelley Area). Lai Fu, William Prince, and Janice Tuten have The individual chapters of the report were been helpful in the preparation of the updated presented at the Global Financial Develop- Little Data Book on Financial Development ment Report seminars. The seminars were 2015/2016, accompanying this report. presented by members of the core team and The authors would like to thank the many benefited from thorough discussions with country officials and other experts who Roberto Rocha and Jeff Chelsky (chapter 1), participated in the surveys underlying this Simon Bell and Andrew Stone (chapter 2), report, including the Financial Development Heinz Rudolph and Catiana Garcia-Kilroy Barometer. (chapter 3), and Mario Guadamillas and Financial support from the Knowledge Fiona Stewart (chapter 4). for Change Program’s research support bud- The report would not be possible without get, the SME Finance Forum, and the U.K. the publishing production team, including Department for International Development is Patricia Katayama, Stephen McGroarty, and gratefully acknowledged. Abbreviations and Glossary BIS Bank for International Settlements G-20 Group of 20 GDP gross domestic product IMF International Monetary Fund OECD Organisation for Economic Co-operation and Development SME small and medium enterprise SWF sovereign wealth fund Note: All dollar amounts are U.S. dollars ($) unless otherwise indicated. GLOSSARY Country A territorial entity for which statistical data are maintained and pro- vided internationally on a separate and independent basis (not neces- sarily a state as understood by international law and practice). Financial Conceptually, financial development is a process of reducing the costs development of acquiring information, enforcing contracts, and making transac- tions. Empirically, measuring financial development directly is chal- lenging. This report focuses on measuring four characteristics (depth, access, efficiency, and stability) for financial institutions and markets (“4x2 framework”). Financial inclusion The share of individuals and firms that uses financial services. Financial system The financial system in a country is defined to include financial insti- tutions (banks, insurance companies, and other nonbank financial institutions) and financial markets (such as those in stocks, bonds, and financial derivatives). It also includes the financial infrastructure (which includes, for example, credit information–sharing systems and payments and settlement systems). GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 xvii xviii A B B R E V I AT I O N S A N D G L O S S A R Y GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Institutional investors Institutional investors include public and private pension funds, life insurance companies, non-life insurance companies, and mutual funds. Long-term finance Long-term finance comprises all types of financing (including loans, bonds, leasing, and public and private equity) with a maturity exceed- ing one year. Maturity refers to the length of time between origination of a financial claim (loan, bond, or other financial instrument) and the final payment date, at which point the remaining principal and inter- est are due to be paid. Equity, which has no final repayment date of a principal, can be seen as an instrument with nonfinite maturity. Nonbank financial Institutional investors and other nonbank financial intermediaries institutions (such as leasing companies and investment banks). Overview W hat role does long-term finance play in economic development? Extending the maturity structure of finance the perceived lack of long-term credit. At the same time, research shows that weak in- stitutions, poor contract enforcement, and is often considered to be at the core of sus- macroeconomic instability naturally lead to tainable financial development. Long-term fi- shorter maturities on financial instruments. nance—frequently defined as all funding for a Indeed, these shorter maturities are an opti- time frame exceeding one year—may contrib- mal response to poorly functioning institu- ute to faster growth, greater welfare, shared tions and property rights systems, as well as prosperity, and enduring stability in two im- to instability. From this perspective, the policy portant ways: by reducing rollover risks for focus should be on fixing these fundamentals, borrowers, thereby lengthening the horizon not on directly boosting the term structure of investments and improving performance, of credit. Indeed, some argue that attempts and by increasing the availability of long- to promote long-term credit in developing term financial instruments, thereby allowing economies without addressing the fundamen- households and firms to address their life- tal institutional and policy problems have of- cycle challenges (Caprio and Demirgüc-Kunt ten turned out to be costly for development. 1998; Demirgüç-Kunt and Maksimovic 1998, For example, efforts to jump-start long-term 1999; de la Torre, Ize, and Schmukler 2012). credit through development financial institu- Attempts to actively promote long-term tions in the 1970s and 1980s led to substan- finance have proved both challenging and tial costs for taxpayers and, in extreme cases, controversial. The prevalent view is that fi- to failures (Siraj 1983; World Bank 1989). In nancial markets in developing economies are response, the World Bank reduced this type of imperfect, resulting in a considerable scarcity long-term lending in the 1990s and the 2000s. of long-term finance, which impedes invest- In recent years, long-term finance has at- ment and growth. Indeed, a significant part tracted heightened interest from policy mak- of lending by multilateral development banks ers, researchers, and other financial sector (including World Bank Group lending and stakeholders. It has also become clearer that guarantees) has aimed at compensating for long-term finance is used to a lesser extent in GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 1 2 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 emerging markets and developing economies. The Group of Thirty called for a multifaceted While emerging markets’ share of the global policy approach to lower the barriers that economy has risen from roughly one-third to constrain the provision of long-term finance. one-half over the past decade, advanced econ- Ensuring more and better long-term finance is omies continue to dominate the use of long- one of the priorities for the Post-2015 Devel- term funding. At the same time, new evidence opment Agenda (United Nations 2013). has accumulated on the use and term struc- The Global Financial Development Report ture of debt for both firms and households 2015/2016: Long-Term Finance seeks to con- and on the effects of long-term finance and tribute to this policy discussion on long-term related policies. In particular, evidence shows finance. It provides stylized facts on the use that long-term finance can, but need not, pos- and provision of long-term finance and ex- itively affect firm performance. amines both new and older evidence on the The global financial crisis of the late 2000s use of long-term finance and its economic led to an even greater policy focus on the im- impact. The report provides a careful review portance of long-term finance. Academics and and synthesis of recent and ongoing research, policy makers have acknowledged that the in- identifying those policies that work to pro- ability of financial firms to roll over debt to mote long-term finance and those that do not, meet their obligations was one of the main as well as areas where more evidence is still drivers of contagious defaults in the recent needed. Box O.1 provides the main messages crisis (Brunnermeier 2009; Financial Stability of this report. Forum 2009a, 2009b). The decreased avail- Despite the renewed interest, policy makers ability of longer-term funding following the and other financial sector practitioners are di- crisis has further heightened existing financial vided on whether and how policy should pro- sector vulnerabilities and widened potential mote long-term finance. According to the third long-term financing gaps for infrastructure Financial Development Barometer—an infor- investment in particular. Although the focus mal poll of the views of policy makers in de- and regulatory response has been on finan- veloping countries undertaken for this Global cial firms, the risks associated with short-term Financial Development Report—slightly more finance are not confined to financial firms than 40 percent of the respondents fully agree alone. Inability to roll over short-term debt that a lack of access to long-term finance rep- has exacerbated the operational losses and led resents a problem for firms and households to sudden defaults of large corporations such in their country (box O.2). While 70 percent as Penn Central in the United States. Concerns of respondents believe the underlying reasons about the detrimental effects of a potentially for underuse of long-term finance are supply constrained supply of long-term finance have driven, views differ significantly on which in- been voiced in the Group of Twenty (G-20) stitutions and markets play the most impor- meetings and by the Group of Thirty. Specifi- tant role in supplying long-term finance, as cally, these bodies consider long-term financ- well as which policies are the most effective ing to be critical for investment and growth, for promoting it. The Global Financial De- particularly in infrastructure sectors, and velopment Report 2015/2016: Long-Term necessary to improve welfare and share pros- Finance brings new data and research and perity and to achieve post-2015 development draws on available insights and experience to goals.1 The G-20 endorsed an action plan to contribute to the policy discussion. support the development of local currency bond markets, noting that during the global LONG-TERM FINANCE: financial crisis domestic bond issuances cush- MEASUREMENT AND RECENT ioned the impact of banking stress on the real TRENDS economy.2 Institutional investors are also in- creasingly seen to play a greater role in financ- Use of long-term finance varies across the ing long-term investment (OECD 2014a). world, but it is generally more limited in GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 3 BOX O.1 Main Messages of This Report Use of long-term fi nance—frequently defi ned as all well, because they rely on international markets to a fi nancing for a time frame exceeding one year—is greater extent than their high-income counterparts. more limited in developing countries, particularly Such fi rms were also more vulnerable to the large among smaller fi rms and poorer individuals. This drop in syndicated lending during the crisis. is true even after controlling for fi rm characteristics Market failures and policy distortions have a such as asset and industry composition and profit- disproportionate effect on long-term fi nance, sug- ability and individual attributes such as wealth and gesting an important role for policies that address education. In developing countries, only 66 percent these failures and distortions. Long-term fi nance is of small fi rms and 78 percent of medium-size fi rms not always optimal—its use in an economy reflects report having any long-term liabilities, compared the risk sharing between users and providers of with 80 percent and 92 percent in high-income fi nance. Shorter maturities shift risk from providers countries, respectively. Firms in high-income coun- to users because these instruments force users to roll tries report financing almost 40 percent of their over fi nancing frequently. Also, because fi rms and fi xed assets externally, whereas this figure is barely individuals tend to match the maturity structure of 20 percent in low-income countries. Similar differ- their assets and liabilities, not every fi rm or house- ences exist for individuals’ use of term fi nance. For hold needs to use long-term fi nancing instruments. example, the average share of individuals with an Hence, use of long-term fi nance across countries may outstanding loan to purchase a home is 21 percent vary naturally depending on the asset being fi nanced in high-income countries, yet barely 2.5 percent and on how borrowers and lenders agree to share the in lower-middle- and low-income countries. Other risks involved between each other. However, limited products such as education loans are not widespread use of long-term fi nance is generally also a symptom in the developing world and, when they are avail- of market failures and policy distortions since long- able, are used by wealthier individuals. term fi nancing instruments are disproportionately Where it exists, the bulk of long-term fi nance is affected by these failures and distortions. provided by banks; use of equity, including private Sustainably extending the maturity structure equity, is limited for fi rms of all sizes. As fi nancial of fi nance is a key policy challenge since long-term systems develop, the maturity of external finance finance can be an important contributor to eco- also lengthens. Banks’ share of lending that is nomic growth and shared prosperity. If long-term long term also increases with a country’s income finance is not available for deserving firms, they and the development of banking, capital markets, become exposed to rollover risks and may become and institutional investors. Long-term fi nance for reluctant to undertake longer-term fixed invest- fi rms through issuances of equity, bonds, and syn- ments, with adverse effects on economic growth dicated loans has also grown signifi cantly over the and welfare. Without long-term financial instru- past decades, but only very few large fi rms access ments, households cannot smooth income over their long-term fi nance through equity or bond markets. life cycle—for example, by investing in housing or The promotion of nonbank intermediaries (pen- education—and may not benefit from higher long- sion funds and mutual funds) in developing coun- term returns on their savings. Empirical evidence tries such as Chile has not always guaranteed an also suggests use of long-term fi nance by fi rms and increased demand for long-term assets. households is associated with better firm perfor- The global fi nancial crisis of 2008 has also led mance and improved household welfare. There is lit- to a reduction in leverage and use of long-term debt tle evidence however, that direct efforts to promote for developing-country firms. Small and medium long-term fi nance by governments and development enterprises in lower-middle- and low-income coun- banks—for example, through directed credit to tries were particularly adversely affected, seeing fi rms or subsidies for housing—have had sustainable a reduction in both their leverage and use of long- positive effects. These policies have generally not term debt. Large fi rms in developing countries that been successful because the underlying institutional are able to access fi nancial markets were affected as problems and market failures that underpin the low (box continued next page) 4 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX O.1 Main Messages of This Report (continued) use of long-term fi nance remain and because politi- to longer-term fi nance. For larger fi rms able to access cal capture and poor corporate governance practices markets, evidence suggests that foreign investors undermine the success of direct interventions by gov- hold more long-term domestic debt than domestic ernments. Similarly, extending maturity structures investors; hence policies that promote foreign invest- by promoting development of institutional investors ment are also likely to extend the maturity structure or by building stock or bond markets has proven dif- of fi nance, although this will also make fi rms more ficult unless there is a commitment to address funda- vulnerable to external shocks. For households, sup- mental institutional problems. porting fi nancial literacy, consumer protection, and There is no magic bullet to promote long-term disclosure rules to improve information and its use, fi nance; governments need to focus on fundamen- and providing investment default options to reduce tal institutional reforms. These include pursuing behavioral biases can help increase individuals’ policies that promote macroeconomic stability, low understanding of long-term fi nance instruments. infl ation, and viable investment opportunities; pro- Well-designed private-public risk-sharing arrange- moting a contestable banking system with healthy ments may also hold promise for mobilizing fi nanc- entry and exit supported with strong regulation and ing for long-term projects. Through public-private supervision; putting in place a legal and contractual partnerships for large infrastructure projects, gov- environment that adequately protects the rights of ernments can mitigate political and regulatory risks creditors and borrowers; fostering fi nancial infra- and mobilize private investment. Sovereign wealth structures that limit information asymmetries; and funds are state-owned investment funds that are seen laying the necessary institutional and incentive as a promising source of longer-term fi nance, given frameworks to facilitate long-term development of their long investment horizon and mandate to diver- capital markets and institutional investors. Most sify economic risks and manage intergenerational of these policies will promote financial develop- savings, but they are not entirely immune to some ment more generally but will disproportionately of the problems of political capture and poor gov- increase long-term fi nance, which is more affected ernance that plagued national development banks. by distortions. Multinational development banks can promote Institution building is a long-term process; hence long-term fi nance by offering knowledge and policy in the short to medium term, market-friendly inno- advice to help shape policy agendas for institutional vations that overcome market failures and institu- reform that are essential for promoting long-term tional weaknesses and that support financial literacy fi nance, as well as by structuring infrastructure or and consumer protection may help extend maturity. other long-term fi nancing projects that allow private Asset-based lending instruments such as leasing may lenders and institutional investors to participate in even help small and nontransparent fi rms gain access this fi nancing while reducing project and credit risk. developing countries. Smaller firms and example, the average share of individuals with poorer individuals also tend to use long-term an outstanding loan to purchase a home is 21 finance less. For example, figure O.1 shows percent in high-income countries, yet barely long-term debt-to-asset ratios for firms of 2.5 percent in lower-middle- and low-income different sizes across a large sample of de- countries. Other products such as education veloping and high-income countries over the loans are not widespread in the developing 2004–11 period. In the median developing world and, when they are available, are used country, small firms’ long-term debt-to-asset by wealthier individuals. ratios are 1 percent, compared with 7 percent One common definition of long-term fi- in high-income countries. Similar differences nance, which also corresponds to the defini- exist for individuals’ use of term finance. For tion of fixed investment in national accounts, GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 5 BOX O.2 Practitioners’ Views on Long-Term Finance: Global Financial Development Barometer To examine views on long-term finance among 2014, covered respondents from 21 developed and some of the World Bank Group’s clients, the Global 49 developing economies. From 70 economies polled, Financial Development Report team has undertaken 42 responded (60 percent response rate). According a new, 2014 round of the Financial Development to poll results, 40–43 percent of respondents fully Barometer. The barometer is a global informal poll agreed that access to long-term finance is a significant of financial sector practitioners (central bankers, problem for firms and households. Most respondents fi nance ministry officials, market participants, and saw this primarily as a supply problem. Interestingly, academics, as well as nongovernmental organization more than half of the respondents felt the availability and think-tank representatives focusing on fi nan- of long-term fi nance had increased since the fi nan- cial sector development issues). This poll examines cial crisis of 2008. The poll also sought views on the sentiments, trends, and important policy issues. For most important institutions and policies for the pro- results from the last Financial Development Barome- vision of long-term fi nance. While 61 percent agreed ter, see Global Financial Development Report 2014. that private domestic banks were the most impor- The barometer survey contained questions in two tant institutions for this purpose, views differed on groups: general questions about fi nancial develop- which other institutions and markets played the most ment, and specific questions relating to long-term important role. When asked about the most effective fi nance, the topic of the 2015/2016 Global Finan- policies to promote long-term fi nance, again views cial Development Report. The poll, carried out in differed on what were the most important policies. TABLE BO.2.1 Selected Results from the 2014 Financial Development Barometer Percentage of respondents agreeing with the statements “Access to long-term finance is a significant problem for households in my country.” 43 “Access to long-term finance is a significant problem for firms in my country.” 40 “Low use of long-term finance in my country is primarily a supply problem.” 75 “Low use of long-term finance in my country is primarily a demand problem.” 15 “In my country availability of long-term finance declined or stayed the same since the global financial crisis.” 40 “In my country availability of long-term finance increased since the global financial crisis.” 60 “Domestic banks play the most important role in promoting long-term finance in my country.” 61 “Development banks play the most important role in promoting long-term finance in my country.” 22 “Domestic stock markets play the most important role in promoting long-term finance in my country.” 13 “Domestic corporate bond markets play the most important role in promoting long-term finance in my country.” 11 “Nonbank financial institutions play the most important role in promoting long-term finance in my country.” 17 “International capital markets play the most important role in promoting long-term finance in my country.” 17 Source: Financial Development Barometer (for full results, see www.worldbank.org/financialdevelopment). (box continued next page) 6 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX O.2 Practitioners’ Views on Financial Inclusion: Global Financial Development Barometer (continued) FIGURE BO.2.1 Views on Policies to Promote Long-Term Finance Percentage of responses to the question “What is the most important policy to promote long-term finance?” Macroeconomic and financial stability 50 Institutional reforms 45 Strength of credit information environment 40 Policies contributing to the development of stock market 36 Policies related to the development of government and corporate bond markets 30 Competition policy to ensure market contest 28 Policies contributing to the access of international markets 24 Direct intervention, including by state-owned banks 11 Other 7 Proportion of respondents, % Source: Financial Development Barometer (for full results, see www.worldbank.org/financialdevelopment). FIGURE O.1 Firms’ Median Long-Term Debt-to-Asset Ratios by is any source of funding with maturity ex- Country Income Group and Firm Size, 2004–11, Country-Level Median ceeding one year. The G-20, by comparison, uses a maturity of at least five years to define 12 long-term financing. In this report, long-term 10 10 finance is frequently defined to cover ma- Long-term debt to total assets, % 8 turities beyond one year, but more granular 8 8 7 7 maturity buckets and comparisons are also examined when data are available. Equity 6 (public or private) is also often considered to 5 be a form of long-term financing, since it is a 4 4 financial instrument with no final repayment date. 2 1 Long-term finance can take the form of either debt or equity financing, but bank 0 finance is the single most common source Total Small firms Medium firms Large firms (< 20) (20–99) (100+) of external finance. When examining the sources of external finance for purchases of High-income countries Developing countries fixed assets, Enterprise Survey data show Source: Calculations for 80 countries, based on ORBIS (database), Bureau van Dijk, Brussels, that bank credit drives differences in the use https://orbis.bvdinfo.com. For a detailed data description, see Demirgüç-Kunt, Martínez Pería, and of long-term finance across firm size. Figure Tressel 2015a. Note: Developing countries include low- and middle-income countries. Firm size is defined based O.2 also shows that use of bank finance var- on the number of employees. Long-term debt is defined as noncurrent liabilities. ies widely across firm size, with small firms GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 7 financing 11 percent of purchases of fixed FIGURE O.2 Sources of External Finance for Purchases of Fixed assets through banks, compared with 26 per- Assets by Firm Size, 2006–14 cent for large firms. In contrast, the use of equity is less than 5 percent for firms of all 30 sizes. 26 25 Fixed asset purchases financed, % The global financial crisis of 2008 ex- acerbated these differences in the use and 20 20 provision of long-term finance. Initially in 2008–09, the crisis led to a reduction in 15 ratios of total debt to total assets, or dele- 11 veraging—mostly for small and medium en- 10 8 terprises (SMEs) in high-income countries— 6 6 as shown in the top half of figure O.3. By 4 4 5 5 3 3 2011, however, deleveraging was occurring 2 across the board in all countries and for all 0 Bank Trade credit Equity Other firm sizes, and although the impact remained larger in the high-income world, larger firms Small firms (< 20) Medium firms (20–99) Large firms (100+) were even more affected than SMEs. The bottom half of figure O.3 shows a different Source: Calculations for 123 countries, based on Enterprise Surveys (database), International trend, this time focusing on long-term debt Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. Note: The figure shows the average percentage of purchases of fixed assets that was financed use. Looking only at firms using long-term from specific external sources—banks, trade credit, equity, and other sources—as opposed to finance in the precrisis period, the figures internal sources. Equity finance includes owners’ contribution or new equity share issues (not retained earnings, which are counted as internal sources of finance). The “other” category of reveal that the crisis led to a significant re- external financing includes issues of new debt, nonbank financial institutions, money lenders, duction in long-term debt use by SMEs in family, and friends. Firm size is defined based on the number of employees. Calculations of the average for each firm size use sampling weights. developing countries. Again, by 2011 firms of all sizes had been affected by declining long-term debt use, but the impact remained WHY DO WE CARE ABOUT significantly greater in developing countries LONG-TERM FINANCE? and for small firms. SCARCITY AND IMPACT For large firms that are able to access mar- kets for long-term finance, developments in The limited use of long-term finance observed the bond and syndicated loan markets had in developing countries is not necessarily a an adverse impact. Despite the significant problem in itself. To the contrary, this lim- development of equity, bond, and syndicated ited use can be optimal since it reflects both loan markets before the crisis, particularly in demand and supply of contracts with longer- developing countries it is still mostly a few term maturities and involves trade-offs in large firms that tap these markets. Although how risk is shared between users and provid- these large firms in developing countries gen- ers. In well-functioning markets, borrowers erally do not show a shorter maturity struc- and lenders may prefer short-term contracts ture than similar size firms in high-income over longer-term contracts for a number of countries, a larger share of their financing reasons. takes place in international markets com- Depending on the kind of asset being pared with firms in high-income countries. financed, short-term finance may be preferred. Hence when the crisis led to a significant fall Firms and households tend to match the in syndicated lending that originated in the maturity structure of their assets and liabilities. high-income countries, developing-country Firms, for example, generally prefer short- firms were especially affected. The financing term loans to finance working capital, such as of infrastructure projects, for which syndi- payroll, and inventory and use longer-term cated loans are key at the early stages, was financing to acquire fixed assets, equipment, severely affected. and the like (Hart and Moore 1995). 8 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE O.3 Change in Leverage and Debt Maturity since the Global Financial Crisis by Country Income Group and Firm Size Average change in total debt to total assets a. Between 2004–07 and 2008–09 b. Between 2004–07 and 2010–11 0.6 0.6 0.35 0.4 0.4 0.2 0.14 0.2 0.03 0 0 Average change, % Average change, % –0.2 –0.2 –0.4 –0.4 –0.35 –0.6 –0.6 –0.54 –0.57 –0.64 –0.8 –0.8 –1.0 –0.78 –1.0 –1.2 –1.06 –1.2 –1.25 –1.27 –1.23 –1.4 –1.4 All firms Large firms Small and All firms Large firms Small and medium firms medium firms Average change in long-term debt to total assets c. Between 2004–07 and 2008–09 d. Between 2004–07 and 2010–11 1.0 1.0 0.5 0.5 0 0 Average change, % Average change, % –0.06 –0.5 –0.20 –0.30 –0.5 –0.38 –0.53 –1.0 –1.0 –0.84 –1.13 –1.5 –1.5 –1.52 –2.0 –1.56 –2.0 –2.13 –2.09 –2.26 –2.5 –2.5 All firms Large firms Small and All firms Large firms Small and medium firms medium firms High-income countries Developing countries Source: Calculations for 80 countries covering 2004–11, based on ORBIS (database), Bureau van Dijk, Brussels, https://orbis.bvdinfo.com. For a detailed data description, see Demirgüç-Kunt, Martínez Pería, and Tressel 2015b. Note: Developing countries include low- and middle-income countries. Firm size is defined based on the number of employees. Leverage and long-term debt values are simple averages for firms within individual countries, averaged across countries in each income group. The differences reported subtract the earlier period values from later period values. In panels c and d, firms with zero long-term debt before the crisis period were excluded from the sample in calculating the averages. Short-term finance has a stronger disci- are not satisfied with the borrower’s perfor- plinary role, overcoming moral hazard and mance (Rajan 1992; Rey and Stiglitz 1993; agency problems in lending. The lender’s Diamond and Rajan 2001). Long-term debt ability to monitor borrowers is improved may also reduce incentives to invest because with short-term financing contracts because firm managers and owners will have to share short-term debt needs to be negotiated fre- the returns with the lender well into the future quently and creditors can cut financing if they (Myers 1977)—a problem especially for firms GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 9 with high-growth opportunities. Hence over- FIGURE O.4 The Relationship between Greater Financial Depth and all, short-term finance can also reduce waste Longer Debt Maturity by Country Income Group, 1999–2012 and improve firm performance. The term of financing reflects the risk- 100 sharing contract between providers and users Private credit through deposit banks of finance. Long-term finance shifts risk to 80 32 as a share of GDP, % the providers because they have to bear the changing conditions in financial markets, such 60 as interest rate risk, including because of fluc- 27 tuations in the probability of default. Often 40 8 providers require a premium as part of the 14 20 compensation for the higher risk this type of 38 financing implies. On the other hand, short- 20 0 term finance shifts risk to users as it forces High-income countries Developing countries them to roll over financing constantly. Maturity < 1 year Maturity 1–5 years Maturity > 5 years Therefore, the amount of long-term finance that is optimal for the economy as a whole is Source: Bankscope (database), Bureau van Dijk, Brussels, http://www.bvdinfo.com/en-gb not clear. In well-functioning markets, bor- /products/company-information/international/bankscope. Note: The ratio of private credit to gross domestic product (GDP) and the maturity distribution are rowers and lenders will enter short- or long- averaged over those years when information for both is available. Figures are averages. term contracts depending on their financing needs and on how they agree to share the risk involved at different maturities. What matters in an economy warrants attention because it for the economic efficiency of the financing is often a symptom of underlying problems, arrangements is that borrowers have access some of which may require policy attention. to financial instruments that allow them to When long-term finance is undersupplied match the time horizons of their investment because of market failures and policy dis- opportunities with the time horizons of their tortions, it is “scarce” and can have adverse financing, conditional on economic risks and implications for development. Scarcity of volatility in the economy (for which long- long-term finance is an important develop- term financing may provide a partial insur- ment concern since deserving firms that do ance mechanism). At the same time, savers not have access to long-term finance become would need to be compensated for the extra exposed to rollover risks and may become risk they might take. reluctant to undertake longer-term fixed in- Nevertheless, even when both users and vestments, with adverse effects on economic providers of finance prefer to contract long growth and welfare (Diamond 1991, 1993). term, the equilibrium amounts observed in Without long-term financial instruments, an economy may be lower than optimal be- households cannot smooth income over their cause of market failures and policy distor- life cycle—for example, by investing in hous- tions. Indeed, long-term financial contracts ing or education—and may not benefit from are likely to be disproportionately sensitive higher long-term returns on their savings to the existence of market failures and policy (Yaari 1965; Campbell 2006). distortions. Figure O.4 shows how the matu- Evidence also suggests that use of long- rity structure of debt lengthens as a country’s term finance by firms is associated with bet- financial depth—measured by bank lending to ter firm performance. Long-term financing is private parties as a proportion of gross domes- important for firms because it allows them to tic product (GDP)—increases. While an aver- undertake lumpy and large investments that age developing country’s financial depth is less might be critical for their growth. Evidence than half of its high-income counterpart, its suggests that developed financial institutions ratio of long-term debt to GDP is only a quar- and markets and their ability to enter into ter. Therefore, limited use of long-term finance long-term contracts allow firms to grow at 10 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 faster rates than they could attain by relying Similarly, when the seniority of claims is not on internal sources of funds and short-term well enforced and lenders cannot coordinate credit alone (Demirgüç-Kunt and Maksimovic their actions, they will protect themselves 1998, 1999). These results do not hold, how- against dilution by simultaneously shorten- ever, when long-term finance is subsidized or ing the maturity of their claims (Bolton and extended through directed credit. Long-term Jeanne 2009; Brunnermeier and Oehmke finance also contributes to higher growth by 2013). This kind of market failure may trig- lowering macroeconomic volatility (Aghion, ger a “maturity rat race” in which all lend- Howitt, and Mayer 2005), and it is critical for ers shorten the maturity of contracts to pro- investments in infrastructure, which are found tect their claims. Hence, policies that reduce to have a positive and significant impact on information asymmetries—such as reforms of long-run growth and a negative impact on in- credit bureaus and collateral registries—are come inequality (Calderón and Servén 2014). particularly important to promote the avail- Long-term finance can also raise house- ability of long-term finance. holds’ welfare. Having access to long-term Policy distortions, such as the absence of a finance allows households to smooth their stable political and macroeconomic environ- consumption over time and facilitates lumpy ment, also tend to reduce the amount of long- investments such as housing and education term finance used in the economy. A stable (Case, Quigley, and Shiller 2013). Home own- political and macroeconomic environment is ership provides households with collateral a necessary condition for long-term finance to that can help alleviate borrowing constraints thrive because it underpins the ability of eco- and that facilitates consumption risk shar- nomic agents to predict the risks and returns ing (Lustig and Van Nieuwerburgh 2004). associated with that finance. For example, This collateral can also increase the likeli- even a history of high inflation is often linked hood of starting a small business, fostering to short-term debt and investments, with Bra- self-employment (Adelino, Schoar, and Sev- zil being one such example despite the numer- erino 2013). On the savings side, long-term ous reforms adopted to promote long-term investment allows households to address the finance (Park 2012). In the short run, the welfare considerations of various life-cycle government can support the market for long- challenges and to share in the financial ben- term finance through sound macroeconomic efits of economic growth. policies that keep inflation in check. Macro- Hence, governments have an important economic policies that render a sustainable role to play in addressing market failures and level of economic growth and foster profit- policy distortions when long-term finance is able investment opportunities in the economy indeed scarce. What are some of these market will also likely promote long-term finance. failures and policy distortions, and what are Underdeveloped financial systems are often the best ways to address them? The next sec- distinguished from more developed ones by tion addresses these questions and provides their lack of long-term finance. As financial general policy recommendations. systems develop, they become more market based, and the maturity structure of finance also lengthens. For example, Demirgüç-Kunt PUBLIC POLICY ON PROMOTING and Maksimovic (1999, 2002) show that de- LONG-TERM FINANCE velopment of both banking and stock mar- Market failures, such as information asym- kets improve access to external financing, yet metries and coordination failures, may limit it is the development of stock markets that long-term finance much more than short-term is more strongly associated with greater use finance. Because extending long-term finance of long-term finance. Well-capitalized, well- implies larger risks for providers, credit ration- regulated, contestable banking systems, where ing, described by Stiglitz and Weiss (1981), is most banks are privately owned, are generally likely to be more severe for long-term finance. associated with greater provision of long-term GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 11 finance. Hence the government can also influ- that is particularly challenging in weak institu- ence the supply of long-term finance by ensur- tional environments where good governance is ing the existence of competitive and contest- difficult to establish. Similarly, extending ma- able markets for financing. For example, by turity structures by promoting development facilitating bank competition and by allowing of institutional investors or building stock or the functioning of other intermediaries such bond markets has proven difficult unless there as leasing companies and private equity inves- is a commitment to address fundamental insti- tors that can also provide long-term finance, tutional problems. the government can shape and potentially Institution building is a long-term process; play a role in expanding the supply of long- hence in the short to medium term, market- term finance. friendly innovations that overcome market Both the absence of a strong legal and insti- failures and institutional weaknesses, along tutional framework and weak contract en- with supportive financial literacy and con- forcement can also disproportionately limit sumer protection, may help extend maturity. the supply of long-term finance. When a coun- Asset-based lending instruments such as leas- try’s contracting institutions have only very ing may even help small and nontransparent weak protections for lenders against nonpay- firms access longer-term finance. For larger ment of debt, lenders tend to rely on short- firms in developing countries that are able to term lending agreements for formal debt con- access markets, evidence suggests that foreign tracts, which make it easier for the lender to investors hold more long-term domestic debt discipline the borrower through the threat of than domestic investors; hence policies that withholding future financing if the borrower promote foreign investment are also likely does not repay. Similarly, in the absence of to extend the maturity structure of finance, contract enforcement, financiers would avoid although firms will also become more vul- lending long term and rely on short-term con- nerable to external shocks. For households, tracts to discipline borrowers and ensure re- supporting financial literacy, consumer pro- payment. The government has an important tection, and disclosure rules to improve infor- role in establishing a sound legal framework mation and its use, and the provision of in- that ensures contract enforcement and that vestment default options to reduce behavioral protects creditor rights to promote the devel- biases can have important effects on increas- opment of markets for long-term finance. ing individuals’ understanding of long-term There is little evidence, however, that di- finance instruments. rect efforts to promote long-term finance by For governments, well-designed private- governments and development banks—for public risk-sharing arrangements may also example through directed credit to firms or hold promise for mobilizing financing for subsidies for housing—have had sustainable long-term projects. Through public-private positive effects. These policies have generally partnerships for large infrastructure projects, not been successful because the underlying governments can mitigate political and regu- problems remain and because political capture latory risks and mobilize private investment. and poor corporate governance practices un- Where governments participate in markets dermine policy success. Government-backed for long-term finance as investors, they can guarantee schemes are often designed to en- delegate investment decisions to separate en- courage lending to certain sectors—for exam- tities, such as sovereign wealth funds. These ple, for SMEs and in mortgage markets—and state-owned investment funds are seen as can allow more risky borrowers to receive a promising source of longer-term finance, loans and also extend maturity structures. In given their long investment horizon and man- practice, however, it is not clear if these poli- date to diversify economic risks and manage cies lead to additional lending, and they need intergenerational savings. Although they are to be designed carefully and managed effec- not entirely immune to some of the problems tively to prevent large-scale losses—a need of political capture and poor governance that 12 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 plagued national development banks, when Against this broader policy context, this these funds are well managed, their incentives overview concludes with four focus areas can be better aligned with market incentives that can be important for long-term finance: and they may be less susceptible to political the importance of information sharing, the capture. Similarly, multinational development role of contract enforcement and protection banks can promote long-term finance by of- of investor rights, the importance of financial fering knowledge and policy advice to help literacy for a household’s use of long-term shape policy agendas for institutional reform finance, and the challenges of extending ma- that are essential for promoting long-term fi- turity structure by promoting development of nance, as well as by structuring infrastructure markets and institutional investors. The focus or other long-term financing projects to allow on these areas reflects not only the impact private lenders and institutional investors to they can have on long-term finance but also participate in this financing while reducing new evidence to highlight. For help in navi- project and credit risk (box O.3). gating the rest of the report, see box O.4. BOX O.3 The Role of Multilateral Development Banks in Mobilizing Long-Term Finance Available long-term fi nancing falls far short of the MDB interventions need to support, and not replace investment needs of developing countries. This or undermine, the formation of sustainable markets. mismatch has been documented in the context of MDBs can play a catalytic role in fostering pri- the discussion of the post-2015 Sustainable Devel- vate long-term fi nance in a number of ways:d opment Goals, which will replace the Millennium Development Goals. a It exists even though devel- 1. They can help countries identify weaknesses in oping countries have introduced many reforms to the macroeconomic and investment environment develop their domestic fi nancial markets and have that prevent private sector fi nancing from flow- enjoyed increased access to international capital ing and can act as “an honest broker” between markets in the past decade. commercial interests and policy makers to bring The gap is especially significant when it comes to about the needed macro and business environ- infrastructure fi nance. A 2014 United Nations report ment reforms. on sustainable development financingb estimates 2. They can support the development of local fi nancing needs for infrastructure projects—water, markets and of domestic institutional investors agriculture, telecommunications, power, transport, through technical expertise and by promoting building, industrial, and forestry sectors—at $5– targeted reforms. 7 trillion annually. The Organisation for Economic 3. They can facilitate large investments in areas such Co-operation and Development estimates a global as infrastructure and energy by the following: infrastructure requirement by 2030 on the order of $50 trillion.c a. Supporting project preparation by setting up Multilateral development banks (MDBs) are dedicated project preparation facilities to build uniquely placed to assist developing countries in clos- up a pipeline of bankable investment-ready ing the existing long-term financing gap. In broad projects. These facilities provide the technical terms, MDBs can help identify areas of market failures expertise to ensure that projects are structured or areas where markets are still underdeveloped and in ways that are familiar and appealing to the can provide the necessary incentives to bring in the private sector. private sector. Mobilizing private long-term fi nance b. Providing risk mitigation tools such as guar- requires a different approach than direct fi nancing. antees, risk insurance, and blended fi nance to (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 13 BOX O.3 The Role of Multilateral Development Banks in Mobilizing Long-Term Finance (continued) fi nancially and economically viable projects teen of the world’s largest asset management, that would not likely be undertaken with- pension, and insurance funds, along with sev- out protection against noncommercial risks eral commercial banks, have signed agreements and enabling investors to access funding on to collaborate on the GIF. The governments of more advantageous terms using the MDBs’ Australia, Canada, Japan, and Singapore and preferred creditor status. In some cases, such MDBs including the Asian Development Bank, as syndications, MDBs can provide partners the European Bank for Reconstruction and with creditor status similar to that of official Development, the European Investment Bank, creditors in the event the borrower runs into and the Islamic Development Bank have also payment difficulties. signed collaborative arrangements, signifying c. Setting up co-investment platforms or pooled their willingness to partner with the GIF. The vehicles that help catalyze private capital. A GIF platform aims to integrate the efforts of recent example of such a platform is the Global MDBs, private sector investors and fi nanciers, Infrastructure Fund (GIF) launched at the and governments interested in infrastructure October 2014 Annual Meetings of the World investment in developing countries through its Bank and International Monetary Fund.e Six- pipeline of projects and programs. a. For proposed Sustainable Development Goals, see https://sustainabledevelopment.un.org/topics/sustainable developmentgoals. b. See http://www.un.org/esa/ffd/wp-content/uploads/2014/12/ICESDF.pdf. See also the Development Committee paper: http://siteresources.worldbank.org/DEVCOMMINT/Documentation/23659446/DC2015-0002(E)Financingfor Development.pdf. c. OECD 2013a. d. World Bank Group. 2013. Financing for Development Post-2015. http://www.worldbank.org/content/dam /Worldbank/document/Poverty%20documents/WB-PREM%20fi nancing-for-development-pub-10-11-13web.pdf. e. For more information on the GIF, see http://www.worldbank.org/en/topic/publicprivatepartnerships/brief/global -infrastructure-facility-gif. BOX O.4 Navigating This Report The rest of the report consists of four chapters that Chapter 1 defi nes long-term fi nance and explains cover the importance of long-term finance, some key why we care about the ability of both firms and facts, and general guidelines for the role of govern- households to have access to long-term finance. It ment in promoting long-term fi nance; use of long- discusses market failures and policy distortions that term fi nance by fi rms and households; provision of may lead to the scarcity of long-term finance and long-term fi nance by markets; and bank and non- provides stylized facts on both users and providers bank fi nancial institutions as providers of long-term of such fi nance. It discusses the importance of pro- fi nance. Within these broader topic areas, the report moting long-term fi nance sustainably and the role of focuses on policy-relevant areas where new evidence government in addressing market failures and policy can be provided. distortions. (box continued next page) 14 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX O.4 Navigating This Report (continued) Chapter 2 examines long-term fi nance from the the factors that affect their choices. In addition, the perspective of firms and households. It asks why chapter examines the investment profiles of two other fi rms and households would want to use long-term types of nonbank fi nancial institutions that are also fi nance and explores what impact long-term fi nance expected to have long investment horizons, namely, has on them. The chapter discusses which country sovereign wealth funds and private equity investors. and individual characteristics determine the use The chapter concludes by discussing the potential of long-term finance by firms and households and limitations of these investors in providing long-term examines the impact of the 2008–09 global fi nancial funding in underdeveloped institutional settings and crisis on leverage and debt maturity. It also provides the resulting policy implications from this evidence. policy recommendations based on the latest research The statistical appendix consists of two parts. fi ndings from the empirical literature on the use of Part 1 presents basic country-by-country data on long-term fi nance. fi nancial system characteristics around the world. It Chapter 3 turns to providers and focuses on mar- also presents averages of the same indicators for peer kets, describing the stylized facts and general trends groups of countries, together with summary maps. that characterize corporate bonds, syndicated loans, It is an update on information from the 2014 Global and equity issuances in terms of maturity at issuance Financial Development Report . Part 2 provides and amounts raised through the use of the different additional country-by-country information on key markets. It discusses country and fi rm differences aspects of long-term fi nance around the world. in the use of long-term capital markets and intro- The accompanying website (http://www.world duces the distinction between domestic and interna- bank.org/fi nancialdevelopment) contains a wealth of tional markets. Finally the chapter analyzes how the underlying research, additional evidence including global fi nancial crisis affected the provision of long- country examples, and extensive databases on fi nan- term fi nance by markets and concludes with policy cial development, providing users with interactive recommendations. access to information on financial systems. Users Chapter 4 focuses on bank and nonbank fi nan- can provide feedback on the report, participate in cial intermediaries and analyzes which institutions an online version of the Financial Development are more likely to extend the maturity structure. Barometer, and submit their suggestions for future The chapter explores the role of bank characteris- issues of the report. The website also presents an tics and regulations in shaping banks’ loan maturity updated and expanded version of the Global Finan- structure. It presents evidence on the extent to which cial Development Database, a dataset of more than mutual funds, pension funds, and insurance com- 70 fi nancial system characteristics for 203 econo- panies hold and bid for long-term instruments and on mies since 1960. FOCUS AREA 1: IMPORTANCE and are especially consequential in the mar- OF INFORMATION SHARING FOR ket for long-term finance. The establishment LONG-TERM FINANCE of credit bureaus and collateral registries can Weaknesses in information sharing help ex- improve the quality of information available plain why the use of long-term finance is less to lenders and can significantly improve the common in developing countries. In many availability of credit at all maturities. In ad- circumstances, lenders and investors are dis- dition to its direct effect on the availability couraged from entering into financial con- of credit, high-quality credit information can tracts with long time horizons because the also have positive spillover effects on other absence of adequate credit market informa- types of long-term financing, given that many tion makes it difficult to form a reliable risk types of direct investments are heavily depen- assessment. Such information problems pose dent on leverage and cofinancing through lo- a barrier to financial contracting in general cal credit markets. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 15 A comprehensive review of the evidence FIGURE O.5 Average Loan Maturity in Credit Bureau Reformer and presented in this report suggests that better Nonreformer Countries, 2002–09 information availability and sharing are in- deed important in lengthening debt maturity. 50 Reducing information asymmetries between firms and lenders also reduces lenders’ need ● to monitor and discipline firm managers 40 ● ● ● Loan maturity, months through short-term debt contracts. One il- ● lustration of the role of credit information on 30 ● ● ● ● lengthening debt maturity comes from recent ● research. Martínez Pería and Singh (2014) 20 ● ● investigate the impact of introducing credit information–sharing systems on firm access 10 to finance and debt maturity using firm-level survey data for more than 75,000 firms in 63 0 countries over the period 2002–13. Credit 2002 2003 2004 2005 2006 2007 2009 information schemes disseminate knowledge ● Credit bureau reformers ● Nonreformers of payment history, total debt exposure, and overall credit worthiness, either through a Source: Based on Martínez Pería and Singh 2014. privately held credit bureau (CB) or publicly Note: Credit Bureau (CB) reformer countries include Armenia, Bulgaria, China, Croatia, Czech Republic, Ecuador, Georgia, Kazakhstan, Kenya, Kyrgyz Republic, FYR Macedonia, Moldova, regulated credit registry (CR). The study ex- Montenegro, Nicaragua, Romania, Russian Federation, Rwanda, Serbia, Slovak Republic, amines countries that introduced a CB or CR Slovenia, Uganda, and Ukraine. Data on loan maturity are not available for all countries in all years. CB reformer countries do not have data in 2009. Also, no data are available for 2008. between 2002 and 2009 (the “reformers”) as well as countries that do not have a CB or CR (“nonreformers”). Figure O.5 displays reasons explain this lack of a significant ef- average loan maturity in CB reformers and fect. First, CRs are often used for supervisory nonreformers over time. Most countries that purposes and hence might have high mini- introduced a CB did so in 2004 or 2005, and mum loan limits. Second, they might not pro- the data show a steep increase in average loan vide positive and negative information, which maturity in CB reformer countries afterward. is most useful to financial institutions. Third, To estimate the size of the effects of CB to the extent that they are run by the govern- reforms on firm financing and loan matu- ment, in countries with bad bureaucracies rity, Martínez Pería and Singh compare firms CRs might not function effectively and there- in countries that introduced a CB or CR to fore might not be used often. firms in countries that did not. The results re- veal that, after the introduction of a CB, the FOCUS AREA 2: ROLE OF likelihood that a firm has access to finance CONTRACT ENFORCEMENT increases and loan maturity lengthens. The AND PROTECTION OF INVESTOR effects of CB reforms are more pronounced RIGHTS the greater the coverage of the reforms and the scope and accessibility of the credit in- A weak contractual environment is an impor- formation sharing scheme. Credit bureau tant reason why long-term finance is less com- reforms also have a greater impact on firms’ mon in developing countries. When lenders access to finance in countries where contract and investors cannot rely on legal institutions enforcement is weaker. Importantly, results to enforce their claims, they prefer short-term also indicate that CB reform effects are more contracts so that the continued need for re- pronounced for smaller, less experienced, and negotiation provides borrowers with the right more opaque firms. incentives to exert effort and make sound in- Interestingly, the analysis finds no robust vestments. Legal institutions that help inves- effect of CR reforms on firm financing. Three tors protect their claims include creditor and 16 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 investor rights, bankruptcy laws, firm corpo- and the use of long-term debt is causal. An rate governance frameworks, and overall con- Indian case study uses the establishment of tract enforcement and efficiency of the legal new specialized courts, debt recovery tribu- system. nals (DRTs), which improved contract en- Research reviewed in this report shows forcement in India, to study the impact of firms tend to use more long-term financing this reform on firms’ use of long-term finance. where the legal system is more efficient and Gopalan, Mukherjee, and Singh (2014), us- the contracting environment better developed. ing the variation in DRT establishment across Indeed, the development of the financial sys- states and time and balance sheet data on tem beyond that predicted by the quality of the about 6,000 Indian firms, showed that DRTs contracting environment is not significantly led to a significant increase in the ratio of related to the ability of firms to obtain exter- long-term debt to total assets. Within three nal finance (Demirgüç-Kunt and Maksimovic years of implementation of a DRT, that ratio 1998, 1999). Recent research using a dataset increased by about 8 percent, whereas short- that covers more than 800,000 publicly listed term debt decreased by a similar amount, and privately held firms from 80 countries suggesting that firms were able to substitute confirms these results; a sound legal environ- long-term debt for short-term debt with more ment and enforcement of contracts are posi- efficient contract enforcement. tively associated with the use of long-term debt Policies and regulations that improve the (Demirgüç-Kunt, Martínez Pería, and Tressel quality of firm corporate governance and that 2015b). Importantly, legal efficiency and bet- strengthen investor protection can also sup- ter contract enforcement tend to dispropor- port the development of markets for long- tionately foster the use of long-term debt by term finance. New research examines whether privately held firms relative to publicly listed better corporate governance at the firm level firms, and by SMEs relative to large firms. can provide an alternative way of monitoring Recent evidence suggests that the positive managers and hence reduce the firm’s reliance relationship between contract enforcement on short-term debt in dealing with agency problems. Anginer and others (2015) investi- FIGURE O.6 Firm Corporate Governance and Use of Short-Term gated 44 different elements of corporate gov- Debt, 2003–08 ernance for over 7,000 firms in 22 countries over the period 2003–08. They saw that firms 0.6 with strong corporate governance, particu- larly with independent boards with effective 0.5 ● Japan size, tend to use less short-term debt (figure Ratio of short-term debt to total debt ● Greece O.6). They also confirmed their cross-country 0.4 Spain ● Finland results by examining changes around substan- ● Belguim France● ● ●Singapore ●Switzerland tial corporate governance reforms imple- Sweden● ● Germany ● Hong Kong SAR, China ●Italy mented over the sample period that strengthen ● Austria United States 0.3 ● Denmark ●●United Kingdom ● Portugal ● Norway ● Netherlands shareholder rights. The results indicate a sig- ● Australia nificant increase in the effect of governance in New Zealand● 0.2 ● Ireland ● Canada reducing the use of short-term debt after the implementation of reforms. 0.1 FOCUS AREA 3: ROLE OF 0 FINANCIAL LITERACY FOR 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 HOUSEHOLD USE OF Governance index LONG-TERM FINANCE Source: Based on Anginer and others 2015. Lack of financial awareness, financial literacy, Note: The figure shows the average firm governance index values and short-term debt (ratio of debt due in one year to total debt). The governance index averages across multiple governance and product transparency constrain house- attributes, with higher values indicating better governance. holds from using financial products or from GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 17 managing them correctly. A comprehensive FIGURE O.7 Effects of Financial Education on Long-Term review of evidence in this report shows that Borrowing lack of understanding of financial products by individuals can lead to costly mistakes. Empirical evidence shows that vulnerable 16.2 consumers can be sold financial instruments that they do not understand and that they 12.1 are unable to service. A key contributing fac- tor to the subprime mortgage crisis in the 0 2 4 6 8 10 12 14 16 18 United States was the overextension of credit Length of loans, months to noncreditworthy borrowers and the relax- Treatment group Control group ation in mortgage-underwriting standards. Recent literature on psychology and finance Source: Based on Berg and Zia 2013. Note: The figure shows the increase in loan maturity in control and treatment groups after an also highlights the role of behavioral biases in entertainment education intervention using the soap opera “Scandal!” in South Africa. shaping households’ financial decisions. On the one hand, people tend to underestimate the future value of their savings given their to watch the soap opera. Moreover, as figure present value, maturity, and rate of return. O.7 shows, while individuals in the treatment On the other hand, borrowers underestimate group did not alter the amount of money bor- the interest rate of a loan given a principal, rowed, they borrowed significantly more from monthly payment, and maturity. These biases formal sources and through longer-term debt are strongly correlated with more borrowing, compared with the control group. These re- less saving, and a preference for short-term in- sults suggest that entertainment media can be stallment debt and short-term assets, even af- an effective tool for influencing key financial ter conditioning on various demographic and decisions and can have lasting implications for income factors. As the World Development long-term financial well-being. Report 2015 highlights, understanding these One reason why Berg and Zia found this behavioral biases and how they influence fi- financial literacy intervention to be effective nancial choices allows for better tailored and while so many other interventions reviewed more effective policies, such as financial edu- in this report have failed may be because they cation interventions, automatic enrollment used an innovative way to reach their audi- systems, or electronic reminders. ence. Evaluations consistently agree that fi- Even though financial education matters, nancial concepts are best taught at what are evidence shows that delivering it effectively known as “teachable moments.” Interven- is challenging. Growing research efforts that tions covering multiple topics tend to perform randomize the provision of financial educa- poorly. Instead, interventions that focus on tion are increasing the ability to identify the concrete concepts and targeted groups are most effective mechanisms for improving and found to do better. For instance, workshops delivering financial education. In one recent about retirement plans targeted to workers example, Berg and Zia (2013) evaluated the when they are deciding on their pension plan effectiveness of financial education through a may effectively help them in making informed popular television soap opera in South Africa, decisions. “Scandal!” The intervention entailed a two- Alternative interventions, such as default month-long storyline featuring a main char- enrollment, or reminders of payments, can be acter who borrowed excessively through shop effective measures to prevent behavioral biases credit and gambling, fell into a debt trap, and that lead households to make financial errors. eventually sought help to find her way out. Default enrollment, for instance, can reduce The analysis focused on borrowing and gam- behavioral problems such as overborrowing bling outcomes and found a significant shift to- or undersaving. Research reviewed in this ward more formal and longer-term borrowing report suggests that the simple action of en- for the treatment group that was encouraged rolling by default workers into pension plans 18 OVERVIEW GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 more than doubles long-term savings through electronic trading systems, privatization pro- pension participation. Given the significant grams, and institutional reforms. The authors size of these effects with default enrollment, found that these government interventions even high-income countries such as the United are associated with significant increases in do- States have facilitated the automatic enroll- mestic stock market capitalization and trad- ment of workers into pension plans. ing volumes. The government can also directly facilitate the development of domestic corporate bond FOCUS AREA 4: CHALLENGES markets by developing the market for sover- OF EXTENDING MATURITY eign debt. In particular, sound sovereign debt STRUCTURE BY PROMOTING management with regular issues of bench- DEVELOPMENT OF DOMESTIC mark bonds at different maturities is central MARKETS AND INSTITUTIONAL to building a yield curve, which is necessary INVESTORS to price corporate bonds efficiently (especially While in theory well-functioning local capi- in the longer term). However, the possibility tal markets could promote long-term finance, of crowding-out effects between government in practice government-led reform efforts to and corporate bond markets through compe- develop them have had mixed success. Local tition for investors’ funds must be taken into capital markets offer benefits to borrowers account. and investors, including governments. They Even in the absence of institutional, legal, facilitate better risk sharing and a more effi- and technological barriers, local markets in cient allocation of capital. Importantly, devel- many emerging economies often lack the opment of local bond and equity markets can critical mass of investors needed for effec- improve the availability of long-term financing tive development. Governments can promote for households and firms as well as govern- development in those cases by opening up to ments. These markets can also increase finan- foreign investors, although potential risks of cial integration by attracting foreign capital, financial integration include greater volatil- which can improve access, lower the cost of ity and vulnerability to international shocks capital, and facilitate risk sharing across coun- and must be carefully considered. Neverthe- tries. Hence by broadening access to long-term less, some economies will simply lack the scale finance beyond a small group of large firms necessary to support a deep local capital mar- and by reducing the reliance of those large ket. They may be better served by promoting firms on international markets, developing foreign listings and regional exchanges rather countries could further develop their domes- than trying to develop shallow, inefficient tic markets by addressing market failures and markets at home. policy shortcomings. However, while capital Promoting long-term finance through de- markets expanded in many countries in the velopment of local institutional investors can recent decade, many developing countries saw also be challenging. One popular policy rec- their markets stagnate despite well-intended ommendation to promote local markets is government interventions (Laeven 2014). through development of institutional inves- Governments can facilitate the develop- tors such as local pension funds. For example, ment of capital markets through sound mac- Chile’s launch of a funded pension system in roeconomic policies, strong institutional and 1981 contributed to its local bond market legal settings, and a well-functioning finan- development, making it one of the most de- cial infrastructure. De la Torre, Gozzi, and veloped in Latin America over the next two Schmukler (2007), for example, studied the decades. However, the Chilean case also il- impact of a set of reforms on stock market lustrates that expanding large institutional development in emerging markets, namely, investors does not necessarily imply more de- stock market liberalization, enforcement of veloped long-term markets. Recent research insider trading laws, and the introduction of by Opazo, Raddatz, and Schmukler (2015) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 OVERVIEW 19 analyzed unique data on the actual portfo- FIGURE O.8 Maturity Structure of Chilean Institutional Investors lios and bids of the universe of domestic in- stitutional investors in Chile. The researchers 100 found that despite favorable institutional con- 90 Cumulative share of total portfolio, % ditions in Chile, asset managers (mutual and 80 pension funds) are significantly tilted toward 70 the short-term end of the country’s maturity 60 structure, with a large portion of their port- 50 folio in assets with maturities less than one 40 year. In contrast, insurance companies invest 30 much more long term, providing clues into 20 what may be behind these differences (figure 10 O.8). 0 The shorter investment horizon of Chilean 0 1 2 3 4 5 6 7 8 9 10 mutual and pension funds compared with Years to maturity insurance companies seems to result from Insurance companies Domestic mutual funds agency factors that tilt the managerial incen- Pension fund administrators tives. In the case of Chilean open-end funds, like mutual and pension funds, managers are Source: Opazo, Raddatz, and Schmukler 2015. monitored in the short run by the underlying investors, the regulators, and the asset manage- ment companies. This short-run monitoring, have a long-run horizon to avoid some of combined with the risk profile of the available the short-termism that has been observed in instruments, generates incentives for managers the case of Chile. In addition, restrictions on to be averse to investments that are profitable portfolio allocations that limit the long-term at long horizons (like longer-term bonds) but instruments funds can invest in should also be that can have poor short-term performance. In removed. contrast, insurance companies are not open- The difficulties of developing local capital end asset managers, receive assets that cannot markets and institutional investors that invest be withdrawn in the short run, and have long- in long-term assets suggest that there are no term liabilities because investors acquire a de- quick fixes. Development of markets is a very fined benefit plan when purchasing a policy. gradual and interactive process that depends Thus, insurance companies are not subject to on the country’s size and stage of develop- the same kind of short-run monitoring. ment and that requires significant reform ef- The regulatory scheme seems to be another forts to improve underlying institutions. In factor behind the short-term nature of pen- an increasingly globalized world, not every sion funds. The Chilean regulation establishes country will need or be able to develop a local a lower threshold of returns over the previous capital market at home. 36 months that each pension fund needs to guarantee. This type of short-term monitor- NOTES ing seems to push managers to move their in- vestments into portfolios that try to minimize 1. World Bank 2014; World Bank 2013c. For fur- ther work in this area, see http://www.g20.org the probability of triggering the guarantee. /news/20130228/781245645.html. Moreover, as this threshold depends on the 2. A diagnostic framework was subsequently average return of the market, it may gener- prepared by the International Monetary ate herding incentives and suboptimal portfo- Fund, the World Bank, the European Bank lio allocations. Hence, governments need to for Reconstruction and Development, and the ensure that compensation and benchmarking Organisation for Economic Co-operation and practices followed by institutional investors Development (IMF 2013b). CHAPTER 1: KEY MESSAGES • 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. Long- term fi nance reduces fi rms’ exposure to rollover risks, enabling them to undertake longer- term fi xed investments, contributing to economic growth and welfare. Access to long-term financial instruments allows households to smooth income over their life cycle—by investing in housing or education, for example—and to benefit from higher long-term returns on their • Financial systems are multidimensional. Four characteristics are of particular interest savings. for benchmarking financial systems: financial depth, access, efficiency, and stability. These • Firm andcharacteristics household data need to be show measured limited for use of financial institutions long-term and markets. fi nance in developing countries, particularly among poorer households and smaller firms. As financial systems develop, the • Financial systems come in all shapes and sizes, and differ widely in terms of the four maturity of external finance lengthens. Banks are the main providers of long-term fi nance characteristics. As economies develop, services provided by financial markets tend to and the share of their lending that is long term increases with countries’ income. As coun- become more important than those provided by banks. tries’ income grows, economies have more developed capital markets and institutional inves- • The tors thatglobal financial can support crisis was long-term not only about financial instability. In some economies, finance. the crisis was associated with important changes in financial depth and access. • The use of long-term finance reflects both the demand for and supply of contracts with long- term maturities and reveals the allocation of risk between users and providers. Greater use of long-term fi nance implies that lenders are exposed to greater risk relative to borrowers. Optimal risk sharing between borrowers and lenders may lead to different equilibrium levels of use of long-term finance for different borrowers and lenders, and in different countries and at different points in time. • Governments have a role to play in promoting long-term fi nance when it is undersupplied because of market failures and policy distortions. The government can promote long-term fi nance without introducing distortions by pursuing policies that foster macroeconomic stability, low inflation, and viable investment opportunities; promoting a contestable bank- ing system with healthy entry and exit and supported with strong regulation and super- vision; putting in place a legal and contractual environment that adequately protects the rights of creditors and borrowers; fostering financial infrastructures that limit information asymmetries; and promoting the development of capital markets and institutional investors. In contrast, efforts to promote long-term fi nance through directed credit, subsidies, and government-owned banks have not been successful in general because of political capture and poor corporate governance practices. CONCEPTUAL FRAMEWORK, STYLIZED FACTS, AND THE ROLE OF THE GOVERNMENT 1 Conceptual Framework, Stylized Facts, and the Role of the Government A developed financial sector should offer a wide range of maturities to meet the varying needs of different borrowers. Depend- The rollover risk is the risk that credit lines are canceled or modified at short notice, and the interest rate risk is the risk that interest rates ing on the circumstances, borrowers might are changed at short notice. These risks gen- prefer long-term debt contracts, and provid- erate economic costs because the mismatch ers will find it to their advantage to offer such between the time horizon of financing and contracts. This chapter begins by laying out the time horizon of investment projects can a conceptual framework for understanding force the premature liquidation of long-term when firms and households find it beneficial projects, which is socially inefficient. This mis- to use long-term finance, when short-term match can also discourage profitable invest- debt will be preferred, and when and why ments with a longer time horizon from being long-term finance might be scarce and gov- undertaken in the first place. Moreover, the ernment action might be required. Next, the academic literature has argued that “short- chapter presents basic stylized facts about the termism” can explain several well-known users and intermediaries of long-term finance, financial crises in both developing and devel- across developing and high-income countries, oped countries (Eichengreen and Hausmann as a preview for the discussion and analysis 1999; Rodrik and Velasco 2000; Tirole 2003; in the rest of the report. Finally, the chapter Borensztein and others 2005; Alfaro and discusses in very broad terms the role of the Kanczuk 2009; Brunnermeier 2009; Jeanne government in promoting long-term finance. 2009; Raddatz 2010; Broner, Lorenzoni, and Schmukler 2013). Households might prefer long-term finance A CONCEPTUAL FRAMEWORK because it can raise their welfare by allowing FOR UNDERSTANDING THE USE them to smooth their consumption over time OF LONG-TERM FINANCE and by facilitating lumpy investments such Users—firms, households, and governments— as housing. The fact that long-term finance might prefer long-term debt because it allows can facilitate access to housing is important them to reduce rollover and interest rate risks. because, as an asset, housing can have large GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 21 22 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 effects on consumption through wealth ef- to interrupt them than short-term invest- fects (that is, increases in value that raise ments. That, in turn, amplifies volatility and household wealth); these kinds of wealth ef- lowers economic growth. Tighter credit for fects have been found to exceed those of stock long-term investment therefore leads to both ownership (Case, Quigley, and Shiller 2013). higher aggregate volatility and lower mean Home ownership also provides households growth for a given total investment rate, a with collateral that can help alleviate borrow- prediction consistent with cross-country evi- ing constraints and facilitate consumption dence (Aghion, Howitt, and Mayer 2005). risk sharing (Lustig and Van Nieuwerburgh Long-term finance is also critical for infra- 2004). Finally, home equity provides collat- structure projects, which by nature take many eral to finance consumption, with potential years to complete and require lumpy invest- aggregate effects on demand and the likeli- ments. In turn, infrastructure development hood of starting a small business, and can has been found to have positive and signifi- also foster self-employment (Adelino, Schoar, cant impact on long-run growth and to lessen and Severino 2013). income inequality (box 1.1). On the savings side, investing long term Long-term finance can be defined in many allows households to address life-cycle chal- different ways. One common definition con- lenges and to ensure that the financial benefits siders it to be any source of funding with of economic growth are shared within the maturity exceeding one year. This definition society. Households require long-term finan- corresponds to the definition of fixed invest- cial vehicles to insure against the challenges ment in national accounts. The Group of 20, of retirement, education needs, health shocks, by comparison, uses a maturity of five years premature death, or longevity risks, and more (G-20 2013). Depending on data availability, generally to smooth consumption over time. the report uses one of these two definitions to Moreover, a financial system’s capacity to characterize the extent of long-term finance. spread risk effectively across time and agents Moreover, because there is no consensus on is crucial to viable funded pension, education, the precise definition of long-term finance, and health systems. wherever possible, rather than use a specific Long-term financing is also important for definition of long-term finance, the report firms because it allows them to undertake provides granular data showing as many ma- lumpy and large investments that might be turity buckets and comparisons as possible. critical for their growth. In the absence of Long-term finance encompasses many in- long-term financing, firms might have to rely struments and intermediaries. Bank loans on short-term debt, and their inability to roll and bond markets are typically discussed in over short-term debt might cause a firm to the literature. To some extent, equity (public exit or to curtail profitable long-term invest- or private) can be considered a form of long- ments with consequences for their growth po- term financing, since it is a financial instru- tential (Almeida and others 2011). ment with no final repayment date. For the economy as a whole, long-term The benefits of long-term finance can ac- finance contributes to higher growth by low- crue not only to borrowers but also to pro- ering macroeconomic volatility. Because long- viders (savers in the economy) and financial term investments take longer to complete, intermediaries (banks and institutional inves- they have a relatively less procyclical return tors). Savers might engage in long-term finan- but also face a higher liquidity risk. Under cial contracts because returns are higher than complete financial markets, long-term invest- short-term contracts and because the maturity ments are countercyclical because their op- of these contracts might match their long- portunity costs are lower during recessions term saving needs. Although different finan- (the return on short-term investments is cor- cial intermediaries differ in the composition related with the cycle). But when firms face of their funding structure, some might find rollover risks, fixed investments turn procy- it profitable to engage in long-term contracts clical because funding shocks are more likely for similar reasons as savers do. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 23 BOX 1.1 The Role of Infrastructure in Economic Development A vast theoretical and empirical literature, recently and using cross-country panel data sets, studies such summarized by Calderón and Servén (2014), under- as Canning (1999), Calderón and Servén (2004), and scores the importance of infrastructure for economic Calderón, Moral-Benito, and Servén (2015) report development. In particular, one strand focuses on the a significant GDP (or productivity) contribution of contribution of infrastructure to the level or growth infrastructure. rate of aggregate output or productivity. The out- In addition to its impact on aggregate income, put impact of infrastructure is typically modeled by infrastructure can also have an impact on income including either the stock of infrastructure assets inequality. In particular, infrastructure development or the flow of infrastructure services as an input in may have a differential effect on the incomes of the the economy’s aggregate production function and poor, over and above its impact on aggregate income, by assuming that infrastructure is a complement to by facilitating the poor’s access to productive oppor- noninfrastructure inputs such as labor and noninfra- tunities and by raising the value of their assets. It can structure capital (Arrow and Kurz 1970). also improve their health and education outcomes, In such a setting, an increase in the volume of thus enhancing their human capital. Empirically, a infrastructure services raises output not only directly number of studies that have examined the inequal- but also indirectly, by “crowding in” other inputs ity impact of infrastructure at the aggregate level, owing to the accompanying rise in their marginal by regressing Gini coefficients and similar inequal- productivity. However, in an endogenous growth ity measures on indicators of infrastructure develop- model setting, such as Barro (1990), the increasing ment in a cross-country panel data setting fi nd that, taxation to fi nance public infrastructure beyond a all else equal, income inequality is negatively related certain optimal level can crowd out the use of other to their respective measures of infrastructure devel- inputs, which can offset the crowding-in effect from opment (Calderón and Chong 2004; Calderón and productivity. The welfare-maximizing level of pro- Servén 2004, 2010a, 2010b; López 2004). ductive expenditure, which maximizes the economy’s Because infrastructure can both raise income growth rate, is achieved when the share of produc- levels and reduce income inequality, its development tive government expenditure in the gross domestic has the potential to offer a powerful tool for reduc- product (GDP) equals the elasticity of aggregate out- ing poverty and boosting shared prosperity. For this put with respect to the same variable—what is often reason, infrastructure development has become a pri- called the Barro rule. ority for the World Bank. To support infrastructure Beyond its potential role as another input in projects, the World Bank has partnered with some the production function, infrastructure may also of the world’s largest asset management and private enter the production function as a determinant of equity fi rms, pension and insurance funds, commer- aggregate total factor productivity. For example, cial banks, multinational development institutions, Bougheas, Demetriades, and Mamuneas (2000) and donor nations to set up the Global Infrastruc- and Agénor (2013) argue that transport and tele- ture Facility (GIF). Launched in October 2014, GIF communications services facilitate innovation and is envisioned as a global open platform that will technological upgrading, which in turn raise output facilitate the preparation and structuring of complex growth, by reducing the fi xed cost of producing new infrastructure public-private partnerships to mobi- varieties of intermediate inputs. Another strand of lize private sector and institutional investor capital. the literature highlights the role of infrastructure in While many development finance institutions and the accumulation of other inputs. For example, bet- other entities (private and public) already provide ter transport networks may reduce installation costs similar support to projects, this support is often frag- of new capital (Turnovsky 1996). Similarly, better mented, with coordination largely dependent upon access to electricity may raise educational attainment coincidental relationships. The aim of the GIF is to and reduce the cost of human capital accumulation, coordinate preparation and structuring support more also fostering growth (Agénor 2011). systematically and to provide resources to fi ll gaps, Empirically, many studies have demonstrated that ensuring a high-quality, comprehensive approach infrastructure matters for output and productivity and early consideration of fi nancing options with the growth (Calderón and Servén 2014). For example, potential to attract a wider range of investors. More employing physical measures of infrastructure assets time is needed to evaluate this novel initiative. 24 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Providers of financing may at times pre- event of default, along with other changing fer short-term contracts to guard against conditions in financial markets, such as inter- moral hazard and agency problems in lend- est rate risk. Naturally, providers require a ing. Financing contracts with a short matu- premium as part of the compensation for the rity improve the lender’s ability to monitor higher risk this type of financing implies, the borrowers through the implicit threat of re- size of which depends on the degree of their stricted access to credit in the future in case of risk appetite. In contrast, short-term finance default (Rajan 1992; Rey and Stiglitz 1993; shifts risk to users because it forces them to Diamond and Rajan 2001). In particular, be- roll over financing constantly. cause debtors need to roll over their financing Therefore, long-term finance may not al- when debt is short term, creditors are able to ways be optimal for the economy as a whole. cut financing if debtors are not taking actions Providers and users will decide how they that maximize the repayment probability of share the risk involved in financing at dif- the financing obtained. Equity might miti- ferent maturities, depending on their needs. gate some of the monitoring issues that lead What matters for the economic efficiency of to short-term financing because shareholders the financing arrangements is that borrow- and, in particular, private equity investors can ers have access to financial instruments that control the management of an investee firm allow them to match the time horizons of more directly than a financial institution can. their investment opportunities with the time Users might also prefer short-term fi- horizons of their financing, conditional on nance in some instances. Firms tend to match economic risks and volatility in the economy the maturity of their assets and liabilities; (for which long-term financing may provide hence, the faster the returns to investment a partial insurance mechanism). At the same are realized, the shorter the optimal payment time, savers would need to be compensated structure will be (Hart and Moore 1995). for the extra risk they might take. For this Thus, long-term loans are usually used to reason, it is still important to understand acquire fixed assets, equipment, and the like. where different economies stand in the al- Short-term loans, on the other hand, tend to location of short- and long-term finance, be used for working capital, such as payroll, because each one has its pros and cons that inventory, and seasonal imbalances. In addi- imply different responses from policy makers tion, a firm or a household that anticipates (box 1.2). improvements in its financial situation might Because of information asymmetries and prefer short-term financing rather than being other market failures, the amount contracted locked in a longer contract that might not in equilibrium could be lower than desired reflect the medium- or long-term prospects. in situations when both users and provid- For example, research suggests that firms ers of finance would ideally prefer long-term with high credit ratings might prefer short- finance contracts. Because extending long- term debt because it allows them to refinance term finance implies large risks for providers, the terms of their debt when good news ar- the same rationale provided by Stiglitz and rives (Diamond 1991). Households and firms Weiss (1981) showing rationing in credit mar- might also prefer short-term contracts if the kets could be applied. In particular, informa- payoffs from available investment projects tion asymmetries could prevent the creditor have a similarly short-term horizon or if the from knowing the true repayment capacity cost of long-term finance is too high. and willingness to pay of the borrower, thus In essence, the use of long-term finance can making the creditor reluctant to agree to the be better understood as a risk-sharing prob- amount of long-term finance requested. lem between providers and users of finance. Coordination problems are another form Long-term finance shifts risk to the providers of market failure that can shorten debt matu- because they have to bear the fluctuations in rity. When the seniority of claims is not well the probability of default and the loss in the enforced and lenders cannot coordinate their GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 25 BOX 1.2 A Conceptual Framework for Understanding the Use of Long-Term Finance The use of long-term fi nance is an equilibrium out- failures and policy distortions can affect the interplay come that reflects both the demand and supply of between the demand and supply of long-term finance. financial contracts with longer-term maturities. It Hence, depending on the situation, short-term finance involves a trade-off in how risk is allocated between may be preferred, or long-term fi nance may be pre- users and providers or their intermediaries. Market ferred, and may be either supplied or scarce. • Users of long-term finance may prefer short-term debt because they anticipate NOT that their fi nancial situation will improve PREFERRED and that they will be able to negotiate better fi nancing conditions in the future. LONG-TERM FINANCE • Users want to fi nance long-term projects and to avoid rollover risks. • Providers or intermediaries have long- PREFERRED SUPPLIED term liabilities and want to match the maturity of their assets and liabilities, or they might want to obtain higher risk- adjusted returns. • Market failures (asymmetric informa- tion, moral hazard, coordination failures) limit the amount of long-term finance contracted in equilibrium, despite users’ preference for longer-term debt. SCARCE • The government has a role to play in help- ing to address market failures and must avoid policy distortions (high infl ation, macroeconomic volatility, and a deficient institutional and contractual environ- ment) that limit long-term fi nance. actions, they will protect themselves against Incentive problems can also give rise to dilution by simultaneously shortening the short-term bias in financing contracts. Even maturity of their claims (Bolton and Jeanne in economies with a well-developed finan- 2009; Brunnermeier and Oehmke 2013). This cial sector, the institutional and managerial situation may trigger a “maturity rat race” in incentives of financial intermediaries may which lenders shorten the maturity of con- lead to an undersupply of long-term financ- tracts to protect their claims and shorten the ing. Opazo, Raddatz, and Schmukler (2015) average maturity of debt contracts available looked at the universe of institutional in- in equilibrium. vestors in Chile and found that mutual and 26 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 pension funds, which manage the long-term Firms assets of individuals and are thus expected to have a fairly long investment horizon, in- Early literature on corporate debt structures, vest predominantly in short-term assets. This using data from the 1980s and 1990s, has preference for short-term investment appears documented that corporate debt is of shorter to be driven not by supply-side factors or a maturity in developing countries than in de- lack of availability of long-term instruments, veloped economies (Demirgüç-Kunt and but rather by the practice of evaluating fund Maksimovic 1999; Booth and others 2001). managers against short-term performance tar- Moreover, in developing countries, firms have gets. This finding underscores that financial lower leverage (defined as the ratio of total market development and the expansion of debt to total assets). To the extent that exter- institutional investors alone are not sufficient nal equity is more difficult to raise than debt for the development of long-term markets. finance, this finding indicates a more gen- eral reduced reliance on external long-term finance in developing economies to finance SOME STYLIZED FACTS ABOUT investment. THE USERS AND PROVIDERS OF More recent research confirms the differ- LONG-TERM FINANCE ences in corporate debt maturity structures The use and availability of long-term finance across countries at different levels of eco- can be analyzed by looking at data from the nomic development and across firms of differ- point of view of the users, intermediaries, and ent sizes. In particular, Demirgüç-Kunt, Mar- the markets where transactions occur. Firms tínez Pería, and Tressel (2015a) show that the and households are the main private sector median share of long-term debt (that is, debt users of long-term finance.1 Banks and insti- of remaining maturity greater than a year) to tutional investors such as mutual funds, pen- total debt is smaller in developing countries sion funds, insurance companies, and private than in high-income economies across all firm equity investors are the main intermediaries. size groups (figure 1.1).2 The authors based Corporate bond and equity markets are also their findings on data for the period 2004–11 key in understanding the use of long-term fi- from ORBIS, a commercial dataset produced nance, as is syndicated lending (box 1.3). by Bureau van Dijk. BOX 1.3 Intermediaries and Markets for Long-Term Finance Various domestic and foreign institutions and mar- create long-term claims while providing liquid kets may have a role to play in the provision of long- fi nancial instruments to savers subject to idiosyn- term finance. The following taxonomy builds on cratic needs. Banks have a comparative advantage earlier World Bank work, including regional reports in monitoring productive projects and can be sig- on Latin America and the Caribbean (de la Torre, nificantly leveraged, thus transforming the maturity Ize, and Schmukler 2012), Africa (Beck and others of fi nancial claims to allow the fi nancing of illiquid 2011), and the Middle East and North Africa (World investments (Diamond 1984). However, banks that Bank 2011). become too dependent on short-term liabilities may shorten the maturity of their loan portfolio to reduce Commercial banks and nonbank intermediaries. the rollover risk (Paligovora and Santos 2014). Commercial banks can play a key role in providing long-term fi nance to the real economy. By pooling Bond markets. Corporate bond markets offer an savings, banks assume a maturity mismatch and alternative to bank fi nancing and could be particu- (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 27 BOX 1.3 Intermediaries and Markets for Long-Term Finance (continued) larly useful for large fi rms, for large fi nancing needs fi nance, in many developing economies. Following that exceed the capacity of the banking system, or the financial crisis, the recovery of private fund- where asymmetries of information and agency prob- raising momentum was particularly strong in Sub- lems are mitigated in stronger institutional environ- Saharan Africa and Latin America. ments. A developed bond market may also enhance the efficiency of bank financing by allowing securiti- International capital markets. When domestic sav- zation or by matching the longer-term assets to their ings are not sufficient, individual countries turn to liabilities and by enhancing competition. international capital markets for long-term fi nance. Foreign direct investments, bank loans, and portfolio Stock markets. The presence of a developed and liq- investments have flowed from advanced economies, uid stock market develops and aggregates informa- where long-term fi nance is more abundant, to devel- tion through stock prices and underwriting, broker- oping countries, where higher returns can be gained age, and other activities and is associated with higher when appropriate institutional and policy environ- borrowing capacity for fi rms (Demirgüç-Kunt and ments are in place. In particular, private equity funds Maksimovic 1998). More generally, securities mar- in advanced economies are increasingly investing in kets allow a more efficient allocation of resources and emerging markets. International syndicated loans for contribute to market discipline through price signals, project fi nancing have been dominated by advanced information production, and takeover activities. economies’ banks—in particular, those from Euro- pean countries. Emerging markets and other devel- Institutional investors. Life insurance companies, oping countries have for many decades borrowed pension funds, endowments funds (such as sovereign from banks in advanced economies or through for- wealth funds), and mutual funds are, in principle, eign currency international bond markets. The pres- suitable providers and intermediaries of long-term ence of foreign investors in domestic capital markets funding to the financial system. Long investment has increased, but evidence is scant on their impact horizons, particularly for pension funds, sovereign on the maturity of claims, while the recent crisis has wealth funds, and insurance companies, may allow heightened the traditional trade-off between access these investors to take advantage of long-term risk to lower fi nancing costs and the risks from external and illiquidity premiums, and, relative to banks, they factors, causing volatility in the availability of for- are less vulnerable to liquidity runs. Some institu- eign long-term fi nance. tional investors are subject to short-run performance metrics, however, which might bias their holdings State-owned financial intermediaries. The debate toward the short term. on the rationale for state intervention in the fi nan- cial sector usually centers on market failures and Hedge funds, venture capital funds, and private externalities (World Bank 2013a). Direct state par- equity funds. High-risk, low-liquidity funds aim at ticipation is warranted to compensate for market the next stage of wealth and sophistication. They are imperfections that leave socially profitable long-term starting to appear in the deepest emerging markets, investments underfinanced. State-owned financial such as Brazil, with an often dominant participation institutions, particularly development banks, have of offshore funds. These types of funds are only very returned to the spotlight of the public debate in lightly regulated. How much they invest in long- recent years, partly in response to their role during term assets remains difficult to ascertain, given the the global fi nancial crisis. Concerned about the lack dearth of data. Their volumes and performance may of notable progress in increasing access to long-term be particularly sensitive to various country risks and finance, policy makers are discussing the efficacy governance arrangements, given their often high illi- of development banks, despite the well-recognized quidity and the idiosyncratic specificities of the proj- misallocation and efficiency losses stemming from ects fi nanced. Private equity has become a growing weak governance and politically motivated lending part of the fi nancial sector, especially for long-term in underdeveloped institutional environments. 28 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 1.1 Ratio of Firms’ Median Long-Term Debt to Total Debt exception. Bank finance accounts for 42 per- by Country Income Group and Firm Size, 2004–11 cent of financing for fixed investment for these firms; informal sources and family members, 30 which account for 24 percent of external fi- 24.3 nancing for fixed investments, make up a Long-term debt to total debt, % 25 21.6 20.4 20.1 large part of the difference. 20 16.6 15 12.7 Households 10 Housing finance is arguably the most im- portant type of long-term financing used by 5 households. A house is the largest asset most 0 individuals will acquire during their lifetime. All firms Large firms Small and medium firms Mortgage loans allow households to spread High-income countries Developing countries the cost of the purchase over many years while enjoying the immediate benefit of hav- Source: Demirgüç-Kunt, Martínez Pería, Tressel 2015a. ing housing. Mortgage market development varies sig- nificantly across countries. Mortgage depth is Banks are the main source of external fi- defined as the outstanding mortgage debt rel- nancing for fixed investments, which tend ative to gross domestic product (GDP). Badev to be long term. Data from the World Bank and others (2014) find that while mortgage Enterprise Surveys conducted between 2006 depth averages close to 40 percent of GDP and 2014 show that on average firms finance in high-income countries, it averages only 50 percent or more of their investments with 7 percent in upper-middle-income countries bank loans (figure 1.2). Small firms in lower- and 3 percent in lower-middle- and low- middle- and low-income countries are the income countries (figure 1.3). The figures for FIGURE 1.2 Sources of External Financing for Fixed Asset Investment by Country Income Group and Firm Size, 2006–14 100 11.9 13.4 11.6 10.0 8.2 11.7 90 15.3 16.8 10.9 23.7 External financing to total financing, % 9.0 10.2 14.4 13.4 12.6 80 9.8 13.4 15.3 70 16.3 9.9 10.3 13.3 15.8 16.0 18.7 60 16.0 50 15.4 40 62.8 66.5 67.4 65.4 30 61.6 58.2 60.6 51.9 20 42.3 10 0 Small firms Medium Large firms Small firms Medium Large firms Small firms Medium Large firms (<20) firms (100+) (<20) firms (100+) (<20) firms (100+) (20–99) (20–99) (20–99) High-income countries Upper-middle-income countries Lower-middle- and low-income countries Banks Supplier credit Equity shares Other Source: Enterprise Surveys (database), International Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 29 the medians are lower but the patterns are FIGURE 1.3 Outstanding Mortgage Debt by Country Income Group, the same. 1980–2011 Survey data suggest that across the world only a small percentage of individuals has 45 42.1 outstanding housing loans, but differences 40 across groups are significant. Individual-level Global Findex data suggest that on average 35 Mortgage debt, % of GDP across all countries, only 8 percent of adult 29.9 30 individuals report having an outstanding loan 25 (formal or informal) to purchase a home (fig- ure 1.4). Comparisons across country group- 20 ings and across income categories within 15 country groupings vary substantially. The av- erage share of individuals with an outstand- 10 7.4 ing home loan is 21 percent in high-income 5 3.7 3.1 economies, while it is 3 percent in developing 1.4 0 countries. Within each of these country Mean Median Mean Median Mean Median groupings, the share of individuals with a High-income Upper-middle- Lower-middle- and housing loan among those in the top 60 per- countries income countries low-income countries cent of income is between 1.5 to 2 times larger than that for those in the bottom 40 Sources: World Development Indicators (database), World Bank, Washington, DC, http://data .worldbank.org/data-catalog/world-development-indicators; Badev and others 2014. percent. The availability of long-term finance for households can also facilitate the accumula- investments are not subsidized by the govern- tion of human capital. The second impor- ments and they impose significant financial tant category of financing with a maturity of costs on the household, since returns are real- more than one year that is frequently used ized only with a significant delay. by households is education loans. Education The use of credit to finance investments loans can facilitate investment in human capi- in education in developing countries is very tal, especially in environments where these low and is more pervasive among richer FIGURE 1.4 Share of Population with an Outstanding Mortgage by Income and Country Income Group, 2011 30 25.7 % of adult population in a country 25 21.3 20 15.0 15 9.6 10 8.0 5.7 5 2.9 3.5 2.1 0 Overall Top 60% Bottom 40% Overall Top 60% Bottom 40% Overall Top 60% Bottom 40% income income income income income income World High-income countries Developing countries Sources: Global Financial Inclusion (Global Findex) Database, World Bank, Washington, DC, http://www.worldbank.org/globalfindex; and World Develop- ment Indicators (database), World Bank, Washington, DC, http://data.worldbank.org/data-catalog/world-development-indicators. 30 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 individuals. According to data from the Banks Global Findex, only 5.4 percent of individu- als in middle- and low-income countries have Banks are the most important providers of an outstanding loan to pay for school fees.3 long-term finance, and long-term financ- ing from banks is particularly important for households and small firms. By pooling sav- FIGURE 1.5 Maturity Structure of Bank Loans by Country Income ings and transforming short-term deposits Group, 2000–13 into long-term loans, banks take on liquidity risks (arising from the maturity mismatch be- 100 tween their assets and liabilities) and can pro- 12.0 22.5 vide financing for illiquid long-term projects 32.8 80 (Diamond and Dybvig 1983). The extent to % of total bank loans 34.7 which banks can perform this intermediary 60 34.3 function depends, among other factors, on 29.8 how well a bank can both assess credit risks 40 24.4 to screen prospective borrowers and monitor 13.9 24.2 borrowers once a loan has been issued. 20 The average share of bank loans with ma- 23.6 28.8 19.1 turity above five years is higher in richer coun- 0 tries. Bank balance sheet data from Bank- High-income Upper-middle- Lower-middle- and countries income countries low-income countries scope, a commercial dataset produced by <3 months 3 months to 1 year Bureau van Dijk, indicates that among high- 1 year to 5 years 5 years+ income economies the share of bank loans with maturities exceeding five years reaches Source: Bankscope (database), Bureau van Dijk, Brussels, http://www.bvdinfo.com/en-gb 33 percent on average, compared with about /products/company-information/international/bankscope. 23 percent for upper-middle-income coun- tries and only 12 percent in lower-middle- FIGURE 1.6 Annual Issuance of Syndicated Loans and Average and low-income countries (figure 1.5). At the Maturity by Country Income Group same time, the share of loans with maturity between one and five years is more similar 7 8 across income groups, accounting for almost 6.7 6.6 6.7 6.6 30 percent among high-income economies 6 6.2 ♦ ♦ ♦ ♦ and 35 percent among developing countries. ♦ 5.7 6 5 ♦ Volume, % of GDP Syndicated Lending Maturity, years 4 4 Syndicated lending as a percentage of GDP is 3 substantially higher in high-income countries relative to developing countries. The average 2 2 share of syndicated lending to GDP in high- 1 income countries is 6.5 percent and the median 6.5 5.2 2.2 1.6 1.8 1.7 is 5.2 percent (figure 1.6). In contrast, in mid- 0 0 dle- and low-income countries, both the aver- Mean Median Mean Median Mean Median age and median shares are close to 2 percent. High-income Upper-middle- Lower-middle- and countries income countries low-income countries The maturity of syndicated loans in high- income countries is lower than that for loans in Issuance volume ♦ Average maturity developing countries. The median and average Sources: World Development Indicators (database), World Bank, Washington, DC, http://data maturity of syndicated loans in high-income .worldbank.org/data-catalog/world-development-indicators; and SDC Platinum (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial countries is close to six years, while in middle- /investment-banking-and-advisory/sdc-platinum.html. and low-income countries these statistics are GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 31 closer to seven years (see figure 1.6). Differ- FIGURE 1.7 Capital Market Sizes by Country Income Group, 2000–11 ences in loan types are the main reason for the differences in maturities. In developing coun- 250 tries, most syndicated loans are for project fi- 203.1 nance or infrastructure loans, which tend to 200 have longer maturities, while in high-income 46.0 165.8 countries the majority of syndicated loans are 150 general purpose corporate loans with shorter 40.6 % of GDP maturities. Chapter 3 offers more granular 75.8 98.0 data and discussion of these patterns. 100 55.6 70.7 38.3 62.4 53.0 50 17.1 28.2 Capital Markets 81.3 69.6 15.1 33.5 32.7 42.6 3.4 3.0 Capital markets, comprising bond and stock 27.4 25.5 17.3 0 markets, are another potential source of long- Mean Median Mean Median Mean Median term financing for firms. These markets are High-income Upper-middle- Lower-middle- and countries income countries low-income countries significantly more developed in high-income countries. From 2000 to 2011, the total capi- Stock market Private debt market Public debt market capitalization capitalization capitalization talization of these markets averaged approxi- mately 203 percent of GDP in high-income Sources: World Development Indicators (database), World Bank, Washington, DC, http://data countries, almost 98 percent in upper-middle- .worldbank.org/data-catalog/world-development-indicators; and Global Financial Development Database, World Bank, Washington, DC, http://data.worldbank.org/data-catalog/global-financial income countries, and 62 percent in lower- -development. income countries (figure 1.7). Median values are lower (in particular, among high-income both the mean and median maturity for cor- countries), showing the influence of outliers porate bond issues by firms in high-income within each income category, but the main pat- countries exceed the mean and median for tern remains the same—capital market capital- firms in lower-middle- and low-income ization is positively correlated with income. countries, the maturity of corporate bond is- The structure of capital markets differs sues in upper-middle-income countries is the significantly across high-income and devel- highest (figure 1.8). The average maturity oping countries. In high-income economies, stock markets tend to dominate, followed by FIGURE 1.8 Maturity of Corporate Bond Issues by Country Income private bond markets. On average, the two Group, 2000–13 markets account for 157 percent of GDP: stock market capitalization is almost 81 per- 9 cent of GDP, and private bond market capi- 7.6 8.0 8 talization accounts for close to 76 percent. In 6.7 7 6.4 6.3 developing countries, stock markets are also 6 5.4 important, but public instead of private debt 5 Years markets come second in importance. On aver- 4 age, in upper-middle-income countries stock 3 market capitalization is almost 43 percent 2 of GDP, and public bond market capitaliza- 1 tion accounts for 38 percent. In contrast, pri- 0 Mean Median Mean Median Mean Median vate bond markets account for 17 percent of High-income Upper-middle- Lower-middle- and market capitalization on average. In the two countries income countries low-income countries lower-income groups, private debt markets are very small at 3 percent of GDP. Sources: World Development Indicators (database), World Bank, Washington, DC, http://data .worldbank.org/data-catalog/world-development-indicators; and SDC Platinum (database), The maturity of corporate bond issues is Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial not clearly tied to country income. While /investment-banking-and-advisory/sdc-platinum.html. 32 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 for firms in these countries is 7.6 years and by financial firms, and these issues tend to the median is 8 years. One reason driving have a shorter maturity. Chapter 3 offers lower maturities for high-income countries more granular data and in-depth discussion is that a larger percentage of bond issues is of these patterns. FIGURE 1.9 Institutional Investor Assets by Country Income Group, Institutional Investors 2000–11 Institutional investors are often discussed 120 as an important source of finance with the potential to be long term. During 2000–11, 100 99.2 however, their participation in developing economies was still relatively small. The cu- 28.6 mulative assets of institutional investors— 80 pension funds, mutual funds, and insurance % of GDP 58.4 companies—averaged 99 percent of GDP in 60 34.8 10.7 high-income economies, with broadly simi- 40 lar shares for the three sets of institutional 27.2 investors (figure 1.9). In contrast, the assets 24.5 20 35.8 12.0 of these institutions averaged only 25 percent 10.8 11.6 20.5 6.7 3.0 6.0 3.2 5.6 1.7 6.1 0.9 of GDP in upper-middle-income economies, 0 5.8 1.8 2.8 3.5 and pension funds dominated. In lower- Mean Median Mean Median Mean Median income countries, the share of assets to GDP High-income Upper-middle- Lower-middle- and countries income countries low-income countries was even lower, averaging close to 12 percent, Mutual funds Insurance Pension funds with pension funds accounting for half of the total. Median shares are significantly lower Sources: World Development Indicators (database), World Bank, Washington, DC, http://data across all income groups, showing that there .worldbank.org/data-catalog/world-development-indicators; and Global Financial Development Database, World Bank, Washington, DC, http://data.worldbank.org/data-catalog/global-financial is quite a bit of heterogeneity in the impor- -development. tance of institutional investors within each income category. That is especially the case in FIGURE 1.10 Private Equity across Income Groups, Average over both groups of developing countries, where 2008–13 the medians are close to half or less of the average. Although private equity is considered a Sub-Saharan Africa promising source of long-term financing, it is Middle East and still negligible in developing countries and is North Africa concentrated in just a few. Statistics compiled Latin America and by the Emerging Markets Private Equity As- the Caribbean sociation (EMPEA) for the period 2008–13 Central and show that while private equity financing av- Eastern Europe eraged around $230 billion in high-income Developing Asia countries, in developing countries it averaged $30 billion or 10 percent of the global amount Developing countries of private equity (figure 1.10). Furthermore, the significance of private equity financing is High-income countries very unbalanced within the developing world, 0 30 60 90 120 150 180 210 240 averaging approximately $17 billion in devel- oping Asian countries, four times more than U.S. dollars, billions the average for Latin America, the region Source: FundLink (database), Emerging Market Private Equity Association, Washington, DC, http:// with the second-highest presence of private empea.org/research/data-and-statistics/fundlink. equity financing. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 33 THE ROLE OF THE GOVERNMENT Empirical studies confirm that political IN PROMOTING LONG-TERM and macroeconomic instability (in particular, FINANCE high inflation) are among the leading reasons for the lack of long-term finance and private Government intervention to promote long- investment. Demirgüç-Kunt and Maksimovic term finance is clearly justified when market (1999) showed that inflation is negatively re- failures that limit its use prevail in financial lated to the use of long-term debt. Kpodar markets. As discussed, these market failures and Gbenyo (2010) found that the share of can arise from asymmetric information, coor- long-term credit to total credit in countries dination, and incentive problems. that are part of the West African Economic Government policies that reduce informa- and Monetary Union was higher for coun- tion asymmetries are useful for promoting tries with lower and less volatile inflation and the availability of long-term finance. The ex- for countries with stable political regimes. istence of credit bureaus and other mecha- Qian and Strahan (2007) and Bae and Goyal nisms that share information among financial (2009) found that increased country risk is as- intermediaries improves access to financial sociated with shorter loan maturity. Tasić and services generally and to long-term finance Valev (2008) also found that inflation has a in particular. Using data on the maturity of negative impact on maturity of domestic bank domestic bank credit to the private sector in credit to the private sector in 74 countries. 74 countries from 1990 to 2005, Tasić and Tasić and Valev (2010) found similar results Valev (2008) found that the presence of a using a panel dataset for a sample of transi- credit bureau or registry is associated with tion economies. longer debt maturity. This result is confirmed Not only the current level of inflation but more robustly by Martínez Pería and Singh also a history of past inflation can have a neg- (2014), using multiyear firm-level surveys ative effect on debt maturity. Using a database for 60 countries covering more than 60,000 on government debt in 19 emerging coun- firms over the period 2002–11. Among other tries over the period 1980–2002, Jeanne and results, they show that after the introduction Guscina (2006) observed substantial cross- of a credit bureau, the maturity of firm loans country variation in the maturity structure of lengthens. debt, finding that countries with lower long- The other important role for the govern- term debt are those with a history of high in- ment is to avoid policy distortions that give flation (that is, inflation of over 100 percent rise to an unstable political or macroeconomic in the previous decade). A history of high environment, which can reduce the amount of inflation is often linked to short-term debt long-term finance used in the economy. A sta- and investments in Brazil, despite the many ble political and macroeconomic environment reforms adopted by the country to develop is a necessary condition for long-term finance long-term finance (Park 2012). to thrive because it underpins the ability of To ensure an adequate supply of finance, economic agents to predict the risks and re- including long-term debt, the government turns associated with that finance. If political needs to build a strong legal and institutional risk is significant or the macroeconomic en- framework.4 When a country’s contract- vironment is unstable, the market is unlikely ing institutions offer only very weak protec- to provide long-term finance at a reasonable tions for lenders against nonpayment of debt, premium. Instead, short-term finance, often lenders tend to rely on short-term lending of small amounts, will be the most preva- agreements for formal debt contracts, which lent form of external financing (Caprio and make it easier for the lender to discipline the Demirgüç-Kunt 1998). At the same time, pro- borrower through the threat of withholding spective borrowers will be reluctant to invest future financing in case of nonrepayment. in their future, and the demand for long-term Consistent with these predictions, Warnock finance will be low. and Warnock (2008) found that countries 34 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 with stronger protections for legal rights have The government can also influence the sup- deeper housing finance systems. Using firm- ply of long-term finance by ensuring the exis- level data for 39 countries between 1991 and tence of competitive and contestable markets 2006, Fan, Titman, and Twite (2012) found for financing. For example, by minimizing that firms in countries with a weaker legal en- entry barriers, ensuring a level playing field, vironment tend to use more short-term debt. and otherwise facilitating bank competition, Qian and Strahan (2007) found that credi- and by allowing the functioning of other tor rights are positively associated with loan intermediaries—leasing companies, private maturity. equity investors, venture capitalists—that can A good legal framework for collateral is also provide long-term finance, the govern- also needed to foster the availability of long- ment can shape and potentially play a role in term finance. Long-term financial contracts expanding the supply of long-term finance. lack the disciplining effect of short-term debt Thus, the presence of a strong supervisory on borrowers and therefore require assets to and regulatory framework that promotes be pledged to alleviate moral hazard. Evi- contestability among existing and potential dence shows that collateral requirements are providers of long-term finance can be very often stringent for loans financing fixed as- important for the development of long-term sets (which are usually long term) and that finance. the lack of collateral is often a constraint on Policies and regulations that improve the investment in fixed assets (Beck, Demirgüç- quality of corporate governance and account- Kunt, and Maksimovic 2005). Using data for ing standards can also support the develop- transition economies, De Haas, Ferreira, and ment of markets for long-term finance. In Taci (2010) found that banks that perceive many developing countries, investment con- the legal collateral environment to be good straints stemming from political and macro- tend to focus more on mortgage lending. Re- economic risks are compounded by insuf- forms of collateral registries have also been ficient transparency at the firm level, caused found to have a significant impact on loans by poor corporate governance and account- to finance fixed assets and on the maturity of ing standards. Lack of transparency makes these loans (Love, Martínez Pería, and Singh, reliable risk assessments difficult, especially forthcoming). Further evidence shows that over a long time horizon, and reduces the collateral requirements become even more availability of long-term financing. Existing important in environments with corruption research has consistently found a positive as- and poor property rights, suggesting that re- sociation between corporate governance and forms reducing the cost of collateral may have the availability of long-term finance.6 stronger impacts in weaker institutional envi- By providing a legal and regulatory frame- ronments (Qian and Strahan 2007).5 work that facilitates the development of effi- A strong capability to enforce contracts is cient capital markets, the government can also also required to promote the use of longer- foster long-term financing. Well-functioning term financial contracts. In the absence of capital markets aggregate information and contract enforcement, financiers would avoid reduce informational asymmetries between lending long term and rely on short-term con- market participants, facilitating the provision tracts to discipline and ensure repayment by of long-term financing (Demirgüç-Kunt and borrowers. Using loan- and firm-level data, Maksimovic 2002). Governments can pursue respectively, Bae and Goyal (2009) and Fan, several policies to support the development of Titman, and Twite (2012) found that bet- deep and liquid capital markets. De la Torre, ter contract enforcement is associated with Gozzi, and Schmukler (2007), for example, longer debt maturity. In fact, Bae and Goyal studied the impact of a set of reforms on stock found that contract enforcement is more sig- market development in emerging markets, nificantly and consistently associated with namely, stock market liberalization, enforce- longer maturities than are creditor rights. ment of insider trading laws, introduction of GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 35 electronic trading systems, privatization pro- Restrictions on portfolio allocations that limit grams, and institutional reforms. The authors the long-term instruments these funds can in- found that these government interventions are vest in should also be removed. associated with significant increases in domes- The evidence on the effects of the direct tic stock market capitalization and in trading provision of long-term financing by govern- volumes. ments is generally not encouraging.7 It shows The government can directly affect the that lending by government-owned banks has development of domestic corporate bond often been associated with political capture markets by developing the market for sover- and a misallocation of resources.8 In particu- eign debt. In particular, sound sovereign debt lar, cross-country studies show that greater management with regular issues of bench- government participation in bank ownership mark bonds at different maturities is central tends to be associated with lower levels of to building a yield curve, which can be helpful financial development, more politically moti- for pricing corporate bonds efficiently (espe- vated lending, lower banking-sector outreach, cially in the longer term). The possibility of wider intermediation spreads, greater finan- crowding-out effects between government cial instability, and slower economic growth and corporate bond markets through compe- (Barth, Caprio, and Levine 2001, 2004; tition for investors’ funds must also be taken Caprio and Martínez Pería 2002; La Porta, López- into account, however (Friedman 1986). For de-Silanes, and Shleifer 2002; Dinç 2005; and example, Graham, Leary, and Roberts (forth- Micco, Panizza, and Yañez 2007). Moreover, coming) documented a negative association detailed case studies on government-owned between government borrowing and corpo- banks in developing and even some developed rate debt issuance, which is consistent with countries offer more robust evidence that gov- a crowding-out effect affecting the demand ernment bank lending is subject to political curve for corporate debt. manipulation and rarely results in improved The government can also promote long- access for constrained borrowers (see, for term financing through policies that support example, Sapienza 2004 for evidence on Italy; the development of institutional investors; Khwaja and Mian 2005 for evidence on Paki- these policies include setting the right incen- stan; Cole 2009a, 2009b for evidence on In- tives and removing unnecessary restrictions on dia; and Carvalho 2014 for evidence on their portfolio allocations so that these inves- Brazil). tors invest long term. Institutional investors Where government-owned banks are in- can play an important role in the development volved in the provision of long-term finance, of markets for long-term finance. The expec- their mandate needs to be clearly defined and, tation is that they are better able to mobilize ideally, should not duplicate functions that the assets, diversify risks, and overcome transac- private sector can provide. To ensure that the tion costs and information problems that pre- involvement of government-owned financial vent other market participants from investing institutions serves as a remedy rather than long term (Caprio and Demirgüç-Kunt 1998; a source of market distortions, the purpose, Corbo and Schmidt-Hebbel 2003; Borensztein scope, and time horizon of the involvement and others 2008; Eichengreen 2009). To invest need to be clearly defined (Rudolph 2009). long term, however, investors have to be pro- In practice, public sector interventions should vided with the right incentives. In particular, occur only in cases where a market failure is governments need to ensure that compensa- apparent and where no private sector solu- tion and benchmarking practices followed by tion is feasible. Moreover, the involvement of institutional investors have a long-run horizon government-owned banks should be limited in to avoid some of the short-termism that has time. For example, “sunset clauses” that limit been observed in some cases (for example, the the time horizon of public lending programs holdings of pension funds in Chile, as shown can prevent such interventions from outliving by Opazo, Raddatz, and Schmukler, 2015). the purpose for which they were designed and 36 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 1.4 Development Banks and Long-Term Finance: Two Different Approaches The Brazilian Banco Nacional de Desenvolvimento available evidence shows significant political dis- Econômico e Social (BNDES) and the Colombian tortions in lending by Brazilian government banks Financiera de Desarrollo Nacional (FDN) highlight during noncrisis times, with funds being channeled two very different approaches to supporting long- to constituencies in which political incumbents face term fi nance through government-owned fi nancial competition (Carvalho 2014) or to fi rms that make institutions. political donations (Claessens, Feyen, and Laeven Brazil’s development bank BNDES has histori- 2008). There is, as a consequence, no indication that cally played a major role in providing long-term this additional credit has had any positive effect on finance through directed lending. This approach employment or fi rm performance (Carvalho 2014; has advantages and drawbacks. On the one hand, Lazzarini and others 2015). Moreover, the scale of the scale of BNDES’s direct lending operations has the intervention is likely to have fi scal effects that enabled the bank to provide long-term fi nancing in are damaging to the market for long-term credit cases where private credit might not have been avail- more broadly. The substantial government transfer able as a substitute. For example, BNDES has pro- to BNDES, fi nanced through bond issuance, is likely vided extensive fi nancing for large-scale investments to crowd out private credit, keep long-term interest in physical and social infrastructure whose social rates high, and reduce the overall availability of pri- returns may not be fully internalized by private vate credit in the economy. investors. Because government banks do not face the Colombia’s development bank FDN has followed same redemption risk as private lenders, it has also a very different approach, supporting long-term been argued that government banks are well suited fi nance through strategic interventions that crowd to provide countercyclical fi nancing during times of in private investment and through fi nancial inno- economic crisis. vations that promote the development of markets Some evidence suggests that direct lending by for long-term fi nance. FDN’s mandate is to focus BNDES had a stabilizing effect on Brazilian credit specifically on support for long-term infrastructure markets during the recent global financial crisis fi nancing in Colombia. Being both smaller and more (Coleman and Feler 2015). While private sector specialized than other government banks, FDN aims banks in Brazil and elsewhere contracted lending to increase the impact of its investments by mobiliz- and loan maturities in the aftermath of the fi nancial ing co-investments by the private sector. crisis, Brazil used its government banks, including One of the bank’s flagship projects is the con- BNDES, to play a countercyclical role. The share struction of 8,000 kilometers of toll road at a cost of credit extended by Brazil’s government banks of about $23 billion. FDN bears the risk of the fi xed rose from 13 to 18 percent of gross domestic prod- up-front investment, and private investors are exten- uct between September 2008 and 2009. Thanks sively engaged in the operational cycle of the project. to a generous capital injection by the government To ensure private sector participation in long-term (R$100 billion in 2009), BNDES was able to extend projects of this kind, FDN has established a special special credit facilities with maturities of more than public-private partnerships unit that will focus on one year at substantially discounted interest rates structuring “bankable” infrastructure projects. So and increased lending, from R$160 billion (at 2005 far, FDN’s efforts at mobilizing long-term fi nance prices) in Q4 2008 to R$277 billion in Q4 2009. has focused on domestic lenders. In the longer term, The reference interest rate for long-term loans was an important goal is to establish conditions that set at 6 percent, which was 7.5 percentage points enable the participation of institutional investors below the market rate (Lazzarini and others 2015). so that FDN can mobilize joint long-term fi nancing On the other hand, the surge of BNDES lend- from banks and from capital markets. ing—while compensating for the contraction of FDN has also been active in supporting finan- private credit and for the shortening of loan maturi- cial innovations that can help mobilize long-term ties during the crisis—may have come at the cost of fi nance. In particular, the bank is developing bonds, significant market distortions in the longer run. The partial guarantees, and other innovative instruments (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 37 BOX 1.4 Development Banks and Long-Term Finance: Two Different Approaches (continued) to support long-term debt fi nancing through capi- capture have been important sources of inefficiency tal markets. Together with the Ministry of Finance, in the lending activities of government banks. The FDN is also supporting several regulatory reforms example of FDN illustrates that development banks and training programs that are prerequisites for can support long-term fi nance through a range of local capital markets to play a more important role interventions other than direct lending. In many in infrastructure fi nancing. FDN is also involved in cases, such innovative approaches are likely to have initiatives to strengthen the corporate governance greater impact and to generate fewer market distor- of long-term projects and to reduce possibilities for tions than the large directed lending programs tradi- political capture; weak governance and political tionally pursued by development banks. from becoming a source of market distortions difficult in weak institutional environments in the longer run. Box 1.4 provides a discus- where good governance is difficult to estab- sion of two different approaches to develop- lish. Catalytic investments that crowd in co- ment banking. founding by the private sector for projects To mitigate political interference, the corpo- with high social returns can be structured as rate governance and risk management frame- public-private partnerships (PPPs). These can work of government-owned banks needs to improve the incentive environment and re- be especially strong. A strong framework en- duce the risk that public spending crowds out tails a number of requirements, as outlined by private investment. Scott (2007). First, there has to be an agency Public-private partnerships are another ex- within the government that is expressly re- ample of how public institutions can support sponsible and accountable for representing the the provision of long-term finance without shareholder. Second, board members need to distorting market incentives. PPPs are com- be appointed in a transparent manner for a monly used for large infrastructure projects fixed period of time, and they should be ac- such as highways, ports, and airports. In a countable for their actions, as they would be PPP, a consortium of public and private in- in listed companies. Third, senior manage- vestors finances and manages the construc- ment at the bank needs to be qualified and be tion and then maintains and operates the fa- held accountable by the board of directors. cilities for a long period of time, often over Governments can share risk and extend several decades. In the construction phase, maturity structures through providing credit private investment is combined with bank guarantees. Government-backed guarantee loans and government grants to diversify the schemes are often designed to encourage lend- risks of a large up-front investment. During ing to certain sectors—for example, small and the operation phase, the private investor cov- medium enterprises—and can allow more ers operational costs and receives a stream risky borrowers to receive loans and also ex- of payments as a return. The PPP contract is tend maturity structures (box 1.5). However, appealing to private investors because it al- in practice, it is not clear if these schemes lead lows for the clear assignment and pricing of to additional lending, and they may distort the risks at each project phase. For the gov- incentives for lenders and borrowers, increas- ernment, long-term finance through PPPs for ing default rates and leading to large-scale long-term projects is an attractive alternative losses. Following best practice in design and to direct public financing for several reasons. management of these schemes tends to be First, PPPs reduce the well-known problem of 38 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 1.5 Using Credit Guarantees to Reduce the Risk of Long-Term Lending Lending long term exposes fi nancial institutions to and Yañez 2012). However, another study questions fluctuations in the probability of borrower default whether FOGAPE truly leads to additional lending. and changing conditions in fi nancial markets. Gov- It points out that approximately 80 percent of the ernments or international organizations can offer fi rms that participate in FOGAPE had bank loans in credit guarantees to share some of this risk. In fact, the past and that many of these fi rms had previously many countries have credit guarantee schemes where received guarantees (Benavente, Galetovic, and San- the guarantor (often the government) pledges to repay hueza 2006). a percentage of individual loan amounts or of a loan Another potential issue with credit guarantees is portfolio to a lender in case of borrower default. A that they can distort incentives for lenders and bor- large number of guarantee schemes were established rowers, thereby increasing default rates and costs for to assist not only small and medium enterprises, but the guarantor. Cowan, Drexler, and Yañez (2012) also other target fi rms in specifi c geographic areas, find that borrowers are less likely to repay guar- sectors such as agriculture, or groups such as women anteed loans than uninsured loans. The study also or minority populations (Beck, Klapper, and Men- shows that the drop in the repayment rate appears to doza 2010). Some guarantee schemes specifically be due to a decrease in collection efforts by lenders. support loans for capital investment. In addition to It is thus important to take incentives into account credit guarantees for fi rms, some countries also pro- when designing credit guarantee schemes. vide guarantees for housing loans. Research and practitioner experience suggest that In practice, a concern with credit guarantees is best practices for credit guarantee schemes include that they may not lead to additional lending. Instead, leaving credit assessments and decision making to the lenders may use guarantees to lower risk on loans private sector, capping coverage ratios and delaying that they would have issued even in the absence of the payout of the guarantee until recovery actions are the guarantees. Some of the most rigorous studies taken by the lender, pricing guarantees to take into on this topic examine FOGAPE (Fondo de Garantía account the need for fi nancial sustainability and risk para Pequeños Empresarios, Guarantee Fund for minimization, and encouraging the use of risk man- Small Businesses), a fund managed by a large public agement tools.a However, many existing schemes do bank (BancoEstado) in Chile that provides guaran- not follow best practices, and designing and operat- tees for loans to small fi rms. Two separate studies ing credit guarantees effectively in poor institutional suggest that FOGAPE has generated additional loans environments may be difficult. to fi rms (Larraín and Quiroz 2006; Cowan, Drexler, a. For an in-depth review, see World Bank (2013a). crowding out private investment by the public funds (SWFs). SWFs have their origins in the sector. Second, PPPs can reduce the cyclicality need to manage cyclical revenues in a way that of public spending by contractually distribut- reduces macroeconomic volatility and to in- ing fixed costs and operational expenses over vest national wealth in a diversified portfolio a long-term horizon. Third, PPPs align institu- of investments with a long time horizon. A tional incentives in large investment projects large and rapidly growing class of institutional more closely with those of the private sector, investors, SWFs currently have an estimated both improving transparency and reducing $6.6 trillion under management—more than political distortions in procurement, credit al- twice the amount of funds managed by all location, and financing. hedge funds combined. Because of their long- In recent years, governments have increas- term horizon and the lack of redemption risk, ingly acted as intermediaries of long-term fi- SWFs are a natural intermediary of long-term nance through their participation in public finance. In addition, they may be preferable to investment companies and sovereign wealth direct public financing or to government banks GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FRAMEWORK, FACTS, AND THE ROLE OF THE GOVERNMENT 39 as a vehicle for governments to provide long- NOTES term finance for two other reasons. First, SWFs 1. The use of long-term debt by governments is are typically run as separate nongovernment not discussed in this report because its focus entities whose managers are compensated and is on households and firms for whom limited evaluated with reference to the market. Sec- access to long-term finance is likely to be more ond, SWFs can leverage investment expertise problematic. Also, data on government debt in specific asset classes, which improves the al- issuances in domestic markets are not readily location of long-term finance. available. While their long investment horizon makes 2. The analysis covers 711,814 firms operating sovereign wealth funds natural providers of in 75 countries (37 high-income, 38 develop- long-term finance, they are not immune to ing) during the period 2004–11. For each firm, averages are computed over the period, then some of the same problems of political cap- the median firm for the country and the median ture and incentive misalignment that plague country for the income group are computed. government banks. That is particularly true 3. Global Findex did not gather these data for where sovereign wealth funds have an explicit high-income countries. mandate to invest in the domestic economy 4. This also refers to the importance of an inde- to support strategic industries or broader de- pendent, clean, and fast judiciary. velopment goals. Such mandates raise two 5. De la Torre, Martínez Pería, and Schmukler concerns. First, they can undermine the im- (2007) showed how banks in Argentina and portant macroeconomic stabilization func- Chile adapt their lending by collateralizing and tion of sovereign funds. Instead of diversify- securing their loans. ing cyclical earnings away from the fund’s 6. Using data on institutional investments in 23 emerging markets, Aggarwal and others (2011) home economy, domestic investments may found that institutional investments are posi- aggravate economic cycles. Second, domestic tively associated with corporate governance investments of sovereign funds are vulnerable at the firm level. Anginer and others (2015) to political capture when they are not man- showed that firms with stronger shareholder aged independently; political capture in turn rights and strong corporate governance provi- can be damaging to corporate governance, sions have less to gain from the use of short- lead to capital misallocation, and ultimately term debt. That is, good governance acts as have negative effects on economic growth. a substitute to short-term debt in reducing Dyck and Morse (2011) showed that SWFs agency problems within a firm. with a development mandate made signifi- 7. Some cases of successful government-owned cantly different asset allocation from those banks exist. Rudolph (2009) reviewed the experience of four state financial institutions of an investor trying to maximize portfolio that have performed relatively well in the past: returns. Bernstein, Lerner, and Schoar (2013) Canada’s Business Development Bank, Chile’s showed that SWFs where politicians are in- Banco del Estado, South Africa’s Development volved in management are much more likely Bank of Southern Africa, and Finland’s Finn- to make poorly performing investments in the vera plc. domestic economy. 8. This evidence is discussed extensively in World Bank 2013a. CHAPTER 2: KEY MESSAGES • From the perspective of the fi rm, long-term fi nance offers protection from credit supply shocks and from having to refi nance in bad times, facilitating long-term investments and improving performance. Because it also shields firm managers from the frequent monitoring that short-term debt requires as it comes up for renewal, long-term fi nance can potentially hamper investment and performance. • Empirical evidence suggests that use of long-term finance tends to be associated with better firm performance: with developed financial institutions and markets and the ability to enter into long-term contracts, firms can grow at faster rates than they could attain by relying on internal sources of funds and short-term credit alone. Consistent with these results, recent research also suggests that differences in corporate debt maturity had important real effects during the fi nancial crisis of 2008–09. Although government subsidies and directed credit can lengthen the maturity structure, there is no evidence that such steps are associated with better firm performance. • Even after controlling for fi rm characteristics—size, asset, industry composition, and prof- itability—long-term fi nance is more prevalent among firms in high-income countries than in developing countries. Use of long-term finance by fi rms increases with a stable political and macroeconomic environment, better-developed fi nancial systems, better information sharing, and sound legal institutions, including speedy contract enforcement, strong creditor • Financial rights, systems are laws, clear bankruptcy multidimensional. and an effectiveFour characteristics corporate are of governance particular interest framework. for benchmarking financial systems: financial depth, access, efficiency, and stability. • Long-term finance allows These characteristics households need to meet for to be measured different objectives financial throughout institutions their life cycle. and markets. Younger households can accumulate wealth and reap term premiums through products such • bonds. as Financial come systems and Mortgages shapes in all loans student and sizes, facilitate and purchases lumpy differ widely in terms of physical of or the four human capi- tal.characteristics. Instruments such As economies as annuities, develop, services insurance, and provided pensions bycan fienable markets nancialolder tend to to households become insure more against important various than risks. life-cycle those Borrowing provided by banks. and investing in these markets also entail risks, however, and active government interventions • The global financial crisis was not only about financial to promote greater instability. Inhousehold participa- some economies, tion may backfi re, as in the case of U.S. subprime mortgages. the crisis was associated with important changes in financial depth and access. • All around the world, wealthier and more educated individuals are more likely to use long- term financial instruments as savers or borrowers. But even after accounting for individual characteristics, households’ participation in long-term fi nance is higher in more-developed countries with a stable macroeconomic environment, low inflation, and sound legal systems. Mortgage markets develop only at relatively high levels of GDP per capita and often depend on the availability of long-term funding through the insurance sector or stock markets. • Government policies to promote long-term finance for firms or households should focus on addressing markets failures; removing policy distortions and maintaining a stable macro- economic environment; promoting competitive and stable financial institutions and markets through laws; and creating policies that regulate healthy entry, operations, and exit and that provide a strong institutional environment for contract enforcement. • For firms, an effective corporate governance framework that improves shareholder rights can lessen reliance on short-term debt. Information sharing through credit bureaus can foster long-term finance by reducing information asymmetries between firms and lenders. Collat- eral registries for movable assets can help firms increase the amount of assets that they can post as collateral to obtain long-term loans. Appropriate contract law or leasing legislation can encourage leasing institutions to provide finance for fixed assets. • For households, financial literacy, consumer regulation, disclosure rules, and the provision of investment default options can have important effects on increasing understanding of long- term finance instruments and on reducing financial mistakes stemming from lack of proper information and behavioral biases. THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS: DETERMINANTS AND IMPACT 2 The Use of Long-Term Finance by Firms and Households: Determinants and Impact T his chapter examines long-term fi- nance from the perspective of firms and households. It asks why firms and households debt to finance working capital such as payroll and inventory. Studies for developed and de- veloping countries find evidence that firms do would want to use long-term finance and ex- match the maturity of their assets and liabilities plores the impact long-term finance has on (Stohs and Mauer 1996 for the United States; them. The chapter discusses those country Schiantarelli and Sembenelli 1997 for Italy and individual characteristics that determine and the United Kingdom; Schiantarelli and the use of long-term finance by firms and Srivastava 1997 for India; and Jaramillo and households. It also provides policy recom- Schiantarelli 2002 for Ecuador). Additionally, mendations based on the latest research find- in a 1999 survey, chief financial officers of ings from the empirical literature on the use U.S. companies reported that matching the of long-term finance. maturity of their firm’s debt with the life of its assets was the most important factor affect- FIRMS’ USE OF LONG-TERM ing their choice between short- and long-term FINANCE debt (Graham and Harvey 2001). Long-term debt also minimizes the risk of Why would a firm want to use long-term, having to refinance in bad times. Chief finan- rather than short-term, finance? cial officers in the United States list this reason Firms tend to match the maturity of their as- as the second-most important one for choos- sets and liabilities, and thus they often use ing long-term over short-term debt (Graham long-term debt to make long-term invest- and Harvey 2001). In the theoretical litera- ments, such as purchases of fixed assets or ture, this problem is called “liquidity risk.” equipment. Theory suggests that the optimal That is, when debt matures at a time when the payment structure for debt is one that matches firm experiences a negative shock to its earn- the timing of project returns (Hart and Moore ings or when credit market conditions dete- 1995). Empirically, this theory implies that riorate, lenders may be reluctant to refinance firms use long-term debt to purchase fixed as- (Diamond 1991, 1993). Long-term debt low- sets or equipment, while they use short-term ers liquidity risk for firms because it does not GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 41 42 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 have to be refinanced as frequently. At the if the firm expects to receive positive returns same time, long-term debt shifts risk to lend- in the future (Diamond 1991). ers because they have to bear the fluctuations On the other hand, long-term finance can in the probability of default and changing distort managers’ incentives, hampering in- conditions in financial markets, such as inter- vestment and firm performance. Economists est rate risk. Often lenders require a premium have uncovered at least two ways through as part of the compensation for the higher risk which long-term debt may distort incentives. this type of financing implies. First, long-term debt implies that the firm Not all firms need long-term finance. shares not only long-term returns but also Whether or not a firm needs long-term fi- long-term losses with the lender, so managers nance depends on the types of assets being or owners may exert less effort to avoid losses financed and on their desired degree of risk- (Rajan 1992). Second, short-term debt has a sharing with lenders. Firms with good growth stronger disciplinary role than long-term debt opportunities—for example, those that expect because it needs to be renegotiated frequently, to experience mostly positive shocks in the fu- resulting in less wasteful activity by firm man- ture—may prefer short-term over long-term agers or owners (Jensen 1986). finance. These firms may want to refinance The theoretical literature is thus incon- their debt frequently to obtain better loan clusive on how the maturity of debt affects terms after they have experienced a positive investment and firm performance, and em- shock (Diamond 1991; Barclay and Smith pirical evidence is needed to shed light on this 1995; Guedes and Opler 1995). In addition, question. It is, however, challenging to iden- firms with high growth opportunities may not tify whether having long-term finance causes want to take on long-term debt because firm changes in investment or firm performance be- managers or owners have to share the returns cause third factors could determine both use with the lender well into the future and thus of long-term finance and investment and firm may earn less than they could have on their performance. For example, firms with better investment (Myers 1977). Empirical evidence managers may obtain more long-term debt from China and the United States shows that and may grow faster. Also, better-performing firms with fewer growth opportunities are firms may have an easier time obtaining long- more likely to rely on long-term debt (Barclay term finance, so that performance may lead to and Smith 1995; Liu and Xu 2014). use of long-term finance instead of the other way around (reverse causality). Many exist- ing studies thus report associations that may What are the implications of long-term not be causal, but the authors typically take finance for firm performance? great care to control for a range of observable For firms that need it, long-term finance is third factors or to minimize the risk of reverse likely to have a positive effect on investment causality.1 and firm performance. Having long-term fi- Evidence from cross-country analysis shows nance allows firms to invest in projects that a positive relationship between long-term fi- bring in returns over a relatively long time ho- nance and firm performance—unless the fi- rizon, such as purchase of fixed assets. These nance is provided in the form of directed credit. investments may increase firm productivity Demirgüç-Kunt and Maksimovic (1998) used and profitability. If only short-term debt is firm-level data for 30 high-income and devel- available, firms may forgo these types of in- oping countries to show that firms with more vestments since they prioritize projects that long-term liabilities tend to grow faster than generate returns in the short run (Hart and they would if they relied solely on internal re- Moore 1995). In the presence of contract en- sources. This finding is robust to controlling forcement problems or asymmetric informa- for firm characteristics, as well as for a coun- tion, short-term debt can also lead to exces- try’s macroeconomic environment, financial sive liquidation of projects by the lender even development, legal efficiency, and the extent of GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 43 government intervention. The authors also Indicators of use of long-term finance examined the role of government subsidies by firms and found that government subsidized or di- rected credit is negatively correlated with firm Information on the use of long-term finance growth. by firms across a large number of coun- The within-country evidence on the link tries comes primarily from balance sheet between long-term debt and firm performance data collected from Bureau van Dijk in the is less clear. Several country studies find a ORBIS database and also from the World positive relationship between long-term debt Bank Enterprise Surveys. ORBIS includes and firm productivity, but the positive corre- comprehensive balance sheet information that lation between the use of long-term debt and makes it possible to calculate firms’ long-term firm productivity is reduced or even reversed liabilities for 87 countries covering the years when the fraction of subsidized credit is high 2004 to 2011. One caveat of the ORBIS data (Schiantarelli and Sembenelli 1997; Schian- is that the coverage of firms varies widely tarelli and Srivastava 1997; Jaramillo and across countries and the data are not neces- Schiantarelli 2002). However, research us- sarily representative of all firms in each coun- ing data on more than 40,000 firms in China try. In addition, the sample is skewed toward showed either no correlation between use higher-income countries.3 The World Bank of long-term debt and productivity (Li, Yue, Enterprise Surveys, which are available for and Zhao 2009) or found a negative correla- 123 countries, are representative at the coun- tion between the two variables (Liu and Xu try level and have greater coverage of lower- 2014).2 Similarly, Jiraporn and Tong (2010) income countries.4 The surveys ask firms found a negative relationship between long- about the sources of financing for any fixed term debt and firm value for listed firms in the assets that they purchased over the past year, United States. Unfortunately, these existing that is, internal funds or various sources of studies do not exploit exogenous variation in external funds. Although the survey does not the availability of long-term debt, so they do ask about the maturity of the external financ- not necessarily measure the causal effect of ing for purchase of fixed assets, it is likely long-term debt on firm performance. to be long term since firms tend to match Within-country case studies find a positive the maturity of their assets and liabilities. In effect of long-term debt on firm investment, a separate question, the Enterprise Surveys however. Evidence from Ecuador, Italy, and ask firms about the duration of their most the United Kingdom shows no robust corre- recently received loan or line of credit. This lation between use of long-term debt and in- question thus includes explicit information vestment (Schiantarelli and Sembenelli 1997; about debt maturity, but it is only available Jaramillo and Schiantarelli 2002). In contrast, for a subset of 43 countries.5 Li, Yue, and Zhao (2009) and Liu and Xu Firms in developing countries have fewer (2014) found that use of long-term debt is long-term liabilities than firms in high-income positively associated with long-term invest- countries, even after controlling for firm char- ment in China. Whether these findings are acteristics. Figure 2.1 displays balance sheet driven by estimation bias is not clear, how- data from ORBIS showing that the percent- ever, and the associations may not be causal. age of firms that report having any long-term Other papers have used the decline in credit liabilities is lower in developing than in high- availability during the recent financial crisis to income countries (Demirgüç-Kunt, Martínez assess the causal effect of long-term credit on Pería, and Tressel 2015a). The difference is firm investment (box 2.1). These papers show particularly prominent for small and medium that the availability of long-term credit has a enterprises (SMEs): in the median developing positive effect on investment in Belgium and country, 66 percent of small and 78 percent of the United States in the context of the finan- medium firms report having long-term debt, cial crisis. compared with 80 percent and 92 percent, 44 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.1 Firms’ Long-Term Finance and Investment after the Global Financial Crisis Several researchers have used the decline in credit precrisis period, long-term credit in the Europe and availability during the recent fi nancial crisis to assess Central Asia (ECA) region grew substantially more the causal effect of long-term credit on fi rm invest- than in other European countries (7.3 percent com- ment. The fi nancial crisis made it difficult for fi rms pared with 2.5 percent) and that this difference was around the globe to get new credit and put a stop larger than that for the growth rates of short-term to the growth of long-term credit in some coun- credit (4.8 percent in ECA countries compared with tries. For example, Park, Ruiz-Ortega, and Tressel 2 percent in non-ECA countries). Once the crisis hit, (2015) looked at panel data from countries in the credit growth rates collapsed to near zero in both European Union over the past decade to examine regions (figure B2.1.1). how bank credit of different maturities to nonfi nan- Duchin, Ozbas, and Sensoy (2010) used data on cial corporations evolved before and after the global publicly traded fi rms in the United States to study fi nancial crisis. The authors found that during the the effect of the recent financial crisis on invest- FIGURE B2.1.1 Growth Rate of Credit, 2003–14 a. Short-term credit b. Long-term credit 40 50 30 40 20 30 Growth rate, % Growth rate, % 10 20 0 10 –10 –20 0 –30 –10 03 04 05 06 07 08 09 10 11 12 13 14 03 04 05 06 07 08 09 10 11 12 13 14 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Non-ECA countries ECA countries Source: Park, Ruiz-Ortega, and Tressel 2015. Note: Short-term credit is defined as credit with maturity up to one year. Long-term credit is defined as credit with maturity over five years. ment. Consistent with the liquidity risk problem of in later years. Results show that firms with high short-term debt, they found that fi rms with higher amounts of maturing debt cut their investment rate amounts of net short-term debt (defi ned as short- (defi ned as the ratio of capital expenditures to fi xed term debt minus cash, divided by total assets) out- assets) by 2.5 percentage points more than otherwise standing before the crisis saw larger declines in similar fi rms whose debt was scheduled to mature investment after the crisis. Higher amounts of out- after 2008. This drop in investment is quite large, standing long-term debt, on the other hand, are not representing a decline of about one-third of precrisis associated with a decline in investment after the investment levels. crisis. Vermoesen, Deloof, and Laveren (2013) also Almeida and others (2011) followed a similar compared firms with different long-term debt approach to measure the effect of long-term debt maturities to estimate the impact of the fi nancial cri- on investment by U.S. fi rms. They compared fi rms sis on private small and medium-size enterprises in whose long-term debt matured at the end of 2008 Belgium. They fi nd that those fi rms that at the start (that is, with more than 20 percent of long-term of the crisis had a larger part of their long-term debt debt due within a year after the crisis) to other fi rms maturing within the next year experienced a signifi- whose long-term debt was scheduled to mature cantly larger drop in investment in 2009. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 45 respectively, in the median high-income coun- FIGURE 2.1 Percentage of Firms with Any Long-Term Liabilities by try. Earlier data on the ratio of long-term Country Income Group and Firm Size, 2004–11 liabilities to total assets for 30 countries av- eraged over 1980 to 1991 shows a similar 100 97 92 92 pattern, and this finding cannot be explained 80 78 by differences in the maturity of assets across 80 countries (Demirgüç-Kunt and Maksimovic 66 1999). Fan, Titman, and Twite (2012) also 60 Median, % found that high-income economies have higher ratios of long-term debt to total debt 40 after controlling for a number of firm char- acteristics in a sample of 39 countries cov- ering the period 1991 to 2006. Enterprise 20 Survey data suggest that firms in developing countries use less external finance to finance 0 fixed assets than those in high-income coun- Small firms (< 20) Medium firms (20–99) Large firms (100+) tries (figure 2.2), and that loan durations are High-income countries Developing countries shorter in developing countries than in high- income countries (figure 2.3). Source: Calculations for 80 countries, based on ORBIS (database), Bureau van Dijk, Brussels, https://orbis.bvdinfo.com. For a detailed data description, see Demirgüç-Kunt, Martínez Pería, and Tressel 2015a. Note: Developing countries include low- and middle-income countries. Firm size is defined based Which factors can limit firms’ access to on the number of employees. The median for each country income group and firm size category is long-term finance? calculated as follows. First, the value of long-term liabilities is averaged over 2004–11 for each firm. Then, the percentage of firms with values above zero is calculated in each country and firm Country characteristics and evidence size category. Finally, the median percentage across countries in each country income group and firm size category is calculated. The figure displays median values across countries instead of averages to lessen the importance of outliers. Macroeconomic and political risks in devel- oping countries often lead to uncertainty, which can raise the cost of long-term finance FIGURE 2.2 Share of Fixed Asset Purchases Financed from External and can make firms reluctant to invest in Sources by Country Income Group, 2006–14 fixed assets. One reason why firms use less long-term debt in developing countries is that 45 it tends to be particularly expensive in these 40 38.1 countries.6 The higher price of long-term debt 36.6 likely reflects risk aversion of lenders who re- 35 quire high returns to compensate for country 30 29.4 risk (Broner, Lorenzoni, and Schmukler Average, % 25 2013). Country risk includes macroeconomic 19.9 instability, as well as the risk that government 20 will appropriate some of the returns to proj- 15 ect investment through corruption or expro- priation. Empirical evidence suggests that 10 firms use less long-term finance in countries 5 with high or volatile inflation, with more gov- 0 ernment corruption, and with weaker prop- High-income Upper-middle- Lower-middle- Low-income erty rights protection (Demirgüç-Kunt and countries income countries income countries countries Maksimovic 1999; Beck, Demirgüç-Kunt, Source: Calculations for 123 countries, based on Enterprise Surveys (database), International and Maksimovic 2008; Fan, Titman, and Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. Twite 2012). Research on the global financial Note: The average for each country income group is calculated as follows. First, numbers are averaged using sampling weights across firms by country and survey year. Second, numbers are crisis by Demirgüç-Kunt, Martínez Pería, and averaged across survey years for each country. Finally, numbers are averaged across countries in Tressel (2015b) also illustrates the importance each income group. 46 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 2.3 Maturity of Loan or Line of Credit by Country Income that cannot be self-financed is positively re- Group, 2006–09 lated to the development of both the securities markets and the banking system but in differ- 70 ent ways, especially at lower levels of financial 58.7 development. While sustainable development 60 of both—when predicted by the underlying contracting environment—improves access to 50 financing, the development of securities mar- Average, months 40 36.8 36.3 kets is more strongly associated with long- term financing, whereas the development of 30 the banking sector is more strongly associated 23.3 with the availability of short-term financing. 20 The relationship between stock market devel- opment and improved availability of long- 10 term debt may be due to the improved quality and availability of information that accompa- 0 High-income Upper-middle- Lower-middle- Low-income nies stock market development. Demirgüç- countries income countries income countries countries Kunt, Martínez Pería, and Tressel (2015a) up- date and confirm these findings using a new Source: Calculation for 43 countries, based on Enterprise Surveys (database), International dataset (box 2.3). Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. Note: The average for each country income group is calculated as follows. First, numbers are Weakness in the contractual environment averaged using sampling weights across firms by country and survey year. Second, numbers are is an important underlying reason why long- averaged across survey years for each country. Finally, numbers are averaged across countries in each income group. term debt is less common in developing coun- tries. The disciplinary role of short-term debt of macroeconomic and financial stability for is more important in an environment with the use of long-term debt, in particular, for weaker rule of law (Diamond 2004). When privately held firms (box 2.2). lenders cannot rely on legal institutions to en- Both financial development and the relative force their claims to loan repayment, they development of banks versus capital mar- may prefer to lend short term so that the con- kets affect firms’ use of long-term finance. tinued need for renegotiation provides incen- Demirgüç-Kunt and Maksimovic (2002) show tives for borrowers to exert effort and make that the proportion of firms that grow at rates sound investments. Legal institutions that BOX 2.2 Did the Global Financial Crisis Affect Firms’ Leverage and Debt Maturity? Evidence is scant so far about the impact of the Demirgüç-Kunt, Martínez Pería, and Tressel global financial crisis on the capital structure of fi rms (2015b) explore the impact of the global financial cri- across countries. Research has focused on the fi nan- sis of 2008–09 and its aftermath on the leverage and cial stability impact of the crisis, on its real effects, debt maturity of nonfi nancial fi rms using the ORBIS and on its international transmission through banks, database. Stylized facts suggest that fi rms, especially capital markets, and international trade (Chudik and small and medium fi rms, have experienced a reduc- Fratzscher 2012; Demirgüç-Kunt, Detragiache, and tion of leverage and a shortening of debt maturity Merrouche 2013). Several country-specific papers since the crisis. have also looked at the relationship between debt The empirical analysis shows that the effect of maturity and fi xed investment during the crisis (see the crisis on fi rm leverage and debt maturity is wide- box 2.1). spread but varies across countries and types of firms. (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 47 BOX 2.2 Did the Global Financial Crisis Affect Firms’ Leverage and Debt Maturity? (continued) After controlling for firm characteristics, such as All in all, the evidence shows that periods of macro- size, profitability, asset composition, and sales turn- economic and financial instability can result in a dele- over, as well as fi rm fi xed effects, small and medium veraging of firms and can widely disrupt the provision enterprises (those with fewer than 100 employees) of long-term finance, both in high-income and devel- in lower-middle- and low-income countries saw a oping countries. In high-income countries, privately reduction in both their leverage and their debt matu- held firms were adversely affected arguably because of rity as a result of the crisis. their reliance on bank finance. Firms listed on a stock In high-income countries, firms that were not exchange, in contrast, could more easily access alterna- listed on a stock exchange reduced their leverage and tive sources of long-term debt finance—such as from debt maturity. That was particularly true in those bond markets that were thriving during the period countries in the epicenter of the global financial crisis. studied—to offset the supply effect (table B2.2.1) TABLE B2.2.1 Impact of the Global Financial Crisis on Firm Leverage, 2004–11 a. Dependent variable: Total debt to total assets High-income Upper-middle- Lower-middle-low- Regression sample All countries countries income countries income countries Average effect 2008–09 –0.00422 –0.00771** 0.00280 0.000898 Average effect 2010–11 –0.0152** –0.0199*** 0.000285 –0.0183 Nonlisted firms 2008–09 –0.0195*** –0.0194*** –0.0272*** –0.00325 Nonlisted firms 2010–11 –0.0219*** –0.0184*** –0.0478*** –0.0148 SME 2008–09 0.000399 0.00418 –0.00575 –0.0301*** SME 2010–11 0.00614 0.00896 –0.0159** –0.0390*** Observations 1,137,311 1,048,368 49,788 39,155 R-squared (within) 0.038 0.037 0.066 0.091 b. Dependent variable: Long-term debt to total assets High-income Upper-middle- Lower-middle-low- Regression sample All countries countries income countries income countries Average effect 2008–09 0.00184 0.00236 –0.00808* –0.00750 Average effect 2010–11 –0.00836* –0.00529** –0.0122* –0.0567** Nonlisted firms 2008–09 –0.00894*** –0.0107*** –0.00645 0.00310 Nonlisted firms 2010–11 –0.00642 –0.00886*** –0.0213*** 0.0331 SME 2008–09 0.000644 0.00183 0.000181 –0.0180*** SME 2010–11 0.00279 0.00311 0.00108 –0.0229*** Observations 1,137,311 1,048,368 49,788 39,155 R-squared (within) 0.076 0.080 0.070 0.055 Source: Demirgüç-Kunt, Martínez Pería, and Tressel 2015a. Note: The table shows the average effects, and, for nonlisted firms and SMEs, their specific effects. The estimation is based on a generalized least squares linear model with first order autoregressive process (Prais-Winsten estimator), with robust standard errors clustered by country-year, and includes firm fixed effects. Control variables include firm level controls (return over assets, the ratio of sales to assets, the ratio of fixed assets to total assets, and total assets), and the log of real GDP per capita. The estimation relies upon the Enterprise Survey definition of small and medium enterprise (SMEs)—firms with fewer than 100 employees. Significance level: * = 10 percent, ** = 5 percent, *** = 1 percent. a. The crisis classification is from Laeven and Valencia 2013. help lenders to back up their claims include tend to have longer debt maturities in coun- creditor rights, bankruptcy laws, and overall tries where these legal institutions are sound contract enforcement or efficiency of the legal (Demirgüç-Kunt and Maksimovic 1999; Qian system. Several researchers confirm that firms and Strahan 2007; Bae and Goyal 2009; Fan, 48 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.3 What Explains the Variation of Firm Debt Maturity across Countries? Demirgüç-Kunt, Martínez Pería, and Tressel (2015a) The authors conducted a variance decomposition use ORBIS data over the 2004–11 period covering analysis and found that country factors are more rel- more than 800,000 publicly listed and privately held evant than fi rm or sector characteristics in account- fi rms from 80 advanced and developing countries to ing for the variance of debt maturity across fi rms and document differences in fi rm capital structures and over time. to study their determinants. They show that firm At the country level, a strong and stable macroeco- debt maturity is shorter in developing countries, par- nomic environment is essential because it allows both ticularly for small fi rms (see figure 2.1). After con- lenders and borrowers to invest at longer horizons. trolling for fi rm characteristics, such as size, sectoral Second, a more developed financial system, including differences, asset composition, and profitability, they both institutions and markets, lengthens debt matu- investigate the impact of country characteristics such rity. Financial intermediaries have a comparative as macroeconomic performance and fi nancial stabil- advantage in screening and monitoring borrowers ity, development of fi nancial institutions and mar- and thus are better placed to facilitate access to long- kets, contract enforcement, and legal effi ciency, as term fi nance to worthy borrowers, particularly small well as creditor rights and investor protection. fi rms. Third, a more contestable and well-regulated The authors generally confi rm the empirical regu- banking system promotes longer-term lending, while larities found in earlier studies. For instance, after developed stock markets can lengthen debt maturity accounting for sectoral differences, firms tend to by improving price discovery and risk monitoring. match the maturity of their assets and liabilities. In Next, from the lender’s perspective, a good institu- addition, larger fi rms and fi rms that are less profit- tional environment where property rights are well able are found to use more long-term debt to finance defi ned and contracts are adequately enforced fosters their activities. the monitoring of fi rms and improves the ability to TABLE B2.3.1 Impact of Firms and Country Characteristics on Debt Maturity Dependent variable: Long-term debt to total debt (1) (2) (3) (4) (5) Firm characteristics Fixed assets to total assets 0.318*** 0.341*** 0.318*** 0.332*** 0.319*** Return over assets –0.0141 –0.0329*** –0.0366*** –0.0252*** –0.0227 Sales to total assets –0.0125*** –0.0144*** –0.0166*** –0.0132*** –0.0189*** Total assets 0.000762 0.00204*** 0.00157** 0.00221*** 0.000962** Log of GDP per capita 0.0425*** 0.0655*** 0.0690*** 0.0869*** 0.0301*** Financial development Private credit to GDP (%) 0.00161*** 0.00218*** Stock market cap. to GDP (%) 0.000677** 0.000577* Banking regulations Index of overall restrictions –0.0255** –0.0210* Institutional factors De jure index of legal rights 0.0160*** 0.0153*** Enforcing contracts (days) 0.00725*** 0.00373*** Creditor rights 0.0265* 0.0433** Investor protection –0.0262 –0.0259 Observations 4,027,551 3,932,856 3,973,469 3,433,322 2,772,311 R -squared 0.138 0.124 0.136 0.125 0.188 Source: Demirgüç-Kunt, Martínez Pería, and Tressel 2015b. Note: GDP = gross domestic product. The dependent variable is the ratio of long-term financial debt at remaining maturity to total financial debt plus trade credit liabilities. The estimation is based on a generalized least squares linear model with first order autoregressive process (Prais-Winsten estimator) with robust standard errors clustered by country-year and sector fixed effects. Regression 5 includes the inflation rate, real GDP growth, bank average regulatory capital to risk-weighted assets, and nonperforming loans ratios as additional control variables. Significance level: * = 10 percent, ** = 5 percent, *** = 1 percent. (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 49 BOX 2.3 What Explains the Variation of Firm Debt Maturity across Countries? (continued) contract. From the borrower’s perspective, a strong use of long-term debt by privately held (that is, non- environment mitigates the risks of undue expropria- listed) fi rms relative to publicly listed fi rms, and by tion of fi xed assets. Strong shareholder rights facili- small and medium fi rms relative to large fi rms. tate access to stock markets and private equity while The evidence suggests that if a firm were to strong creditor rights also support the rights of long- relocate to a more developed country with a better term debt holders to repossess collateral. contracting environment or with a more developed The results of the analysis support these argu- fi nancial sector, it may expect, other things equal, to ments. A deeper financial system, as measured by receive more long-term credit, especially if it were a bank credit to the private sector and a larger stock privately held fi rm or a small or medium fi rm. For market, lengthens debt maturity; so do stronger reg- example, based on the estimates in column (3) of ulations. The quality of legal institutions, such as the table B2.3.1, an increase of one standard deviation efficiency of the legal framework, contract enforce- in the log of GDP per capita and an index of legal ment, and strong creditor rights, are positively associ- efficiency are associated with an increase in the ratio ated with the use of long-term debt. Macroeconomic of long-term debt to total debt of, respectively, 7 shocks and fi nancial instability do indeed decrease and 9 percentage points. Reforms that sustain long- leverage and shorten maturity in some cases (see box term growth, that mitigate distortions related to the 2.2). Importantly, across fi rms, a sound legal envi- contracting environment, and that support fi nancial ronment, better contract enforcement, and a deeper development are critical to promote the use of long- banking system tend to disproportionately foster the term fi nance. Titman, and Twite 2012; Kirch and Terra They found that firms’ average loan maturity 2012; Demirgüç-Kunt, Martínez Pería, and lengthens after the introduction of a private Tressel 2015a). Evidence from India suggests credit bureau but not after the introduction that the positive relationship between con- of a public credit registry (box 2.5). tract enforcement and the use of long-term Collateral registries for movable assets can debt is indeed causal (box 2.4). help firms obtain long-term loans. Firms often Information sharing through credit bu- need to post tangible assets as collateral for reaus fosters long-term finance. Reliable long-term loans. Movable assets, such as ma- information from credit bureaus reduces in- chinery or equipment, typically account for a formation asymmetries between firms and large share of assets, particularly for micro, lenders, thereby reducing lenders’ need to small, and medium enterprises. Banks in de- monitor and discipline firm managers through veloping countries may be reluctant to accept short-term debt (Magri 2010). Cross-country movable assets, however, if these are not listed research shows a positive relationship be- in a registry. Registries for movable assets tween information sharing and the use of fulfill two key functions: they notify parties long-term finance. Using data on the maturity about the existence of a security interest in of credit to private sector firms in 74 coun- movable property (that is, existing liens), and tries during the period 1990 to 2005, Tasić they establish the priority of creditors relative and Valev (2008) found that countries with to third parties (Alvarez de la Campa 2011). a credit bureau or registry have more long- These registries can thus increase the amount term credit as a share of total credit. Martínez of assets that firms can successfully post as Pería and Singh (2014) analyzed World Bank collateral. Research using World Bank Enter- Enterprise Survey data for 33 countries over prise Survey data for 38 countries has shown the period 2002 to 2009 to refine this result. that the introduction of registries for movable 50 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.4 Contract Enforcement and Use of Long-Term Finance: Evidence from Debt Recovery Tribunals in India India provides an interesting case study for examin- ian court that had no DRT (Visaria 2009). DRTs ing the effect of contract enforcement on fi rms’ use thus improved contract enforcement for lenders in of long-term finance. While creditor and investor India. While the DRTs began to be set up soon after rights are well established on the books in India, at the law was passed, with five states receiving tribu- par with developed countries, contract enforcement nals in 1994, this process was halted by a legal chal- has been weak. Corporate bankruptcies take on lenge to the law until the implementation of DRTs average six years to resolve, during which time fi rms resumed in 1996. During the disruption, existing enjoy a complete moratorium on all debt payments DRTs continued to function, and by 2000, all Indian (Gopalan, Nanda, and Seru 2007). Despite no large states had access to a DRT. improvement in substantive law over the past two Gopalan, Mukherjee, and Singh (2014) use the decades, fi nancial depth has increased substantially variation in DRT establishment across states and from 40 percent of GDP in the 1980s to 90 percent time to measure the effect of improved contract of GDP in 2012. Inadequate enforcement due to enforcement on firms’ use of long-term finance. court delays and excessive formalism were cited as Using balance sheet data on about 6,000 Indian the reasons for the low level of lending to the private firms, they find that DRTs led to a significant sector and for widespread default in the early 1990s increase in the ratio of long-term debt to total assets. (Government of India 1991). Within three years of implementation of a DRT, that In 1993 the government of India passed a law ratio increased by 7.9 percent (going from 0.29 to establishing new specialized courts, called debt 0.31). The use of short-term debt decreased by a recovery tribunals (DRTs), to process debt recovery similar magnitude, suggesting that improvements in cases. A subsequent study found that cases were pro- contract enforcement cause fi rms to use more long- cessed much more quickly in a DRT than in a civil- term debt instead of short-term debt. BOX 2.5 The Impact of Credit Information Sharing on Loan Maturity The disciplinary role of short-term debt is particularly that introduced a CB or CR between 2002 and 2009 important when lenders have little information on (the “reformers”), as well as countries that do not borrowers that can help them assess creditworthiness have a CB or CR (“nonreformers”). Martínez Pería and predict repayment behavior. In countries where and Singh used a difference-in-difference approach, such information is more readily available through comparing fi rms in countries that introduced a CB credit information–sharing schemes, lenders may or CR to fi rms in countries that did not, before and thus be more willing to lend long term. Credit infor- after the introduction of the CB or CR; they also con- mation schemes disseminate knowledge of payment trolled for potentially confounding country and fi rm history, total debt exposure, and overall creditwor- characteristics. thiness, either through a privately held credit bureau The results reveal that after the introduction of a (CB) or publicly regulated credit registry (CR). CB, the likelihood that a fi rm has access to fi nance Using data from the World Bank Enterprise Sur- increases and loan maturity lengthens. These effects veys for 33 countries, Martínez Pería and Singh are both statistically and economically significant. (2014) analyzed the impact of introducing credit The introduction of a CB is associated with a 7 per- information–sharing schemes on fi rm fi nancing and centage point increase in the probability that a fi rm loan maturity. Their study sample includes countries will use credit and with a seven-month extension (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 51 BOX 2.5 The Impact of Credit Information Sharing on Loan Maturity (continued) in loan maturity. The fi ndings are robust to a num- lack of a significant effect. First, CRs are often used ber of empirical checks, including panel estimation for supervisory purposes and hence might have high with fi rm fi xed effects and an instrumental variables minimum loan limits. Second, they might not provide technique where the authors use existence of a CB positive and negative information, which is most use- in other countries in the region to predict the likeli- ful to fi nancial institutions. Third, to the extent that hood that a country introduces a CB. they are run by the government, in countries with The analysis fi nds no robust effect of CR reforms bad bureaucracies CRs might not function effectively on fi rm fi nancing. A number of reasons explain this and therefore might not be used often. assets is indeed associated with an increase FIGURE 2.4 Share of Fixed Asset Purchases Financed through in the maturity of bank loans to firms (Love, Internal and External Sources by Firm Size, 2006–14 Martínez Pería, and Singh, forthcoming). Leasing institutions can provide financing 100 2 5 3 for fixed assets in countries with strong con- 4 3 4 6 90 6 8 tractual environments or with specific leas- Fixed asset purchases financed, % 80 11 ing laws. Leasing is a financial arrangement 20 26 that allows firms to use and eventually own 70 fixed assets and equipment. In this arrange- 60 ment, leasing institutions purchase the equip- 50 ment and provide it to firms for a set period 40 of time. Firms make periodic payments to 74 30 66 62 the leasing institution, covering the cost of 20 the equipment and an interest rate. Leasing thus focuses on the firm’s ability to generate 10 cash flow from business operations to service 0 leasing payments rather than on its credit his- Small firms (< 20) Medium firms (20–99) Large firms (100+) tory or ability to pledge collateral. Ownership Internal Bank Trade credit Equity Other of the equipment is often transferred to the firm at the end of the lease period. Brown, Source: Calculation for 123 countries, based on Enterprise Surveys (database), International Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. Chavis, and Klapper (2010) show that close Note: The figure shows the average percentage of fixed asset purchases financed from internal to 34 percent of firms in high-income coun- sources and specific external sources: banks, trade credit, equity, and other sources. Equity finance includes owners’ contribution or new equity share issues (not retained earnings, which are tries use leasing, compared with only 6 per- counted as internal rather than external sources of finance). The “other sources” category includes cent in low-income countries. The study also issues of new debt, nonbank financial institutions, moneylenders, family, and friends. Firm size is defined based on the number of employees. Calculations of the average for each firm size use finds that a strong institutional environment sampling weights. is associated with greater use of leasing. In a country that does not have strong contract law provisions, a specific law on leasing can finance a lower percentage of purchase of help to fill legislative gaps (IFC 2009). fixed assets from external sources than do medium firms (firms with 20 to 99 employ- ees) or large firms with more than 100 em- Firm characteristics and evidence ployees (see also Beck, Demirgüç-Kunt, and Small firms use less long-term finance than Maksimovic 2008 and Knack and Xu 2015). larger firms. Figure 2.4 displays World Bank Researchers who examined balance sheet Enterprise Survey data to illustrate that small data found a similar pattern across firm size: firms (those with fewer than 20 employees) Demirgüç-Kunt and Maksimovic (1999) 52 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 examined the ratio of long-term liabilities to is discussed in more detail in chapter 3. The total assets in 30 countries, and Liu and Xu Enterprise Survey data does not include com- (2014) and Magri (2010) studied the ratio of parable data on new debt issues across coun- long-term debt to total debt in China and It- tries. Corporate debt issuance as a source of aly, respectively. Figure 2.1 shows that in both long-term finance is also covered in chapter 3. developed and developing countries, small Lenders typically have less information firms are less likely than medium or large on smaller firms than on large ones, which firms to report holding any long-term liabili- makes lenders reluctant to provide long-term ties. Long, Xu, and Yang (2014) used survey debt to small firms. Small firms are less likely data on Chinese firms and again found that to keep adequate records and accounts to large firms are more likely to report holding document their operations and performance any long-term debt. and are thus more opaque than larger firms. Differences in use of long-term finance Lenders may find it difficult to obtain reli- across firm size are driven by bank credit; the able information on these firms and may thus use of equity is limited for firms of all sizes. prefer to lend to them short term as a way to When examining the sources of external fi- monitor and discipline firm managers (Magri nance for purchases of fixed assets, Enterprise 2010).7 Recent research by Custódio, Fer- Survey data show that bank finance is the sin- reira, and Laureano (2013) on publicly listed gle most common source of external finance firms in the United States suggests that the use (see figure 2.4). Use of bank finance varies of long-term debt among the smallest firms widely across firm size, however, with small has decreased over time because of increasing firms financing 11 percent of fixed asset pur- information asymmetries between firms and chases through bank loans, compared with lenders (box 2.6). 20 percent for medium firms and 26 percent A strong legal environment can substi- for large firms. Firms of all sizes finance less tute for lack of information and can thus than 5 percent of these investments with eq- particularly facilitate access to long-term fi- uity. The use of equity finance, including pri- nance for small firms. Lenders can use short vate equity and related policy interventions, debt maturity to monitor and discipline small BOX 2.6 Information Asymmetries and Use of Long-Term Debt in the United States Custódio, Ferreira, and Laureano (2013) used data FIGURE B2.6.1 Debt Maturity of U.S. Publicly Listed from the Compustat Industrial Annual database, Firms, 1976–2008 covering close to 13,000 publicly listed firms in 70 Debt maturing in more than three years, median, % the United States to study trends in debt maturity from 1976 to 2008. The data show that the use of 60 long-term debt has declined over the period (figure B2.6.1) and that this trend differs across fi rm types. 50 The median percentage of debt maturing in more 40 than three years decreased from 53 percent in 1976 to 6 percent in 2008 for small fi rms but remained 30 comparatively constant over time for medium and 20 large fi rms. Further investigation reveals that the decrease in 10 debt maturity seems to be due to increasing informa- tion asymmetries between fi rms and lenders. Debt 0 1976 1980 1984 1988 1992 1996 2000 2004 2008 maturity fell significantly more for research and development–intensive fi rms and for fi rms with low Source: Custódio, Ferreira, and Laureano 2013, table 2. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 53 BOX 2.6 Information Asymmetries and Use of Long-Term Debt in the United States (continued) tangibility of assets. The fall in debt maturity is also Overall, the increase in information asymme- positively related to other measures of information tries seems to be driven by changing characteristics asymmetries, such as low analyst coverage and high of publicly listed fi rms. Firms that were listed in the dispersion of analyst forecasts. For example, fi rms 1980s and 1990s tended to be smaller, with low with low analyst coverage saw a drop in the median profitability and strong growth opportunities. The percentage of debt maturing in more than three number of small listed fi rms decreased again in the years from 59 percent in 1976–79 to 24 percent in 2000s, which may explain why median debt matu- 2005–08, while firms with high analyst coverage rity for all fi rms increased again over this period, as saw no corresponding drop. shown in figure B2.6.1. borrowers, but this solution can potentially FIGURE 2.5 Share of Fixed Asset Purchases Financed from External lower investment and growth for small firms Sources by Firm Size and Strength of Creditor Rights, 2006–14 that would like to obtain long-term finance. Alternatively, lenders can rely on detailed con- 40 37 tracts and legal institutions to enforce their 35 35 claims.8 In fact, stronger creditor rights may 32 32 help lengthen the maturity of debt more for 30 28 small and medium enterprises than for large 25 24 Average, % firms (Demirgüç-Kunt, Martínez Pería, and Tressel 2015a). Figure 2.5 shows that the per- 20 centage of fixed asset purchases financed from 15 external sources differs more across firm size 10 in countries with weak creditor rights than in countries with strong creditor rights. Within- 5 country research from Italy also shows that 0 firm size displays a stronger relationship with Small firms (< 20) Medium firms (20–99) Large firms (100+) debt maturity in regions with poorer legal en- Strong creditor rights Weak creditor rights forcement than in regions with strong legal enforcement (Magri 2010). Source: Calculation for 122 countries, based on Enterprise Surveys (database), International Firms with more tangible assets are more Finance Corporation and World Bank, Washington, DC, http://www.enterprisesurveys.org. Note: Firm size is defined based on the number of employees. The measure of creditor rights is likely to use long-term debt, especially in the “strength of legal rights” index from the World Bank’s Doing Business project. It measures countries with stronger creditor rights. Long- the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending. The index ranges from 0 to 12, with higher scores indicating that these term loans often require collateral, which laws are better designed to expand access to credit. Countries with weak (strong) creditor rights firms provide through tangible (or fixed) have a value of the index below (above) the median (5). The average for each bar is calculated as follows. First, numbers are averaged using sampling weights across firms by firm size group, coun- assets, such as land and buildings. Empiri- try, and survey year. Second, numbers are averaged across survey years for each firm size group cal studies consistently show that the use of and country. Finally, numbers are averaged across countries in each firm size group and creditor rights category. long-term finance is greater for firms with more tangible assets, measured by the ratio of fixed assets to total assets9 (see Demirgüç- China). Use of collateral is particularly effec- Kunt and Maksimovic 1999 across 30 coun- tive in countries with strong creditor rights tries for 1980–91; Giannetti 2003 across Eu- because these rights help creditors seize col- ropean countries; Magri 2010 for Italy; Fan, lateral in case of default. Qian and Strahan Titman, and Twite 2012 across 39 countries (2007) found that tangible assets display a for 1991–2006; Kirch and Terra 2012 for particularly strong correlation with debt ma- South America; and Liu and Xu 2014 for turity in countries with better creditor rights. 54 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Good corporate governance can help to interventions are likely to backfire (Schiantar- monitor managers and can thus allow firms elli and Sembenelli 1997; Demirgüç-Kunt and to use more long-term debt. One advantage Maksimovic 1998). of short-term debt is that its frequent need Sound legal institutions can increase firms’ for renegotiation can play a positive role in use of long-term finance. When lenders can reducing agency conflicts between manag- rely on legal institutions to enforce their ers and shareholders. However, Anginer and claims to loan repayment, they are less likely others (2015) pointed out that firms have al- to use short-term debt to discipline borrowers ternative ways of reducing agency problems. (Diamond 2004). Quick contract enforcement These authors examined whether internal through specialized debt recovery courts, in monitoring through independent boards and particular, has been shown to increase firms’ stronger shareholder protections can substi- debt maturity (Gopalan, Mukherjee, and tute for external monitoring through the use Singh 2014). Other legal institutions that help of short-term debt. Data from 7,000 firms in lenders enforce their claims include creditor 23 countries for the 2003–08 period show rights and bankruptcy laws. that firms with better corporate governance An effective corporate governance frame- use less short-term debt, at least in countries work can lessen firms’ reliance on short-term with strong investor protection laws (box debt. Corporate governance matters for loan 2.7). A related literature has studied the re- maturity because monitoring firm managers lationship between political connections and through independent boards and stronger firms’ use of long-term debt. Empirical evi- shareholder protections can substitute for dence from China suggests that political con- monitoring through the use of short-term nections have contributed to the use of long- debt. Anginer and others (2015) found that term debt (box 2.8). firms with good corporate governance use even less short-term debt after substantial cor- porate governance reforms to improve share- Policy recommendations on the use of holder rights that have been implemented in long-term finance by firms a country. A stable political and macroeconomic envi- Information sharing through credit bu- ronment is a necessary condition for long- reaus fosters long-term finance by reducing term finance to thrive. Political and macro- information asymmetries between firms and economic stability underpins the ability of lenders. Information from credit bureaus re- economic agents to predict the risks and re- duces lenders’ need to monitor and discipline turns associated with long-term investments. firm managers through short-term debt. Re- If political risk is high or the macroeconomic search shows that firms’ average loan ma- environment is unstable (if inflation is high, turity lengthens after the introduction of a for example, or volatile), firms may be reluc- private credit bureau. However, there is no tant to invest in fixed assets, and the demand relationship between the introduction of a for long-term finance is likely to be low (see public credit registry and firms’ loan maturity also Caprio and Demirgüç-Kunt 1998). (Martínez Pería and Singh 2014). Financial development matters for firms’ Collateral registries for movable assets can access to long-term finance. Firms’ ability to increase the amount of assets that firms can obtain long-term financing tends to be greater post as collateral, helping them obtain long- in countries with a contestable, well-regulated term loans. Firms often need to post tangible banking system and with developed capital assets as collateral for long-term loans, and markets (Demirgüç-Kunt and Maksimovic movable assets such as machinery or equip- 2002; Demirgüç-Kunt, Martínez Pería, and ment typically account for a large share of Tressel 2015a). Governments sometimes try firms’ assets. The introduction of registries for to extend debt maturity artificially, through movable assets is associated with an increase subsidies, directed credit, and government in the maturity of bank loans to firms (Love, banks. Evidence suggests, however, that these Martínez Pería, and Singh, forthcoming). GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 55 BOX 2.7 Short-Term Debt and Good Governance: Are They Substitutes or Complements? Short-term debt exposes fi rms to credit supply shocks ciency in bankruptcy. From the creditor’s perspective, and to liquidity risk. Academics and policy makers they are also less likely to rely on internal monitoring acknowledge that the inability of fi nancial fi rms to by boards when they have more power and therefore roll over debt to meet their obligations was one of can more effectively monitor fi rms themselves. Con- the main drivers of contagious defaults in the 2008 sistent with this view, Anginer and others fi nd that global fi nancial crisis. governance, board independence, and effective board At the same time, short-term debt can also reduce size are negatively related to short-term debt in com- potential agency conflicts between managers and mon-law countries, which tend to have fewer creditor shareholders. Short-maturity debt exposes manag- rights and greater investor protection. ers to more frequent monitoring by underwriters, Anginer and others (2015) confi rmed their cross- investors, and rating agencies before the debt is country results by examining changes around sub- issued. Because short-term debt comes up for fre- stantial corporate governance reforms implemented quent renewal, it can be a powerful tool to monitor over the sample period that strengthened shareholder management. rights. They found a significant increase in the effect Given both the negative effects of liquidity risk of governance and board independence in reducing and the positive effects of monitoring associated with the use of short-term debt after the implementation the use of short-term debt, a natural empirical ques- of reforms (figure B2.7.1). tion is whether fi rms that have alternative ways of reducing agency problems use less short-term debt. That is, does good governance act as a substitute for short-term debt in reducing agency problems within FIGURE B2.7.1 Firm Corporate Governance Reforms and Short-Term Debt a fi rm? Anginer and others (2015) used firm level data 0.32 from 23 countries during 2003–08 to investigate whether internal monitoring through independent 0.31 boards and stronger shareholder protections can substitute for external monitoring through the use 0.30 of short-term debt. They found that the relationship between debt maturity and governance depends on 0.29 Value the institutional environment that determines the extent of shareholder and creditor rights in a given 0.28 country. 0.27 Their results suggest that fi rms with strong share- holder rights and strong corporate governance pro- 0.26 visions have less to gain from the use of short-term debt. That is, good governance acts as a substitute to 0.25 short-term debt in reducing agency problems within Governance Short-term debt a fi rm. But when creditors have substantial rights in Before reform After reform bankruptcy, good governance and board indepen- Source: Anginer and others 2015. dence act as complements to short-term debt. When Note: The figure shows the average firm governance index values and short- creditors can impose substantial costs on managers term debt (ratio of debt due in one year to total debt) one year before and one year after the implementation of governance reforms that improve share- and the fi rm during distress, boards and sharehold- holder rights. The governance index is an average across multiple governance ers of well-governed fi rms employ greater amounts of attributes, with higher values indicating better governance. The economies that have implemented governance reforms during the study period include short-term debt to expose managers to external mon- Australia; Canada; Finland; Hong Kong SAR, China; Italy; Norway; and itoring by these powerful creditors, reducing ineffi- Sweden. 56 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.8 Political Connections and Firms’ Use of Long-Term Debt in China Results from two different studies suggest that polit- FIGURE B2.8.1 Use of Long-Term Debt by Chinese ical connections contribute to fi rm use of long-term Enterprises finance in China. Li, Yue, and Zhao (2009) used 70 data from the Annual Survey of Industrial Firms (ASIF), covering more than 400,000 Chinese fi rms 60 for the years 2000–04, to show that state-owned Firms that use long-term debt, % enterprises (SOEs) tend to have more long-term debt, 50 controlling for other fi rm characteristics. More recently, Liu and Xu (2014) investigated 40 the role of political connections in China using data from three complimentary data sets: the World 30 Bank Enterprise Surveys for 2000 through 2002, 20 the China Stock Market and Accounting Research (CSMAR) data set of publicly listed fi rms for 1992 10 through 2011, and ASIF for 1998 through 2007. Their study showed that SOEs have more long-term 0 debt than non-SOEs and that this difference has 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 persisted over time (figure B2.8.1). Moreover, other State-owned enterprises Private enterprises (non-SOEs) measures of political connections, such as having Source: Liu and Xu 2014. government officials facilitating government loans or Note: This figure is based on ASIF data, which covers all firms in China with being a fi rm affi liated with the central or provincial sales exceeding 5 million yuan and all state-owned enterprises (regardless of size). government, are also positively associated with the use of long-term loans. Leasing institutions can provide financing capital, and some hold illiquid assets such as for fixed assets. Leasing is a financial arrange- housing. As households age, their uncertainty ment that allows firms to use and eventually about the future declines while their prob- own fixed assets and equipment. While leas- ability of death increases. Investment and ing tends to be more prevalent in strong insti- precautionary motives are the main reasons tutional environments, countries that do not for young households to accumulate assets have strong contract laws can still develop a (Gourinchas and Parker 2002). At this stage, leasing market if they pass appropriate leas- households may demand financial products ing legislation (IFC 2009). such as bonds, mortgages, and student loans that help them to prepare for the future or to pay for lumpy purchases of physical or hu- HOUSEHOLD USE OF man capital. At later stages, precautionary LONG-TERM FINANCE motives become less important, but retire- ment motives begin to gain relevance.10 Long- Why would households use long-term term financial instruments such as annuities, financial instruments? insurance, and pensions become relevant Long-term finance can allow households to products for older households.11 achieve their changing objectives throughout their life cycle. As Campbell (2006) observed, Long-term finance and household households must plan over long but finite life-cycle risks horizons, and while they may face constraints on their ability to borrow, they have impor- Households face various life-cycle challenges tant nontraded assets such as their human such as those related to longevity, health, and GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 57 death—which can be more effectively sizable reduction of 3.2 percent in its lifetime smoothed by relying on long-term financial consumption. Deviations from the optimal instruments. In 1965, Yaari emphasized that demand are driven either by market incom- when consumers plan for the future, they pleteness, such as private information or bor- must do so without knowing how long they rowing constraints, or by suboptimal choice will live. He proved that lifetime uncertainty by households. resulted in slower consumption growth Other studies suggest that demand for throughout the life cycle. Having insurance annuities in particular remains very low against lifetime uncertainty allows consump- among households. The United Kingdom, tion growth rates to be similar to those for example, provides a good laboratory to reached under lifetime certainty. Instruments investigate this issue because it has a large such as annuities, pensions, and insurance can array of annuity market products available protect households from this uncertainty. An- to consumers. Using biannual panel sur- nuities and pensions help households prepare vey data on people age 50 and over in the for retirement and longevity risks. The sim- United Kingdom, for example, Inkmann, plest annuity contract consists of an agree- Lopes, and Michaelides (2011) examined ment between an insurance company and a voluntary participation in the annuity mar- consumer in which the consumer makes a ket. They found that only 6 percent of house- lump-sum payment to obtain in return peri- holds acquired a voluntary annuity. Acquir- odical allowances so long as he or she lives. ing an annuity is positively associated with Likewise, pensions are in general fixed trans- life expectancy, education, financial wealth, fers that begin after retirement and are paid and previous participation in the stock mar- on a regular basis until the death of the bene- ket. By calibrating a model of life-cycle sav- ficiary. Other products, such as life, health, ings and quantifying the impact of each of and long-term care insurance, transfer the these factors in the demand for annuities, cost of a potential loss, such as the death or Inkman, Lopes, and Michaelides concluded sickness of the breadwinner of the family, to a that the observed low annuity demand is third party in return for regular payments, explained by a combination of factors, known as premiums. Yaari’s work demon- spanning from access to pension plans to strated that for risk-averse households, buy- bequest motives of households that make ing annuities that were actuarially fair was an annuities a less attractive instrument. One optimal strategy as protection against the life exception to low levels of annuity demand expectancy risk. Imposing less restrictive as- is Chile, where the annuity market has been sumptions, Davidoff, Brown, and Diamond increasing during the past decades (box 2.9). (2005) reached similar conclusions. Because annuities, social security, pen- Yet in the data, household use of certain sions, and insurance can partially substitute long-term financial products is low. In the for or complement each other, it is important United States, for instance, Koijen, Van Nieu- to study these instruments jointly. Take the werburgh, and Yogo (2011) used data from example of social security and the life insur- the Health and Retirement Study to provide ance market. On the one hand, social security a full overview on how households use finan- schemes can reduce the demand for life insur- cial tools to smooth long-term health, longev- ance by allowing households to smooth health ity, and death risks. By calibrating a life-cycle and longevity risks (Lewis 1989). Using a model of insurance choice, annuities, and sample of 25 members of the Organisation for private pensions, they estimated how much Economic Co-operation and Development to it costs for a household to deviate from its study insurance markets, Li and others (2007) predicted optimal plan. Comparing the actual find a negative association between the size of demand for private insurance to the optimal the social security system and the development demand estimated in their model, the study of the insurance market. They argue that so- showed that for the median household ages cial security may crowd out the development 51 to 57, the welfare cost is equivalent to a of life insurance. On the other hand, if social 58 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.9 The Rise of the Annuity Market in Chile Chile is the first country in the world to require FIGURE B2.9.1 Fraction of Pensioners in Chile workers to have retirement products. Its retirement by Type of Retirement Product Selected products provide for regular income streams over the 100 3.2 0.0 life of beneficiaries, either in the form of life annui- Pensioners with specific retirement product, % ties or phased withdrawals keyed to life expectancy. 90 Whereas in 1985 only 3 percent of Chilean pen- 80 35.5 44.6 sioners opted for annuities, 58 percent of pension- 70 55.2 58.4 60.4 ers in 2007 had them, positioning Chile as one of 0.3 60 the countries with the highest levels of annuitization 3.6 in the world (figure B2.9.1). As Rocha and Rudolph 50 96.8 1.9 (2010) discuss, several factors have helped raise the 40 1.2 1.4 demand for annuities in the country. 30 64.2 One main driver was the national pension reform 51.8 20 42.9 38.4 40.2 that took place in 1981 when Chile replaced its old public pay-as-you-go system with a new private, 10 fully funded system operating on a defi ned contribu- 0 1985 1990 1995 2000 2005 2007 tion basis. Under the new system, retirement contri- butions are mandatory for all workers and consist Phased withdrawals Temporary withdrawals Annuities of 10 percent of workers’ wages, which accumulate Source: Chilean Superintendency of Pensions, Santiago, http://www in individual accounts. When they retire, workers .spensiones.cl. decide whether to use their accumulated contribu- tions to purchase an annuity from an insurance com- decline over time, they can eventually run out, in pany for phased withdrawals (PWs) from a pension which case the holder receives a minimum payment fund, or temporary withdrawals (TWs) combined from the government (the PBS level). TWs can offer with a deferred annuity. Restrictions on lump-sum larger payouts in the early years, combined with payments have expanded the demand for all retire- longevity insurance when the deferred annuity is ment instruments, including annuities. received. Each of these retirement products appeals to Given the relatively low value of the PBS and the workers with different needs and risk profi les. While lack of a universal public pension in Chile, medium- annuities provide protection against various risks and high-income retirees have favored annuitization such as inflation, investment, and longevity, in gen- over the other phased withdrawal instruments. This eral these instruments do not allow for bequests. inclination toward annuities has been reinforced by On the other hand, PWs not only allow bequests strong marketing strategies of life insurance compa- but also allow their holders to share capital market nies. Low-income workers with benefits close to the gains. However, they do not protect holders against PBS level fi nd PWs more attractive because they can investment and longevity risks. Since PW payments enjoy high returns in the early stages of retirement. security benefits finish when the wage earner Long-term financial instruments for long-term dies and are not replaced by survivorship ben- investments by households efits, social security represents a household asset that increases family consumption only As is the case with firms, households can so long as the wage earner survives. In those make use of long-term financial instruments cases, social security expenditures may be to make lumpy purchases or investments. positively correlated with life insurance con- By spreading out payments over time, long- sumption (Browne and Kim 1993). Although term finance products, such as mortgages or the impact of one market on the other may be student loans, can help households afford in- ambiguous, these linkages are important to vestments in physical or human capital or the consider when studying these products. purchase of housing and other durable goods. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 59 Investment in human capital is very sen- effect, a more relevant determinant of college sitive to the development of financial mar- enrollment is the lack of long-term invest- kets. Because returns to human capital are ments that begin when children are in their commonly observed over longer periods, formative years and that continue as they age. long-term financial instruments such as stu- The authors suggest that most of the fam- dent loans are effective tools to make this ily income gap in enrollment is explained by investment affordable. Human capital differs these long-term factors: families with higher substantially from physical capital in that it levels of resources produce children who are cannot be sold, its investments are irreversible, better able to perform in school and to take and people cannot use it as collateral because advantage of higher education. Carneiro and it cannot be repossessed. Importantly, invest- Heckman suggest that policies aimed at subsi- ment in human capital generally takes place at dizing tuition or supplements to families with a critical age and thus cannot be postponed. adolescent children will not solve these prob- Financial instruments that fit all these charac- lems. They argue that policies that allow fam- teristics are more likely to be found in more- ilies to invest in their children’s education over developed financial markets. A cross-country the years will be a more effective avenue for study on a set of Latin American countries increasing college enrollment in the long run. found that even after controlling for vari- ous factors, there is a very strong correlation Long-term finance and housing between the development of credit markets and school enrollment (Flug, Spilimbergo, and In high-income countries, housing is often the Wachtenheim 1998). However, this finding largest and most important asset in house- should be regarded only as a correlation, since hold portfolios. Because most houses are af- other factors may be driving this result. fordable only if payments can be spread out Even though the positive returns on invest- over time, the availability of housing finance ment in human capital are constantly docu- is essential. mented in the literature, in many countries Besides being a durable good, housing is an schooling attainment still lags significantly investment that can substantially alter house- across family income. As box 2.10 discusses, holds’ financial portfolios. Recent work by various studies in developing countries show Chetty and Szeidl (2010) identified the effects how underinvestment in children’s education of housing on portfolio choice by distinguish- and child labor can arise because of imperfect ing the effect of property value from that of capital markets and the lack of credit markets home equity wealth on portfolio choice for (Jacoby and Skoufias 1997; Baland and Rob- a sample of 60,000 households in the United inson 2000; Ranjan 2001). Ranjan (1999) States. Since both financial portfolios and theorized that if poor households could bor- housing are decisions that households make row sufficiently against the future earnings of using information that cannot always be ob- children, they would be willing to send their served, such as risk preferences, Chetty and children to school instead of sending them to Szeidl used an instrumental variables strategy work. In the absence of credit opportunities, that isolates variation in both mortgage debt it is too costly for poor households to send and home equity wealth. This strategy exploits children to school. the differences across housing markets in av- Even in high-income countries, the gap in erage housing prices and housing supply elas- schooling attainment across income is large. ticities. On the one hand, the authors found Using data from the United States, Carneiro that, holding wealth fixed, higher mortgage and Heckman (2002) explored two factors debt causes households to participate less in explaining the gap in college attainment: the stock market, both in the extensive and in- short-term credit constraints at the time of tensive margins. On the other hand, increases schooling attainment and credit constraints in home equity while holding mortgage debt spanning longer terms. They argue that al- constant raise households’ participation in the though short-term credit constraints have an stock market through a wealth effect.12 60 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 2.10 Sensitivity of Human Capital Investment to the Development of Credit Markets Since the 1990s a growing literature has examined and investments in human capital. They focused on the role of borrowing constraints on human capital how child school attendance in rural India responds accumulation and child labor in developing coun- to aggregate and idiosyncratic income shocks. Their tries. Empirical and theoretical evidence suggests fi ndings suggest that fluctuating attendance results that releasing households’ credit constraints can have from household attempts to self-insure against important consequences for investments in children’s income shocks, but that these fluctuations on average human capital. result in very modest losses of human capital. Jacoby (1994) was one of the first to examine A similar study by Beegle, Dehejia, and Gatti empirically how constraints on borrowing altered (2003) examined the relationship between child school attendance; his focus was on children in Peru. labor, income shocks, and credit constraints in Tan- He developed a human capital investment model of zania. They hypothesized that rural households in the household in which credit is rationed. The stron- developing countries use child labor as a mecha- gest implication of the model is that the decision to nism to smooth their consumption, a practice that invest in human capital is independent of parental can have a substantial negative impact on the future income only for households that are not credit con- income of households. They found that crop shocks strained. If households are constrained in their ability lead to more child labor and that households that to borrow, then this separation between consumption own durable assets are better able to offset such and human capital decisions breaks down, and lower- shocks. Their results suggest that child labor is influ- income households will sacrifice investment in human enced by borrowing constraints and that more devel- capital to achieve higher consumption. When testing oped credit markets can have important implications this prediction in the data, Jacoby found that for the in the human capital investment undertaken by poor sample of households that had access to credit, higher households. family income did not increase school progress. In In South Africa, Edmonds (2006) compared contrast, for the sample of credit-constrained house- schooling attainment and child labor between two holds, higher income increased school attendance. groups: families that are currently eligible for a pen- Jacoby’s results suggest that policies such as stu- sion and families who know they will be eligible to dent loans or stipends may be effective in increasing receive the pension in the next years. He found that educational achievement of children from credit- children from families who receive the pension expe- constrained households. Such policies, however, rienced large increases in their schooling and declines should be carefully targeted because they would only in total hours worked, while children from the other affect the schooling behavior of children from credit- group did not experience any change. His fi ndings constrained households. are consistent with the presence of credit constraints Other work has reached similar conclusions. and their effects on forcing families to opt for less Jacoby and Skoufias (1997), for instance, studied the schooling for children than they would choose absent relationship between incomplete fi nancial markets the constraints. Housing can also allow households to is scarce nationally, regional consumption is relax their credit constraints by serving as col- about twice as sensitive to income shocks. lateral to access credit markets. As collateral, Higher sensitivity is also present in regions housing helps households in various ways, with lower housing collateral. The authors from facilitating consumption risk sharing calibrated a general equilibrium model that to altering labor and investment decisions of they then compared to the data trends. households. Lustig and Van Nieuwerburgh As collateral, housing may also allow (2004) found that housing collateral relieves households to benefit from better investment household borrowing constraints and thus fa- opportunities. Adelino, Schoar, and Severino cilitates consumption risk sharing. They find (2013) showed that, separate from these chan- that in periods when U.S. housing collateral nels and aggregate demand effects, housing GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 61 collateral also facilitates business start-ups FIGURE 2.6 U.S. Treasury Yield Curve and self-employment in the United States. They found that during the U.S. housing price 5 boom of 2002–07, areas where housing prices increased experienced a significant increase in 4 small business openings and a rise in the num- ber of people employed in small establish- 3 Yield, % ments, compared with areas that did not see changes in their housing prices. Importantly, 2 large establishments in areas with rising hous- ing prices did not change. Research from other countries supports 1 these latter findings. Studies from high-income and developing countries consistently find 0 that credit constraints at the household level th s s r rs rs rs rs s s s ea th th ar ar ar ea ea ea ea on on on ye ye ye 1y 2y 3y 5y 7y 1m matter for the creation of new businesses 3m 6m 10 20 30 (Evans and Jovanovic 1989; Holtz-Eakin, 2008 2014 Joulfaian, and Rosen 1994; Gentry and Hub- bard 2004; Cagetti and De Nardi 2006). Source: U.S. Department of the Treasury, Washington, DC, http://www.treasury.gov. Note: The curves compare the yields of short-term Treasury bills with long-term Treasury notes and Wang (2012) analyzed the effects of a reform bonds. Treasury bills are issued in terms of 1, 3, and 6 months. Treasury notes are issued in terms of employer-provided housing in China on la- of 1 to 10 years. Treasury bonds are issued in terms of 20 and 30 years. bor market decisions. The reform offered state employees who were provided rental housing from their employers the opportunity to pur- figure, the 2014 yield curve reflects a lower chase their homes at subsidized prices. The premium for saving long term than in 2008. empirical findings suggested that the probabil- In recent years the term premium has de- ity that former state-housing residents entered clined, and research suggests that the decline into self-employment increased by 2 to 8 per- is associated with less volatile macroeco- centage points, representing a doubling of the nomic conditions. Various studies argue that base rate of self-employment in the treatment the term premium mainly reflects uncertainty group. The data also indicated an increase in about future inflation: the higher future uncer- the rate of job changes among former resi- tainty is, the more investors will need to be dents who now owned their homes, as well as compensated when saving long term. Mea- a substantial growth in the amount of busi- sures that reduce this uncertainty also reduce ness capital that they owned. the risks for long-term investors, as well as the compensation from long-term saving instru- ments. While most of the existing literature Long-term savers and the term premium on the estimation of the term premium has Long-term assets also allow households who focused on the United States, Wright (2011) save to accumulate and reap important term constructed a panel dataset of nominal zero- premiums, but at the cost of incurring more coupon government bond yields for 10 high- risk (Merton 1971, 1973). Because long-term income countries.13 He estimated and com- savings typically carry more risk than short- pared the term premium for each country and term savings, riskier investments need to offer found that over the past 20 years, the term higher expected returns to attract investors premium had declined for all 10 countries. than do safer ones. As the U.S. Treasury yield His results are consistent with inflation uncer- curve shows (figure 2.6), the yield that inves- tainty being an important component of the tors expect to obtain from bonds of equal term premium: the largest declines occurred quality but different maturities increases with in countries that had made radical changes the maturity of the bond. As noted in the in their monetary policy frameworks, such as 62 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 introducing inflation targeting and increasing prime mortgage crisis. As discussed in previ- the independence of their central banks. ous Global Financial Development Reports (World Bank 2013a, 2014), a key contribut- ing factor to the subprime mortgage crisis in Risks associated with household use of the United States was the overextension of long-term finance credit to noncreditworthy borrowers and the Borrower and saver households can benefit relaxation in mortgage-underwriting stan- from different long-term finance products, dards. As a consequence, many homeowners but the use of these products can also entail took out mortgages that exceeded their means substantial risks. Empirical evidence shows of repayment. Using a random sample of in- that vulnerable consumers may buy financial dividual credit files from a national consumer instruments that they do not understand and credit bureau agency, Mian and Sufi (2009) that they are unable to service. A growing examined the credit behavior of 70,000 literature on these issues suggests that behav- homeowners in the United States from 1997 ioral biases or low levels of financial educa- to 2008. They found that younger homeown- tion, financial awareness, consumer protec- ers with high rates of credit card use and low tion, and product transparency may restrain credit scores at the beginning of the sample households from using financial products or had the strongest tendency to borrow against from managing them correctly (Hastings and increases in their home equity. Mian and Sufi Tejeda-Ashton 2008; Lara-Ibarra 2011; Cull estimated that home-equity-based borrowing and others 2014a, 2014b). from 2002 to 2006 accounted for at least 34 Financial providers may have incentives percent of new defaults from 2006 to 2008. to exploit shortcomings in understanding, Studies in various countries document that if which can lead to substantial error in financ- housing prices strongly affect the borrowing ing choices. For example, lack of product behavior of homeowners, drastic movements transparency in Chile allowed brokers to sell in the housing market may have real effects annuities from insurance companies that of- on the economy through consumption and fered them the highest commissions but that mortgage defaults (box 2.11). were not necessarily the best product for the retirees. Even though retiring workers were Indicators and determinants of the use required to obtain at least six annuity quotes of long-term finance by households from the market before making their selec- tion, brokers were still able to direct custom- Over the past 50 years, the development of ers to insurance companies with the highest financial systems around the world has ex- commissions. In 2004 the Chilean govern- panded substantially in various ways. That ment introduced an electronic quotation development has not been uniform, however. system for annuities to address this problem. In middle- and low-income countries, the The system increased the quality of informa- deepening of the financial system has not been tion available to consumers because it en- as fast as in upper-income countries (Beck, abled direct access to a full range of annuity Demirgüç-Kunt, and Levine 2010). The evi- quotations. Over the years, it has increased dence on long-term household finance shows transparency and price competition and has a similar pattern: its use remains substantially successfully reduced the influence of brokers higher among high-income countries (Hono- in the selection of annuities. Latest indicators han 2008; Badev and others 2014). suggest that the system has helped retiring Recent data compilation efforts have led to workers to select annuities based on the best the development of new indicators that mea- quotes (Rocha and Rudolph 2010). sure the use of long-term finance by house- Government policies to promote greater holds, both within and across countries. Spe- household participation in long-term finance cifically, we present a series of indicators that may backfire, as happened in the U.S. sub- proxy for the development of insurance and GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 63 BOX 2.11 Housing Booms and Busts The steep increase in mortgage default rates in the tion of exotic mortgage products as the key triggers United States led to one of the most severe fi nancial of the unusual subprime mortgage growth (Glick and crises in the country (figure B2.11.1). Mian and Sufi Lansing 2010; Rajan 2010; World Bank 2014). (2009) showed that the rise in mortgage defaults in As Glick and Lansing (2010) noted, various 2007 was disproportionally higher in counties with high-income countries (such as Ireland, Spain, and large shares of subprime borrowers as of 1996. Inter- the United Kingdom) experienced a similar housing estingly, with the rise in securitization of subprime boom-bust cycle. Data from the Organisation for mortgages (from 2002 to 2005), mortgage credit Economic Co-operation and Development reveals increased at unusually high rates in subprime ZIP that during the precrisis period, household leverage codes. increased substantially in several European coun- Their study suggests that to understand the mort- tries. Housing prices in these same countries were gage default crisis, it is crucial to identify the factors also more likely to increase over the same period. In that led to the disproportionate expansion of mort- the crisis period, once housing prices began falling, gage credit to subprime counties all across the United consumption declined significantly. This evidence States. Various studies point to expansionary mort- suggests that the crisis was more severe in countries gage credit policies, the weakening of lending stan- where prior growth was caused by an unsustainable dards associated with securitization, and a prolifera- borrowing trend. FIGURE B2.11.1 Delinquency Rates on Real Estate Residential Loans at U.S. Commercial Banks, 1991–2014 12 10 8 Delinquency rate, % 6 4 2 0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: Federal Financial Institutions Examination Council (FFIEC) Consolidated Reports of Condition and Income (1985–2000: FFIEC 031 through 034; 2001–14: FFIEC 031 and 041). Note: Delinquent loans are those past due 30 days or more and still accruing interest, as well as those in nonaccrual status. They are measured as a percentage of end-of-period loans. mortgage markets across countries. Making as income and education.14 Based on several use of information collected by the Global studies, we then discuss what the main driv- Findex (Demirgüç-Kunt and Klapper 2012), ers of the development of long-term financial we provide a series of stylized facts that re- markets are. late the usage of various long-term financial Indicators of the development of insurance products with household characteristics, such markets show that high-income countries have 64 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 larger insurance sectors relative to gross do- tive to its GDP and reflects the penetration of mestic product (GDP) than developing coun- insurance markets in that country. The second tries. To study the development of the insur- indicator is the ratio of total assets of insur- ance sector, Feyen, Lester, and Rocha (2011) ance companies to GDP. As figure 2.7 shows, compiled annual data from various sources these indicators suggest that insurance mar- for 90 countries during the 2000–08 period. kets in developing countries are still substan- They used two indicators that measure the tially underdeveloped. Moreover, regions such importance of the insurance market in a given as the Middle East and North Africa have the country. One corresponds to the gross volume least developed insurance markets. of life insurance premiums of a country rela- Stable and sound macroeconomic condi- tions are associated with more-developed in- surance markets. Identifying in a clean way FIGURE 2.7 Penetration and Size of Insurance Markets across Regions, 2000–08 those factors that drive the development of insurance markets is very challenging with 4 cross-country data because omitted vari- ables or reverse causality issues are difficult 3 to account for. Nevertheless, Feyen, Lester, 2 and Rocha (2011) found suggestive evidence that at the macroeconomic level the develop- 1 ment of the insurance sector is strongly and positively associated with income and infla- Value 0 tion. This association seems intuitive: because –1 insurance is a normal good, higher income levels raise households’ demand for life in- –2 surance products (as figure 2.8 indicates). –3 Conversely, as inflation increases, the value of insurance policies declines, making insurance –4 products less attractive for households. These Europe and Latin Middle East South Sub-Saharan High- Central Asia America and Asia Africa income findings are also present in related literature and the North Africa countries (Browne and Kim 1993; Beck and Webb Caribbean 2003; Li and others 2007). Gross volume of life insurance premiums to GDP, log Population and population density, reli- Total assets of insurance companies to GDP, log gion, and the institutional environment also influence the size of insurance markets. Popu- Source: Feyen, Lester, and Rocha 2011. lation and population density, which proxy not only for larger markets but also for larger FIGURE 2.8 Volume of Life Insurance Premiums and Income pools to share risks, are important predictors of the size of the insurance sector (Feyen, Les- 4 ter, and Rocha 2011). Although in theory ed- ucation levels should also positively influence Gross volume of life insurance 2 the demand for insurance, only some empiri- premiums, % of GDP, log cal studies have found a positive and signifi- 0 cant association between education levels and the development of insurance products. –2 Religion is a relevant variable; Muslim coun- –4 tries have weaker insurance sectors, which suggests that the insurance products offered –6 there might not conform to the beliefs of the 5 6 7 8 9 10 11 citizens. Finally, at the institutional level, pri- GDP per capita, log vate competitors, solid legal frameworks, and Source: Feyen, Lester, and Rocha 2011. more-developed credit and bond markets are GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 65 positively associated with the development of Although deeper mortgage markets also the insurance sector. reach a larger fraction of the population, Recent efforts to compile data on housing loan-to-value (LTV) ratios are not associated finance provide new insights on the size and with more-developed mortgage markets. The penetration of mortgage markets around the data suggest that, even though some coun- world. The data set, compiled by Badev and tries may have greater mortgage depth than others (2014), collected information for up to penetration (or the opposite), the correlation 148 countries from the World Bank Global between these two indicators is high. Interest- Findex, the Housing Finance Information ingly, data from HOFINET shows that the Network (HOFINET), and each country’s typical LTV ratio at origination is not strongly central bank, financial regulatory or oversight associated with either housing finance penetra- agency, or housing finance agency.15 With this tion or depth (figure 2.10). Countries such as data, the researchers constructed two indica- Mexico or Georgia, where both the mortgage tors for each country in their sample. The first depth and penetration indicators are low, have indicator is mortgage depth, defined as the LTV ratios as large as countries with the high- outstanding mortgage debt of a country rela- est mortgage development indicators. This tive to its GDP. The second indicator is mort- finding suggests that the barriers of the mort- gage penetration, or the percentage of the gage market lie in its extensive rather than in adult population with an outstanding loan to the intensive margin. Conditional on having a purchase a home. mortgage, the intensive margin across coun- Similar to the insurance markets, these tries is relatively similar. two indicators show that housing finance So what are the factors at the macroeco- markets are severely limited in many coun- nomic level that determine the development of tries. Mortgage depth is less than 10 percent mortgage markets across countries and over of GDP for most countries in the sample, and time? Mortgage depth increases only at very only a few countries, such as Denmark, the high levels of income and decreases in the same Netherlands, and Switzerland, have mort- manner with inflation (figure 2.11). Badev and gage debt higher than 80 percent of GDP. others (2014) document this finding both for Similarly, in half the countries, less than 4 mortgage depth and for housing loan penetra- percent of adults have an outstanding loan to tion: across low- and middle-income coun- purchase a house (figure 2.9). tries, mortgage depth and penetration are low FIGURE 2.9 Frequency of Depth and Penetration of Mortgage Markets a. Mortgage debt b. Housing loan penetration 60 60 50 50 Countries from sample, % Countries from sample, % 40 40 30 30 20 20 10 10 0 0 0 10 20 30 40 50 60 70 80 90 100 0 5 10 15 20 25 30 35 40 45 50 55 Mortgage debt, % of GDP Housing loan penetration, % Source: Badev and others 2014. 66 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 2.10 Mortgage Depth and Typical First Mortgage Loan-to- contracts such as mortgages. For a different Value Ratios at Origination sample of countries, Warnock and Warnock (2008) have presented evidence suggesting 100 that mortgage terms are less favorable to the 90 borrower in developing countries than in 80 high-income countries. The typical mortgage 70 in developing countries is more likely to ma- ture faster and to have a variable, rather than Loan-to-value, % 60 a fixed, interest rate. 50 Even after controlling for macroeconomic 40 conditions, other policy factors remain strongly 30 related to the development of mortgage mar- 20 kets. Cross-country regressions conducted by 10 Badev and others (2014) suggest that govern- 0 ment-owned banks and regulatory restrictions 0 20 40 60 80 100 120 on banks’ real estate activities are negatively Outstanding amount of home mortgage loans, % of GDP associated with the depth and penetration of mortgage systems. In contrast, stronger credi- Source: Housing Finance Information Network (HOFINET), University of Pennsylvania, Philadelphia, PA, http://www.hofinet.org. tor rights and more effective construction permit procedures have a positive association with mortgage market development. Findings and start increasing in an exponential manner from Warnock and Warnock (2008) coincide only at very high-income levels. with those from Badev and others (2014) in This pattern suggests that, in contrast to showing a strong positive association between the banking system, the mortgage sector tends the development of housing finance and legal to develop only when countries reach higher- rights for borrowers and lenders (measured by income levels. Likewise, at medium and high collateral and bankruptcy laws).16 inflation levels, these indicators remain low Importantly, a deeper insurance sector and and only increase at low inflation levels. As more liquid stock markets are also positively the authors indicate, this relationship is con- linked to stronger mortgage markets. This sistent with previous findings suggesting that finding suggests that housing finance grows as stable macroeconomic conditions are a criti- long-term funding sources such as the insur- cal element for the development of long-term ance sector also develop.17 FIGURE 2.11 Relation of Mortgage Debt to Income and Inflation a. Inflation b. GDP per capita 120 120 mortgage as loans, % of GDP Outstanding amount of home mortgage as loans, % of GDP Outstanding amount of home 100 100 80 80 60 60 40 40 20 20 0 0 –5 0 5 10 15 20 25 30 35 5 6 7 8 9 10 11 12 Inflation, % GDP per capita, log Source: Housing Finance Information Network (HOFINET), University of Pennsylvania, Philadelphia, PA, http://www.hofinet.org. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 67 A further benchmarking exercise identi- The development and use of long-term fies whether a country’s mortgage market is finance varies substantially not only from below or beyond its predicted frontier. Badev country to country but also within countries. and others (2014) used regression analysis to Among other things, data from Global Fin- determine how much country factors (such dex provide information on the fraction of as GDP, population size, and density) can ac- adults in a given country who have a mort- count for the indicators of mortgage depth gage, together with other sociodemographic and penetration of a given country. This ex- information. These data allow us to highlight ercise, explained in more detail in box 2.12, the main household characteristics associated allows the authors to predict what the con- with the use of this long-term finance product. strained optimum for the mortgage market of Within a country, income is a major factor a country should be. behind the variation in the use of mortgages.18 BOX 2.12 Benchmarking Housing Finance Badev and others (2014) conducted an empirical market of a country should be. Figure B2.12.1 shows exercise to benchmark how large a country’s mort- the housing fi nance gaps, or the difference between gage market could be and then compare that to its the predicted and the current values of mortgage current size. This benchmarking exercise identified debt penetration and depth. A positive gap cor- countries where the size of the mortgage market responds to cases in which the predicted frontier exceeded expectations because of a housing boom, is above the actual size of the mortgage market, for instance, government subsidies, or some other whereas a negative gap corresponds to countries unusual factor that is not likely to be sustainable. whose actual mortgage market overpasses the pre- The exercise also identified countries where housing dicted frontier. markets were below expectations because of poor In the East Asia and Pacific and Middle East competition or regulatory restrictions. and North Africa regions, mortgage debt is above By regressing the indicators of mortgage depth its predicted value. Given their country characteris- and penetration on country factors such as GDP, tics, Europe and Central Asia, South Asia, and Sub- population size and density, and other variables Saharan Africa have mortgage markets roughly the proxying country demographic and economic char- same size as their predicted frontiers. Mortgage mar- acteristics, Badev and others were able to predict kets in Latin America, on the other hand, lie below what the constrained optimum for the mortgage their predicted values. FIGURE B2.12.1 Housing Finance Gaps on Mortgage Penetration and Depth a. Mortgage depth b. Mortgage penetration 0.6 0.2 0.15 0.4 Housing finance gap on Housing finance gap on mortgage penetration 0.1 mortgage depth 0.2 0.05 0 0 –0.05 –0.2 –0.1 –0.4 –0.15 –0.2 –0.6 –0.25 –0.8 –0.3 4 5 6 7 8 9 10 11 12 4 5 6 7 8 9 10 11 12 GDP per capita, log GDP per capita, log Source: Badev and others 2014. 68 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 2.12 Adults with a Mortgage by Income and Region One reason for lower saving rates among lower-income households is that high yield 35 comes with high risk, and poorer households 30 are less willing to take on the extra risks. Zimmerman and Carter (2003) developed a Adults with a mortgage, % 25 model of asset portfolio decisions in an envi- 20 ronment characterized by low income, risks, and incomplete markets, and they found that 15 the cost and ability to deal with risk differs 10 between rich and poor households. In their 5 model, heterogeneous households select be- tween two types of assets. One corresponds 0 to productive, high-yield assets with variable Poorest Second Middle Fourth Richest quintile quintile quintile quintile quintile returns, such as land or livestock. The other East Asia and Pacific Europe and Central Asia includes nonproductive assets with low but Latin America and the Middle East and North Africa stable yields, such as cash, stored grain, or Caribbean High-income countries jewelry. Because the threat of approaching Sub-Saharan Africa South Asia the consumption floor is substantially higher Source: Global Financial Inclusion (Global Findex) Database, World Bank, Washington, DC, http:// for poor households, poorer consumers pur- www.worldbank.org/globalfindex. sue more conservative but less remunerative investment strategies. Rather than trying to smooth their consumption, poorer house- Higher-income individuals are more likely to holds try to smooth their asset holdings. As have a mortgage. Moreover, cross-region com- a result, not only do the poor forgo the re- parisons show that the poorest individuals in turns from high-yield investments, but the high-income countries are more likely to have differences in types of investment exacerbate a mortgage than the richest individuals in low- inequality between poor and rich households. income countries (figure 2.12). In addition, In sum, income and education at the indi- although income is almost linearly related to vidual level, together with income, macroeco- the probability of owning a mortgage in high- nomic stability, and legal institutions at the income countries, in many developing coun- country level, are important determinants of tries the shape of this relationship is more ex- household use of long-term finance. Higher- ponential, suggesting that only individuals at income and more-educated individuals are relative high levels of income have mortgages. more likely to use long-term financial instru- While detailed information on the usage of ments as either savers or borrowers. Even af- long-term savings products across countries ter controlling for individual characteristics, is not available, information collected in the however, higher-income countries with stable Global Findex helps to draw some insights on macroeconomic environments, low inflation, the saving patterns of households. When asked and sound legal systems have more developed if they save for the future, either to afford a long-term finance markets. major purchase or expense or to prepare for an emergency, on average between 28 and 50 per- How education and cognitive biases cent of adults in developing and high-income affect the use of long-term finance countries respectively report doing so. In high- income countries, most adults with tertiary Lack of financial awareness, financial literacy, education or higher save regardless of their and product transparency constrain house- income level. In contrast, only at the highest holds from using financial products or from education and income levels do more than 50 managing them correctly. Lusardi and Mitch- percent of adults in developing countries save. ell (2006) included a financial literacy module Box 2.13 presents further details on how poor in the 2004 Health and Retirement Study to households in developing countries save. better understand how people in the United GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 69 BOX 2.13 How do the Poor in Developing Countries Save? Do the poor in developing countries demand sav- credit associations or deposit collectors, who charge ings products? Several studies have shown that poor high fees for holding savings (Rutherford 2000). households are willing to pay high prices for savings As several randomized experiments have shown, products that entail little risk, reflecting the high households in developing countries would save more value these households place on being able to save if they were given access to more savings products (Wright and Mutesasira 2001). that better fit their needs (Dupas and Robinson Banerjee and Duflo (2007) analyzed household 2009; Brune, Goldberg, and Yang 2011; Dupas and surveys conducted in 13 developing countries to others 2014). Like wealthier households, the poor document the lives of low-income households. Two also need to save to prepare for life-cycle challenges, groups were studied: the extremely poor, compris- to protect against emergencies, and to accumulate ing households whose consumption per capita is assets. Because their income tends to come in small less than $1.08 a day; and the poor, who live on installments, they need products that allow them to less than $2.16 a day. The authors found that low- make small deposits and large withdrawals while income households rarely participated in formal offering them safe and convenient places to keep savings and credit markets. For instance, credit their money and structure their many small deposits. activity was high across the surveys, but very few More and more, practitioners are engaging in of the poor households got loans from a formal various innovations that take these principles to provider. Most borrowed from relatives, shopkeep- the field. In Bangladesh, for example, the Grameen ers, and neighbors, a practice that tends to be more Bank launched a pension product, called the Gra- unreliable and expensive. Their savings patterns are meen Pension Savings, that requires clients to make no different. fi xed monthly deposits. After five or ten years, cli- The poor who do save, save informally. In part, ents receive their accumulated savings with interest. this is because the range of products available for Although this product is intended to prepare house- savings is limited. In developed countries, even poor holds for their old age, these accounts are also being households may have access to basic products such used to save for housing improvements and other as savings accounts or even more complex products commitments (Karlan and Morduch 2010). While such as savings bonds or certificates of deposit. more evidence is needed, these types of savings prod- These products are often not available to poor ucts seem to be increasingly popular in Bangladesh. households in developing countries, as Karlan and In a recent survey collected among 2,100 garment Morduch (2010) discuss. Those who save therefore workers, about one-fi fth reported owning a fi xed- often invest in risky assets such as livestock or use term savings account with a bank (Breza, Kanz, and informal arrangements such as rotating savings and Klapper 2015). States plan for retirement. Financial illiteracy Lack of product transparency makes it more was found to be widespread among respon- complicated for customers to make informed dents who were older, less educated, female, decisions. or a minority. The authors found a high cor- Lack of understanding of financial prod- relation between financial knowledge and ucts can lead to costly mistakes. This is espe- planning for the future. Some other findings cially true for mortgage contracts, which are were more surprising: people with low levels among the most important financial contracts of financial literacy thought less about retire- that households sign. Several studies find that ment and most of them had not planned for households, particularly less-educated and retirement at all. Fewer than one-third of lower-income ones, commonly misunderstand the respondents who were 50 years or older mortgage contracts. By comparing lender- had a retirement plan. Moreover, financial reported data with household-reported in- products, particularly long-term ones, are formation, Bucks and Pence (2006) found complex and can be difficult to understand. that households that have adjustable rate 70 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 mortgages, which tend to be more com- financial choices allows for better tailored plex mortgage contracts, underestimate the and more effective policies, such as financial amount by which their interest rates could education interventions, automatic enrollment change and in general are not familiar with systems, or electronic reminders. Box 2.14 the terms of their contract. Campbell (2006) summarizes recent research to convey experi- also showed that in the United States, many ential, rather than conventional, learning. households fail to refinance their mortgages Even though financial education matters, during periods of declining interest rates. evidence shows that delivering it effectively Recent literature on psychology and fi- is challenging. Growing research efforts that nance also highlights the role of behavioral randomize the provision of financial educa- biases in shaping households’ financial deci- tion help to show whether financial educa- sions. Stango and Zinman (2009) found that tion can be improved and to identify the most individuals display different biases when sav- effective delivery mechanisms for doing so. ing and borrowing. On the one hand, people While these studies vary substantially in terms tend to underestimate the future value of their of the setting, the targeted groups, or the savings given their present value, maturity, duration of the intervention, there are some and rate of return. On the other hand, bor- lessons to be learned. rowers underestimate the interest rate of a For example, Bruhn, Lara-Ibarra, and loan given a principal, monthly payment, and McKenzie (2013) conducted a randomized maturity. The authors reported that, even af- experiment providing financial education in ter conditioning for various demographic and Brazilian high schools. School-based inter- income factors, these biases are strongly cor- ventions offer the opportunity for repeated related with more borrowing, less saving, and instructions and exercises that may facilitate a preference for short-term installment debt sustained learning of concepts. A large num- and short-term assets. As the World Develop- ber of high schools were randomly selected ment Report 2015 highlights, understanding into either a treatment or a control group. these behavioral biases and how they influence Students from treated high schools received BOX 2.14 Changing Gambling Behavior through Experiential Learning Abel, Cole, and Zia (2015) took an innovative in rural South Africa. The study had two stages of approach to delivering the message of probabilities. randomization. The fi rst one was that only half of Instead of adopting instructional messages, they the sample was randomly selected to play the dice examined how experiential learning affects behav- game; the other half became the control group. The ioral biases of people. second one referred to the intensity of treatment To do so, they conducted a randomized experi- and only makes use of the subjects who played the ment in which subjects were asked to roll a six-sided dice. For each player, the number of rolls it took to die until they got a six. Once they got a six, they get two sixes was random, and the longer it took repeated the exercise with two dice until they got two for two sixes to show up, the clearer it was to the sixes. Very soon most players realized the low odds player that the chance of winning the lottery was of getting two sixes in the same roll. They were then very low. told that winning the national lottery in South Africa The results showed that, compared with the con- was equivalent to getting sixes on nine dice in the trol group, players who were “unlucky” (those who same roll. Through this basic game, players under- took more than the median number of rolls to obtain stood the concept of probability without having to go two sixes) were 40 percent less likely to gamble in a through any complicated math or statistics course. lottery offered soon after the intervention and were The experiment was conducted on a sample of 35 percent less likely to have participated in a lottery 840 women with relatively little formal education one year after the intervention. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 71 financial education classes over 17 months. television soap opera in South Africa, “Scan- Although the results were modest in magni- dal!” The intervention entailed a two-month- tude, even 16 months after the intervention long storyline featuring a main character who ended, students from treated high schools borrowed excessively through shop credit and scored higher in financial knowledge and gambling, fell into a debt trap, and eventually were more likely to save for future purchases sought help to find her way out. The results of rather than using installment loans. the intervention showed that individuals who A second example comes from interven- viewed this storyline shifted their behavior to- tions that are increasingly popular among fi- ward more formal and longer-term borrowing. nancial institutions and policy makers. These Several lessons from the literature on fi- programs generally consist of free financial nancial literacy can help develop more effec- education courses that convey basic financial tive interventions. Efforts that target financial knowledge on how to better manage personal education to the masses in broad multitopic finances responsibly. Bruhn, Lara-Ibarra, and financial education sessions, such as the one McKenzie (2013) conducted an evaluation evaluated in Mexico City, tend to achieve of this type. The program they studied took little. One reason may be that having adults place in Mexico City and consisted of half- in a classroom setting is not the best way to day courses offered to the general public. deliver a message. More research on how to Modules on saving, retirement, credit cards, better educate broader audiences is needed, and responsible use of credit were covered in but one promising way is entertainment me- the courses. To evaluate the effect of the inter- dia, as Berg and Zia (2013) confirmed. Also, vention, the researchers relied on an encour- evaluations consistently agree that financial agement design strategy, which randomly en- concepts are best taught at what are known courages some individuals to participate in the as “teachable moments.” Interventions that program. Their first finding was that the take- focus on giving concrete concepts to targeted up rate was very low, even among the sample groups are found to be more effective. For of interested individuals. Six months after instance, workshops about retirement plans attending training, savings outcomes of the targeted to workers at the time when they are treated group improved modestly, but admin- deciding on their pension plan may help them istrative data suggest that the savings impact make better-informed decisions. was relatively short-lived. While the modules Alternative interventions, such as default contained information on retirement, no im- enrollment or reminders of payments, can pact on awareness of retirement products or be effective in preventing households from saving for retirement was found. making financial errors. Default enrollment Current studies are now exploring how ef- can help reduce behavioral biases or lack of fective alternative innovative channels such literacy. Research suggests that the simple ac- as videos, mass media, and video games are tion of automatically enrolling workers into in increasing household financial education. pension plans stimulates pension participation Entertainment media offer a broad outreach and contribution. Madrian and Shea (2001) because nearly every household nowadays found that after a company automatically en- has a TV and is also a captive audience. Fur- rolled its new hires in a new 401(k) retirement thermore, as emotional connections are es- plan, plan participation increased from 37 tablished between a show and its audience, percent to 86 percent. Other researchers have the program provides a potentially powerful also found sizable effects (Thaler and Benartzi platform for communicating messages and in- 2004). Based on this evidence, the 2006 U.S. fluencing behavior (World Bank 2014). Con- Pension Protection Act facilitated the auto- siderable evidence, especially in the health and matic enrollment process of firms’ workers education fields, shows the success of media into pension plans. Reminders also can be an campaigns in improving social behavior. Berg effective tool. In field experiments conducted and Zia (2013) evaluated the effectiveness in Bolivia, Peru, and the Philippines, a number of financial education through a popular of clients with savings accounts were randomly 72 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 selected to receive monthly text messages or Other innovative ways to reach lower-income letters reminding them of their savings com- households have been piloted in recent years. mitments (Karlan and others 2010). These re- One example is the microinsurance sector, minders increased the fraction of clients who which has been gradually gaining attention as reached their savings goal by 3 percent and the an instrument for reducing vulnerabilities of amount they saved by 6 percent. the poor (Arun, Bendig, and Arun 2012). Regulators should also promote product transparency and consumer protection in the Policy recommendations for the use of financial market. Financial products, particu- long-term finance by households larly long-term ones, can be overwhelmingly Summing up, a range of policy recommenda- complex instruments for users. This complex- tions can help foster the development of both ity, together with incentives for financial pro- firm and household long-term finance. On the viders to direct customers to products that are one hand, cross-country studies have found more profitable for the providers, could lead that several common factors at the macroeco- households to make costly financial mistakes. nomic level are associated with strong long- Product transparency can raise the quality of term finance markets. This evidence suggests the information available to consumers. that both the insurance and the mortgage sec- One way to increase the financial education tors benefit from a sound and stable macro- and awareness of households is through finan- economic framework. cial education interventions that use more in- The institutional framework of a country is novative mechanisms to deliver information. also related to the development of long-term New attempts to convey experiential, rather finance. In the insurance sector, for example, than conventional, learning may provide use- private ownership is found to foster the sec- ful delivery channels; one example is enter- tor’s growth, even though in many countries tainment media interventions that reach large the state is a major player in the sector. A sup- audiences. Interventions that cover too many portive legal framework and developed credit topics in classroom settings tend to achieve and bonds markets also enhance the growth little. Studies agree that financial concepts are and development of the sector. Similarly, best taught at what are known as teachable government-owned banks and regulatory moments. restrictions on banks’ real estate activities Other interventions such as default enroll- are negatively related to both the depth and ment and reminders could offer practical rem- penetration of mortgage markets. Addition- edies to the incidence of financial mistakes. ally, studies find a strong positive association Insights from behavioral economics suggest between the development of housing finance that these instruments may help reduce be- and stronger creditor and legal rights for bor- havioral problems such as overborrowing rowers and lenders in the form of collateral or undersaving. Even high-income countries and bankruptcy laws. such as the United States are starting to auto- For households, more tailored instruments matically enroll workers into pension plans. that fit the needs of different customers should be explored. While more work is needed to NOTES understand the competing relationship be- tween stronger institutions and sound macro- 1. Another empirical challenge is that some studies may include both firms that do and economic conditions at the country level and that do not need long-term finance whereas behavioral biases and financial literacy issues measuring the effect of long-term finance on at the individual level, research suggests that investment and firm performance is most rel- the latter are important constraints on house- evant for firms that need long-term finance holds. For instance, as with other financial (but may or may not be able to obtain it). products, insurance products need to take 2. These findings may be driven by subsidized cultural and religious beliefs into account. credit to Chinese firms, consistent with other GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF LONG-TERM FINANCE BY FIRMS AND HOUSEHOLDS 73 studies showing that long-term credit is not vision is present, demand for private products necessarily associated with better firm per- tends to be lower, as also mentioned through- formance when it is provided on nonmarket out the discussion of specific long-term finan- terms (Schiantarelli and Sembenelli 1997; cial instruments. Demirgüç-Kunt and Maksimovic 1998). 12. Fougère and Poulhes (2012) replicated this 3. The ORBIS data used in this chapter include analysis using data on French households and only 1 low-income country and 13 lower- found qualitatively similar results. Quantita- middle-income countries, but 30 upper- tively, however, they found that the wealth middle-income countries and 43 high-income effect of holding more home equity domi- countries. nated the risk effect of owning a more expen- 4. The Enterprise Survey data include 30 low- sive house, as opposed to the U.S. data where, income countries, 43 lower-middle-income on net, effects of both canceled each other. countries, 39 upper-middle-income countries, 13. The 10 countries were Australia, Canada, and 11 high-income countries. Germany, Japan, New Zealand, Norway, 5. Data on long-term finance through stock and Sweden, Switzerland, the United Kingdom, bond markets are discussed in chapter 3. The and the United States. percentage of firms accessing these markets 14. Global Findex data come from a World tends to be small in most countries. Bank survey conducted in 2011. The survey, 6. Broner, Lorenzoni, and Schmukler (2013) which is representative at the national level, constructed a database of sovereign bond collected information on use of financial prices, returns, and issuances at different products as well as other sociodemographic maturities for 11 emerging economies from characteristics of adults in 148 countries. 1990 to 2009 and showed that, on average, 15. HOFINET (Housing Finance Information these countries paid a higher risk premium on Network) is a nonprofit organization funded long-term than on short-term bonds. by the Wharton School of the University of 7. Larger firms may also hold more assets, Pennsylvania, the World Bank Group, and the which may make them more likely to obtain Netherlands Development Finance Company longer-term debt. However, Magri (2010) (FMO), which consolidates regularly updated shows that the number of employees has a international housing finance information. strong positive association with debt maturity 16. Warnock and Warnock (2008) also find a even after controlling for tangible assets and positive association between credit informa- assets maturity. tion systems and housing finance develop- 8. For example, Bradley and Roberts (2004) found that debt covenants to impose con- ment, an association that is not statistically straints on management’s activities are com- significant in the study by Badev and others monly included in loans to U.S. firms and that (2014). loans are more likely to include protective 17. Conceptually, the development of a real estate covenants when the borrower is small. market can also be important for the mort- 9. Another explanation for this finding could gage market, for example, through providing be that higher tangibility also means that liquidity and facilitating market valuation. the firm has assets that are of longer matu- 18. Global Findex data also show that women rity, and it is optimal to match assets of long are less likely to have a mortgage than men, maturity with liability of long maturity (Hart but the difference is not as large as differences and Moore 1995). across income groups. In high-income coun- 10. Gourinchas and Parker (2002) estimate a tries, 20 percent of women have a mortgage structural life-cycle model with U.S. house- on average, compared with 23 percent of holds to identify the main motives for house- men. The corresponding numbers in devel- holds to save. Their results suggest that when oping countries are 2.7 and 3.5 percent. The household members reach 40 years of age, gender differences in the use of mortgages their savings begin switching from precau- may in part be due to the fact that, in some tionary motives to retirement reasons. countries, women face different legal rights 11. This chapter focuses on the provision of pri- for owning property than men do (World vate products. In countries where public pro- Bank 2013b). CHAPTER 3: KEY MESSAGES • Long-term fi nance for fi rms through issuances of equity, bonds, and syndicated loans has grown significantly since 1991. The aggregate amount raised through these instruments increased 5-fold in high-income countries and 15-fold in developing countries in real terms. • The growth in long-term markets has been driven mainly by debt markets (syndicated loans and corporate bonds), which account for 80 percent of the total amount raised. • Not all firms raise long-term finance through equity or bond markets. Only a few very large firms do so, and only the largest and oldest ones issue debt at the long end of the maturity spectrum. Because firms in developing countries tend to be much smaller, a smaller propor- tion of developing-country firms taps these markets. the set ofsystems • Financial • For multidimensional. aredo firms that Four access debt markets, characteristics those are of particular located in developing interest countries do not for benchmarking fi nancial systems: fi nancial depth, access, effi ciency, and stability. issue at shorter maturities than the ones located in high-income ones. This is partially driven by These characteristics differences between fineed to be nancial andmeasured for fifi nonfinancial nancial rms andinstitutions by the type and markets. of projects financed. • Financial systems • International marketscome to all seem in play a keyand shapes rolesizes, in theand differ widely provision in terms of long-term of the finance four for firms characteristics. As economies develop, services provided by fi nancial markets tend in developing countries. The larger share of their capital raised at the long end of the matu- to become more important than those provided by banks. rity spectrum takes place through international issues. Domestic debt markets remain highly underdeveloped in most • The global financial of the crisis countries. was not only about financial instability. In some economies, the crisis was associated with important • The global fi nancial crisis of 2008–09 hit debt changes in financial markets depth and particularly access. hard. Because banks from high-income countries were at the center of the crisis, syndicated lending originating in those countries experienced the largest drop, and financial firms experienced a sustained fall in corporate bond issuances. Developing-country firms were especially affected by the crisis because foreign borrowing represented nearly 100 percent of their total debt raised through syndicated loans. • After the crisis corporate bonds and domestic syndicated loans in developing countries expanded, but these increases remained concentrated in very few countries and, thus, did not typically compensate for the drop in long-term credit provided by international syndicated loan markets. • To broaden access to long-term finance beyond the small group of large firms and to reduce the reliance of those with access to international markets on those markets, developing coun- tries should further develop their domestic markets by addressing market failures and policy shortcomings. In particular, a stable macroeconomic environment, institutional stability, the development of a domestic financial system, and the development of government bond markets (that do not crowd out the private sector) seem to aid the development of domestic markets. THE USE OF MARKETS FOR LONG-TERM FINANCE 3 The Use of Markets for Long-Term Finance T he lack of developed markets for long- term finance has become an important and challenging issue in many developing stitutions (Rajan 1992; Rey and Stiglitz 1993; Diamond and Rajan 2001). In particular, be- cause debtors generally need to roll over their economies. Since the global financial crisis financing when the debt is short term, credi- of 2008–09, this issue has become even more tors are able to cut financing if debtors are not prominent in policy discussions. Having ac- behaving as expected to guarantee the repay- cess to long-term funds allows governments ment of the financing obtained. As a conse- and firms to finance large investments as well quence, shorter-term debt tends to be more as to reduce rollover risks and the potential prevalent in economies with less-friendly in- for runs that could lead to costly crises. The vestor policies (Jeanne 2009). When the cost literature is replete with evidence that short- of long-term debt exceeds the cost of short- termism explains several well-known financial term debt, a shorter debt maturity might ac- crises in both developing and high-income tually be chosen (Alfaro and Kanczuk 2009; economies (Eichengreen and Hausmann 1999; Broner, Lorenzoni, and Schmukler 2013). Rodrik and Velasco 2000; Tirole 2003; Boren- Thus, the issue of long-term debt can be sztein and others 2005; Brunnermeier 2009; better understood as a trade-off between Jeanne 2009; Raddatz 2010). In this context, creditors and debtors in the allocation of risk. a number of policy proposals have been put Long-term debt shifts risk to the creditors be- on the table to help economies lengthen debt cause they have to bear the fluctuations in the maturity; these include the introduction of ex- probability of default and in other changing plicit seniority or sovereign debt instruments conditions in financial markets. Naturally, linked to gross domestic product (GDP) (Bo- creditors require a premium as part of the rensztein and others 2005). compensation for the higher risk this type of Although it is not optimal in all situations, debt implies, and the size of this premium de- short-term debt has its uses. Among other pends on the degree of their risk appetite. In things, it allows creditors to monitor debtors contrast, short-term debt shifts risk to debtors and to cope with moral hazard, agency prob- because it forces them to roll over debt con- lems, risk, and inadequate regulations and in- tinually. Because of this trade-off, long-term GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 75 76 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 debt is not necessarily optimal in all situa- cent financial crisis affect the main trends in tions. Ideally, creditors and debtors will even- each of these markets? tually decide how they share the risk involved The chapter first describes the general in lending at different maturities. trends that characterize equity, corporate In many economies, however, creditors and bonds, and syndicated loans issuances. It pro- debtors do not have ready access to long-term vides stylized facts on the number and char- financing. This scarcity of long-term debt acteristics of firms using these markets and instruments can signal underlying problems on where high-income and developing econo- such as market failures and policy distortions. mies stand in terms of maturity at issuance. Lack of long-term financing also has adverse The chapter then introduces the distinction implications for economic growth and devel- between domestic and international markets, opment. In particular, firms in these econo- analyzes how the global financial crisis of mies would be reluctant to finance long-term 2008–09 affected the main trends in domestic projects because of their exposure to the roll- and international corporate bonds and syn- over risk associated with short-term financing dicated loans markets, and concludes with a (Diamond 1991, 1993). policy discussion. To help understand how firms from dif- ferent economies access short- and long-term FINANCIAL MARKETS AND financing, this chapter documents the use of LONG-TERM FINANCE key markets (equity, bonds, and syndicated loans) by firms from all over the world from This section provides systematic evidence on 1991 to 2013. The chapter analyzes the how (financial and nonfinancial) firms used growth of long-term financial markets, illus- equity, bond, and syndicated loan markets trates how many firms benefit from access to during 1991–2013, distinguishing the differ- these markets, and shows how different these ent maturities of financing within debt mar- firms are from the ones that do not issue debt kets.1 It shows how broad the use of capital at all. The chapter also compares the matu- markets is and discusses the association be- rity structure at issuance for high-income and tween the use of capital markets and firm developing economies, distinguishes between characteristics following de la Torre, Ize, and domestic and international markets, and illus- Schmukler (2012) and Didier, Levine, and trates the extent to which the global financial Schmukler (2014). Most of the extensive lit- crisis of 2008–09 affected the main trends in erature on the importance of well-developed these markets. The data used in this chapter financial markets and their links to economic come from Cortina, Didier, and Schmukler growth focuses on the size of these markets (2015), where all the series and sources are (Levine 2005; Beck, Demirgüç-Kunt, and described in detail. Levine 2010).2 The evidence presented here The evidence discussed in this chapter ad- expands on that literature by examining the dresses several questions. In particular, which activity in primary markets and by differenti- markets do firms use to obtain long-term ating between short- and long-term financing. funds? How have those markets evolved? The total amount raised in equity, bond, Which firms access these markets? How many and syndicated loan markets has grown rap- firms use long-term markets? What firm attri- idly during the past two decades. The to- butes are related to accessing these markets? tal amount firms in high-income economies Are longer-term issuers different from shorter- raised using these markets increased 5-fold term and equity issuers? Are there differences between 1991 and 2013; firms in developing between firms from high-income and devel- economies saw a 15-fold increase. Despite the oping economies? Are there differences in the substantial growth observed in developing provision of long-term finance by domestic economies, the gap between the two groups and international markets? How did the re- of economies persists. Although developing- GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 77 FIGURE 3.1 Total Amount Raised in Equity, Corporate Bond, and Syndicated Loan Markets, 1991–2013 a. High-income countries 9 20 8 18 16 2011 U.S. dollars, trillions 7 6 14 12 % of GDP 5 10 4 8 3 6 2 4 1 2 0 0 01 11 91 09 92 93 94 96 98 99 00 02 03 04 06 08 10 12 13 95 97 05 07 20 20 19 20 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 19 19 20 20 b. Developing countries 1.4 6 1.2 5 2011 U.S. dollars, trillions 1.0 4 % of GDP 0.8 3 0.6 2 0.4 0.2 1 0 0 91 92 93 94 95 96 97 98 99 00 01 02 03 06 07 08 09 10 11 12 13 04 05 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Equity Corporate bonds Syndicated loans Equity, share of GDP Total debt, share of GDP Source: Cortina, Didier, and Schmukler 2015. economy firms captured 16 percent of the In developing economies, the total amount total amount issued in 2013, compared with rose from around $40 billion to $1.2 trillion.4 6 percent in 1991, that total equaled about 5 In both economy groups, the use of equity percent of GDP. In high-income economies, rose more slowly. The rapid growth in the the total raised in these markets in 2013 was use of debt markets by developing economies equivalent to about 15 percent of GDP. did not begin in earnest until the early 2000s. Most of the growth was in the primary As a consequence, the ratio of long-term debt corporate bond and syndicated loan markets over equity grew from 4 to 10 in high-income rather than in the equity markets. The two economies and from 1 to 5 in developing debt markets accounted for about 86 percent economies during 1991–2013. of the total annual financing raised by firms Although debt is the primary source of in high-income economies and for about 72 external financing by firms, equity and debt percent of that financing for developing- markets could play complementary roles. economy firms.3 The total amount raised In particular, some studies document that a annually through debt markets grew from developed and liquid stock market is key in around $1 trillion in 1991 to $6 trillion in creating and aggregating information about 2013 in high-income economies (figure 3.1). economic activity and firms’ fundamentals. 78 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 According to this view, which dates back to also avoids excessive single-name exposure, Hayek (1945), stock prices aggregate infor- which can be prohibited by banking regula- mation from many market participants— tion, but still preserve the commercial rela- information that, in turn, might be useful for tionship with the borrower. Moreover, the firm managers and other decision makers such lead bank (that is, the bank that oversees the as capital providers, consumers, competitors, arrangement of the syndicated loan) can ob- and regulators. Recent empirical evidence sup- tain fee income, thus diversifying its income ports the influence of stock price information sources. Last but not least, syndication allows on firms’ investment and other corporate de- banks suffering from a lack of origination ca- cisions (Bond, Edmans, and Goldstein 2012). pabilities in certain types of transactions to Other studies highlight the complementarities fund loans. Later in the chapter, the trends in between equity and debt markets. For exam- and patterns of syndicated loans are directly ple, Demirgüç-Kunt and Maksimovic (1996) compared with those of corporate bonds.5 show how large firms in economies with less- The importance of syndicated loan financ- developed financial systems become more lev- ing has increased over time. Corporate bonds eraged as the stock markets develop. were the main source of long-term finance Within debt markets, some studies high- during the 1990s, capturing around 65 per- light the importance of syndicated loans as cent of the total debt issued annually. In the a source of firm financing. Recent studies early 2000s, syndicated loans began to ex- estimate that syndicated loans account for pand at a faster pace and by 2004 had sur- roughly one-third of total outstanding loans, passed the use of corporate bonds, accounting and their relative importance has increased for about 60 percent of total annual firm debt over time (Huang 2010; Ivashina and Scharf- issued in high-income and developing econo- stein 2010; Cerutti, Hale, and Minoiu 2014). mies during 2004–08.6 The global financial Syndicated loans also tend to be larger and crisis slowed the growth of this market (see to have longer maturities than other types figure 3.1). of loans (Cerutti, Hale, and Minoiu 2014). Despite the rapid increase in equity and Moreover, because syndicated loans and debt issuances, few firms use these mar- corporate bonds are similar in deal size and kets and those that do tend to be large. On maturity, they constitute two similar sources average, in the median high-income economy, of financing from a firm’s perspective (Altun- there were only 19 issuing firms a year in bas, Kara, and Marques-Ibañez 2010). The equity markets, 22 in corporate bond mark- development of regulated secondary mar- ers, and 10 in syndicated loan markets. The kets and independently rated loan issuances numbers were smaller for the median de- for syndicated loans have contributed to the veloping economy: 8, 6, and 6, respectively convergence of the two debt markets. Other (table 3.1a). None of these markets seem to benefits of syndication may also contribute have widened over the years for the typical to these trends. Allen (1990) and Altunbas country in either income group (figure 3.2). and Gadanecz (2004) found that origination The limited number of firms using these fees are lower for syndicated loan issuances markets is consistent with large size require- than for bond issuances and that syndicated ments for issues and high fixed costs associ- loans can be arranged more quickly and more ated with the issuance process. The median discreetly. Furthermore, in developing econo- corporate bond issue is $89 million, the me- mies, syndicated loans might be more avail- dian syndicated loan $94 million, and the me- able than corporate bonds for those firms that dian equity issuance $15 million, respectively.7 need large loans. Syndication is also attractive Issues tend to be for large amounts because to lenders, according to Godlewski and Weill small issues are not cost efficient. Fixed costs (2008). Banks can achieve a more diversified of issuance include disclosure (indirect costs), loan portfolio through syndication, decreas- investment bank fees (the highest costs, typi- ing the likelihood of bank failures and con- cally), legal fees, taxes, rating agency fees, and tributing to financial stability. Syndication marketing and publishing costs (Blackwell GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 79 TABLE 3.1 Average Annual Number of Issuing Firms, 1991–2013 Issuing region/country income group Equity Bonds Syndicated loans a. Median country High-income countries 19 22 10 Developing countries 8 6 6 b. Pooled data by country/region United States 1,277 1,220 1,916 China 217 127 62 India 319 83 70 Africa 32 8 18 Australia and New Zealand 650 103 102 High-income Asia 681 494 853 Eastern Europe and Central Asia 69 54 89 Developing Asia 247 122 84 Latin America and the Caribbean 110 270 69 Middle East 46 15 40 Western Europe 854 799 627 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the average annual number of firms active in equity, bond, and syndicated loan markets. The figures in panel a are calculated as the average across years and then the median across countries, reported by country income group. Panel b reports the average across years by region. FIGURE 3.2 Average Number of Issuers per Year by Period a. High-income countries 25 21 20 20 18 17 Number of issuers 15 15 13 13 12 10 5 3 0 Equity Bond Syndicated Equity Bond Syndicated Equity Bond Syndicated loan loan loan 1991–99 2000–07 2008–13 25 b. Developing countries 20 Number of issuers 15 15 10 6 6 6 6 5 4 4 3 2 0 Equity Bond Syndicated Equity Bond Syndicated Equity Bond Syndicated loan loan loan 1991–99 2000–07 2008–13 Number of equity issuers Number of bond issuers Number of syndicated loan issuers Source: Cortina, Didier, and Schmukler 2015. 80 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 and Kidwell 1988; Zervos 2004; Borensztein The use of capital markets seems to be and others 2008). Because they restrict the much wider for some economies and re- ability of smaller firms to issue securities in gions than for others. For instance, the aver- capital markets, these costs have an impact age number of issuers per year in the United on the supply side of the issuance activity.8 States is above 1,000 in each type of market Demand forces (such as the investor base) are (see table 3.1b). Some developing economies also important because they drive the charac- also stand out. Brazil in particular experi- teristics of the securities offered. In some econ- enced a rapid development of capital markets omies, such as Chile and Mexico, institutional thanks to well-established institutional inves- investors demand certain types of securities tors and better governance (de la Torre, Ize, and thus determine the cohort of companies and Schmukler 2012). using capital markets. Small and medium en- Among listed firms (large, mature, and terprises (SMEs), which are particularly de- with access to capital markets), those few that pendent on external finance, cannot benefit recurrently issue equity and bonds are larger, from the use of these markets and have to rely faster growing, and more leveraged than non- on banks (through bilateral loans) to finance issuers (see box 3.1 for the cases of China investments. and India). These differences across firms are BOX 3.1 Finance and Growth in China and India China and India are hard to ignore. Over the past 2007; Neftci and Menager-Xu 2007; Shah, Thomas, 20 years, they have risen as global economic powers and Gorham 2008; Patnaik and Shah 2011). at a very fast pace. By 2012 China had become the Importantly, this expansion was not associated second-largest world economy (based on nominal with widespread use of capital markets by fi rms. For gross domestic product [GDP]) and India the tenth. example, the number of Chinese fi rms using equity Together, China and India account for about 36 per- markets to raise capital increased from an average of cent of the world’s population.a 87 a year in 2000–04 to 105 in 2005–10, out of an Their fi nancial systems have also developed rap- average of 1,621 listed fi rms. idly and have become much deeper according to sev- At the same time, fi rms that use equity or bond eral broad-based standard measures, although they markets are very different and behave differently still lag behind in many respects. For example, stock from those that do not do so. While nonissuing fi rms market capitalization in China increased from 4 per- in both China and India grew at about the same rate cent of GDP in 1992 to 80 percent in 2010; in India as the overall economy, issuing fi rms grew twice as it rose from 22 percent of GDP to 95 percent during fast in 2004–11. Firms that raise capital through the same period. By 2010, 2,063 fi rms were listed in equity or bonds are typically larger than nonissuing China’s stock markets; 4,987, in India’s. fi rms initially and become even larger after raising The financial systems of these two countries capital. Firms grow faster the year before and the have not only expanded but have also transitioned year in which they raise capital. from a mostly bank-based model. Equity and bond These fi ndings suggest that even in fast-growing markets in China and India have expanded from an China and India, where fi rms have plenty of growth average of 11 percent and 57 percent, respectively, opportunities and receive large inflows of foreign of the fi nancial system in 1990–94 to an average of capital, and where thousands of fi rms are listed in 53 percent and 65 percent in 2005–10 (Eichengreen the stock market, only a few fi rms directly partici- and Luengnaruemitchai 2006; Chan, Fung, and Liu pate in capital market activity. a. See Didier and Schmukler (2013) for a more detailed analysis. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 81 TABLE 3.2 Firm Characteristics by Country Income Group, 2003–11 Shorter-term Longer-term Characteristic Nonissuers Equity issuers bond issuers bond issuers a. High-income countries Total assets (millions, 2011 $) 123.4 246.2** 1,406.7*** 6,739.8*** Sales (millions, 2011 $) 114.8 1,140.1** 295.2*** 2,569.5*** Number of employees 225 344*** 948*** 5,521*** Asset growth (%) 3.6 8.5*** 8.9** 6.7*** Sales growth (%) 4.2 8.8*** 5.7** 5.5** Employee growth (%) 0.7 4.9*** 5.0*** 3.2*** Leverage (%) 49.4 52.2*** 57.3*** 62.5*** Long-term debt/total liabilities (%) 16.7 21.0*** 29.7*** 39.1*** Return on assets (%) 3.1 2.7** 1.3*** 3.9** Firm age (in 2011) 23 17*** 20** 32** Number of firms 16,857 11,516 1,166 2,587 Share of total firms (%) 56.27 38.44 3.89 8.6 Number of observations for total assets 119,001 81,949 8,984 20,022 b. Developing countries Total assets (millions, 2011 $) 66.0 191.2*** 866.7*** 2,027.3*** Sales (millions, 2011 $) 49.6 111.8** 257.9*** 744.1*** Number of employees 498 814** 3,750*** 2,777*** Asset growth (%) 4.3 13.1*** 12.3*** 11.4*** Sales growth (%) 7.6 10.5*** 13.9*** 11.7*** Employee growth (%) 1.6 4.2** 4.3** 4.5** Leverage (%) 47.3 51.2** 57.8*** 59.1*** Long-term debt/total liabilities (%) 11.8 20.9*** 30.7*** 42.0*** Return on assets (%) 4.1 4.6** 5.0** 4.8** Firm age (in 2011) 30 21*** 25** 35** Number of firms 10,328 4,682 558 688 Share of total firms (%) 66.3 30.1 3.6 4.4 Number of observations for total assets 69,650 31,579 4,262 5,150 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the attributes for the median firm. They are calculated as the median across countries of the median firm per country. The firm-level data are averages across time per firm. The table also reports the statistical significance of median tests for each group of issuing firms vs. nonissuers. Nonissuing firms are those that did not issue during this time period. Longer-term bond issuers are defined as firms that issue bonds with maturity beyond five years at least once over the period. Shorter-term bond issuers are the rest of bond issuers in the sample. Significance level: * = 10 percent, ** = 5 percent, *** = 1 percent. statistically significant (table 3.2). There are smaller proportion of firms uses these mar- also large differences across issuers: firms that kets.10 The larger proportion of small and issue bonds are larger, more leveraged, and medium firms in developing economies also older than firms that issue equity.9 This re- implies that a larger proportion of firms is un- sult stands in contrast with the pecking-order able to access external finance through the use view of corporate finance which suggests that of these markets (Tybout 2000; Gollin 2008; more opaque firms have a greater tendency Poschke 2011). to tap bond markets before issuing equity Within the maturity spectrum, firms that (Myers and Majluf 1984; Fama and French raise capital at the long end are typically the 2002; Frank and Goyal 2003, 2008). largest, oldest, and most leveraged. For exam- Although large firms have access to se- ple, the median equity issuer in high-income curities markets in both high-income and economies has assets of about $246 million, developing economies, there are fewer large the median shorter-term bond issuer (firms firms in the developing world, and so a much issuing bonds with maturity of five years or 82 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE 3.3 Average Maturity of Corporate Bonds, 1991–2013 Years Issuing region/country income group All fi rms Nonfi nancial fi rms Financial fi rms a. Median country High-income countries 6.7 8.6 5.9 Developing countries 7.2 8.2 6.7 b. Pooled data by country/region United States 7.8 10.8 5.6 China 7.3 5.9 9.1 India 7.5 8.3 7.2 Africa 7.7 7.9 7.5 Australia and New Zealand 6.1 9.6 5.2 High-income Asia 7.1 7.6 6.3 Eastern Europe and Central Asia 7.2 8.2 6.3 Developing Asia 8.1 8.6 7.6 Latin America and the Caribbean 8.4 9.1 7.3 Middle East 7.6 10.2 6.5 Western Europe 6.7 8.4 6.2 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the weighted average maturity (in years) of newly issued corporate bonds by high-income and developing countries. It distinguishes between nonfinancial and financial firms. Panel a pools all issuances for each country, calculates the weighted average maturity for each country, and then reports the results for the median country by country income group. Panel b pools all issuances for each country or region and then calculates and reports the weighted average maturity by country or region. shorter) has assets of about $1.4 billion, while developing economies is slightly higher than the median longer-term bond issuer (firms is- in high-income economies. For instance, the suing bonds with maturity beyond five years) average maturity of corporate bonds is 6.7 has assets of about $6.7 billion. In developing years in the median high-income economy economies, those numbers are $191 million, and 7.2 years in the median developing econ- $867 million, and $2 billion. These differences omy (table 3.3a).11 This pattern is consistent in size among different types of issuers are also across economies and regions (table 3.3b). apparent if the number of employees or sales Among different sectors, financial firms is considered rather than total assets (see table typically issue shorter maturities than nonfi- 3.2). Moreover, longer-term bond issuers are nancial firms and capture a larger share of the around 12 years older than shorter-term is- total amount issued in bond markets by high- suers in high-income economies and 10 years income economies compared with developing older in developing economies. These findings ones. In high-income economies, the finance regarding firm size and maturities are con- sector captures 65 percent of the total amount sistent with the theory that smaller firms are raised and the average maturity is 5.9 years; more likely than larger firms to face agency in developing economies, the financial sector problems or asymmetric information between accounts for 49 percent of the total with an corporations and investors and thus issue in average maturity of 6.7 years (figure 3.3; table relatively shorter terms (Myers 1977; Barnea, 3.3a). Within the nonfinancial sector, firms lo- Haugen, and Senbet 1980; Titman and Wes- cated in high-income economies issue bonds at sels 1988; Barclay and Smith 1995; Custódio, slightly longer maturities (0.4 years longer on Ferreira, and Laureano 2013). average) than those in developing economies. Conditional on access to debt markets, In syndicated loan markets, the average firms located in developing economies do maturity of loans is shorter for firms in high- not issue more short-term debt than firms income economies than for firms in develop- in high-income economies. The average ma- ing economies. The average maturity is 5.8 turity of newly issued corporate bonds by years in the median high-income economy GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 83 FIGURE 3.3 Share and Maturity of Corporate Bonds Raised by Firm Sector and Country Income Group, 1991–2013 a. Share raised 100 90 Share of total raised, % 80 70 60 50 40 30 20 10 0 Agriculture, Construction Finance, Manufacturing Mining Retail trade Services Transportation Wholesale forestry, insurance, trade and fishing and real estate b. Average maturity 14 12 10 Maturity, years 8 6 4 2 0 Agriculture, Construction Finance, Manufacturing Mining Retail trade Services Transportation Wholesale forestry, insurance, trade and fishing and real estate High-income countries Developing countries Source: Cortina, Didier, and Schmukler 2015. TABLE 3.4 Average Maturity of Syndicated Loans, 1991–2013 Years Issuing region/country income group All fi rms Nonfi nancial fi rms Financial fi rms a. Median country High-income countries 5.8 6.1 4.7 Developing countries 6.6 7.6 4.0 b. Pooled data by country/region United States 4.2 4.5 3.2 China 9.6 10.5 7.6 India 9.4 10.0 4.8 Africa 6.7 7.4 4.1 Australia and New Zealand 4.6 4.8 4.1 High-income Asia 4.2 4.2 4.4 Eastern Europe and Central Asia 5.3 6.3 2.8 Developing Asia 6.7 7.4 4.3 Latin America and the Caribbean 6.0 6.3 4.1 Middle East 8.3 9.4 4.8 Western Europe 5.5 5.6 4.8 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the weighted average maturity (in years) of newly issued syndicated loans in high-income and developing countries. It distinguishes between nonfinancial and financial firms. Panel a pools all issuances per country, calculates the weighted average maturity per country, and then reports the results for the median country by country income group. Panel b pools all issuances per country or region and then calculates and reports the weighted average maturity by country or region. 84 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 and 6.6 years in the median developing econ- struction, mining, and transportation sectors omy (table 3.4a). This pattern is consistent is more intensive in developing economies across economies and regions (table 3.4b). (figure 3.4). Moreover, in developing econo- Furthermore, as in the case of corporate bond mies “project finance,” a category that con- markets, syndicated loans to financial sec- sists primarily of infrastructure projects that tor firms have shorter maturities on average. require very long-term financing, accounts However, the share borrowed by financial for about 25 percent of all syndicated loans firms is relatively small—about 15 percent of and has an average maturity of about 12 the total—and similar between the two econ- years (figure 3.5).12 In fact, most finance for omy income groups. infrastructure projects comes from syndicated The more intensive use of syndicated loans (box 3.2). In high-income economies, loans for infrastructure projects in develop- general corporate purposes and refinancing ing economies explains, in part, the relatively each account for about 35 percent of syndi- longer-term borrowing by firms in these econ- cated loans and have maturities of 4 and 5 omies. For instance, borrowing by the con- years, respectively. FIGURE 3.4 Share and Maturity of Syndicated Loans Raised by Firm Sector and Country Income Group, 1991–2013 a. Share raised 70 60 Share of total raised, % 50 40 30 20 10 0 Agriculture, Construction Finance, Manufacturing Mining Retail trade Services Transportation Wholesale forestry, insurance, trade and fishing and real estate b. Average maturity 14 12 10 Maturity, years 8 6 4 2 0 Agriculture, Construction Finance, Manufacturing Mining Retail trade Services Transportation Wholesale forestry, insurance, trade and fishing and real estate High-income countries Developing countries Source: Cortina, Didier, and Schmukler 2015. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 85 FIGURE 3.5 Share and Average Maturity of Syndicated Loans Raised by Firm’s Primary Use of Proceeds and Country Income Group, 1991–2013 a. Share raised 70 60 Share of total raised, % 50 40 30 20 10 0 Acquisition financing General corporate Others Project finance Refinancing and leveraged buyouts purposes and working capital b. Average maturity 14 12 10 Maturity, years 8 6 4 2 0 Acquisition financing General corporate Others Project finance Refinancing and leveraged buyouts purposes and working capital High-income countries Developing countries Source: Cortina, Didier, and Schmukler 2015. BOX 3.2 Infrastructure Finance and Public-Private Partnerships In recent years, discussions have been increasing (CAF), have become interested in participating in about the need to increase infrastructure finance. these partnerships. Public-private partnerships (PPPs), as a way to A PPP bundles investment and service provision replace or complement the public provision of infra- of infrastructure into a single long-term contract structure, have become very common in recent years. through a so-called special purpose vehicle (SPV). A Not only domestic institutions but also international group of private investors, commonly known as the ones, such as the International Finance Corporation sponsors, fi nances and manages the construction of (IFC), the Inter-American Investment Corporation the project, then maintains and operates the facili- (IIC), and the Development Bank of Latin America ties for a long period, usually 10 to 20 years, and (box continued next page) 86 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 3.2 Infrastructure Finance and Public-Private Partnerships (continued) at the end of the contract transfers the assets to the behavior of the SPV and its contractors. To control government. Until that turnover, the private partners behavior, banks disburse funds only gradually as receive a stream of payments to compensate for both project stages are completed. And even when design the initial investment and operation and maintenance changes are unforeseen, banks can quickly negotiate expenses. Depending on the project and type of restructurings among each other. infrastructure, these revenues are derived from user After completion of the project, risk falls sharply fees or from payments by the government’s procuring and is limited only to events that may affect the cash authority. flows from the operation. This phase should be suit- The typical PPP infrastructure project involves able for bond fi nance because bond holders care only a large initial up-front investment that is sunk and about events that significantly affect the security of relatively smaller operations and maintenance costs the cash flows underpinning repayment and are not paid over the lifetime of the project. Four economic directly involved in management or in control of the characteristics of most PPP projects are important project. for understanding the choice of fi nancial arrange- The popularity of PPPs has nurtured the view in ments. First, PPP projects are usually large enough to fi nancial markets that infrastructure is a new asset require independent management, especially during class with distinctive characteristics: high barriers to construction, and frequently even in the operational entry and economies of scale (many projects are nat- phase. Often there are few, if any, synergies to be ural monopolies), inelastic demand for infrastructure realized by building or operating two or more PPP fi nancing services and little fluctuation with the busi- projects together. For instance, the projects may be ness cycle, high operating margins, and long dura- located far apart and far from the place where the tions. These economic characteristics seem to have service is consumed, and efficient scale is site specific. an attractive financial counterpart: returns with low Project assets are thus illiquid and have little value correlation with the country and the returns of other if the project fails. Second, most of the production asset classes, long-term and stable cash flows that are processes, both during construction and operation, often covered against inflation, and low default rates. are subcontracted. Hence, any scale and scope econ- In principle, these characteristics could be especially omies are internalized by specialized service provid- attractive to long-term investors like insurance com- ers (construction companies, maintenance contrac- panies, some types of pension funds, and wealth tors, or toll collectors). Third, bundling construction funds. and operation is efficient. Bundling forces investors Most fi nance for infrastructure comes from syn- to internalize operation and maintenance costs and dicated bank loans. In the United States and other generates incentives to design the project to minimize high-income countries, the ratio of bond finance life-cycle costs. Perhaps even more important, when to syndicated bank loans is 1:5 to 1:6. The ratio in builders are responsible for enforceable service stan- emerging countries, excluding China, is 1:5. The dards, they have an incentive to consider such stan- paucity of bond issues to fi nance infrastructure proj- dards when designing the project. ects remains a puzzle. A possible explanation could The life cycle of PPP fi nance and the change in be that infrastructure projects are riskier and their financing source are determined by the different probability of default is higher. However, whereas incentive problems faced in the construction and the default rate of investment-grade infrastructure operational phases. Construction is subject to sub- bonds tends to be higher than the default rate of stantial uncertainty, including major design changes, other nonfi nancial corporate issuers during the fi rst and costs depend crucially on the diligence of the four years, defaults are less frequent from year four sponsor and the building contractor. Thus there is onward. Thus, over time infrastructure bonds tend ample scope for moral hazard in this stage. As is well to become safer than other types of bonds. And when known, banks perform a monitoring role that is well default occurs, the recovery rate on infrastructure suited to mitigate moral hazard by exercising tight bonds is higher than the recovery rate on other cor- control over changes to the project’s contract and the porate bonds. (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 87 BOX 3.2 Infrastructure Finance and Public-Private Partnerships (continued) Ehlers, Packer, and Remolona (2014) argue words, because the market for project bonds is small, instead that a lack of a pipeline of properly structured intermediaries specialized in these securities might projects often reflects an inadequate legal and regu- not yet have emerged. The authors also argue that latory framework. Infrastructure investments entail the lack of coherent and trusted legal frameworks for complex legal and financial arrangements requir- infrastructure projects might hamper the develop- ing significant expertise. Building up this expertise ment of infrastructure finance. Moreover, a project’s is costly, and investors will be willing to incur these economic viability is often dependent on government fi xed costs only if there is a suffi cient and predict- decisions such as pricing, environmental regulation, able pipeline of infrastructure investment opportu- or transportation and energy policy, and even if solid nities. Otherwise, the costs can easily outweigh the legal frameworks exist, best practices or experience potential benefits of investing in infrastructure over with large infrastructure projects can be lacking on other asset classes such as corporate bonds. In other the side of the government. Source: Engel, Fischer, and Galetovic 2014. DOMESTIC AND INTERNATIONAL 1991 to 2013 (table 3.5a).14 Only in six de- DEBT MARKETS veloping economies (Bolivia, China, Malaysia, Pakistan, Thailand, and Vietnam) does the The distinction between domestic and inter- amount raised in domestic markets account national markets is important. In an era of for more than 70 of the total.15 globalization and market integration, firms Domestic bond issues in high-income have access to both domestic and interna- economies have longer maturities than those tional markets. Furthermore, these markets in developing economies. In particular, the could provide different funding options for average maturity of domestic issues by the firms, including different maturities, different median high-income economy is 1.6 years amounts, and issues denominated in different longer than that of domestic issues by the me- currencies (Gozzi and others, forthcoming). dian developing economy. The difference is This is especially the case for firms from devel- almost 4 years when considering the pooled oping economies because international mar- data (table 3.6a). kets, which tend to be located in the world’s A positive relationship exists between do- more developed financial centers, may of- mestic financial development and the average fer these firms access to financing that is not maturity of corporate bonds issued in domes- available domestically. The rest of this chapter tic markets, and this relationship is consistent focuses on finer partitions of the results re- with the relatively shorter-term bonds issued ported above using only data for nonfinancial within developing economies. This relation- corporations because these firms make up a ship is shown by plotting the average ma- more homogeneous set.13 turity of domestic corporate bond issuances Most of the proceeds raised annually in for each economy in the sample against four corporate bond markets by the median high- different measures of financial market devel- income and developing economy are raised opment: private bond market capitalization abroad. The median developing economy to GDP, private credit to GDP, stock market raised slightly more (83 percent) than the me- capitalization to GDP, and the total number dian high-income economy (76 percent) in the of domestic market issuances (figure 3.6). The international corporate bond market from four panels in the figure all show a positive 88 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE 3.5 Amount Raised per Year in Corporate Bond Markets by Market Location, 1991–2013 Domestic market International market International market Issuing region/country income group (millions of 2011 $) (millions of 2011 $) as a % of total a. Median country High-income countries 490 1,558 76.1 Developing countries 72 361 83.3 b. Pooled data by country/region United States 309,484 78,264 20.2 China 29,373 2,393 7.5 India 3,555 1,786 33.4 Africa 160 1,146 87.8 Australia and New Zealand 2,731 10,077 78.7 High-income Asia 75,511 22,287 22.8 Eastern Europe and Central Asia 4,128 6,512 61.2 Developing Asia 8,350 3,768 31.1 Latin America and the Caribbean 17,296 19,297 52.7 Middle East 266 2,678 91.0 Western Europe 62,195 151,599 70.9 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the average total amount raised annually by firms through the use of domestic and international corporate bond markets. Panel a calculates the average across years by country and then reports the median across countries by country income group. Panel b reports the average across years by country or region. TABLE 3.6 Average Maturity of Domestic and International Corporate Bonds Issuances, 1991–2013 Years Issuing region/country income group Domestic market International market a. Median country High-income countries 8.0 8.6 Developing countries 6.4 10.0 b. Pooled data by country/region United States 11.3 8.9 China 5.8 6.9 India 8.8 7.2 Africa 6.3 8.1 Australia and New Zealand 10.0 9.6 High-income Asia 8.0 6.7 Eastern Europe and Central Asia 8.3 8.2 Developing Asia 7.6 10.9 Latin America and the Caribbean 7.5 10.6 Middle East 10.5 10.2 Western Europe 9.2 8.0 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the weighted average maturity (in years) of newly issued corporate bonds by high-income and developing countries. It distinguishes between issuances in domestic and those in international markets. Financial sector issuances are excluded. Panel a pools all issuances per country, calculates the weighted average maturity per country, and then reports the results for the median country by country income group. Panel b pools all issuances per group of countries and then calculates and reports the weighted average maturity by country or region. correlation between financial development certainty (Siegfried, Simeonova, and Vespro and the average maturity at issuance, which 2007). In their initial phases of development, suggests that longer-term markets develop securities issued in domestic markets would after shorter-term markets, which tend to tend to be comparatively simple (“plain va- prevail in economies with more economic un- nilla”) and have short maturities. Once the GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 89 FIGURE 3.6 Average Maturity in Domestic Markets Compared with Continuous Measures of Domestic Financial Development by Country Income Group, 1991–2013 a. Private bond market capitalization b. Private credit 100 200 90 180 80 160 70 140 60 120 % of GDP % of GDP 50 100 40 80 30 60 20 40 10 20 0 0 0 2 4 6 8 10 12 14 16 0 2 4 6 8 10 12 14 16 Maturity, years Maturity, years c. Stock market capitalization d. Domestic issuances 350 6.0 Log of number of domestic issuances 300 5.0 250 4.0 % of GDP 200 3.0 150 100 2.0 50 1.0 0 0 0 2 4 6 8 10 12 14 16 0 2 4 6 8 10 12 14 16 Maturity, years Maturity, years High-income countries Developing countries Linear fit Source: Cortina, Didier, and Schmukler 2015. domestic markets become larger and more ones, independent of the currency denomina- liquid, securities with more complex struc- tion. That is, these results hold both for issu- tures and longer maturities could be issued ances denominated only in domestic currency (IMF 2013b). These results highlight the im- and for those denominated only in foreign portance of domestic financial development, currency. These results also hold for firms that which seems to correlate with firms’ access to issue corporate bonds both domestically and longer-term financing in domestic markets. abroad, suggesting that the differences in ma- Firms in developing economies tap interna- turities are not completely driven by whether tional markets to issue bonds at the long end firms issue only in domestic or only in inter- of the maturity spectrum. Specifically, domes- national markets.16 These results suggest that tic bonds issued by firms from the median de- firms from developing economies tap interna- veloping economy have an average maturity tional markets to overcome incompleteness in of 6.4 years compared with 10 years for those the domestic markets. issued abroad (see table 3.6a). Moreover, in- International bond issues are larger than ternational issuances by developing-economy domestic ones, and firms issuing in interna- firms have longer maturities than domestic tional markets are larger than firms issuing 90 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 in domestic markets. The size distribution of economies, only the largest ones issue abroad, bonds issued in international markets is to where they issue larger and longer-term bonds the right of the size distribution of domestic than they would at home. These results imply bonds, and the size distribution of interna- that relatively smaller firms in developing tional issuers is to the right of the size distribu- economies are constrained from issuing inter- tion of domestic issuers (Cortina, Didier, and national bonds because of the high costs, and Schmukler 2015). Moreover, the international they therefore have little access to longer ma- issuances with the longest maturities are of- turities. In contrast, in high-income econo- fered by the largest firms. The rightward shift mies, where firms are on average larger than of both international bond and international they are in developing economies, firms have issuer distributions is more prominent for de- greater access to longer-term financing through veloping economies. These results are prob- the use of both their more liquid domestic ably a consequence of the higher barriers as- markets and their international markets. sociated with the use of international markets Similarly, in both the median high-income compared with domestic markets. To meet and the median developing economy, most of the liquidity and size requirements of interna- the financing raised through syndicated loans tional buyers, the minimum deal size is typi- is originated abroad (table 3.7a). International cally much larger than in domestic markets lending accounts for between 73 percent and (Zervos 2004). Moreover, the international 93 percent of the total in the developing- issuance of securities includes high legal costs economy regions (table 3.7b), suggesting that to meet international regulations and interna- the largest volumes of syndicated lending are tional rating fees. In fact, the median corpo- originated within a few (high-income) econo- rate bond issuance in domestic markets is $47 mies, mainly the United States and the econo- million in high-income economies and $118 mies of Western Europe. India is the only de- million in developing economies, whereas in veloping economy in which domestic markets international markets the median is $186 mil- capture more than 70 percent of the total lion and $206 million, respectively. syndicated loan market. In most developing In other words, among the small set of economies in the sample, domestic syndicated firms accessing capital markets in developing loan activity is very small or nonexistent. TABLE 3.7 Amount Raised per Year in Syndicated Loan Markets by Market Place, 1991–2013 Domestic market International market International market Issuing region/country income group (millions of 2011 $) (millions of 2011 $) (% of total) a. Median country High-income countries 593 5,292 89.9 Developing countries 62 1,283 95.4 b. Pooled data by country/region United States 543,326 252,902 31.8 China 7,200 4,385 37.8 India 14,837 4,609 23.7 Africa 1,331 5,593 80.8 Australia and New Zealand 14,356 21,889 60.4 High-income Asia 101,275 20,546 16.9 Eastern Europe and Central Asia 2,379 27,972 92.2 Developing Asia 4,048 11,133 73.3 Latin America and the Caribbean 1,600 22,118 93.3 Middle East 5,396 17,773 76.7 Western Europe 135,962 294,006 68.4 Source: Cortina, Didier, and Schmukler 2015. Note: This table reports the average total annual amount raised by firms through the use of domestic and international syndicated loan markets. Panel a calculates the average across years per country and then reports the median across countries by country income groups. Panel b reports the average across years by country or region. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 91 The reliance of developing-economy firms could immediately and severely worsen bal- on international markets for longer-term fi- ance sheets and could greatly increase debt nancing makes these economies prone to repayment burdens (Goldstein and Turner external shocks. Close to 100 percent of the 2004).17 The development of local currency total amount of debt that developing-econ- corporate bond markets has been a persistent omy firms issue in international markets is challenge, even as developing-economy gov- denominated in foreign currency. Debt de- ernments have seen success in issuing govern- nominated in foreign currency can be risky ment bonds in the local currency at relatively if not properly hedged because the exchange long maturities (overcoming the “original rate depreciation in the event of capital flight sin”) (box 3.3).18 The slower pace of growth BOX 3.3 Supporting Local Currency Market Development Over the past two decades international organi- gram were later combined in the book Develop- zations (IOs) have gradually increased their focus ing the Domestic Government Debt Market: From and efforts to support countries in developing their Diagnostic to Reform Implementation. domestic debt markets to enhance stability of fi nanc- ing and to provide a foundation for broader fi nancial MOVE FROM REFORM DESIGN TO sector development. IMPLEMENTATION As more developing countries shifted from issuing BUILDING A CONCEPTUAL FRAMEWORK hard currency external debt to issuing local currency FOR GOVERNMENT BOND MARKET domestic debt, the need for initiatives to increase DEVELOPMENT depth and liquidity of these markets expanded, and Triggered by major global events such as the Asian IOs moved toward supporting countries in implement- fi nancial crisis in 1997, local currency bond market ing market reform initiatives. As part of this effort, development became an increasing priority for devel- the World Bank launched the Global Emerging Mar- oping countries in the late 1990s and early 2000s to kets Local Currency Bond (Gemloc) market initiative help develop local capital markets and reduce fi nan- in 2007 to enhance the advisory services provided cial vulnerability. The broad international attention to countries developing government bond markets. and increased demand from developing countries for Under this and other programs, the World Bank works support in building deeper and more effective bond with ministries of finance, central banks, and securi- markets caused IOs, such as the World Bank and the ties regulators to design solutions based on clients’ International Monetary Fund (IMF), to concentrate needs and to actively support their implementation. on and to scale up efforts to support policy makers The assistance includes targeted assistance to address in this area. The fi rst initiatives focused on bringing specific issues, such as linking local market infrastruc- together sound practices and on developing a consis- ture to international settlement, as well as compre- tent conceptual framework to guide policy makers hensive assistance to address broader objectives, such in their efforts to build domestic government bond as strategies and instruments to build reliable inter- markets. As a result the World Bank, in partner- est rate benchmarks. The World Bank program also ship with the IMF, published in 2001 the handbook provides a virtual forum for in-depth exchange of Developing Government Debt Markets to serve as a ideas and experiences among countries through Peer reference for policy makers. In complement to these Group Dialogues, where policy makers share experi- guidelines—and to help countries move from a mar- ences and expertise on issues related to debt markets, ket assessment stage to reform implementation—the and through South-South collaborations, which pro- support from IOs moved into actual operational mote in-depth engagement by authorities from many work. For example, a World Bank pilot program sup- countries and World Bank experts to tackle common ported 12 countries in preparing diagnostic assess- reform priorities. Since its launch in 2009, the Peer ments and action plans for developing government Group Dialogue has engaged 25 countries in discus- bond markets. The lessons learned from this pro- sions on 14 different topics such as policy challenges (box continued next page) 92 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 3.3 Supporting Local Currency Market Development (continued) and impacts of global financial crises, primary dealer and by providing low-cost distribution of govern- systems, and use of electronic trading platforms. ment securities through mobile phone technology. An innovative fi xed-income exchange traded fund (ETF) model supported by the issuer—to address DEVELOPING DOMESTIC GOVERNMENT market liquidity constraints of traditional ETFs and BOND MARKETS—A FEW EXAMPLES to help broaden the investor base—is being piloted Over the past five years, the World Bank has sup- in Brazil, where the World Bank supports the design ported more than 25 countries across six regions in and launch of the new model. The issuer-driven ETF developing their domestic government bond markets. is a new fi nancial product developed to improve the The solutions and advice provided to these coun- economic viability of ETFs in developing countries. tries span from enhancing core elements of market functioning to innovative solutions targeting specific JOINT EFFORTS TO PROMOTE LOCAL bottlenecks in the market. CORPORATE BOND MARKETS In Morocco, the World Bank supported imple- mentation of a comprehensive program to build Since 2008, the World Bank Group and other IOs reliable interest rate benchmarks and to promote have supported the Group of 20 in work related to increased market liquidity. As part of this effort, a the development of local currency bond markets.a As primary market issuance program was constructed part of this work, a joint action plan was adopted by to support the benchmark building program, the pri- a broad group of IOs in November 2011 to coordi- mary dealer agreement was revised to better enforce nate and consolidate efforts to promote local corpo- price quoting obligations, and an electronic trading rate bond markets in developing countries. In 2013, platform was established to improve price transpar- a common local corporate bond market diagnostic ency and to appraise primary dealer activity. framework was published to help policy makers and To support diversification of the investor base and providers of technical assistance assess the state of to provide access to formal savings instruments for development and efficiency of these markets and to the retail segment in Kenya, an innovative program design strategies for their development. The collabo- was launched to design and implement a new distri- ration between IOs also involves coordination of the bution channel for government securities via mobile technical assistance provided to developing countries phones. The Treasury Mobile Direct program aims for local corporate bond market development, which at broadening the access of retail investors to the gov- is supported by a shared project database and by ernment securities market by simplifying procedures annual meetings between the IOs. Sources: IMF and World Bank 2001; World Bank 2007; IMF 2013b; www.worldbank.org/capitalmarkets; www.gemloc.org. a. The organizations involved in the IO working group include the World Bank Group (WBG), International Monetary Fund (IMF), Asian Development Bank (ADB), African Development Bank (AfDB), Inter-American Development Bank (IDB), European Bank for Reconstruction and Development (EBRD), Organisation for Economic Co-operation and Development (OECD), and the Bank for International Settlements (BIS), with active support from the Deutsche Bundesbank. in corporate bond markets in these economies gate the impact of external crises or reversals suggests that private credit markets are more of capital flows, provide a stable source of fi- complex to develop than public credit markets nancing to domestic firms, and, complementa- and require stronger institutional and regula- rily, constitute a source of investment to chan- tory frameworks. nel broad savings bases (Gyntelberg 2007; Several studies highlight the benefits and Laeven 2014; Levinger and Li 2014).19 Impor- rationale for developing local corporate bond tantly for developing economies, the develop- markets. A well-established corporate bond ment of domestic markets would help diver- market would improve the availability of long- sify their financial systems, which, as shown, term financing, facilitate capital inflows, miti- now typically rely on international markets. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 93 Moreover, having a well-developed corporate sistent with these results, Claessens, Klingebiel, bond market allows firms to access alternative and Schmukler (2007) documented that econ- sources of long-term funds other than bank omies with deeper financial systems (larger in- finance. That in turn would not only directly vestor bases) have larger domestic government lower the cost of capital for these firms but bond markets. A well-developed government would also increase competitive pressures on bond market can be considered a cornerstone the banking system, improving the efficiency for domestic corporate bond market develop- of capital allocation in the economy. ment because it acts as a benchmark against The development of domestic bond mar- which to price bonds and to create the neces- kets requires macroeconomic and institu- sary infrastructure for trading (box 3.4). tional soundness, a well-functioning financial The services provided by international infrastructure, and liquid government bond markets are also important for financial devel- markets. Burger and Warnock (2006) showed opment because they can complement devel- that countries with better historical inflation oped domestic debt markets by offering cor- performance, better institutions, and enforce- porations access to a global, well-diversified able creditor rights also have more-developed pool of investors. Foreign markets also could local corporate bond markets. This research act as a substitute market and could drive li- also found that the necessary conditions for quidity away from less-developed domestic corporate bond market development are very markets, thus hindering their development. similar to those that foster the development Gozzi and others (forthcoming) showed that of related markets, such as government bond such substitution is unlikely because firms markets. Guscina and Jeanne (2006) found that are able to issue debt both abroad and at a positive association between the share of home tap international and domestic markets domestic government debt, monetary stabil- with different types of bonds, suggesting that ity, and domestic financial development, sug- international markets act for these very large gesting that a large banking sector helps the corporations as complements, not substitutes government to sell its debt domestically. Con- of domestic markets. BOX 3.4 Building Blocks for Domestic Corporate Bond Market Development While a number of developing countries such as Regarding the primary market framework, the Chile and Malaysia have successfully developed deep starting point is to define the financing needs of primary corporate bond markets, achieving the bal- potential domestic bond issuers. In particular, an anced conditions in which a corporate bond market assessment of the market should consider the size can thrive has been challenging in many other devel- and type of issuers, as well as possible structural oping countries, where a few buy-and-hold investors constraints. For example, in some countries the need often predominate and where there is a lack of mar- for capital market fi nancing to the corporate sector ket liquidity (Garcia-Kilroy and Caputo Silva 2011). is limited because of well-established and effective An active bond market with adequate scale banking relations with large corporate borrowers. In requires sound corporate governance, a robust legal such countries, stimulating growth of the corporate framework, a diversified investor base, and an efficient bond market may be more challenging and may take infrastructure (Laeven 2014). In particular, given the longer. Moreover, facilitating access to the corporate relatively illiquid nature of corporate bonds, the focal bond market requires a regulatory framework that efforts to develop the corporate bond market should is not unduly onerous in its disclosure requirements, be placed on enhancing the efficiency of the primary approval procedures, duration, and costs. market while ensuring adequate arrangements to pro- The sound development of domestic corporate vide exit mechanisms in the secondary market. markets also requires the good performance of (box continued next page) 94 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 3.4 Building Blocks for Domestic Corporate Bond Market Development (continued) related markets (IMF 2013b): As some studies report, however, it is important First, well-functioning money markets are a pre- to also take into account the possibility of crowding- condition for the development of well-functioning out effects between government and corporate bond longer-term debt markets because they anchor the markets through competition for investors’ funds short-end pricing of debt instruments. Money mar- (Friedman 1986). For example, Graham, Leary, kets provide investors with instruments to manage and Roberts (forthcoming) documented a negative risks and maturities and are also important for sec- association between government borrowing and ondary market liquidity. In this sense, an effectively corporate debt issuance, which is consistent with a functioning money market provides key market pric- crowding-out effect on the demand curve for corpo- ing at the short end of the yield curve, influencing the rate debt. rate of longer-term corporate bonds. Third, the banking system also plays an impor- Second, government debt markets are the corner- tant role as a supplier, underwriter, and buyer of cor- stone of domestic corporate bond markets. Sound porate bonds (for itself or for its clients). This role sovereign debt management with regular issues of will evolve as countries develop, the fi nancial system benchmark bonds at different maturities is central deepens, and the domestic investor base becomes to building a yield curve, which is necessary to price diversified. At the same time, the banking system corporate bonds efficiently (especially in the longer provides fi nancial services to households that can- term). Additionally, the fi nancing needs of the cen- not access securities markets and, as a result, helps tral government determine the scope for corporate enhance market liquidity and lengthens the maturity bonds, especially in relatively small markets where of fi nancial securities because the banking system the government and private entities typically compete can hold securities on behalf of those households. for limited long-term funding. GLOBAL FINANCIAL CRISIS: percent (56 percent) between 2007 and 2009. EVIDENCE ON BONDS AND Although the volumes of syndicated loans SYNDICATED LOANS have since begun to grow, the totals in 2013 were still below those observed in 2007. The The global financial crisis of 2008–09 tem- faster expansion of syndicated loans during porarily halted the fast expansion in debt is- the precrisis period, together with the larger suance activity in both high-income and de- drop during the postcrisis period, shows how veloping economies.20 The total amounts of syndicated bank lending is a more volatile corporate bonds and syndicated loans issued and procyclical source of finance than corpo- by nonfinancial firms grew at an average an- rate bond financing. nual rate of about 10 percent in high-income As a consequence, corporate bonds have economies and 23 percent in developing econ- become more important in relative terms since omies during 2000–07. In 2008 total debt is- the crisis, especially in developing economies. sued decreased by 40 percent and 33 percent, In 2007, corporate bonds captured around 19 respectively. percent and 29 percent of the total long-term Corporate bond issues began to grow again debt issued by high-income and developing in 2009, but the collapse in syndicated loan fi- economies, respectively; in 2009 these shares nancing was larger and longer lasting. Corpo- were about 49 percent and 64 percent. In some rate bond markets quickly rebounded in 2009 regions a rapid expansion of corporate bond and continued increasing during the postcrisis issuance completely compensated (in vol- period, especially in developing economies. In ume) for the fall of syndicated loans. In Latin contrast, syndicated loan financing by high- America and the Caribbean, for example, the income (developing) economies declined 63 total amount raised through corporate bonds GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 95 increased 170 percent from 2008 to 2013, corporate bonds to fund operations previously whereas syndicated lending declined 42 per- funded by syndicated loans. cent. The acceleration in the corporate bond During the crisis, the average maturity of issuance was partially prompted by global in- newly issued corporate bonds declined in both vestors searching for higher yields in an over- economy groupings, while the average matu- all low interest rate environment driven by rity of newly issued syndicated loans declined low government yields. The shift away from only in high-income economies. More specifi- bank financing to bond financing has affected cally, between 2007 and 2009, the average ma- some sectors more than others. The infrastruc- turity of corporate bonds declined by almost 3 ture sector was hard hit because syndicated years in high-income economies and by more loan financing plays a very important role at than 2 years in developing economies.21 The the early stages of the projects. Moreover, al- average maturity of syndicated loans conceded though the data were silent on substitution be- to high-income economy firms decreased by tween markets, it is possible that some of the 1.6 years during the same period, while in increase in bond issue could be attributable developing economies it actually increased by to the refinancing of bank loans or to using more than 2 years (figure 3.7). This increase FIGURE 3.7 Average Maturity of Corporate Bond and Syndicated Loan Issuances, 2000–13 a. High-income countries 14 13 12 11 10 9 Maturity, years 8 7 6 5 4 3 2 1 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 b. Developing countries 14 13 12 11 10 9 Maturity, years 8 7 6 5 4 3 2 1 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Corporate bonds Syndicated loans Source: Cortina, Didier, and Schmukler 2015. 96 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 3.8 Total Amount Raised in Domestic and International Corporate Bond Markets by Nonfinancial Firms, 2000–13 a. High-income countries 0.7 0.6 2011 U.S. dollars, trillions 0.5 0.4 0.3 0.2 0.1 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 b. Developing countries 0.25 0.20 2011 U.S. dollars, trillions 0.15 0.10 0.05 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Domestic markets International markets Domestic markets (excluding China) Source: Cortina, Didier, and Schmukler 2015. was driven by a decline in shorter-term loans, the increasing exposure of developing econo- however, rather than by an increase in longer- mies to currency mismatches and to potential term financing (longer-term loans also col- changes in international investor sentiment lapsed during the crisis). (Chui, Fender, and Sushko 2014; The Econo- A closer look at corporate bond activity mist 2014a, 2014c; IDB 2014; Turner 2014). during and after the crisis shows that interna- The volume of domestic corporate bonds tional bond issues rapidly rebounded after the issued by developing economies during and crisis, particularly in developing regions (figure after the crisis also accelerated. That expan- 3.8). For example, the international issuance sion was heavily concentrated in a few coun- of bonds in Latin America and the Caribbean tries, however. Overall, firms in developing increased almost 8-fold between 2008 and economies more than doubled the domestic 2009 and has remained high since then. The issuance of corporate bonds during 2008–13 issuance in international markets of some spe- (see figure 3.8).22 Chinese firms accounted cialized local securities such as Islamic bonds for 58 percent of that total, followed by Bra- (sukuk) has also been on the rise (box 3.5). zil (12 percent), the Russian Federation (8 Because bonds issued in international markets percent), and India (6 percent).23 These four are almost exclusively denominated in foreign economies plus six others captured 99 per- currency, some studies have warned about cent of the total amount raised domestically GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 97 BOX 3.5 Sukuk: An Alternative Financing Source The recent growth of Islamic fi nance, based on the securities with high-quality credit ratings that con- principles of risk sharing and participatory fi nance, form to principles of Islamic finance is evident by offers potential alternatives for long-term fi nancing. the fact that the U.K. issuance was oversubscribed The total size of fi nancial assets under management by approximately 12 times. Tapping into this emerg- in this growing industry was estimated to exceed ing instrument, the World Bank successfully raised $2 trillion by the end of 2014. For instance, the $500 million through sukuk issuance in 2014 to African region is embracing large-scale Islamic help with the funding of an immunization program finance to finance large infrastructure programs. in Africa. The Islamic Development Bank (IsDB) has Although the banking sector dominates the mar- been the leading multilateral institution mobilizing ket, asset-based capital market instruments are a fi nancing for development through sukuk. IsDB’s lat- growing source of fi nancing for both Muslim and est public offering of sukuk in 2014 raised $1.5 bil- non-Muslim countries in domestic and international lion for development in its member countries. Malay- markets. sia has been the leader in issuing domestic sukuk and A sukuk is an asset-backed security representing a represents the largest share of the global market. right of ownership for the holders to the underlying Moreover, sukuk has been used successfully for assets and the income they generate. In particular, a the fi nancing of long-term infrastructure projects. sukuk is commonly used as the Islamic equivalent of Sadara Company, a joint venture between Saudi bonds. In contrast to conventional bonds, however, Aramco and the Dow Chemical Company, origi- which merely confer ownership of a debt, sukuk nated a $2-billion sukuk with a maturity of 16 years grants the investor a share of an asset, as well as to fi nance the construction of a petrochemical plant the associated cash flows and risk. Therefore, sukuk (planned to cost around $12.5 billion). Tenaga Nasi- securities adhere to Islamic laws that prohibit the onal Berhad from Malaysia issued a $1.09 billion charging or payment of interest. The total outstand- sukuk with a maturity of 27 years to fi nance con- ing amount of sukuk stood close to $300 billion by struction of a 1,000 megawatt ultra-supercritical the end of 2014. coal-fi red power plant. Because of the asset-based nature of the security, Although still in its infancy, with its asset-based sukuk are attractive to a diverse group of borrowers structure and risk-sharing aspects, sukuk bonds seem and investors in both Muslim and non-Muslim coun- to have significant potential to be used in infrastruc- tries. The utilization of sukuk as a fi nancing vehicle ture and fi nancing for small and medium-size fi rms by several leading high-income economies includ- not just for the Middle East and North Africa region ing Hong Kong SAR, China; Luxembourg; South (estimated to need $75 billion–$100 billion infra- Africa; and the United Kingdom during 2014 is testi- structure investments annually over the next 10–15 mony to the wider acceptance of the instrument and years), but also for both high-income and developing emergence of a new asset class. Strong demand for markets around the globe. Sources: Bank Negara Malaysia 2014; IIFM 2014; Standard & Poor’s 2014; http://www.zawya.com/islamic-fi nance. within developing economies during the pe- share of developing economies, government riod (figure 3.9). Although the experience of bond markets also expanded during and af- these 10 countries indicates how these domes- ter the crisis; see box 3.6. As noted, these tic bond markets can play a “spare tire” role markets constitute a cornerstone of domestic (Chan and others 2012), local bond markets debt markets and are central to building a did not develop at all for most developing yield curve that will allow private bonds to be economies. Domestic bond markets remained priced at long maturities.) completely untapped for 14 of the 33 devel- The largest decline in corporate bond ac- oping economies in the sample. (For a large tivity occurred in the financial sector of high- 98 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 3.9 Share Raised by the 10 Most Active Developing income economies, which experienced a sharp Countries in Domestic Corporate Bond Markets, 2008–13 and sustained fall in issuance volumes after 2007 (financial firms were studied separately 70 from nonfinancial firms). The total amount fi- 60 nancial firms raised through corporate bonds in 2013 was about 58 percent the amount Share of total raised, % 50 raised in 2007 (figure 3.10). In contrast, fi- 40 nancial companies in developing economies 30 have quickly recovered the upward trend in corporate bonds activity since 2009. In 2013 20 the total amount raised doubled that of 2007. 10 In syndicated loan markets, both domestic 0 and international lending collapsed for high- income economies, while only international ra an ile ia ia ico ia es il ina d ys es az de ssi Ind Ch an pin n ex Ch ala Br tio on ail Fe Ru lending collapsed for developing economies. M ilip Ind Th M Ph The aggregate amount raised by high-income economies in both domestic and international Source: Cortina, Didier, and Schmukler 2015. markets decreased 60 percent between 2007 BOX 3.6 Macroeconomic Factors and Government Bond Markets in Developing Countries The experience of developing countries in the 2000s of debt to GDP. Fiscal indicators, interest rates, and shows that improvements in macroeconomic funda- GDP growth represent the key determinants in the mentals created a momentum to build local bond dynamics of these ratios. Most developing countries markets and helped them weather the global fi nan- enjoyed a long period where this positive combina- cial crisis. tion was in place. In the years preceding the crisis, developing Improvements in developing countries’ external countries achieved significant improvement in their accounts provided solid foundations to reduce vul- macroeconomic environments. nerability to shocks and to reversals in capital flows. Governments’ primary balances, as a percent- While external accounts improvements were driven age of GDP, were overwhelmingly positive or were by cyclical factors that led to extremely high inter- becoming positive during this period, and overall national liquidity conditions, proactive policies to budget balances, as a percent of GDP, were improv- reduce debt vulnerabilities (buybacks of external debt ing steadily across all regions. and a shift to funding in local markets) were highly Greater price stability and positive expectations instrumental in the rapid pace of change witnessed in in developing countries were favorable ingredients external debt vulnerability indicators. boosting confidence in longer-term bonds, includ- On the back of healthier macroeconomic fun- ing government bonds. In many countries, especially damentals, developing countries were able to trans- those that had been historically plagued by volatile form their government debt portfolios and to grow and high inflation levels, this scenario paved the way domestic bond markets. The average ratio of exter- for interest rate cuts, the development of local cur- nal to domestic debt for selected developing coun- rency yield curves, and the lengthening of the average tries dropped steadily from 0.75 in 2000 to 0.22 in time to maturity of the domestic government debt. 2009. Currency composition of the government debt Buoyant growth, together with sounder fiscal portfolio moved drastically in favor of local currency, policy, contributed to a downward trend in ratios reducing the exposure to changes in exchange rates. (box continued next page) GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 99 BOX 3.6 Macroeconomic Factors and Government Bond Markets in Developing Countries (continued) The structure of the domestic debt experienced progress achieved during the precrisis period made a significant transformation as debt managers were developing countries more resilient to the global cri- able to reduce risk exposures through the issue of sis, allowing them to experience a faster rebound long-term fi xed-rate instruments. The ratio of float- (Didier, Hevia, and Schmukler 2012). That is, sound ing and short-term to fi xed-rate debt contracted from macroeconomic policies seem to have been critical in 2.0 in 2000 to 0.7 in 2009. creating a buffer and in positioning developing coun- The extension of the average life of debt was sup- tries for quicker recovery from the crisis. Developing ported by increased credibility of monetary policy countries arrived at the global fi nancial crisis with and diversification of the investor base. More stable government debt portfolios that were more resilient and sounder macroeconomic policies, together with to shifts in the economic cycle and market sentiment. reforms in the pension and insurance industries, The increase in the share of domestic debt reduced changed the investor base that previously comprised the exposure to exchange rate shocks and the vulner- almost exclusively commercial banks. Holdings of ability to sudden stops in capital flows. The lengthen- domestic institutional investors (pension and insur- ing of maturities in local currency fi xed-rate instru- ance) grew steadily. Foreign investors showed appe- ments reduced rollover and interest-rate risk in the tite for local currency, long-term fi xed-rate instru- time of crisis. During the crisis, debt managers had ments in countries like Mexico and Brazil. room to maneuver and were able to adapt quickly, Although developing countries were initially hit by absorbing some risk from the market. the global crisis as much as developed countries, the Source: Anderson, Caputo Silva, and Velandia-Rubiano 2010. FIGURE 3.10 Total Amount Raised in Corporate Bond Markets by Financial and Nonfinancial Companies, 2000–13 a. High-income countries 3.0 2.5 2011 U.S. dollars, trillions 2.0 1.5 1.0 0.5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (figure continued next page) and 2009 (figure 3.11). This collapse was es- tional lending to developing-economy firms pecially hard for developing-economy firms declined from $256 billion to $64 billion dur- that received most of their syndicated loan ing the two-year period. The largest fraction financing in the international market. Interna- of syndicated loans to developing economies 100 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 3.10 Total Amount Raised in Corporate Bond Markets by Financial and Nonfinancial Companies, 2000–13 (continued) b. Developing countries 0.40 0.35 2011 U.S. dollars, trillions 0.30 0.25 0.20 0.15 0.10 0.05 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Financial companies Nonfinancial companies Source: Cortina, Didier, and Schmukler 2015. FIGURE 3.11 Total Amount Raised by Nonfinancial Firms in Domestic and International Syndicated Loan Markets, 2000–13 a. High-income countries 2.5 2.0 2011 U.S. dollars, trillions 1.5 1.0 0.5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 b. Developing countries 0.30 0.25 2011 U.S. dollars, trillions 0.20 0.15 0.10 0.05 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Domestic borrowing International borrowing Domestic borrowing (excluding China and India) Source: Cortina, Didier, and Schmukler 2015. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 101 originated in Western European banks, the loans are not perfect substitutes, particularly at major source of syndicated funding for firms the construction phase of these projects. Syn- in the developing world, fell 80 percent be- dicated loans are most suited to the complex- tween 2007 and 2009, and has remained very ity and higher risks associated with the initial weak since then (figure 3.12).24 phases of the projects (planning and construc- Although the overall volume of domestic tion) whereas bonds are more appropriate for syndicated lending in developing economies more consolidated stages (operational).26 The rapidly increased during and after the crisis bank retrenchment that followed the crisis se- years, China and India alone fully absorbed verely constrained syndicated loans and thus three-quarters of it. More specifically, the ag- the financing of infrastructure projects in de- gregate amount raised in domestic markets by veloping countries, which had few alternatives developing-economy firms was $51 billion in for financing these operations at their initial 2007, $76 billion in 2009, and $116 billion phases. Lending originated in high-income in 2013 (see figure 3.11). Domestic lending in economies to finance infrastructure in devel- China and in India accounted for 23 percent oping ones declined 62 percent between 2007 and 53 percent of the total amount lent, re- and 2009, threatening the long-term growth spectively.25 Most developing economies did associated with these projects (Calderón and not see any increase in domestic syndicated Servén 2014). See figure 3.13. lending during 2008–13. This lack of growth, Cyclical and structural reasons seem to be together with the collapse in international behind the collapse and the weak recovery of lending, meant that firms from most develop- syndicated loan financing. Part of this decline ing economies have been struggling in recent may reflect a drop in demand as firms scaled years to tap long-term funding through the back expansion plans during the recession use of syndicated loans. (Ivashina and Scharfstein 2010). Neverthe- Because syndicated loans are key at the less, the fall in syndicated loans was greater early stages of infrastructure projects, these than in a typical recession because the de- projects have been severely affected by the lack mand drop was reinforced by a drop in sup- of syndicated funding. Bonds and syndicated ply caused largely by deleveraging pressures FIGURE 3.12 Total Amount Lent to Developing Countries through Syndicated Loan Markets by Lender Region, 2000–13 200 180 160 2011 U.S. dollars, trillions 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Western Europe United States High-income Asia Others Source: Cortina, Didier, and Schmukler 2015. 102 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 3.13 Syndicated Lending to Developing Countries for Project Finance, 2000–13 80 70 60 2011 U.S. dollars, trillions 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 High-income countries lending to developing countries Developing countries lending to developing countries Developing countries lending to developing countries (exlcuding China and India) Source: Cortina, Didier, and Schmukler 2015. and tightened banking regulations (Chui and use these financial markets, and only the larg- others 2010). The contraction in supply put est and oldest ones issue at the long end of the upward pressure on interest rate spreads and maturity spectrum. For the set of firms that led to a greater fall in lending. Laeven and do use long-term markets, those in developing Giannetti (2012) argued that a “flight home” economies do not issue at shorter maturities was another reason for the collapse of the than those in high-income economies. cross-border syndicated loan market; that is, Because developing-economy firms tend lenders rebalanced their portfolios toward to be smaller in size, a smaller proportion their domestic borrowers. Recent reports of firms is able to access equity, bond, and have argued that the reduction in cross-bor- syndicated loan markets. Therefore, the larger der flows may also have been the consequence proportion of SMEs in these countries has of the acute financial stress experienced by fewer alternatives when it needs external fi- European banks as a result of the sovereign nance to realize investment opportunities and debt crisis affecting several European coun- has to rely, at least for a while, on other in- tries (Feyen and Gonzalez del Mazo 2013; struments such as bilateral loans. These firms IMF 2013a; Laeven and Tressel 2014). Other are thus at a disadvantage for several reasons. possible factors in decreasing supply included First, bank lending could sometimes be more increases in loan maturities, low rates of re- volatile (and procyclical) than market-based financing, and an increase in drawdowns on securities. Second, market-based securities existing syndicated credit lines in the years be- and syndicated loans provide an alternative fore the crisis (Roberts and Sufi 2009; Cerutti, and perhaps complementary form of financ- Hale, and Minoiu 2014). ing. And third, firms with access to market- based sources of external finance seem to experience better credit conditions (lower CONCLUSIONS spreads) than those that only access private Capital and syndicated loan markets have markets (bank loans), even when controlling seen significant growth during the past de- for loan- and firm-specific factors, especially cades. However, only a few very large firms during recessions (Santos and Winton 2008). GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 103 Broadening the access to long-term capital have to overcome an apparently even larger markets beyond a very select group of large minimum size requirement than those firms firms is a big challenge. Reducing the transac- that use domestic markets to obtain longer- tion costs associated with the issuance process term funds. That is, while international mar- could enlarge the number of firms able to ac- kets support larger issuances (which are the cess capital markets, with positive spillover ones demanded by global underwriters and effects on the secondary markets and on the investors), only the largest firms can access overall economic growth of countries. To the them. This implies that only a very small pro- extent that these markets are already com- portion of developing-country firms has ac- petitive in some countries, reducing the costs cess to finance at the long end of the maturity through government interventions would spectrum. be difficult. Another way to allow smaller, Moreover, the reliance on only one type lower-rated firms to issue securities in capi- of market to finance long-term projects is tal markets would be to develop innovative risky, and countries can become susceptible instruments (such as minibonds) and securiti- to shocks. In particular, the higher reliance zation (Borensztein and others 2008; Giovan- of developing-economy firms on interna- nini and others 2015). tional capital markets to access longer-term A related challenge is to broaden the in- funds also makes them more vulnerable to vestor base and to expand the scope of inves- currency mismatches and to shocks on inter- tors’ portfolios. In principle, countries with national markets. small market sizes and investor bases would As a result, developing-economy firms gain from promoting foreign investor partici- would benefit from further development of pation in domestic markets or from gaining their domestic bond markets. More-developed more access to foreign markets. In fact, higher domestic bond markets would reduce the reli- competition from a broader set of investors ance on international markets for those firms and intermediaries in countries with well- that are able to issue in developing economies developed financial systems seems to allow and would imply a more inclusive, broader for wider access to finance and for easier ac- use of long-term finance in these countries. To cessibility to longer terms. Didier, Levine, and do this, governments must develop the under- Schmukler (2014) have shown how, in high- lying institutions and address policy distor- income economies with the most-developed tions. In particular, a stable macroeconomic capital markets, relatively smaller firms are environment, institutional stability, improved able to issue capital. This suggests that, as fi- financial infrastructure, competitive pressures nancial markets develop, the extensive margin on the banking system, local credit rating of firms using these markets might expand agencies, liquid secondary markets, and the so that smaller firms could participate more development of government bond markets in these markets. Broadening investors’ port- (that do not crowd out the private sector) folios that currently only include a few firms could aid in the development of domestic cor- from a few economies is also important (Di- porate bond markets. dier, Rigobon, and Schmukler 2013). Insti- The use of international capital markets tutional investors have preferences for (or also has its benefits. International markets are restricted to) high-rated bonds issued by complement domestic markets by allowing few large (creditworthy) companies. In prin- firms to access a wider and more diverse set ciple, institutional investors would gain from of investors. This could be a way to extend greater diversification, which would help the maturity profile of corporate debt in de- broaden these markets, but some constraints veloping countries. Foreign investors might in the intermediation process seem to prevent be willing to take more risk when investing them from achieving that benefit. in developing countries, especially when the Because developing-economy firms rely on returns of investing in high-income economies international capital markets to raise funds at are compressed (by, among other things, lax the long end of the maturity spectrum, they countercyclical monetary policy). 104 THE USE OF MARKETS FOR LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Finally, the reliance on a single type of smaller in size than government bond mark- instrument to finance long-term projects is ers (Didier and Schmukler 2014). risky. The overreliance on international syn- 5. Moreover, the data are available in a similar dicated loans to finance infrastructure proj- format, making the comparison feasible. 6. The share of syndicated lending in total loan ects in developing economies has emphasized claims has also increased over time (Cerutti, the need to design alternative instruments. In Hale, and Miniou 2014). principle, these alternative instruments would 7. Around 67 percent of all bonds, 70 percent of generate new sources (broader sets of inves- all syndicated loans, and 35 percent of equity tors) to finance infrastructure projects. The issued exceeded $40 million. emergence of infrastructure as an asset class 8. Similarly, banks originate syndicated loans and of infrastructure investment funds seem for lending to large corporations (Altunbas, to be promising options to fill the infrastruc- Kara, and Marques-Ibañez 2010; Ivashina ture finance gap (Ehlers 2014). International and Scharfstein 2010). financial institutions and initiatives such as 9. Consistent with the results on firm size, bond the International Finance Corporation or issues are larger than equity issues. In high- income economies, the average bond issue the Global Infrastructure Facility Initiative (a is $238 million, more than twice the size of World Bank Group initiative) can help in this the average equity issue of $109 million. The regard by fostering public-private partner- spread is not as large in developing econo- ships (PPPs), creating the necessary conditions mies: bond issues average $111 million, com- to crowd in private markets, and aiding in the pared with $91 million for the average equity process of financial innovation. issue. 10. Table 3.2 includes only publicly listed firms. 11. The main difference between the figures NOTES showing the median economy and the figures 1. This section refers only to use of these mar- showing pooled data by region (panel b) is kets by firms and does not take into account that the second method gives more weight whether the issuances come from the domes- to larger economies (because these absorb a tic or the international market. larger portion of the total issuance), while the 2. More recent research studies the connec- first method weights each economy equally. tion between primary capital markets and The chapter provides systematic evidence growth at the microeconomic level (Didier using the two methods. and Schmukler 2013; Didier, Levine, and 12. According to Blanc-Brude and Ismail (2013), Schmukler 2014). 80 percent of all project finance around the 3. The value of debt issuances is not directly world finances infrastructure, and the rest comparable to that of equity issuances goes to oil and gas projects. because equity issuances have no maturity, 13. Most of this section focuses on corporate while debt issuances must be repaid. Part bond markets because of the difficulties in of the proceeds from debt issuances is typi- performing a similar analysis for syndicated cally used to repay maturing debt, and there- loan markets. A caveat for the syndicated fore only a fraction of debt issuances can loan analysis in this section: tranches of these be considered new financing. Henderson, loans usually come from different banks Jegadeesh, and Weisbach (2006) tried to located in different countries. Because the adjust the data on debt issuance to take this analysis presented here assumes that each fact into account and concluded that, even participant bank in the loan lends the same with these adjustments, debt issuance con- amount of money to a given firm, the average stituted a much larger source of new capital maturities per loan and market location are than equity issuance at the aggregate level. not reported. Furthermore, the evolution in the amount 14. A large number of high-income countries raised by new financing in the different mar- (especially the ones located in Europe) are kets is also informative. highly integrated. 4. Despite their rapid growth, corporate bond 15. The level of corporate bond market activity in markets in developing economies are still Bolivia, Pakistan, and Vietnam is very low. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 THE USE OF MARKETS FOR LONG-TERM FINANCE 105 16. Consistent with this result, Schmukler and 21. The average maturity of newly issued corpo- Vesperoni (2006) document how firms rate bonds had previously jumped by almost increase their long-term debt and extend their four years between 2006 and 2007. debt maturity after accessing international 22. This increase in domestic bond financing in markets. developing economies was accompanied by 17. Multinational firms might sometimes find it an increase of issues denominated in domestic desirable to issue in foreign currency to match currency. the currency denomination of their expendi- 23. State-owned enterprises issued around 54 tures with their external financing. percent of the total amount in corporate bond 18. The “original sin” literature discussed how markets in China during 2008–13. during the 1990s governments in develop- 24. Lending from the other largest high-income ing countries could borrow only short term regions also collapsed. and in foreign currencies (Eichengreen and 25. The larger developing economies in terms of Hausmann 1999). This inability to borrow capturing domestic syndicated loan activity long term in domestic currency was associ- during 2008–13 are Brazil (4.4 percent of the ated with a higher frequency of financial and total), Thailand (3.7 percent), the Russian balance-of-payment crises and with higher Federation and Malaysia (3.1 percent each), macroeconomic costs associated with these Turkey (2.9 percent), Indonesia (2.7 per- crises (Rodrik and Velasco 2000). cent), South Africa (1.6 percent), and Nigeria 19. It is also important to take into account (1 percent). the residence of the debtholders. Having 26. Ehlers (2014) reports the key advantages of a substantial presence of foreign investors loans over bonds at the early stages of infra- in domestic currency debt means that the structure projects: the monitoring role neces- exchange rate may be subject to consider- sary at the initial stages of the project is better able and volatile pressures coming from fluc- served by banks, which have greater exper- tuations in foreign appetite for local currency tise; bank loans are more flexible in providing bonds. gradual disbursement of funds; and, com- 20. As in the previous section, this section focuses pared with bond financing, banks can more mainly on nonfinancial corporate issuances easily negotiate debt restructurings resulting and borrowing. from unforeseen events. CHAPTER 4: KEY MESSAGES • There are significant and informative differences in the maturity holdings across different types of fi nancial intermediaries and across countries. Overall, the evidence suggests that extending maturities through financial institutions in developing countries is more difficult than is usually thought. • First, despite their advantage due to relationship lending, banks in developing countries do • Financial not systems seem to have are multidimensional. compensated Four for the potential characteristics information are of particular asymmetries interest and other market for benchmarking failures financial prevalent in these systems: countries. financial Their depth, loans have access, signifi efficiency, cantly shorter and stability. maturities than These those characteristics in high-income need to be countries. measured Even in weakfor financial institutions institutional and markets. settings, however, establishing a well-regulated, contestable, and private banking system with stable and long-term sources of • Financial systems come in all shapes and sizes, and differ widely in terms of the four funding is associated with the provision of longer-term maturity debt. characteristics. As economies develop, services provided by financial markets tend to become • Second, themore important development ofthan largethose provided by banks. and sophisticated nonbank intermediaries does not guar- antee an increased demand for long-term assets. Evidence from Chile shows that domestic • The global financial crisis was not only about financial instability. In some economies, mutual and pension funds tend to invest short term, especially when compared with insur- the crisis was associated with important changes in financial depth and access. ance companies. Short-term strategies seem to arise from market and regulatory mechanisms that monitor managers on a short-term basis and give some of them incentives to invest shorter term. • Third, international evidence on mutual funds suggests that foreign investors hold more long- term domestic debt than domestic investors. Thus, it might be difficult to extend the maturity structure toward the long term by relying only on domestic mutual funds. • Fourth, although sovereign wealth funds (SWFs) have grown rapidly, their overall invest- ments remain concentrated in liquid-asset classes in high-income countries, while thin capital markets, as well as political and economic risks, still limit the role of SWFs as providers of long-term finance in developing countries. • Fifth, private equity (PE) investments are an increasingly important source of entrepreneurial finance in developing countries. However, PE investments are relatively small and are heavily dependent on the institutional quality and depth of capital markets in the country of invest- ment. This limits their viability as a source of long-term finance in many economies. BANK AND NONBANK FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 4 Bank and Nonbank Financial Institutions as Providers of Long-Term Finance T his chapter studies the role of bank and nonbank financial intermediaries in the provision of long-term finance. In particular, take advantage of long-term risk and illiquid- ity premiums to generate higher returns on their assets. Moreover, they were expected to based on data from different financial institu- behave in a patient, countercyclical manner, tions, it reports on the extent to which finan- making the most of cyclically low valuations cial institutions hold long-term securities in to seek attractive investment opportunities, their portfolios and which of them are more thus helping to deepen long-term financial likely to extend the maturity structure toward markets and, more generally, increase access the long term. to finance. This view has been expressed in Banks are the main source of finance for several studies and articles (see, for exam- firms and households across countries. There- ple, Caprio and Demirgüç-Kunt 1998; Da- fore, understanding the degree to which banks vis 1998; Davis and Steil 2001; Corbo and lend long term and what drives maturity Schmidt-Hebbel 2003; Impavido, Musalem, lengths is of crucial importance. Furthermore, and Tressel 2003; BIS 2007a; Borensztein the recent global financial crisis has high- and others 2008; Eichengreen 2009; Im- lighted the risk that banks’ deleveraging could pavido, Lasagabaster, and Garcia-Huitron result in a shortening of the maturity of loans. 2010; Della Croce, Stewart, and Yermo 2011; Also, forthcoming changes in international The Economist 2013, 2014c; OECD 2013a, bank regulation could alter the composition 2013c, 2014a; and Financial Times 2015). of bank loans and could reinforce the need to Nonbank institutional investors have, monitor and understand the degree to which in fact, become increasingly important par- banks lend long term. ticipants in global financial markets. The Over the past two decades, many countries proportion of household savings channeled have also tried to foster long-term lending through these institutional investors has through the promotion of nonbank domestic grown significantly in recent decades, and institutional investors. The expectation was their assets under management are rapidly that these investors would have long invest- catching up with those of the banking system ment horizons, which would allow them to (BIS 2007b). Data from the Organisation for GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 107 108 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.1 Assets under Management of Nonbank Institutional managers have and the maturity profile of the Investors, 2001–13 portfolios they choose. This chapter contributes to these discus- 90 sions by providing empirical evidence on the 80 investment strategies and, more specifically, on 70 the portfolio maturity and composition of dif- U.S. dollars, trillions 60 ferent classes of bank and nonbank financial 50 intermediaries. Because gathering evidence on 40 the maturity structure of different financial 30 institutions is difficult, the chapter relies on 20 various types of evidence that are different in 10 nature, and in some cases new. The chapter 0 starts by presenting evidence on loan matu- 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 rity for banks in different countries. Then it Pension funds Insurance companies Investment funds presents country-specific evidence across dif- ferent nonbank institutional investors and in- Source: OECD 2014b. ternational evidence based on bond funds to Note: Only data for OECD countries are included. Investment funds include both open-end and closed-end funds. Pension funds and insurance companies’ assets include assets invested in study the extent to which mutual funds, pen- mutual funds, which may be also counted in investment funds. sion funds, and insurance companies hold and bid for long-term instruments. In addition, the chapter examines the investment profiles Economic Co-operation and Development of two growing types of nonbank financial (OECD) show that in 2013 financial assets institutions that are also expected to have under management reached $24.7 trillion for long investment horizons, namely, sovereign pension funds, $26.1 trillion for insurance wealth funds (SWFs) and private equity (PE) companies, and $34.9 trillion for investment investors. The analysis is performed across funds (figure 4.1). different countries, with special emphasis in Little evidence exists, however, on whether developing (low- and middle-income) coun- these investors actually invest in long-term tries, and discusses the potential limitations of securities or on how they structure their as- these investors in providing long-term fund- set holdings. While macroeconomic factors ing. The chapter concludes by discussing some and strong institutions may contribute to policy implications from this evidence. lengthening the maturity structure of these investors, this chapter highlights the role of BANKS incentives, market forces, and regulations in shaping investors’ maturity structure. Differ- Bank-level data across countries reveal that ent types of institutions with different objec- the maturity of bank loans in high-income tives are likely to provide funding for financial countries is significantly longer than it is in markets in distinct ways. For example, some developing countries.1 Aside from data on institutions might need to match the maturity syndicated lending, discussed in chapter 3, the of their assets to their liabilities, while others main source of comparable international data might have only fiduciary responsibilities for on bank lending is Bankscope, a commercial managing their assets without specific direc- database produced by Bureau van Dijk. Data tives to invest short or long term. When sav- on the maturity breakdown of bank loans ings from the public are delegated to financial is available for 3,400 banks operating in institutions, the regulator has to ensure that 49 countries from 2005 to 2012. Figure 4.2 managers are doing a good job at managing shows the mean share of bank loans across these savings, avoiding excessive risk taking, three maturity buckets: up to one year, two and minimizing loses. The way these regula- to five years, and more than five years. While tions are set up can affect the incentives that close to a third of bank loans in high-income GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 109 countries have a maturity that exceeds five FIGURE 4.2 Average Share of Bank Loans by Length of Maturity and years, for developing countries the share of Country Income Group, 2005–12 loans with maturity longer than five years av- erages 18 percent. In contrast, while half of 60 bank loans are short term (less than one year) 50 50 in developing countries, the share of short- Share of total loans, % 40 term loans in high-income countries averages 40 32 31 40 percent. There are smaller differences be- 28 30 tween high-income and developing countries in the share of loans with maturity between 20 18 two and five years: this share averages 28 per- 10 cent for high-income countries and 32 percent for developing countries. 0 There are also differences between high- Up to 1 year 2–5 years Over 5 years income and developing countries in the re- High-income countries Developing countries cent evolution of the share of bank loans by maturity buckets. In both country groups, Source: Bankscope (database), Bureau van Dijk, Brussels, http://www.bvdinfo.com/en-gb however, there is no consistent evidence that /products/company-information/international/bankscope. the recent crisis led to a significant decline in the share of long-term loans when the overall patterns could hide significant differences in loan portfolio is considered.2 For high-income the composition of borrowers—it is possible countries, short-term debt declined from an that, while the share of long-term bank lend- average of 40 percent in the precrisis period ing remained fairly stable, fewer small or me- to 37 percent in the postcrisis period, while dium firms, for example, might have received the share of long-term debt rose from 31 long-term financing (see chapter 2). percent to 33 percent (table 4.1). It is likely Even when focusing on international bank that as short-term debt matured, it was not claims, where deleveraging has been well doc- renewed and, hence, the share of medium- umented, there is no compelling evidence of and long-term debt increased. For develop- a significant and across-the-board shortening ing countries, the share of short-term debt of maturities following the financial crisis.3 remained fairly stable at around 50 percent, The Bank for International Settlements (BIS) while the share of long-term debt increased reports quarterly data on international claims somewhat. In particular, the average share from banks operating primarily in developed of bank loans with maturity greater than five countries vis-à-vis most countries around the years increased by 3 points, from 16 percent world. International claims consist of cross- to 19 percent, while the median rose from 8 border claims (that is, claims extended from percent to almost 13 percent. Of course, these the home country where the international TABLE 4.1 Share of Bank Loans across Different Maturity Buckets (percent) Precrisis period Crisis period Postcrisis period 2005–07 2008–09 2010–12 Maturity bucket Country classification Mean Median Mean Median Mean Median High income 40.2 36.4 40.4 33.9 36.8 29.0 Up to 1 year Developing 49.9 52.1 48.4 49.6 49.1 47.9 High income 28.6 26.6 26.2 24.8 29.5 29.9 2 to 5 years Developing 32.5 32.3 33.4 31.0 31.6 30.4 High income 30.6 29.1 33.0 33.6 33.3 30.1 More than 5 years Developing 16.4 8.0 17.9 13.0 19.0 13.3 Source: Bankscope (database), Bureau van Dijk, Brussels, http://www.bvdinfo.com/en-gb/products/company-information/international/bankscope. 110 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.3 Share of International Bank Claims with Maturity with shorter loan maturities. As for the im- above Two Years by Period and Country Income Group, 2005–13 portance of the institutional environment, Fan, Titman, and Twite (2012) found that in 60 countries with weaker laws, firms tend to use 49 50 more short-term bank debt. 50 45 44 44 47 41 43 43 43 Other country characteristics, such as the Share of total claims, % 38 40 40 degree of development of the financial sec- tor, the ability to effectively enforce finan- 30 cial contracts, the collateral framework, and 20 the credit information environment, are also important determinants of bank loan matu- 10 rity. First using data on the maturity of do- 0 mestic bank credit to the private sector in 74 High-income countries Upper-middle-income Lower-middle- and countries and then using a panel dataset for countries low-income countries a sample of transition economies, Tasić and 2005–07 2008–09 2010–11 2012–13 Valev (2008, 2010) found that financial sec- tor development, as captured by the ratio of Source: Consolidated Banking Statistics (database), Bank for International Settlements, Basel, bank credit to gross domestic product (GDP), http://www.bis.org/statistics/consstats.htm. has a positive impact on bank loan maturity. Note: International claims consist of cross-border claims and local claims denominated in foreign currencies. Bae and Goyal (2009), using loan data, and Fan, Titman, and Twite (2012), using firm- level data, found that better contract enforce- bank is headquartered to borrowers in other ment is associated with longer debt maturity. host countries) and local claims denominated Using a database of credit institutions in 129 in foreign currencies (that is, claims extended countries, Djankov, McLiesh, and Shleifer through subsidiaries operating in host coun- (2007) showed that legal creditor rights and tries denominated in a currency other than information-sharing institutions are statisti- that of the host country). The BIS reports cally significant and quantitatively important data on the maturity breakdown of interna- determinants of private credit development. tional claims, distinguishing between three Qian and Strahan (2007), using a database of maturity buckets: less than one year, between syndicated bank loans in 43 countries, found one and two years, and more than two years. that creditor rights are positively associated Among high-income countries, the share of with loan maturity. De Haas, Ferreira, and claims above two years increased steadily Taci (2010), using data for transition econo- throughout the 2005–13 period (figure 4.3). mies specifically, found that banks that per- In developing countries, the share of claims ceive the legal collateral environment to be above two years decreased slightly during the good tend to focus on mortgage lending. The 2008–09 crisis period but then climbed above introduction of collateral registries and credit its precrisis levels in 2012–13. bureaus, which strengthen the collateral and Substantial evidence shows that macroeco- information environment, have been found to nomic factors such as low inflation and coun- result in a lengthening of bank loan maturities try risk, as well as strong institutions, help (Martínez Pería and Singh 2014; Love, Mar- lengthen bank maturity. Demirgüç-Kunt and tínez Pería, and Singh, forthcoming). Maksimovic (1999), Tasić and Valev (2008, The significance of most of these country 2010), and Kpodar and Gbenyo (2010) found characteristics was confirmed by a recent that inflation is negatively related to the share analysis using Bankscope data (box 4.1). This of long-term loans banks make. Qian and analysis also revealed that the presence of Strahan (2007) and Bae and Goyal (2009) fewer restrictions on bank entry is associated found that increased country risk is associated with a larger share of long-term loans. Along GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 111 BOX 4.1 The Correlates of Long-Term Bank Lending What factors are correlated with bank long-term with a higher share of long-term fi nancing. Among lending over the period 2005–12? Bank-level data the macroeconomic factors, the estimations show from Bankscope on the share of loans with maturity that infl ation is negatively and signifi cantly corre- greater than one year can be combined with coun- lated with long-term lending. Stronger legal rights try-level data to answer this question. In particular, and lower political risk are positively correlated with these data can help to assess the association between long-term lending, indicating that institutional fac- long-term lending and macroeconomic, institutional, tors are important. Finally, banking regulations also and regulatory factors. matter. In particular, more stringent requirements The estimations reported in table B4.1.1, based for bank entry (including limits on foreign bank on data for 3,400 banks operating in 49 countries, entry) and higher capital requirements are negatively suggest that macroeconomic, institutional, and regu- correlated with bank long-term debt. latory factors all seem to be significantly correlated TABLE B4.1.1 Estimations for the Share of Bank Loans with Original Maturity Greater than 1 Year Variables Dependent variable: Share of bank lending greater than 1 year Lag log of assets 5.975*** 3.243** 6.085*** 6.954*** 5.089*** 6.444*** [3.079] [2.148] [3.238] [2.878] [3.300] [3.202] Lag deposits to liabilities –0.009 –0.023 –0.011 0.001 –0.012 –0.003 [–0.359] [–0.994] [–0.465] [0.024] [–0.472] [–0.129] Lag equity to assets 0.058 –0.023 0.068 0.075 0.044 0.070 [0.639] [–0.257] [0.764] [0.781] [0.522] [0.734] Lag liquidity to assets 0.015 0.019 –0.003 0.001 –0.005 0.000 [0.646] [0.880] [–0.133] [0.038] [–0.234] [–0.018] Lag return on assets 0.108 0.526* 0.114 –0.001 0.247 0.008 [0.379] [1.879] [0.390] [–0.004] [0.867] [0.031] Inflation –0.864*** [–2.916] Strength of legal rights 8.084*** [5.092] Lack of political risk 1.004** [2.517] Limits on foreign entry –3.879* [–1.738] Index of bank entry requirements –2.901** [–2.489] Index of capital regulation –1.220* [–1.918] Constant –5.115 –30.545 –92.091* –4.300 27.012 –5.107 [–0.188] [–1.087] [–1.712] [–0.112] [1.390] [–0.196] Observations 14,997 14,955 14,933 14,739 14,770 14,671 R -squared 0.093 0.147 0.095 0.076 0.103 0.090 Number of banks 3,415 3,413 3,391 3,362 3,370 3,359 Sources: Calculation based on data from Bankscope (database), Bureau van Dijk, Brussels, http://www.bvdinfo.com/en-gb/products/company-information /international/bankscope; World Bank, Washington, DC. Note: Estimations include bank fixed effects. Standard errors are clustered at the country-year level. Significance level: * = 10 percent, ** = 5 percent, *** = 1 percent. 112 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 with the negative impact of inflation and the transition countries during the period from positive impact of legal rights and low coun- 1992 to 2007, Tasić and Valev (2010) found try risk, this exploratory analysis found that that the asset share of state-owned banks has bank entry restrictions and limits on foreign a negative and statistically significant effect on entry are negatively related to bank loan ma- measures of bank loan maturity. In turn, ana- turity, suggesting an important role for estab- lyzing a cross-section of banks operating in the lishing a contestable banking environment in Russian Federation during 2007, Chernykh extending debt maturity. and Theodossiou (2011) found that foreign Research has also found that bank char- banks are more likely than state-owned banks acteristics such as size and capitalization can to extend a larger share of long-term business affect the maturity of bank loan portfolios. loans in Russia. Using data from 220 banks Other things equal, larger banks are expected operating in 20 transition countries, De Haas, to exhibit higher shares of long-term to total Ferreira, and Taci (2010) found that foreign loans relative to other banks because they banks are relatively more strongly involved in tend to be more diversified, have greater ac- mortgage lending than other banks. cess to funding, and have more resources to Some research also shows that the type develop credit risk management and evalu- of funding banks use to finance the loans ation systems to monitor their loans. Some they make is significantly correlated with the empirical evidence confirms this prediction. maturity structure of their debt. In particular, Using data from 35 commercial banks of empirical studies of the loan maturity struc- six African countries of the Central African ture of African (Constant and Ngomsi 2012) Economic and Monetary Community over and Russian (Chernykh and Theodossiou the period 2001–10, Constant and Ngomsi 2011) banks show that banks with a higher (2012) found that larger banks tend to make share of long-term liabilities exhibit higher business loans of longer maturity. Chernykh shares of long-term loans. That is consistent and Theodossiou (2011) found a similar re- with the evidence from the corporate finance sult when they analyzed the determinants of literature discussed in chapter 2, which shows long-term business lending by Russian banks. that firms tend to match the maturity of their On the surface, the impact of bank capitaliza- assets and liabilities. tion on loan maturity is ambiguous. On the Despite the correlation between the ma- one hand, banks with larger capital might turity structure of bank assets and liabilities, have a higher capacity to deal with unex- some degree of maturity transformation is pected losses resulting from extending risky inherent in banking and facilitates long-term long-term loans. On the other hand, high lending. Banks typically borrow money on levels of capital can signal that a bank is risk demand or sight from depositors and lend averse and conservative and that it may be most of these funds at longer terms. By vir- reluctant to issue risky long-term loans. Ex- tue of the role they play in maturity transfor- isting empirical evidence supports the notion mation, banks are exposed to investor and that better-capitalized banks are more likely deposit runs with potential implications for to issue long-term loans because they are bank liquidity and solvency. more capable of dealing with the associated Policies, such as deposit insurance, set up risks (Chernykh and Theodossiou 2011; Con- to minimize the risk of depositor runs, can stant and Ngomsi 2012). affect the ability of banks to lend long term. Evidence suggests that bank ownership By lowering the risk of bank runs, deposit in- also influences bank loan maturity. Despite surance may reduce banks’ need to hedge this the conventional wisdom that government risk by extending a larger share of short-term ownership of banks is associated with greater loans. Fan, Titman, and Twite (2012) showed long-term lending, existing empirical evidence that firms located in countries with deposit in- does not support such an association. For surance have more long-term debt. Although example, using quarterly data on lending by policies such as deposit insurance could miti- commercial banks to the private sector in 14 gate such risks, they may also generate moral GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 113 hazard problems and higher risk taking by structural funding mismatches (such as higher banks in some circumstances (Demirgüç-Kunt loan to deposit and short-term to total liabili- and Detragiache 2002). ties ratios) are more vulnerable to banking While some degree of funding risk is ex- distress and failure.4 pected in banking, evidence from the recent Regulations that affect bank size, capital- global crisis suggests that excessive maturity ization, and funding are likely to affect long- transformation risk can be a major source of term finance, because these bank characteris- bank failure and ultimately can be pernicious tics are correlated with the maturity structure to long-term lending. Banks’ recent increasing of bank loans. Basel III is a comprehensive set reliance on wholesale funding and derivative of reform measures, developed by the Basel financing has been identified as one of the Committee on Banking Supervision, with the major sources of bank instability and failure objective of strengthening the regulation, su- during the recent banking crisis (Huang and pervision, and risk management of the bank- Ratnovski 2010; Shleifer and Vishny 2010; ing sector. Its capital requirements and new Gorton and Metrick 2012; Brunnermeier minimum liquidity standards do not specifi- and Oehmke 2013). Empirically, Yorulma- cally target long-term bank finance, but they zer (2008), Vazquez and Federico (2012), may still affect it, as the Financial Stabil- and the International Monetary Fund (IMF ity Board recognized in a recent report (box 2013a) have found that banks with excessive 4.2).5 In particular, the combined effects of BOX 4.2 The Basel III Framework The Basel III framework is designed to strengthen assets (RWA), of which 4.5 percent has to be in the the regulation, supervision, and risk management of form of common equity (CET1). In addition, the the banking sector. It includes a comprehensive set of same institutions are subject to an additional conser- policy measures divided into two categories: capital vation buffer of 2.5 percent of RWA and to a coun- reforms and liquidity reforms. The capital reforms tercyclical buffer of 0–2.5 percent of RWA, depend- are primarily directed at improving the quality of ing on national circumstances. An additional capital capital, while the liquidity reforms are intended to surcharge of 1–2.5 percent of RWA also applies to minimize liquidity shortages and stresses, and to systemically important banks (that is, those whose reduce the risk of spillover from the fi nancial sector failure might trigger a fi nancial crisis) (figure B4.2.1). to the real economy. Moreover, banks will be subject to a leverage ratio Under the new Basel III capital regime, Tier 1 of 3 percent, a requirement that aims to contain the capital has to be at least 6 percent of risk-weighted buildup of excessive leverage in the banking system. FIGURE B4.2.1 Basel III Requirements 15.5 Share of risk-weighted assets (RWA), % 1–2.5% Capital surcharge for global systemically important institutions 13.0 0–2.5% Countercyclical buffer 10.5 2.5% Capital conservation buffer 8.0 Lower tier 2 Tier 2: 2% > 8% total capital 6.0 Minimum Upper tier 2 Additional tier 1: 1.5% requirements > 6% CET1 4.5 > 4.5% CET1 Innovative tier 1 Common eqity Noninnovative tier 1 (CET1): 4.5% Core tier 1: 2% 0 Basel II Basel III (in 2019) (box continued next page) 114 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 4.2 The Basel III Framework (continued) The liquidity component of Basel III consists of a maturity greater than one year are to be covered two new ratios: the liquidity coverage ratio (LCR) by stable funding with a maturity greater than one and the net stable funding ratio (NSFR). Under the year (for example, bank equity and liabilities such as LCR, banks are required to hold sufficient high- deposits and wholesale borrowing). quality liquid assets (HQLA) that can be converted The Financial Stability Board (FSB) has analyzed into cash to meet all potential demands for liquid- the potential consequences of Basel III for long-term ity over a 30-day period under stressed conditions. fi nancing (Financial Stability Board 2013) and does The numerator contains two categories of easy-to- not anticipate any direct effects on long-term loans sell asset classes. Level 1 assets include government from the introduction of the LCR. The board notes, bonds, cash, and certain central bank reserves. Level however, that in order to meet the LCR requirement, 2 assets include long-term securities such as corpo- banks may prefer to hold certain liquid assets that rate bonds and covered bonds rated A+ to BBB–, are treated more favorably under the HQLA defi ni- certain equities, and mortgage-backed securities that tion (such as sovereign bonds). The FSB expects that meet specific conditions. The denominator is the dif- the NSFR allows for considerable maturity transfor- ference between total expected cash outflows minus mation since a long-term loan can be fully funded total expected cash inflows during the 30-day stress with bank liabilities of one year or greater, but it rec- scenario. The ratio must be at least 100 percent. ognizes that if the long-term loan is funded through The NSFR aims to promote resilience over a one- short-term deposits or other liabilities (that are regu- year time horizon by ensuring that long-term assets larly rolled over), the maturity mismatch will need are funded with at least a minimum amount from to be covered by lengthening the term of funding, by a stable funding source. In particular, loans with reducing the maturity of loans, or both. the reforms will be to increase the amount standards so that banks can tap into longer- of regulatory capital for such transactions term funding sources including those from and to dampen the scale of maturity trans- domestic and international capital markets formation risks. The overall effects will vary (Gobat, Yanase, and Maloney 2014). depending on several factors—in particular, the alternative funding sources in different PORTFOLIO MATURITY OF markets segments. In this regard, concerns DOMESTIC INSTITUTIONAL have been raised that the impact on devel- INVESTORS: THE CASE OF CHILE oping countries could be more severe, since these countries have less-developed markets This section describes the differences in the and fewer nonbank financial intermediaries maturity structure of Chilean nonbank in- and, therefore, would suffer more if banks cut stitutional investors and analyzes the factors back on long-term finance as a result of these that lie behind them. The analysis is based regulatory changes. on Opazo, Raddatz, and Schmukler (2015), The impact of ongoing regulatory changes which used unique monthly asset-level data should be monitored carefully, but in the on Chilean domestic bond mutual funds, meantime government policies that help banks pension funds, and insurance companies dur- access stable sources of funding might be de- ing 2002–08. This was a period with stable sirable. These policies may include improving growth in capital markets and in overall financial inclusion to grow banks’ depositor economy and is thus ideal for investigating bases, promoting banks’ issuance of covered the extent to which these nonbank financial bonds, and having banks improve their finan- institutions invest long term as the global cri- cial reporting on liquidity and other risks as sis did not hit Chile until 2009. In addition, well as strengthen accounting and auditing because these investors operate in the same GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 115 macroeconomic and institutional environ- long-term local currency and inflation-indexed ment and have access to the same set of in- bonds. Many high-income and developing struments, their comparison allows observa- countries have followed the Chilean example tion of their different behavior. The data on and have reformed their pension regimes, Chilean mutual funds’ and insurance compa- shifting away from DB schemes toward pri- nies’ holdings came from the Chilean Super- vately managed DC plans (Antolín and Tapia intendency of Securities and Insurance. The 2010; OECD 2013b). Figure 4.4 shows that data on Chilean pension funds came from the the DC system is the most-used scheme nowa- Chilean Superintendency of Pensions. days in many members of the OECD. Although the private pension industry in The kind of regulations adopted in the developing countries is typically small—man- Chilean pension fund system are not Chile- datory state-owned pension schemes domi- specific and are typical of systems that have nate the landscape—a few economies such DC pension programs, where the regulator as Chile have large pension systems covering wants to ensure the safety of public savings. most workers. Chile was the first country to For example, the Chilean regulation estab- adopt, in 1981, a mandatory, privately man- lishes a minimum return band that pension aged defined contribution (DC) pension fund funds must guarantee. This type of guaran- model by replacing the old public defined ben- tee is common in Latin American countries, efit (DB) system. Since then, pension funds and it also has been used in Central European have become very large, holding most of the countries (Castañeda and Rudolph 2010) and population’s long-term retirement savings. in high-income countries (Antolín and others Chile also has developed other institutional 2011). Chile, therefore, stands as a bench- investors and has provided a stable macroeco- mark case, and the numerous challenges faced nomic and institutional framework for long- by the Chilean policy makers shed light on the term financing to flourish. On the demand difficulties of developing long-term financial side of funds, Chile introduced several reforms markets. to foster capital market development, leading The Chilean evidence challenges the expec- to a varied range of securities issued, including tation that institutional investors across the FIGURE 4.4 Relative Shares of Defined Benefi t and Defined Contribution Pension Fund Assets in Selected Countries, 2013 100 Share of total pension fund assets, % 80 60 40 20 0 ep e Es lic Fra a Gr e Hu ce ov Po y Re nd Sl blic De nia k Au ly Ne Me a Ze o Ice d Un S d d S in Tu s y re el mb . Po urg Ca al Fin a Ge d itz ny d xe ep ar ar te rke h R Chil ni nc ali w xic n lan d lan lan Ita ite pa Ko Isra g ub ee Sw rma ak la ala na to ng e nm ta Lu a, R rtu o pu str ov er ec Cz Sl Defined contribution Defined benefit / Hybrid-mixed Source: OECD 2014b. Note: Selected countries are members of the OECD. For the United States and Canada, data refer to occupational pension plans only. For Luxembourg, data refer to pension funds under the supervision of the Commission de Surveillance du Secteur Financier (CSSF) only. 116 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.5 Differing Maturity Structures of Chilean Institutional The short-termism of pension funds is not Investors constrained by the supply side of instruments. Chilean asset managers choose short-term a. Share of total portfolio instruments even when assets for long-term 45 investments are widely available and held by 40 other investors. In particular, pension funds Share of total portfolio, % 35 do not exhaust the supply of long-term gov- 30 ernment and corporate debt instruments. 25 Moreover, individual biddings at government 20 paper auctions suggest that pension funds bid 15 less aggressively for long-term instruments, 10 both relative to other instruments and relative 5 to insurance companies. 0 The incentives faced by these investors ap- <1 1–3 3–5 5–7 7–10 10–15 15–20 20–30 pear to be essential to understanding their Years to maturity different preferences for debt maturity struc- Insurance Domestic Pension fund tures. In this sense, the comparison between companies mutual funds administrators insurance companies and pension funds is b. Average maturity, years particularly illustrative because, in principle, Insurance companies 9.77 both should be long-term investors. Insur- Domestic mutual funds 3.97 ance companies provide mainly long-term Pension fund administrators 4.36 annuities for retirement, while pension funds Source: Opazo, Raddatz, and Schmukler 2015. invest for the retirement of their affiliates. In- Note: The maturity structure is calculated for each mutual fund, insurance company, and pension deed, upon retirement individuals can choose fund administrator at each moment in time using monthly bins. Then the maturities are averaged between buying an annuity or keeping their across each set of investors and then averaged over time. The sample period is September 2002 to June 2008. assets in a pension fund and gradually draw- ing the principal according to a program board would help lengthen the maturity struc- that considers expected longevity. Despite ture and raises the question of what lies behind the similarity in their implicit operational their short-termism. While the presence of goals, given their different natures (open- and these investors has played an important role in closed-end) and the monitoring exercised by improving market depth and in increasing pri- the underlying investors and the regulator, vate savings, their contribution to the length- these intermediaries face very different incen- ening of financial contracts seems limited.6 In tives, which lead to different maturities pro- particular, the evidence shows that Chilean as- files. These incentives are analyzed in more set-management institutions (mutual and pen- detail in box 4.3. sion funds) hold a large amount of short-term The short-termism of pension funds has im- instruments and overall invest shorter term portant consequences for future pensions. In relative to insurance companies (figure 4.5). fact, some discussions have started to emerge Both mutual funds and pension funds invest in Chile and elsewhere (BIS 2007a; The more than half of their portfolios in maturi- Economist 2014a) about their pension system ties of three years or less, whereas insurance and how to reform it given the lower-than- companies invest a little more than one-third expected replacement rates. According to some of their portfolios in these shorter-term ma- estimates, the amount in the average 65-year- turities. The differences are even starker at the old pensioner’s account is $55,000. With longer maturities. As a result, average matu- an expected remaining life of 15 years, that rity for insurance companies (9.77 years) is amount is equivalent to about $310 a month, more than double that of mutual funds (3.97 or one-third of the average salary in Chile. years) and pension funds (4.36 years). Rela- Chile’s experience shows that the develop- tive to outstanding bonds, mutual and pension ment of large and sophisticated intermedi- funds also invest shorter term. aries with deep pockets does not guarantee GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 117 BOX 4.3 What Drives Short-Termism in Chilean Mutual and Pension Funds? Although identifying the ultimate underlying factor Chilean regulation establishes a lower threshold is difficult, the shorter investment horizon of Chilean of returns over the previous 36 months that each open-end mutual and pension funds compared with pension fund needs to guarantee. This type of insurance companies seems to result from agency fac- short-term monitoring seems to push managers to tors that tilt managerial incentives.a In Chile, manag- move their investments into portfolios that try to ers of open-end funds are monitored in the short run minimize the probability of triggering the guaran- by the underlying investors, the regulator, and the tee (Randle and Rudolph 2014). Moreover, because asset-management companies. This short-run moni- this threshold depends on the average return of the toring, combined with the risk profile of the available market, it may generate incentives to herd (Raddatz instruments, generates incentives for managers to be and Schmukler 2013; Pedraza, forthcoming) and averse to investments that are profitable at long hori- to allocate portfolios suboptimally (Castañeda and zons (such as longer-term bonds) but that can have Rudolph 2010). poor short-term performance. In contrast, insur- The minimum return rate might be driving the ance companies are not open-end asset managers, equilibrium toward the short term because, even receive assets that cannot be withdrawn in the short when a manager’s portfolio is close to that of peers, run, and have long-term liabilities because investors small differences in holdings of more volatile longer- acquire a defi ned benefit (DB) plan when purchasing term securities may increase the manager’s exposure a policy. Thus, insurance companies are not subject to the peer-based performance penalty. Moreover, to the same kind of short-run monitoring. to the extent that longer-term bonds are less liquid, In the case of mutual funds, their short-termism is these bonds might be harder to rebalance because driven mainly by the short-term monitoring exercised traders may find it difficult to either enter or exit by the underlying investors. In particular, Chilean these positions at their requested price, experience mutual funds are subject to significant redemptions execution delays, or receive a price at execution sig- related to short-run performance. For example, dur- nificantly different from their requested one. There- ing the 2002–08 period, mutual funds in Chile were fore, longer-term bonds might hamper the ability exposed to much greater outflows than were mutual to follow the changes of the market, increasing the funds in the United States. This short-run monitoring exposure to the peer-based penalty. might explain why these funds avoid investing in long- Whereas this type of short-run monitoring can term bonds, which may have poor short-term perfor- play a role in open-end funds, it is unlikely to affect mance, and prefer to invest in shorter-term bonds. insurance companies. These companies are not eval- Because saving for retirement is mandatory, flows uated on a short-term return basis by investors who to pension funds tend to be very stable, even during can redeem their shares on demand, and the com- crises. That is, unlike mutual funds, pension funds panies are not required to be close to the industry are not exposed to significant outflows. Neverthe- at each point in time. Instead, the maturity struc- less, within the same pension fund, investors might ture of the insurance companies’ assets seems to transfer funds across different fund managers seek- be determined by that of their liabilities. Insurance ing higher performance. Da and others (2014) showed companies have long-term liabilities because they that, in Chile, individuals often reallocate their mostly provide annuities to pensioners. Thus, the investments between riskier funds (holding mostly need to meet these liabilities gives them incentives to stocks) and funds that hold mostly risk-free govern- hold long-term assets. In contrast, mutual funds and ment bonds. Pension fund contributors, in an appar- pension funds are pure asset managers and have no ent effort to “time the market,” frequently switch liabilities beyond their fiduciary responsibility. within funds following the recommendations issued In sum, the long-term nature of their liabilities by a popular investment advisory fi rm. In response shapes the incentives of the insurance companies to this behavior, pension fund managers have signifi- toward portfolios with longer maturities. In contrast, cantly reduced their holdings of stocks and bonds and given the lack of a liability structure, the incentives have replaced them with cash to avoid costly redemp- of Chilean pension and mutual funds to take matu- tions resulting from frequent portfolio rebalancing. rity risk are determined mainly by the constant mon- The regulatory scheme seems to be another fac- itoring exerted by the underlying investors, their own tor behind the short-termism of pension funds. The companies, and the regulator. a. See Opazo, Raddatz, and Schmukler (2015) for a more detailed analysis. 118 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 an increased demand for long-term assets. the minimum return that pension funds must Merely establishing asset management insti- guarantee was changed from 12 months to tutions and assuming that managers will in- the current 36 months, presumably giving vest long term does not appear to yield the pension funds more flexibility to deviate in expected outcome, especially if the policy the short term from their peers and to invest contexts involve a similar type of market longer term. The change did not have the and regulatory short-term monitoring to that expected result, however, and the maturity in Chile. For pension funds, Chilean policy structure of pension funds did not vary sig- makers have tried unsuccessfully to make nificantly. Alternative performance measures the system more conducive to long-term in- based on risk-adjusted returns, as opposed to vestments. For example, in October 1999 the peer-based benchmarks, should be more con- average real rate of returns for calculating ducive to lengthening the maturity structure of pension funds’ portfolios and at the same time should eliminate some of the pervasive FIGURE 4.6 Worldwide Total Net Assets Held by Mutual Funds by Degree of Development and Region incentives that lead to herding among these managers. The regulatory authority needs to a. By degree of development focus on aligning the long-term objectives of the fund contributors with the sometimes 2,500 100 short-term objectives of fund managers. 2,000 80 Share of total assets, % INTERNATIONAL EVIDENCE ON U.S. dollars, billions 1,500 60 MUTUAL FUNDS 1,000 40 Although the mutual fund industry has been growing in developing countries during the 500 20 last decade, it is still dominated by high- income countries. Assets under management 0 0 of mutual funds domiciled in developing coun- 2006 2007 2008 2009 2010 2011 2012 2013 tries more than doubled between 2006 and Assets under management, Developing High-income 2013. However, these still represent a small developing countries countries countries fraction of mutual funds’ assets worldwide: (right axis) (right axis) funds in high-income countries controlled over 90 percent of mutual fund assets, with b. By region more than $28 trillion under management in 2013 (figure 4.6a). The regional distribution 24% also remains highly uneven, with the United 32% 31% States accounting for half of the total assets 13% worldwide and a couple of European coun- 50% 15% 16% tries accounting for almost one-third (figure 7% 4.6b). Still, in some developing countries, such 11% as Brazil, the mutual fund industry has been growing fast and is rather large. 1% Luxembourg In recent years, the importance of interna- France tional mutual funds has been growing.7 This Europe Americas (excluding Ireland growth is attributable mainly to investors in Asia and Pacific United States)a United Kingdom United States Africa Other European countries high-income countries who have increasingly sought to diversify their portfolios by invest- Source: Investment Company Fact Book 2014, Investment Company Institute, Washington, DC, ing in other countries, including develop- http://www.icifactbook.org. ing ones, often through dedicated emerging Note: The sample period for panel b is 2013. The classification between high-income and develop- ing countries is based on the World Bank classification of countries as of 2012. markets funds or through increased emerging a. Argentina, Brazil, Canada, Chile, Costa Rica, Mexico, and Trinidad and Tobago. market participation by globally active funds GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 119 (Gelos 2011). This trend coincides with an countries might play in lengthening the ma- extended period of low interest rates in high- turity structure of financial contracts in devel- income countries, which has led investors to oping countries. In particular, this section ex- look for higher-yielding assets in developing plores the role that international funds from countries. Emerging Portfolio Fund Research the United States and the United Kingdom (EPFR) data show that assets under manage- might play in lengthening the maturity struc- ment of emerging markets’ equity funds in- ture of financial contracts in both developing creased from $702 billion at the end of 2009 and other high-income countries. Throughout to $1.1 trillion at the end of 2013, and bond the section, only fixed-income mutual funds funds quadrupled from $88 billion to $340 are considered. Although equity funds are billion over the same period (Miyajima and also a source of long-term financing and play Shim 2014). an important role in stock markets (box 4.4), Given the limited size of the mutual fund the analysis focuses exclusively on bond funds industry in developing countries, this section to be able to compute the maturity structure aims to shed some light on the role that in- of the funds’ portfolio and to make compari- ternational mutual funds from high-income sons across countries. BOX 4.4 Institutional Investors in Equity Markets In both high-income and developing countries, equity of stock market development—market capitalization, fi nancing plays a smaller role in fi rms’ funding than turnover, and price informativeness (a measure of the do bond issuances and syndicated loans (chapter 3). information content of stock prices)—are presented Still, a developed and liquid stock market is expected in table B4.4.1. According to the table, the pres- to play a key role by creating and aggregating infor- ence of domestic and foreign institutional investors mation about economic activity and firms’ funda- is positively correlated with market size and liquid- mentals. According to this view, stock prices aggre- ity. Moreover, in both high-income and developing gate information from many market participants, countries, a greater presence of institutional inves- information that in turn might be useful for fi rms’ tors is positively associated with more informative managers and other decision makers such as capital prices, consistent with the idea that institutions, as providers and regulators (Bond, Edmans, and Gold- opposed to retail investors, have a greater capability stein 2012). In this sense, stock markets can facilitate to gather private information and that their presence fi rms’ access to credit by reducing information asym- facilitates information aggregation into stock prices. metries between capital providers and fi rms. The table also shows a negative relationship between Institutional investors might contribute impor- institutional ownership concentration and the dif- tantly to information production in stock markets. ferent measures of stock market development. For That is, besides the direct contribution to firms’ equity instance, countries with high levels of concentration financing, some empirical evidence indicates that in institutional equity ownership exhibit lower trad- institutional activity in equity markets results in bet- ing volumes (figure B4.4.1). ter monitoring of corporations and in better corporate When the concentration of institutional ownership governance structures (Gillan and Starks 2000). For is high, these institutions effectively become corpo- example, foreign institutional investors from coun- rate insiders, a situation that discourages the partici- tries with strong shareholder protection appear to pation of other equity investors and that undermines promote good corporate governance practices around liquidity. Concentration also leads to market power the world (Aggarwal and others 2011). Alternatively, and hence the ability to trade without affecting the presence of institutional investors in a stock might prices. Additionally, in smaller markets, domestic increase the exposure of the firm to capital providers, institutional investors are more likely to have differ- thereby improving its ability to raise funds. ent ties to local publicly traded companies, whether The relationships between the share of institu- directly or indirectly (they might belong to the same tional investors’ equity ownership and three measures economic group, for example, or the firm might (box continued next page) 120 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 BOX 4.4 Institutional Investors in Equity Markets (continued) TABLE B4.4.1 Stock Market Development and Institutional Investors, 2000–11 High-income countries Developing countries Countries sorted by Below median Above median Below median Above median Foreign institutional ownership Turnover/market capitalization 71.8 94.9 41.3 55.7 Market capitalization/GDP 64.4 86.8 42.1 45.5 Price informativeness 65.5 90.1 15.2 39.5 Domestic institutional ownership Turnover/market capitalization 46.0 100.1 39.8 60.6 Market capitalization/GDP 56.3 86.3 36.3 67.1 Price informativeness 32.5 96.5 18.2 38.5 Institutional ownership concentration Turnover/market capitalization 98.9 67.5 55.6 43.0 Market capitalization/GDP 90.9 58.2 43.4 39.7 Price informativeness 88.1 67.2 45.5 12.5 Sources: Global Financial Development Database, World Bank, Washington, DC, http://data.worldbank.org/data-catalog/global-financial-development; Institutional Ownership Database, FactSet, Norwalk, CT, http://factset.com. Note: This table reports the averages of three measures of stock market development, sorted by institutional investors’ presence. FIGURE B4.4.1 Trading Volume versus Institutional Concentration, 2000–11 a. High-income countries b. Developing countries 250 100 Thailand Stock market turnover to market Stock market turnover to market United States 200 80 Hungary capitalization, % capitalization, % Spain Russian Federation 150 Italy United Kingdom 60 Netherlands Czech Republic South Africa Germany Finland Sweden Brazil Indonesia Japan Norway 100 Switzerland France 40 Poland Canada Australia Denmark Malaysia Singapore Mexico Israel Portugal 50 GreeceNew Zealand 20 Philippines Morocco Ireland Austria Belgium Chile Peru Colombia Luxembourg 0 0 0.2 0.3 0.4 0.5 0.6 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Institutional ownership concentration Institutional ownership concentration receive lending through a bank member of the same makers could focus not only on strengthening the fi nancial conglomerate as the institutional investor). investors’ bases but also on improving the level Such relationships can be additional sources of asym- of competition in their respective markets. For metric information, which would reduce trading in instance, stock markets with large but few dominant the stock. In all these cases, stock prices might be institutional investors might end up producing little more opaque and less likely to reflect fundamentals. valuable information about fundamentals. After all, In summary, the extent to which institutional well-functioning and competitive stock markets are investors produce information in equity markets expected to benefit long-term fi nance and economic seems to depend on the market structure. Policy activity, both directly and indirectly. Sources: Global Financial Development Database, World Bank, Washington, DC, http://data.worldbank.org/data-catalog/global-financial-development; and Institu- tional Ownership Database, FactSet, Norwalk, CT, http://factset.com. Note: This figure shows the relationship between stock trading volume and institutional equity ownership concentration for high-income and developing countries. Concentration is measured as the percentage of domestic equity holdings of the largest five institutional investors. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 121 The data come from various sources. Fund- SDC Platinum database.9 The data on out- level data on mutual fund holdings come from standing sovereign bonds come from the BIS. Morningstar Direct and include the holdings The investments of international mutual of international mutual funds (Global Fixed funds from the United States and from the Income and Emerging Markets Fixed Income United Kingdom are very similar, and thus the funds) from the United States and the United following analysis pools the funds from both Kingdom, as well as holdings of mutual funds countries. U.S. mutual funds invest 55 percent set up to invest domestically (Domestic Fixed in high-income countries outside the United Income funds) for several developing and States, 35 percent in developing countries, high-income countries for 2013.8 The section and the rest in domestic bonds (figure 4.7a). also examines information on outstanding Similarly, U.K. mutual funds invest 65 percent corporate and sovereign bonds to benchmark in high-income countries outside the United the mutual fund holdings. The data on corpo- Kingdom, 20 percent in developing countries, rate bonds come from the Thomson Reuters and the rest in domestic bonds. Regionally, FIGURE 4.7 Shares and Average Maturity of Investments of U.S. and U.K. Mutual Funds, 2013 a. By degree of development b. By region 14 14 12 12 Average maturity, years Average maturity, years 10 10 8 8 6 6 4 4 2 2 0 0 High-income Developing Domestic Africa Asia Australia Europe Latin countries countries investments (except U.K.) America (except domestic) and the Caribbean c. By issuer type 14 12 Average maturity, years 10 8 6 4 2 0 Agency Corporate Sovereign Sub- Supranational sovereign U.S. funds U.K. funds Sources: Calculations based on data from Morningstar, Chicago, IL, http://www.morningstar.com; and DataStream (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial/investment-management/datastream-professional.html. Note: This figure shows the portfolio shares and average maturities of global and emerging markets fixed income mutual funds from the United States and the United Kingdom in high-income and developing countries. The size of each bubble represents the portfolio share invested in each set of countries (panels a and b) or issuer type (panel c). 122 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.8 Shares and Average Maturity of U.S. and U.K. Mutual Funds by Industry, 2013 a. Top 2 industries 100 Share of mutual fund investments, % 14 80 12 Average maturity, years 10 60 8 40 6 4 20 2 0 0 High-income Developing U.S. and High-income Developing U.S. and High-income Developing U.S. and countries countries U.K. countries countries U.K. countries countries U.K. (except U.S. (except U.S. (except U.S. and U.K.) and U.K.) and U.K.) Public administration Finance, insurance, and real estate Other b. Rest of top 5 industries 60 14 Share of mutual fund investments, 50 12 % of “other” industries Average maturity, years 40 10 30 8 6 20 4 10 2 0 0 High-income Developing U.S. and High-income Developing U.S. and High-income Developing U.S. and countries countries U.K. countries countries U.K. countries countries U.K. (except U.S. (except U.S. (except U.S. and U.K.) and U.K.) and U.K.) Manufacturing Mining Transportation, communications, electric, gas, and sanitary services Portfolio share Average maturity (right axis) Sources: Calculations based on data from Morningstar, Chicago, IL, http://www.morningstar.com; and DataStream (database), Thomson Reuters, New York City, NY, http:// thomsonreuters.com/en/products-services/financial/investment-management/datastream-professional.html. Note: This figure shows the portfolio shares and average maturities of global and emerging markets fixed income mutual funds from the United States and the United Kingdom in high-income and developing countries by the issuer’s industry. U.S. and U.K. mutual funds both invest half U.S. and U.K. mutual funds invest longer of their portfolio in Europe (excluding the term in developing than in high-income coun- United Kingdom), around one-third in Asia, tries. Overall, the average maturity of U.S. and almost one-fifth in Latin America and the and U.K. funds is about 6.4 years in high- Caribbean (figure 4.7b). Moreover, U.S. and income countries and almost 8.0 years in de- U.K. funds both invest heavily in sovereign veloping countries. These results hold regard- bonds (almost 70 percent), followed by cor- less of the industry. The principal industry in porate bonds from financial and nonfinancial which U.S. and U.K. funds invest is, by far, firms (figure 4.7c). The maturity structure of public administration: 80 percent of their as- their investments is also similar.10 Given these sets are invested in this category in develop- similarities, the following analysis pools the ing countries and 70 percent in high-income funds from both countries. countries (figure 4.8a). Within this category, GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 123 they invest longer term in developing coun- in sovereign bonds than in corporate bonds. tries (7.7 years) than in high-income ones (6.9 Overall, for the countries depicted in the scat- years). Finance, insurance, and real estate is ter plot shown in figure 4.9a, the average the second industry in which U.S. and U.K. maturity of U.S. and U.K. funds is 8.6 years funds invest more, but there are important for sovereign bonds and 7.1 years for corpo- differences between high-income and develop- rate bonds. This pattern is consistent with the ing countries: for high-income countries, they fact that the average maturity of outstanding invest more than 25 percent of their holdings sovereign bonds is typically longer than that in this category, while for developing coun- of corporate bonds (figure 4.9b). Given these tries they invest only 7 percent. Given that differences, when comparing the maturity this industry has a lower average maturity (for structure across international and domestic both high-income and developing countries), funds, the analysis separates between the cor- the larger weight assigned to this category in porate and sovereign case. high-income countries also helps explain the The evidence suggests that international longer average maturity of U.S. and U.K. in- mutual funds help lengthen the maturity vestments in developing countries. Investment structure of corporate bonds in developing patterns in other industries are shown in fig- and high-income countries. For most of the ure 4.8b. Once again in each of these indus- countries analyzed, U.S. and U.K. funds in- tries the average maturities of U.S. and U.K. vest longer term than the average maturities mutual funds’ investments are longer in devel- of the outstanding corporate bonds in the oping than in high-income countries. countries in which they invest (figure 4.10a).11 In the vast majority of countries analyzed, This finding is consistent with evidence that U.S. and U.K. mutual funds invest longer term foreign corporate issuances from developing FIGURE 4.9 Average Maturity by Country and Issuer Type, 2013 a. U.S. and U.K. mutual funds holdings b. Outstanding bonds 20 20 18 18 Average maturity of sovereign bonds, years Average maturity of sovereign bonds, years 16 U.K. 16 14 14 12 U.K. 12 U.S. 10 10 8 8 6 6 4 4 U.S. 2 2 0 0 0 2 4 6 8 10 12 14 16 18 20 0 2 4 6 8 10 12 14 16 18 20 Average maturity of corporate bonds, years Average maturity of corporate bonds, years Asia Europe Latin America and the Caribbean Other Sources: Calculations based on data from SDC Platinum (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products -services/financial/investment-banking-and-advisory/sdc-platinum.html; Debt Security Statistics (database), Bank for International Settlements, Basel, http://www.bis.org/statistics/secstats.htm; Morningstar, Chicago, IL, http://www.morningstar.com; and DataStream (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial/investment-management/datastream-professional.html. Note: Panel a shows the average maturity, by country, of sovereign and corporate bonds held by global and emerging markets fixed income mutual funds from the United States and the United Kingdom. Only countries with more than 30 observations in both the sovereign and corporate category are included. Panel b shows the average maturity of outstanding sovereign and corporate bonds by country. 124 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.10 Average Maturity of U.S. and U.K. Mutual Funds Compared with Outstanding Bonds by Country, 2013 a. Corporate bonds b. Sovereign bonds 20 20 Average maturity of outstanding bonds, years Average maturity of outstanding bonds, years 18 18 U.K. 16 16 14 14 12 12 10 10 8 U.S. 8 U.K. 6 6 4 4 U.S. 2 2 0 0 0 2 4 6 8 10 12 14 16 18 20 0 2 4 6 8 10 12 14 16 18 20 Average maturity for U.S. and U.K. mutual funds, years Average maturity for U.S. and U.K. mutual funds, years Asia Europe Latin America and the Caribbean Other Sources: Calculations based on data from SDC Platinum (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products -services/financial/investment-banking-and-advisory/sdc-platinum.html; Debt Security Statistics (database), Bank for International Settlements, Basel, http://www.bis.org/statistics/secstats.htm; Morningstar, Chicago, IL, http://www.morningstar.com; and DataStream (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial/investment-management/datastream-professional.html. Note: Panel a compares, by country, the average maturity of corporate bonds held by global and emerging markets fixed income mutual funds from the United States and the United Kingdom to the average maturity of the outstanding corporate bonds in the countries in which they invest. Panel b makes the same comparison for sovereign bonds. Only countries with more than 30 observations in both the sovereign and corporate category are included. countries tend to be longer-term than domes- portfolios are benchmarked with the maturi- tic issuances (chapter 3), signaling that firms ties of the outstanding bonds. in developing countries might find it easier For developing countries, the compari- to obtain long-term financing from foreign son suggests that foreign funds invest longer investors than from domestic ones. More- term than domestic ones when investing in over, this finding suggests that international the same domestic debt instruments. The re- mutual funds could play some role in extend- sults show that U.S. and U.K. mutual funds ing the maturity structure of the countries in invest significantly longer than the Chilean, which they invest. Unlike the corporate case, Mexican, and South African domestic mu- however, the evidence is mixed for sovereign tual funds (figure 4.11a). For example, the bonds. That is, it is not clear whether U.S. average maturity of U.S. and U.K. mutual and U.K. funds can extend the maturity struc- funds in Chilean (Mexican) bonds is 7.6 (9.4) ture of these bonds (figure 4.10b).12 years, while the average maturity of domestic The analysis then compares the maturity Chilean (Mexican) funds is 4.8 (3.1) years. structure of U.S. and U.K. international mu- In the case of Brazil, the domestic funds in- tual funds with that of domestic mutual funds vest slightly longer than U.S. and U.K. funds from developing and high-income countries. (10.1 and 9.4 years, respectively). However, It first compares by country the entire port- as discussed later, the higher average matu- folio of international mutual funds and do- rity of Brazilian funds is explained entirely by mestic funds and then compares separately their sovereign bonds purchases: if only cor- sovereign and corporate bonds holdings. In porate bonds are considered, U.S. and U.K. the latter case, the average maturities of the mutual funds invest significantly longer than GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 125 FIGURE 4.11 Comparison of Average Maturity of U.S. and U.K. Mutual Funds to Domestic Mutual Funds, 2013 a. Entire portfolio 14 Average maturity, years 12 10 8 6 4 2 0 Brazil Chile India Mexico South Australia Hong Kong Israel New Korea, Rep. Africa SAR, China Zealand b. Corporate bonds c. Sovereign bonds 14 14 12 12 Average maturity, years Average maturity, years 10 10 8 8 6 6 4 4 2 2 0 0 p. p. ca ca a a ico ico ina l l il il nd Re Re ali ali ae ae fri fri az az ex ex Ch ala str str Isr Isr hA hA Br a, Br a, M M re re Au Au Ze R, ut ut Ko Ko SA w So So Ne ng Ko ng Ho Outstanding bonds Domestic funds U.S. and U.K. funds Sources: Calculations based on data from SDC Platinum (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products -services/financial/investment-banking-and-advisory/sdc-platinum.html; Debt Security Statistics (database), Bank for International Settlements, Basel, http://www.bis.org/statistics/secstats.htm; Morningstar, Chicago, IL, http://www.morningstar.com; and DataStream (database), Thomson Reuters, New York City, NY, http://thomsonreuters.com/en/products-services/financial/investment-management/datastream-professional.html. Note: This figure compares, by economy, the average maturity of global and emerging markets fixed income mutual funds from the United States and the United Kingdom with that of domestic mutual funds and outstanding bonds. Only domestic bonds are included in the portfolio of the domestic mutual funds. Brazilian funds. The only developing country domestic mutual funds (see figure 4.11a). For in the sample in which domestic funds invest example, the average maturity of U.S. and significantly longer term is India. Similar to U.K. mutual funds in Hong Kong SAR, China Brazil, however, the Indian funds in the sam- (Israeli) bonds is 6.0 (9.4) years, while the av- ple only purchase sovereign bonds (which are erage maturity for domestic Hong Kong SAR, longer term in the Indian case) while the U.S. China (Israeli) mutual funds is 3.0 (6.0) years. and U.K. funds invest more heavily in Indian In the case of the Republic of Korea, the aver- corporate bonds. age maturity of U.S. and U.K. funds is similar The comparison of U.S. and U.K. mutual to that of Korean funds. Australia is the only fund investment with that of local funds in high-income country in the sample in which other high-income economies shows similar the domestic funds invest longer term than patterns: U.S. and U.K. funds typically invest U.S. and U.K. mutual funds. longer term there as well. In Hong Kong SAR, When considering only corporate bonds, China; Israel; and New Zealand, U.S. and U.S. and U.K. mutual funds tend to invest U.K. mutual funds invest longer term than the longer term than the average maturities of 126 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 the domestic funds in the countries in which investing in different countries around the they invest. With the exception of Australia world. In addition, according to the Chilean and South Africa, U.S. and U.K mutual funds’ evidence presented earlier, domestic funds foreign corporate holdings have an average in developing countries might be subject to maturity longer than that of the domestic mu- larger outflows related to performance, and tual funds (figure 4.11b). In the cases of Brazil; so they might have incentives to hold a higher Hong Kong SAR, China; Mexico; and New proportion of short-term instruments. At the Zealand, the investments of U.S. and U.K. mu- same time, given that international mutual tual funds are significantly longer term than funds do not seem to invest more long-term in those of the domestic funds. Moreover, the the case of sovereign bonds, the evidence sim- domestic funds of these four economies have ply might be reflecting differences in the at- a shorter average maturity than that of the tributes (size or asset tangibility) of the firms outstanding corporate bonds, while U.S. and in which they invest. For example, because U.K. investments are longer. These patterns of information asymmetries, the domestic suggest that foreign investors might be an av- funds might be providing finance to smaller enue through which to extend debt maturities. firms that are not able to raise funds in in- For sovereign bonds, U.S. and U.K. mutual ternational markets or that are not targeted funds do not seem to invest longer term than by foreign investors, and these firms might be the domestic funds in the countries in which raising bonds at shorter maturities.14 Never- they invest. Unlike the corporate case, the evi- theless, even if differences in firm character- dence is mixed, and it is not clear whether in- istics explain part of the results, the evidence ternational funds can be an avenue to extend presented here, together with the fact that the maturity structure of sovereign bonds. In foreign corporate issuances from develop- this case, U.S. and U.K. funds invest longer ing countries are of longer-term nature than term than the domestic funds only in Israel domestic issuances (chapter 3), indicates that and Mexico. In Australia, Brazil, Korea, and firms in developing countries find it easier to South Africa, they invest shorter term (figure obtain long-term financing from foreign in- 4.11c).13 Nevertheless, in Israel and Mexico, vestors. The analysis presented in this chapter where domestic funds invest shorter term does not explore these potential explanations, than the average maturity of the outstanding and much more work is needed in this regard. sovereign bonds, while U.S. and U.K funds invest longer term, the role of international SOVEREIGN WEALTH FUNDS funds might still be important. In addition, in Brazil, U.S. and U.K. funds still have a longer Sovereign wealth funds (SWFs) are a large and average maturity than that of the outstanding growing class of institutional investors. SWFs sovereign bonds, and thus may still contribute are state-owned funds that invest sovereign to lengthening their average maturity. revenues in real and financial assets, typically Summing up, mutual funds from interna- with the aim of diversifying economic risks tional financial centers seem to play some role and managing intergenerational savings. Cur- in extending the maturity structure of cor- rently, all SWFs combined have an estimated porate bonds in developing and other high- $6.6 trillion under management (Gelb and income countries. Although the evidence pre- others 2014)—more than twice the amount sented here does not imply causality, it does managed by all hedge funds combined. The suggest that fostering foreign institutional in- assets managed by SWFs have been growing vestors might be one avenue for extending the rapidly and have increased more than 10-fold maturity profile of debt. One potential reason over the past two decades. Excluding SWF for this behavior is that international mutual home economies, SWF investments could ac- funds might be willing to take the higher risk count for more than 10 percent of GDP in of investing more long-term given their larger many developing economies of Africa, Eastern size and their ability to diversify this risk by Europe, and Latin America, and for up to 1–2 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 127 percent of the market capitalization of traded portfolio of investments, whose return would companies in these countries (Curto 2010). benefit future generations. It is estimated that Because SWFs have very low redemption more than 60 percent of current SWF assets risk (the risk of investors withdrawing funds), are linked to oil and gas revenues. At the same they are in principle a natural provider of time, a number of large SWFs are not linked long-term finance. Many SWFs often have to natural resource earnings. Sovereign funds an explicit mandate to manage intergenera- in China; Hong Kong SAR, China; and Singa- tional savings, so they typically also have a pore, for example, emerged as a result of per- much longer investment horizon than other sistent trade surpluses and the desire to diver- investors. As a result, SWFs are better able sify the resulting foreign currency holdings to invest in illiquid assets with longer maturi- away from safe but low-yielding U.S. Trea- ties, which in turn can reduce the volatility sury bonds (see table 4.2 for an overview of of capital flows to the markets in which they the world’s largest SWFs). This highlights that invest. Initially SWF investments were highly not all SWFs are alike: SWFs have different concentrated in traditional asset classes and funding sources, which in turn result in differ- high-income countries, but these funds have ent investment mandates and governance been increasingly active in developing econo- structures. Commodity-abundant countries mies where they have provided various forms typically establish SWFs to help stabilize gov- of long-term financing, either through capi- ernment revenue (stabilization funds) and to tal markets or in the form of direct equity manage these revenues intertemporally (sav- investments. ings funds). Noncommodity SWFs (mostly SWFs have their origins in the need to coming from East Asia) are funded by trans- manage cyclical state revenues. In many econ- ferring assets from international reserves, gov- omies, windfall earnings from the discovery of ernment budget surpluses, and privatization natural resources increased domestic inflation revenues. Commodity and noncommodity and short-term government spending in ways SWFs can take the form of pension reserve that proved inefficient or unsustainable in the funds or of reserve investment corporations. long run. To address this problem, sovereign Pension reserve funds accumulate resources in entities as dissimilar as Saudi Arabia and the current period to provide for future liabili- Timor-Leste established state funds to set ties related to pensions and social security aside natural resource earnings in a diversified (examples include Australia, Chile, New TABLE 4.2 Sovereign Wealth Funds by Total Assets under Management, 2014 Assets Inception Economy Name (billions, $) year Origin of funds Norway Government Pension Fund 878.0 1990 Oil United Arab Emirates Abu Dhabi Investment Authority 773.0 1976 Oil Saudi Arabia SAMA Foreign Holdings 737.6 — Oil China China Investment Corporation 575.2 2007 Noncommodity China SAFE Investment Company 567.9 1997 Noncommodity Kuwait Kuwait Investment Authority 410.0 1953 Oil Hong Kong SAR, China Hong Kong Monetary Authority Investment Portfolio 326.7 1993 Noncommodity Singapore Government of Singapore Investment Corporation 320.0 1981 Noncommodity China National Social Security Fund 181.0 2000 Noncommodity Singapore Temasek Holdings 173.3 1974 Noncommodity Qatar Qatar Investment Authority 170.0 2005 Oil and gas Australia Australian Future Fund 90.2 2006 Noncommodity United Arab Emirates Abu Dhabi Investment Council 90.0 2007 Oil Russian Federation National Welfare Fund 88.0 2008 Oil Russian Federation Reserve Fund 86.4 2008 Oil Source: Sovereign Wealth Fund Institute, Las Vegas, NV, http://www.swfinstitute.org. Note: — = not available. 128 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.12 Targeted Asset Allocation of Selected Sovereign Wealth Funds 100 90 80 Share of portfolio, % 70 60 50 40 30 20 10 0 Abu Dhabi Australian Chile ESSF Government of New Zealand Norway Government Investment Future Fund Singapore Investment Superannuation Pension Fund Authority Corporation Fund Equities Debt Real estate Hedge funds Private equity Infrastructure Other Sources: Gelb and others 2014; and Sovereign Wealth Fund Institute, Las Vegas, NV, http://www.swfinstitute.org. Note: The targeted asset allocation is a benchmark portfolio that maximizes expected investment returns subject to the fund’s risk tolerance, taking into account the uncertainty of inflows (outflows) to (from) the fund. The fund’s portfolio includes not only debt and public equities but also other asset classes such as real estate, hedge funds, private equity, and infrastructure. Chile ESSF refers to the Chilean Economic and Social Stabilization Fund. Zealand, and Norway). Reserve investment as Singapore’s Temasek, in contrast, target a corporations will maximize returns on funded higher share of equity investments that are assets subject to risk considerations (examples less liquid and that require greater monitoring include the Singapore Investment Corpora- and specialized expertise. As a result, strate- tion and the Korea Investment Corporation). gic SWFs are much more likely to act as ac- Differences in the origins and purposes of tive investors through private or public equity SWFs are reflected in the significant varia- holdings. tion of investment behavior across SWFs Traditionally, SWFs have invested primar- (Gelb and others 2014). This variation, in ily in liquid assets. In recent years, however, turn, affects how well-placed different SWFs they have increasingly invested in alternative are to provide long-term financing and how assets and asset classes with a longer invest- likely they are to invest in new markets and ment time horizon. Dyck and Morse (2011) asset classes. The targeted asset allocation of assembled data on the portfolios of all sov- six leading SWFs is compared in figure 4.12. ereign funds with more than $10 billion in The asset allocations plotted in the figure are assets under management and found several benchmark portfolios that maximize expected striking results in the portfolio allocation of investment returns subject to the fund’s risk these funds. First, the sovereign funds in the tolerance. Reflecting the significant differences dataset allocate only half of their invested in SWF mandates, risk appetites, and invest- capital to public equities and hold the remain- ment horizons, the figure shows striking dif- der in asset classes with a longer-term invest- ferences in the targeted holdings of debt versus ment horizon, such as private equity limited equity instruments, as well as in asset classes partner positions (29 percent) and real estate with different liquidity and time horizons. (19 percent). These shares are significantly Stabilization funds, such as Chile’s Economic higher than comparable figures for banks and Social Stabilization Fund (ESSF), tend to and other institutional investors. Second, the target a relatively high share of high-liquidity, equity holdings of these SWFs are targeted low-risk investments. Strategic investors, such primarily to sectors with significant demand GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 129 for long-term finance, including financial in- because they are mandated to invest in their stitutions, infrastructure development, and home economies for economic development telecommunications. Sovereign funds tend to purposes. Such investments have often taken invest actively and often hold equity stakes the form of equity stakes with a long-term in- of 5 percent or more in their investee com- vestment horizon and have been spearheaded panies. Third, SWFs also exhibit severe home by funds with local expertise. Examples in- bias in their public and private equity hold- clude investments by Singapore’s Temasek ings, which is more pronounced when SWFs Holdings in the Indian financial sector, the are exposed to political influences (Dyck and Abu Dhabi Investment Authority’s invest- Morse 2011; Bernstein, Lerner, and Schoar ments in Malaysian land and real estate, and 2013). Bortolotti and others (2009); Chhao- the Dubai Investment Corporation’s stakes in chharia and Laeven (2008); and Bernstein, the African telecommunications sector. Some Lerner, and Schoar (2013) examined the tim- emerging SWFs that are headquartered in de- ing and performance of SWF investments veloping countries have also undertaken sub- and found that, on the whole, they tend to stantial investments in their home economies. be associated with positive abnormal returns These investments helped finance physical and but with negative returns in the longer run. social infrastructure, but there are concerns This finding suggests that in many cases SWFs that they may undermine the goal of economic engage in procyclical “trend chasing” rather stabilization through a diversification of na- than provide long-term finance that reduces tional assets away from the home economy. macroeconomic volatility. SWF investments have been viewed as As the size and complexity of SWF invest- a promising source of long-term finance in ment portfolios have grown, one challenge many developing countries. This is particu- has been to maintain investment expertise larly true in the aftermath of the global finan- and returns. That is particularly true for in- cial crisis, which led to a reduction in debt vestments in alternative assets, such as pri- maturities and capital flows to developing vate equity, venture capital, and real estate. countries (see chapter 3). In addition to pro- SWFs have addressed these diseconomies of viding a substitute for traditional sources of scale in two different ways. At one end of the long-term finance, the emerging market in- spectrum, some large funds avoid investing vestments of SWFs have often been geared in private equity and alternative assets alto- toward areas with significant financing gaps, gether. At the other extreme, some funds have such as the development of physical and social established specialized units with a mandate infrastructure. Moreover, SWF investments in to make equity investments in specific mar- developing country infrastructure, health care, kets, industries, and asset classes. This latter and telecommunications have often been able approach, pioneered by funds such as Sin- to mobilize additional long-term finance from gapore’s Temasek and several Middle East- the private sector. It is estimated that if sov- ern funds, is a useful approach for investing ereign funds invested only 1 percent of their in new asset classes. Greater specialization total assets in Sub-Saharan Africa—the world is also likely to facilitate direct investments region where the gap between the supply and in developing countries, which often require demand for long-term finance is perhaps most greater monitoring and localized expertise. acute—it could mobilize joint investments Although SWF portfolio investments tra- of about $420 billion over the 2010–20 de- ditionally have been concentrated in high- cade, enough to account for half of the in- income countries (often in asset classes with frastructure investment required to meet the high liquidity, such as currency and equi- Millennium Development Goals (Turkisch ties), more recently SWFs have increasingly 2011). There are several examples of suc- undertaken investments in developing coun- cessful co-investments by sovereign funds tries either because they want to diversify and private investors in developing countries. their portfolios and achieve higher returns or The China-Africa Development Fund (CAD 130 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Fund), for example, is an equity fund that need legitimacy and credibility so that their was established by the Chinese government capital is not depleted by the government or but that also engages in fund-raising from allocated to inefficient investments for po- private sector investors. The fund invests in litical reasons. Some countries have enacted Chinese enterprises with operations in Africa, laws and created institutions to set up sound with investments of more than $1 billion. The corporate governance and investment poli- investments of this SWF alone are thought cies for their funds. The specific procedures to have facilitated additional investments of that govern a fund’s asset allocation have to more than $2 billion by Chinese enterprises, be tailored to the SWF’s goals. In this con- particularly in the agriculture, infrastructure, text, SWF spending plans should be part of energy, and manufacturing sectors across Sub- a coherent policy framework that is flexible Saharan Africa. and that is designed to meet unexpected and The impact of SWF investments in develop- large adverse shocks. For instance, Timor- ing countries should not be overstated, how- Leste’s Petroleum Fund has invested resources ever. Despite the overall increase of sovereign in the country’s electricity grid. The invest- fund investments in developing countries, the ment mandate might, at the same time, need total value of these transactions remains ex- to minimize unexpected resource demands tremely small. The geographical distribution from the government. Transparency and ac- of sovereign fund deals, summarized in table countability are crucial for the effectiveness of 4.3, shows that more than 80 percent of all SWFs. Some funds submit regular reports to deals between 2010 and 2013 occurred be- the government or to the public. The Chilean tween high-income countries. Moreover, the government, for example, has enacted a fiscal geographical distribution of sovereign fund responsibility law that strengthens the rela- deals in developing countries has been very tionship between the fiscal rule and the use of uneven—more than 77 percent of all SWF government savings (Schmidt-Hebbel 2012). investment in developing countries between Chile has established two SWFs: the Pension 2010 and 2013 was located in East Asia and Reserve Fund (PRF), created to finance the Pacific (58 percent) and South Asia (19 per- government’s future pension liabilities, and cent). Thus, although SWFs have made many the new Economic and Social Stabilization highly visible investments in developing coun- Fund (ESSF). The law establishes clear pro- tries, their overall investment patterns are still cedures for funding these SWFs and specific heavily concentrated in developed markets, so rules to deploy resources from them—espe- despite their different mandate and risk pro- cially the ESSF. Furthermore, it outlines pro- file, they do not differ very much from other cedures for the international investment of the institutional investors in this respect. resources held in these funds. The law has also Because SWFs can be susceptible to politi- created an independent committee—the Advi- cal influence, transparency and good corpo- sory Financial Committee for Fiscal Respon- rate governance standards can improve the sibility Funds—which provides nonbinding effectiveness of SWF investment strategies— recommendations to the Ministry of Finance especially in developing economies. SWFs on fund investment policies and regulations and publishes an annual report of the finan- TABLE 4.3 Percentage Share of Sovereign cial performance of the SWFs. Wealth Fund Transactions by Level of Economic Many large SWFs have an explicit mandate Development, 2010–13 to support the long-run development of their Target home economies. SWFs in resource-rich Mid- Origin High income Developing Total dle Eastern economies are prominent exam- High income 80.9 14.8 95.7 ples. To achieve this goal, these funds invest a Developing 0.8 3.3 4.1 part of their portfolio in “strategic industries” Total 81.7 18.1 100.0 at home, with the goal of diversifying their Source: Calculations based on data from World Bank. economies and of reducing the reliance on GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 131 natural resources. Table 4.4 provides a list of However, the impact of SWF domestic in- the largest SWFs with an explicit domestic in- vestments remains highly controversial. There vestment mandate (Gelb and others 2014). In are two main concerns. On the one hand, sov- recent years, the number of SWFs that invest ereign funds may have superior information in their domestic economies, as well as the and expertise in the domestic economy, allow- overall volume of such investments, has been ing them to provide long-term finance to lo- increasing. In many cases, the SWF domestic cal firms that are financially constrained and investments have provided financing in social that subsequently perform well. If this view is and physical infrastructure, which are of stra- correct, the domestic investments of sovereign tegic importance for long-run development. funds would be expected to be anticyclical Moreover, in the aftermath of the global fi- and directed toward firms that subsequently nancial crisis of 2008–09, many governments outperform their peers. On the other hand, have seen these investments as a useful sub- SWF domestic investments may be subject to stitute for other sources of long-term finance significant political involvement, which can that mitigated the negative consequences of create agency problems and induce distortions the global credit crunch. in SWF investment decisions. For example, a TABLE 4.4 Selected Sovereign Wealth Funds with a Domestic Investment Mandate, 2014 Inception Assets Country Fund year Objectives (billions $) United Arab Investment Council 2007 • To assist the government of Abu Dhabi in achieving continuous 627.0 Emirates (Abu Dhabi) financial success and wealth protection, while sustaining prosperity for the future. • To increasingly participate in and support the sustainable growth of the Abu Dhabi economy. Angola Fundo Soberano de 2012 • To generate sustainable financial returns that benefit Angola’s 5.0 Angola people, economy, and industries. Bahrain Mumtalakat 2006 • To create a thriving economy diversified from oil and gas, 13.5 focused on securing sustainable returns and generating wealth for future generations. Kazakhstan Samruk-Kazyna 2008 • To develop and ensure implementation of regional, national, and 47.4 international investment projects. • To support regional development and implementation of social projects. • To support national producers. Malaysia Kazanah 2003 • To promote economic growth and make strategic investments 34.4 on behalf of the government, contributing to nation building. • To nurture the development of selected strategic industries in Malaysia with the aim of pursuing the nation’s long-term economic interests. Nigeria Nigeria 2011 • To invest in projects that contribute to the development of 1.0 Infrastructure Fund essential infrastructure in Nigeria. Russian Russia Direct 2011 • To make equity investments in strategic sectors within the 10.0 Federation Investment Fund Russian economy on a commercial basis by co-investing with large international investors in an effort to attract long-term direct investment capital. Source: Gelb and others 2014. 132 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 sovereign fund subject to political influence that are not listed on a stock exchange—has may exhibit disproportionate home bias and become an increasingly important source of use domestic equity investments to subsidize long-term finance in developing countries, al- or bail out underperforming industries (Dyck though it remains relatively small. The capi- and Morse 2011). If this less benevolent view tal raised by developing-country PE funds holds, the domestic investments of sovereign has increased more than 20-fold since 2005 funds would be expected to be cyclical and (WEF 2010). It is estimated that at the end directed toward firms that do not have profit- of 2014, PE funds had approximately $3.4 able investment opportunities and that there- trillion under management. Between 2008 fore fail to outperform the market. and 2014, approximately 10 percent of new The existing evidence suggests that SWF PE investments and 15 percent of PE fund- equity financing to domestic firms is indeed raising took place in emerging markets. Al- more likely to cause political distortions rather though PE investments in developing coun- than solve credit constraints for productive tries have increased dramatically in recent firms in need of long-term financing. Bern- years, they remain small relative to GDP stein, Lerner, and Schoar (2013) combined in both developing and developed econo- data on the board composition and direct mies. The total volume of PE investments investments of SWFs to test these competing remained below 0.5 percent of GDP in Eu- hypotheses. They found that domestic invest- rope between 2007 and 2013 and accounted ments are more common among SWFs where for less than 1.5 percent of GDP in Brazil, politicians are involved in management. Sec- China, India, and Russia, the emerging mar- ond, they found that the domestic investments kets with the highest PE activity globally. PE of sovereign funds subject to political influ- investments also tend to be concentrated in ence in their decisions are highly cyclical. That a relatively small group of industries, such is, these SWFs tend to invest in industries with as technology, health care, and telecommu- high price-to-earnings ratios that subsequently nications. The stylized evidence therefore underperform. This deviation from long-run suggests that, to the extent that long-term profit maximization is true overall, but it is financing through PE creates value, these especially pronounced for the domestic invest- benefits remain confined to a small set of in- ments of these funds. These results mirror the dustries and economies. evidence on misallocation of capital stemming PE investors typically specialize in a partic- from state ownership of banks and from mis- ular stage of investee company development, management of state-owned companies and a particular set of industries, or a combina- suggest that problems of political capture and tion of these two key dimensions, and their corporate governance are among the main ob- investment strategies differ accordingly. How- stacles that prevent the domestic investments ever, all PE investors provide comparatively il- of sovereign funds from serving as a substitute liquid longer-term equity investments to facil- for other sources of long-term finance that can itate growth, innovation, or restructuring of contribute to sustainable economic growth. investee companies. The ultimate aim of a PE These findings thus highlight the special im- investor is to realize a return on these activi- portance of sound corporate governance and ties either through a sale or through a merger transparency in the case of SWFs with a do- or by taking the investee company public, mestic investment mandate. which typically occurs in three to seven years. PE firms generally operate as part of a larger financial corporation or as limited liability PRIVATE EQUITY IN partnerships that raise funds independently. DEVELOPING COUNTRIES Unlike other forms of long-term finance, PE Private equity (PE)—an asset class consisting investors provide investee companies with of long-term equity investments, typically more than capital. Typically PE investors lasting several years, in private companies take an active role in company operations by GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 133 improving management practices, facilitating Maula 2010). As recently as the early 2000s, knowledge transfer and innovation, or creat- the vast majority of PE activity was concen- ing economies of scale and scope through the trated in the United States. Since then, both restructuring of investee companies. PE inves- cross-border PE fund-raising and cross-border tors thus bring a set of skills that differentiate PE investments have surged, although the them from other institutional investors and United States remains the center of PE activity. add value to investee companies in ways that Some observers have described this growth as can be especially beneficial to firms in devel- the “globalization of alternative investments” oping countries. (WEF 2008). PE funds come in a number of forms, The regional distribution of PE invest- which may differ in their ability to substitute ments, however, remains highly uneven. The for other sources of long-term finance. Table regional distribution of PE investments for 4.5 provides a stylized summary of the main the years 2001–13 reveals a number of in- classes of PE funds: early-stage or venture cap- teresting facts (figure 4.13). First, while PE ital funds, industry-specific or growth funds, investments remain concentrated in high- and later-stage or buyout funds. Each class of income countries, the overall share of PE in- PE fund can be broken into several subtypes vestments in developing countries rose from of funds and investment strategies. In addi- 12 percent in 2000 to nearly 33 percent be- tion, some of the larger private equity firms fore the global financial crisis. Second, the employ multiple PE investment strategies si- geographical distribution of PE flows to de- multaneously. Some types of PE funds that veloping countries remains unbalanced. In are likely to be a particularly useful source of 2013 Asian economies accounted for 71 per- long-term finance have grown especially rap- cent of all developing economies’ PE flows, idly in recent years. PE infrastructure funds, whereas Latin America accounted for only for example, grew from $17 billion in 2004 to 9 percent. This imbalance is similarly pro- $244 billion in 2013. nounced when PE flows are scaled by the re- PE investments to developing countries ceiving region’s total GDP. Third, PE flows to have expanded rapidly in the past two de- developing countries correlate strongly with cades (Bottazzi, Da Rin, and Hellmann 2004; the business cycle of high-income countries. TABLE 4.5 Types of Private Equity Funds and Investment Strategies Private equity (PE) fund type Defi nition Related PE fund types Early-stage or venture Early-stage/VC funds invest in start-ups and early stage “Angel investors,” seed financing, capital (VC) funds entrepreneurial firms, frequently pairing their capital with start-up financing. an array of other business resources (such as networks for additional hiring and specialized consultants, improving management, identifying alliances and acquisitions, and searching for appropriate market applications). Industry-specific Industry-specific funds offer investee companies focused Industry focus could range from funds industry knowledge and relationships, making them real estate, infrastructure, biotech, particularly well equipped to get deeply involved in key information technology, and media strategic decisions and to assist in efforts to grow through and telecom to agribusiness, climate acquisitions. Except in the largest economies, an industry change, education, health care, focus usually precludes a geographic focus. microfinance, and forestry, etc. Late-stage or Buyout funds invest in mature companies, often using Leveraged buyout (LBO) funds, buyout funds substantial debt to simultaneously reduce the capital the “special situations investing.” fund puts in and increase the return on that capital. These investments frequently aim to improve the profitability of the investee firm through reorganization and replacement of top managers. 134 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FIGURE 4.13 Private Equity Fund-Raising in Developing Countries by Region, 2001–13 70 60 U.S. dollars, billions 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Developing Asia Europe and Latin America Middle East and Sub-Saharan Multiregion Central Asia and the North Africa Africa Caribbean Source: FundLink (database), Emerging Market Private Equity Association, Washington, DC, http://empea.org/research/data-and-statistics/fundlink. This is true even though many large devel- point was first made by Jensen (1989) and oping countries, including China and India, is supported by empirical evidence in John, were relatively resilient during the global fi- Lang, and Netter (1992). While opportunities nancial crisis of 2008–09; PE flows to these to invest in the development of new technolo- markets collapsed to about one-third of their gies may be less abundant in developing coun- precrisis volume. tries, PE investors play an important role in A first advantage of financing entrepreneur- facilitating technology transfer. Indeed, some ial firms with PE is that, unlike other forms of of the most successful PE deals in develop- long-term finance, PE investments can provide ing countries have funded faster adaptations not only capital but also management exper- of existing technologies and business models tise and incentives for technology transfer to local markets. Prominent examples include and innovation. An extensive body of litera- PE investments in generic drug manufacturers ture has documented a robust link between and the adaptation of online shopping and PE investments and innovation in developed e-business platforms to developing countries markets. Kortum and Lerner (2000) showed such as Brazil, China, and India. that venture capital activity in an industry sig- Second, PE investments may serve as a nificantly increases innovation as measured by signal to other private investors and may at- increases in patents. While the ratio of ven- tract cofunding from traditional providers of ture capital to research and development av- finance. Hellmann, Lindsey, and Puri (2008) eraged less than 3 percent between 1983 and showed that banks have increasingly made 1992, estimates suggest that venture capital forays into PE investing in an effort to build accounted for 8 percent of industrial innova- lending relationships with the most success- tions during the period. PE investments could ful entrepreneurial firms. Firms benefit from be increasing innovation through two possible this relationship through more favorable loan channels. First, venture capital may directly pricing and access to credit. Thus, one of the increase resources and incentives for innova- key functions of PE investors in developing tion at investee companies. Second, an inflow countries with less-developed credit markets of PE investments into an industry is likely to may be to screen entrepreneurial firms to increase product market competition, forcing graduate the most promising entrepreneurial competitors to improve their operations. This ventures to public equity or to bank financing. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 135 Third, PE investments—unlike other forms evidence also appears to refute earlier con- of long-term finance—may benefit investee cerns that PE investments may have little ef- companies by strengthening their corporate fect on real economic activity but may mag- governance and transparency directly. Bloom, nify cyclical fluctuations in the economy (see, Sadun, and Van Reenen (2009) looked at for example Guo, Hotchkiss, and Song 2011). data from a global survey of management The evidence does, however, support the practices (Bloom and Van Reenen 2007) and conclusion that the economic effects of PE in- found that firms controlled by PE investors vestments depend on the type of investment— have significantly better management prac- with growth funds and venture capital being, tices. Entrepreneurial firms funded by PE are in most cases, less likely to sacrifice long-run significantly better managed than state-owned value for short-term performance than buy- firms, family firms, or other privately owned out funds. firms. Interestingly, they also perform better PE investment effects also depend on the than publicly traded firms along several hu- broader economic context in which the in- man resource management and operational vestments take place. Bernstein and others measures. Looking at within-firm variation, (2010), for example, noted that the buyout the same data suggest that PE investors target boom in the United States in the early 2000s poorly managed firms and create value by im- “was so massive, and the subsequent crash in proving management practices over time. activity so dramatic” that, viewed in isolation, Fourth, private equity investments can af- its consequences would most likely suggest fect real economic activity through their ef- a more pessimistic view of the link between fect on firm ownership. Bernstein and others PE financing and the real economy than later (2010), for example, found that industries waves of PE activity. Using a large sample of with a high share of PE investment are no PE investee firms in the United States, Davis more volatile than other industries and in and others (2011) showed that PE invest- some cases less so. One possible explanation ments lead to an efficient reallocation of jobs for this finding is that more concentrated but no significant net job losses at investee ownership makes it easier to undertake firms. Hence, taken together, the available efficiency-improving reforms early—often evidence suggests various ways in which PE ahead of a crisis—which ultimately improves financing can improve economic efficiency. It the investee company’s ability to weather is, however, worth noting that much of the negative economic shocks. existing evidence on the impact of PE comes The evidence also suggests that increased from developed markets, so more research is access to long-term PE financing has had tan- needed to assess the extent to which these po- gible positive effects on industry performance tential benefits of PE investments carry over and economic growth (Bernstein and others to developing economies. 2010; Davis and others 2011). Bernstein and A number of caveats constrain the impact others (2010) examined the impact of PE in- of PE investments in developing countries. vestments in 20 industries across 26 markets First, the distribution of global PE flows is over two decades and found that productiv- highly uneven. PE flows are highly sensitive ity and employment grow more quickly in to the quality of legal and market institutions industries with PE investments than those in the recipient country (Lerner and Schoar without such investments. Importantly, the 2005). This implies that, among developing authors showed that this growth is not driven countries, only the most developed markets by reverse causality—that is, “trend chas- tend to receive sufficient PE inflows to make ing” by PE investors entering industries that these alternative investments an economically would have had similarly high growth rates meaningful source of long-term finance. Sec- in the absence of PE funding. Their findings ond, PE fund-raising still takes place predom- also hold for economies outside the United inantly in developed markets, and hence PE States and the United Kingdom. This recent flows remain cyclical and highly correlated 136 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 with the business cycle of high-income coun- premium. As a result, PE firms are hesitant to tries. Even though some categories of PE in- invest in economies where poor legal institu- vestments (such as PE infrastructure funds) tions compound the idiosyncratic risk of their have been less volatile and remained stable investment. Second, PE investments are sensi- in the aftermath of the 2008–09 financial tive to the availability of exit opportunities, crisis, the correlation between PE flows and which depend crucially on the development business cycles external to the destination of local capital markets. Hence, it is not sur- economy suggests significant inefficiencies in prising that the evidence suggests that PE in- the allocation of PE capital. It also highlights vestments primarily complement other forms that, from a macroeconomic perspective, PE of financing in relatively developed emerging investments are subject to some of the same markets rather than act as a substitute for problems of cyclicality as other forms of for- other forms of long-term finance. eign direct investment. Although political and economic risks PE flows are strongly correlated with the place limitations on PE activity in develop- quality of legal and economic institutions in ing countries, private investors have adjusted the recipient country. PE investments out- their investment strategies in ways that partly side North America and Western Europe go compensate for these factors and have en- predominantly to developing countries with abled greater PE investments to developing strong legal and economic institutions and countries. As figure 4.14 shows, the distri- comparatively developed capital markets bution of PE fund types varies substantially (Jeng and Wells 2000; Guler and Guillén between developing countries and traditional 2010). There are several reasons for this cor- markets in advanced economies. The clear- relation. First, PE investments are sensitive to est distinction is the greater tendency of PE the expected level of returns, which in devel- funds in developing countries to invest in oping countries often need to be high enough the growth stage for SMEs and in late-stage to compensate investors for a substantial risk deals rather than in seed stages. The focus on growth-stage deals is consistent with strate- gies aimed at maximizing the opportunities FIGURE 4.14 Private Equity Fund Types by Country Income Group, created by improving macroeconomic condi- 2014 tions. The overall preference of PE firms to do this through investments in more mature a. High-income countries b. Developing countries companies, rather than in early-stage firms, reflects a combination of the benefits of in- 14% 9% cumbency to potential investees and the aver- 4% 28% sion of investors to piling company-level risk 31% on top of the already substantial contextual risk that characterizes emerging markets. 25% The evidence is mixed on whether the cur- 63% rent share of PE capital going to developing 26% countries is appropriate and sufficient to serve as a meaningful source of long-term finance. Measured by total investment as a share of Small and medium enterprise growth GDP, PE industries in developing countries Later stage/buyout Early stage/venture capital remain substantially less mature than in ad- Real estate vanced economies. Such numbers lie behind Other both the consistent claims of limited partners that they will expand their allocations toward Sources: Calculations based on data from International Finance Corporation, Washington, DC; PE in developing countries in coming years, Private Equity (database), Preqin, New York City, NY, https://www.preqin.com. Note: The figure is based on data covering 7,071 private equity funds in Q1 2014 for which informa- and the arguments for sustained or even in- tion on investments by region was available. creased involvement of development finance GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 137 institutions (DFIs) in promoting PE industries CEO and chairman of China’s CITIC Capi- in these countries (Divakaran, McGinnis, and tal: “there is often a strong connection be- Shariff 2014). Others, however, counter that tween management and the asset, and if an underdevelopment of other domestic financial investor tries to separate the two, the result markets in most developing countries leads could be a great deal of value reduction” investment-to-GDP numbers to overstate the (EMPEA 2014). As a result, much like with unmet PE opportunity. This argument rests on venture capital in advanced economies, many the assumption that the ratio of PE investment developing countries’ experienced PE inves- to GDP would be much lower in advanced tors emphasize that the original decision to economies in the absence of the substantial invest involves a major bet on the quality of leveraging applied to most larger-scale deals. the existing top management team. Hence, The performance of PE funds in develop- the greater difficulty of separating ownership ing countries has improved over the past de- from control adds to the risk of PE invest- cade. Although that performance is widely ments in developing countries. understood to have been relatively poor in The difficulty of separating ownership its early stages (Fox 1996; Leeds and Sun- and management also has implications for derland 2003), it has improved since the late the common practice among many PE firms 1990s as PE investors have adapted their in- of seeking majority ownership stakes in their vestment strategies to the economic and in- investees. PE funds in the Lerner and Schoar stitutional challenges they face in emerging (2005) study were actually more likely to markets. There is also significant variation in take majority equity stakes when operating PE performance across developing countries in countries that do not have British common that relates systematically to the institutional law origins. The authors hypothesize that this environment in which the investee company is finding reflects a strategy of using ownership located. Lerner and Schoar (2005) found that control to overcome weaker legal protection PE deals in countries with British colonial ori- against expropriation by other company in- gins such as the United States and India per- siders (that is, fellow owners and managers). formed significantly better than similar deals However, PE investors who take a majority elsewhere; they argued that this heightened position can also reduce incentives for insid- performance shows the central importance ers who have been crucial to making the com- of strong contract enforcement for successful pany an attractive investment to begin with. implementation of the traditional PE business Given the context of substantial information model. Certainly poor country-level corporate asymmetries that characterize most develop- governance structures and inadequate research ing countries, such a reduction in incentives coverage make the identification and assess- can then lead to shirking by these key players ment of potential investment targets a major and, in turn, lower returns for the PE investor. challenge for PE funds—especially funds man- There can also be a selection issue, whereby aged by PE firms with limited country-specific many of the most promising firms are unwill- experience. ing to sell any more than a minority stake. The poor performance of early PE invest- The performance of PE investments in de- ments in developing countries can be related veloping countries is often also constrained by to poorly developed legal institutions as well insufficiently developed local capital markets, as to other features of the business environ- a situation that reduces exit options and that ment, such as the difficulty of separating makes it difficult for PE investors to use local ownership from management. PE firms in sources of debt to increase their margins. The advanced economies commonly aim to in- relationship between weak legal institutions crease the value of their investee companies and a country’s level of financial and capital by, for example, bringing in new manag- market development is well established. It is ers with greater experience and specialized therefore only natural that leveraging strate- skills. However, as noted by Yichen Zhang, gies, which are an important component of 138 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 many PE deals, are less feasible in developing Finance Corporation (IFC). This dataset con- countries. Similarly, PE investors seek to re- tains investments and returns for 7,729 PE structure or grow firms with the objective of funds globally over the years 2001–14, rep- an ultimate profitable exit by taking the com- resenting investments of $350 billion. These pany public, selling it to a strategic acquirer data were used to calculate PE returns, which through a merger or acquisition—known as a indicated a similar convergence of PE perfor- “trade sale”—or selling it to another private mance across regions, as shown in table 4.6. equity firm. Each of these strategies becomes There is some evidence to suggest that the im- more difficult (and less profitable in expecta- provement in developing-country PE perfor- tion) in markets where debt and equity mar- mance is driven by learning among PE inves- kets are not well developed. Although there tors. Taussig and Delios (2014) showed that is no doubt that underdeveloped capital mar- PE firms that either originate in the investee kets deter PE investments overall, there are country or have raised multiple country- some indications that emerging-market PE specific funds enjoy higher returns in econo- investors have partly adjusted their invest- mies with weak contract enforcement. This ment strategies to this fact. While globally, importance of local expertise in developing- 53 percent of all PE exits were trade sales (26 country PE investing parallels the importance percent were sales to other PE investors and of “localness” in early-stage venture capital 19 percent were initial public offerings), this investing documented in the United States share is generally higher in developing coun- (Sorensen and Stuart 2001). tries with poorly developed capital markets. Overall, the evidence suggests that PE in- Despite these challenges, the performance vestments in developing countries have become of PE in developing countries looks much bet- more viable for international investors and are ter today than it did in the past. Cambridge likely to become a more important source of Associates reports returns of 15 percent for long-term finance in emerging markets in the PE in developing countries over the past 5 years ahead. However, given the concentration years, compared with 16 percent in the United of PE investments in a small number of indus- States and 13 percent in Western Europe. tries in firms that are comparatively larger, at Over a time horizon of 10 years, these returns later stages of their development, and located are 15 percent, 14 percent, and 16 percent for in economies with comparatively developed developing countries, the United States, and legal and financial institutions, PE investments Western Europe, respectively. To verify these will likely play only a complementary role to results, and to examine PE returns in a sam- traditional sources of long-term financing in ple that is more representative of emerging- most developing economies. (See box 4.5 for market PE funds, we compiled a new dataset a discussion of how international financial that combines data from the Prequin database institutions could enhance PE investments in with proprietary data from the International developing countries.) TABLE 4.6 Private Equity Returns by Region, 2001–14 Region Number of funds Mean IRR (%) Median IRR (%) OECD 2,893 9.72 8.90 East Asia and Pacific 264 11.72 9.00 Eastern Europe and Central Asia 175 11.31 8.60 Latin America and the Caribbean 70 14.69 7.20 Middle East and North Africa 56 5.54 3.75 South Asia 35 –0.98 0.10 Sub-Saharan Africa 46 5.99 8.46 Sources: Calculations based on data from International Finance Corporation, Washington, DC; and Private Equity (database), Preqin, New York City, NY, https://www.preqin.com. Note: IRR = internal rate of return. OECD = Organisation for Economic Co-operation and Development. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 139 BOX 4.5 International Financial Institutions and PE Investments in Developing Countries Because the viability of private equity investments is currently the largest single PE investor in low- and heavily dependent on host country institutions and middle-income countries. expertise, international fi nancial institutions (IFIs), The IFC recently launched the SME Ventures such as the International Finance Corporation (IFC), Project to provide both risk capital and support to have often played a pioneering role in two respects: SMEs in low-income countries where political risks providing technical assistance and aiding the and insufficiently developed capital markets still pose establishment of markets for private equity (PE) in obstacles to attracting substantial PE funding by developing countries as active PE investors. private investors. Under the program, the IFC pro- First, in addition to capital, PE investors bring vides private equity funds that are managed through knowledge and expertise to the companies in which independent investment managers who are selected they invest. However, in many less-developed mar- on a competitive basis. The program thereby helps kets, PE investors find it difficult to identify and develop the capacity of investment managers to invest support promising smaller firms. Technical assis- risk capital successfully in small businesses in these tance to PE funds investing in emerging markets can countries. Capacity building is a crucial component improve the ability of investors to identify promis- of this initiative. The IFC provides financing and ing investments in a nontransparent market environ- technical assistance to fund managers in areas such ment. Technical assistance to fi rms can help small as partial support for start-up and operational costs, and medium enterprises (SMEs) raise PE capital. In legal structuring and registration, and capacity build- recent years, numerous technical assistance facilities ing among new staff. SME Ventures also offers advi- fi nanced by third parties, such as IFIs or national sory services to the SME business community. SMEs governments, have emerged to fi ll the need for tech- selected for private equity investments receive tailored nical assistance for PE in emerging markets (Diva- business support to prepare them for the investment karan, McGinnis, and Shariff 2014). These techni- as well as during the life of the investment. These cal assistance facilities have promoted the model of services include business planning, market research, twinning PE capital with advisory services and have governance, management information and account- been especially successful at helping smaller fi rms ing systems, and upgraded environmental and social overcome some of the challenges of raising equity standards. capital in markets with poorly developed legal and One of the funds created through SME Ventures economic institutions. is the West Africa Fund for Liberia and Sierra Leone. Second, IFIs have also supported the development It currently has an approved investment portfolio of of markets for emerging-market PE by acting as pio- 19 projects worth $7.4 million in different sectors, neer investors. Early-stage investments in countries including food processing, transportation, construc- with low levels of PE activity can be helpful in sev- tion, health, and light manufacturing. To help man- eral respects. In addition to providing capital and agers identify investment opportunities, the IFC expertise to local SMEs, PE investments by IFIs can advisory services team conducted market surveys also act as an important signal to private investors. and identified more than 240 high-potential SMEs The presence of an IFI PE investor can, for example, in Liberia and Sierra Leone. In a fi rst phase, 60 of ensure compliance with corporate governance stan- these SMEs developed business plans, and the 20 dards and legal regulations, thus partly compensat- best plans were submitted to the West Africa Fund, ing for some of the disadvantage that markets with resulting in five investment appraisals. In a second poorly developed legal institutions and capital mar- phase, the remaining high-potential SMEs are also kets have in attracting PE investments. The IFC has encouraged to develop business plans, which can lead played a key role in catalyzing PE investments in the to additional appraisals and investments. An impor- developing world. It has a track record of having tant objective of the initiative is to support a local PE been among the fi rst PE investors in many emerging market by identifying high-potential SMEs, improv- markets. With PE investments of over $3 billion in ing transparency and corporate governance, and act- more than 180 emerging market funds, the IFC is ing as a catalyst for mobilizing institutional capital. 140 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 POLICY LESSONS instruments or from a weak legal framework. In fact, Chile has done well on the demand The evidence in this chapter suggests that the side of capital: it has introduced several re- ability of bank and nonbank financial institu- forms to foster the demand of capital, leading tions to provide long-term finance is limited. to a wide range of securities issued by both Contrary to the expectations that maturity corporations and the government, includ- structures could be lengthened by promoting ing long-term local currency and inflation- the development of bank and nonbank finan- indexed bonds. Moreover, Chile’s stable cial institutions, the ability of these institu- macroeconomic performance since the early tions to provide long-term finance effectively 1990s has also reduced the risk associated tends to be constrained by market failures with long-term investments. The Chilean evi- and by institutional and policy weaknesses. dence thus highlights the importance of align- Although banks are the most important ing fund managers’ incentives with those of source of long-term finance for firms in de- the investors by reducing the focus on regula- veloping countries, banks in developing coun- tions based on short-term performance. tries lend at significantly shorter maturities To reduce the focus on short-term perfor- than those in high-income countries and thus mance, some studies have recommended the are not able to compensate for market failures introduction of long-term benchmarks for de- and policy distortions. Data from both firms fined contribution (DC) pension funds (Hinz and banks confirm this finding. Research on and others 2010; Berstein, Fuentes, and Vil- the maturity of bank loans shows that mac- latoro 2013; Stewart, 2014). According to roeconomic, institutional, and contractual Stewart (2014), regulatory authorities could factors are not the only significant determi- set long-term benchmarks derived from port- nants of long-term bank lending. The extent folio optimization exercises based on deliver- of financial development, ownership structure ing target pension outcomes. Stewart argues of banking, regulations regarding bank en- that long-term benchmarks would encourage try, and bank capital all matter as well. Pol- managers to invest with the long-term goal icy makers will find it important to monitor of delivering adequate retirement income as how the Basel III regulatory changes in bank opposed to focusing on short-term volatility capital and liquidity requirements affect long- management and short-term performance. To term finance in the near future. Furthermore, the extent that other market conditions make policies that facilitate long-term funding for the current short-term equilibrium stable, banks without distorting their risk-taking however, it is not clear that such benchmarks incentives are likely to mitigate the risk of would necessarily shift the investment strate- deposit runs and to reduce the maturity mis- gies toward longer maturities. For instance, match between bank assets and liabilities, in in some countries, DC pension funds have turn enabling bank long-term lending. market power because of their size relative The Chilean evidence on domestic non- to their domestic markets; that is, they af- bank institutional investors shows that, given fect security prices when they trade.15 Under the institutional framework, incentives matter these circumstances, managers of these funds in lengthening the maturity structure. Despite might avoid securities with lower liquidity managing long-term savings, domestic pen- (which is the case for many long-term corpo- sion funds in Chile structure their portfolios rate bonds) to limit the price effect of their with significantly shorter maturities than do- trades. Additionally, even if pension funds mestic insurance companies. In fact, the ma- hold long-term securities until maturity, turity of pension fund portfolios surprisingly mark-to-market valuation implies that low resembles that of domestic mutual fund port- returns in the short run are possible. Since folios. The short-termism of Chilean pension pensioners and pension fund contributors are funds does not stem from a lack of long-term often reluctant to see the value of their assets GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 141 decline, underlying investors might still fo- transparency and public accountability, and cus on short-term performance, disregarding be more prone to political capture. long-term benchmarks. In the aftermath of financial crises, some There is also an important trade-off be- countries have reduced or eliminated DC pen- tween monitoring managers according to sion schemes while using these contributions their short-term performance (which leads to to meet other fiscal obligations. However, short-term investments) and seeking higher pension funds and other savings for retire- returns by investing long term (at the cost ment are likely to continue to grow in most of higher risks). On the one hand, under countries. In fact, based on behavioral incen- asymmetric information, giving fund man- tives, recent experiences in pension reform agers leeway to make long-run bets exposes have focused on increasing private savings by investors and regulators to the possibility of promoting voluntary contributions through realizing too late that managers did not col- default or automatic enrollment options (Ru- lect sufficient information and that long-run dolph 2014). As highlighted in this chapter, investments thought to be good were really even if these reforms lead to higher savings, unprofitable risky bets, even from an ex ante agency frictions from delegating these savings perspective. On the other hand, subjecting to asset management institutions might still managers to continuous short-run monitoring constitute a challenge for the promotion of might reduce their willingness to undertake long-term finance. long-run investments, might lead them to rely The evidence on international mutual excessively on short-term assets, and might funds indicates that foreign investors might reduce returns for underlying investors. Policy be an avenue for extending corporate debt makers and regulators need to decide where maturities because they hold more long-term to draw the line in this trade-off according domestic debt than domestic investors. How- to the individual market characteristics of ever, given that international mutual funds their countries. For instance, countries with a do not seem to invest more long-term in the strong guarantee of a minimum replacement case of sovereign bonds, the evidence might rate could allow pension funds more leeway be simply reflecting differences in the attri- in choosing long-term investments. This de- butes of the firms in which they invest. For sign has important social consequences given example, Kang and Stulz (1997), Dahlquist the large retirement savings managed by these and Robertsson (2001), Edison and War- institutional investors. However, the socially nock (2004), and Ferreira and Matos (2008) optimal design to balance this trade-off is not show that, because of information asymme- obvious (Acemoglu, Kremer, and Mian 2008) tries, foreign investors prefer to invest in large and requires further work. firms with a presence in international markets As an alternative to DC pension systems (cross-listed firms). Therefore, it is possible based on individual retirement accounts, that domestic institutional investors are pro- several high-income countries have focused viding finance to smaller firms that are not recently on strengthening or on creating new able to raise funds in international markets public pension funds.16 Most of these reforms or are not targeted by foreign investors, and rely on centrally managed plans funded by these firms might be issuing bonds at shorter compulsory contributions with total or par- maturities. Whether that results from supply tial guarantees of the benefits.17 The long- or demand considerations requires further term nature of the liabilities of these funds investigation. and the absence of redemption risks are ex- Attempts to extend debt maturities through pected to result in investments with longer the promotion of foreign institutional inves- horizons. In countries with weak financial tors, however, entail an important trade-off oversight, however, these funds might exhibit because economies become more suscep- weak governance structure, have low levels of tible to foreign shocks. The financial crisis 142 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 of 2008–09 provided clear evidence on the in infrastructure financing, health care, and potential destabilizing role that some institu- telecommunications. The governments of tional investors can exert in financial markets. host countries can set the framework for such For instance, institutional investors facing the investments to occur in the first place. Host possibility of massive withdrawals following governments can also take steps to minimize poor performance would have to meet the re- the risk of misusing those public funds. Par- demption claims by liquidating some of their ticipation of SWFs could be encouraged in assets. Under these circumstances, investors sectors with monopolistic or quasi-monopo- can either sell the assets that are directly af- listic structures (OECD 2008), as is the case fected by the crisis and book losses at fire sale in a growing number of infrastructure proj- prices (exacerbating the initial shock) or sell ects in developing countries. Investments other more liquid assets, thereby transmit- that require large long-term commitments ting the crisis across securities and markets by SWFs can also be structured similarly to (Scholes 2000).18 Furthermore, the portfolio public-private partnerships, in which some of allocation of these institutional investors is af- the initial investment risks are guaranteed by fected by principal-agent considerations and the host state. Finally, to harness the multiplier by other trading restrictions based on risk effect of large SWF investments in physical or measures, typically used by banks and other social infrastructure and to align incentives, leveraged players. As such, some institutional host governments can create the legal and reg- investors might exhibit the same type of pro- ulatory conditions that allow for cofinancing cyclical risk taking that banks are known for and participation by the private sector. and might not conform to the textbook pic- The promotion of other institutional in- ture of long-term investors but instead have vestors, such as private equity, as providers much in common with banks in amplifying of long-term finance might require further shocks (Shin 2013). An extensive body of strengthening of the legal and institutional evidence documents procyclical and other frameworks in host countries. For PE inves- destabilizing behavior of institutional inves- tors, corporate governance standards and le- tors in both domestic and international mar- gal institutions of the investee country play a kets.19 In this context, while the presence of crucial role. The available evidence suggests foreign institutional investors does seem to be that globally, as well as within developing correlated with longer-term financing, regu- countries, PE investments go predominantly latory authorities need to be mindful of the to countries with better investor protection, consequences for financial stability, given the legal institutions, and corporate governance transmission mechanism through portfolio standards. The reason is straightforward: rebalancing of these market players. How- evaluating the risk and return profile of non- ever, relying on domestic mutual funds (as on listed companies in developing countries is pension funds) to extend maturity structures difficult, which explains why local investors might not yield expected results either, and enjoy an especially large advantage over for- their behavior in crises is understudied. eign investors in these markets (Taussig and Given the problems of promoting long- Delios, 2014). If idiosyncratic risks in these term financing through mutual or pension markets are compounded by additional ag- funds, governments can generate incentives gregate uncertainty arising from weak con- to facilitate long-term investments by alter- tract enforcement and poor corporate gover- native institutional investors—for instance, nance, expected returns are further reduced SWFs. Unlike mutual or DC pension funds, and equity investments can be discouraged SWFs face no redemption risk, and so they altogether. Hence, improvements in market are in principle a natural provider of long- transparency, auditing standards, and corpo- term finance. Moreover, SWFs have increas- rate governance are a set of policies that can ingly engaged in direct equity investments significantly improve the viability of PE in- with significant social returns—for example, vestments in developing countries. Moreover, GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 143 although difficult to achieve, any policies that on portfolios and institutional ownership of help develop capital markets would give PE debt securities and bank loans. Although most investors a viable exit strategy and thus more national authorities collect this information, a incentives to enter in the first place. Neverthe- joint effort is needed to consolidate it and to less, given the limited size of PE flows, policies make it comparable across countries. Such ef- are unlikely to be geared toward PE invest- forts should highlight further steps to foster ments in the short term. long-term financing via financial institutions. In the presence of market failures, the government can play a catalytic role so that NOTES institutional investors may finance long-term projects. For instance, recent efforts through 1. The stylized fact that the maturity of bank public-private partnerships have sought to loans in developing countries is lower than attract institutional investors to infrastruc- that for developed countries is based on ture financing. Beyond strengthening the in- aggregate bank data where it is not possible to separate retail, mortgage, and corporate stitutional framework, such efforts have been loan portfolios; nor is it possible to control accompanied by the introduction of new fi- for other characteristics of the loan or the nancial instruments tailored to institutional borrower. investors. Because the success of these invest- 2. This is not to say that total bank lending and ments is heavily dependent on host country long-term bank lending did not decline. Such a institutions and expertise, the presence of decline, in particular for European banks, has international development institutions may been documented in the literature (for exam- further encourage the participation of institu- ple, Feyen and Gonzalez del Mazo 2013). tional investors. By bringing sound practices, Furthermore, as discussed in chapter 2, debt enhanced transparency, and internationally financing for some firms was more affected accepted standards, international develop- than for others. In particular, debt financing ment institutions may ameliorate some of the for SMEs and nonlisted firms was particularly information asymmetries and other market impacted. failures faced by investors (especially in devel- 3. See G-20 (2013) for example. 4. At the same time, limited wholesale funding oping countries), reducing risks and attracting could not only signal better risk management institutional investors. on the part of banks but, in certain countries, Besides some of the challenges for policy could also indicate the absence of a shadow makers presented in this section, additional banking sector or of institutions that could work is needed to understand the interactions facilitate wholesale funding. between different financial institutions and 5. See Financial Stability Board (2013) at http:// their implications for long-term financing. www.financialstabilityboard.org/wp-content For example, given the relationship between /uploads/r_130216a.pdf. institutional investors and banks through 6. For example, Schmidt-Hebbel (1998) esti- ownership, deposits, and other debt con- mated that 10–40 percent of the increase in tracts, institutional investors might facilitate national savings in Chile in the 1990s was long-term bank lending indirectly. Addition- attributable to the pension reform. Lopez ally, changes in regulation, such as in the capi- Murphy and Musalem (2004) presented cross-country evidence that pension reforms tal requirements for banks, might limit the introducing mandatory second pillars lead to ability of financial institutions to lend long increased private savings. term. Whether nonbank financial institutions 7. By definition, international funds invest only can substitute for changes in the provision of in foreign markets, whereas global funds may bank lending remains an open question. invest both domestically and abroad. The Perhaps one of the major obstacles to analysis in this section, however, does not dif- studying the role of financial intermediaries ferentiate between these two categories and in the provision of long-term finance is the simply calls both of these types “international shortage of international and domestic data funds.” 144 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 8. Money market funds are excluded from the zil; Canada; Chile; China; Colombia; Den- analysis because their inclusion would create mark; France; Germany; Hong Kong SAR, a bias when comparing international funds China; India; Indonesia; Ireland; Israel; and funds that invest domestically (by lower- Italy; the Republic of Korea; Luxembourg; ing the maturity of domestic funds). Never- Malaysia; Mexico; the Netherlands; Nor- theless, the predominance of money market way; Peru; Singapore; South Africa; Spain; funds in many developing countries is infor- Sweden; Thailand; the United Arab Emirates; mative and could indicate the failure of the the United Kingdom; and the United States. mutual fund sector to mobilize long-term 12. There are fewer observations in this case financing. The economies covered in the sam- because there are fewer countries in the ple are Australia; Brazil; Chile; Hong Kong BIS database. The countries considered are SAR, China; India; Israel; the Republic of Australia, Belgium, Brazil, Canada, Chile, Korea; Mexico; New Zealand; South Africa; Colombia, Germany, Indonesia, Israel, the the United Kingdom; and the United States. Republic of Korea, Malaysia, Mexico, Peru, The sample contains 2,709 mutual funds with the Philippines, Singapore, South Africa, a total of 133,997 holdings. Additional infor- Spain, Thailand, the United Kingdom, and mation on these holdings, such as redemption the United States. date, issuer’s country, issuer’s type (sovereign, 13. India and Hong Kong SAR, China, are omit- corporate, agency, and so forth), and issuer’s ted from the analysis because there are few industry was retrieved from DataStream. observations for U.S. and U.K. funds. Chile is 9. This database has information on the redemp- excluded because the sample does not provide tion date of corporate bond issuances since information regarding the issuer type for the 1990. To compute the average maturity of the domestic mutual funds’ holdings. New Zea- outstanding bonds by country in 2013, the land is also excluded because the BIS data- estimates had to be aggregated over time and base does not provide information about the by country. The procedure employed is as fol- average maturity of its outstanding sovereign lows. First, for the initial month of the sample, bonds. using as a weight the amount raised in each 14. Kang and Stulz (1997), Dahlquist and Rob- issuance, the average maturity was computed ertsson (2001), and Edison and Warnock for each country. For the following periods, (2004) have shown that information asymme- the maturity at origin of new issuances was tries do play a role and that foreign investors computed, and the maturity of the previous prefer to invest in large firms with a presence issuances was updated. With this informa- in international markets (cross-listed firms). tion, the average maturity of the outstanding Similarly, Ferreira and Matos (2008) showed bonds was computed, using as a weight the that foreign and domestic institutional inves- amount raised in each issuance (as a propor- tors diverge in some stock preferences. For- tion of the total amount outstanding). Given eign institutional investors have a strong bias a lack of information, a shortcoming of this for firms listed in the MSCI World Index, procedure is that it does not take into account firms that are cross-listed on a U.S. exchange, the repurchases of outstanding shares by a and firms that have external visibility through company (buybacks). high foreign sales and analyst coverage. In 10. The main difference between U.S. and U.K. contrast, domestic institutions underweight funds is given by the average maturity of their these same stocks. Nevertheless, even in domestic holdings: 6.6 years for U.S. mutual this scenario, small firms might benefit from funds and 11.8 years for U.K. funds. This dif- foreign investments through a freeing up of ference seems to be explained by the fact that domestic capital (Knill 2013). the average maturity of outstanding sover- 15. See Larrain, Muñoz, and Tessada (2014) eign bonds from the United Kingdom is more for Chilean pension funds and Acharya and than double the average maturity of U.S. out- Pedraza (2015) for Colombian pension funds. standing sovereign bonds (14.7 and 5.6 years, 16. Vittas, Impavido, and O’Connor (2008) dis- respectively) and U.S. and U.K. funds both cuss the cases of Norway, Canada, and Ire- invest heavily in these bonds. land. Rohde and Dengsoe (2010) describe 11. The economies included in the sample are recent changes in Denmark’s labor market Argentina; Australia; Austria; Belgium; Bra- supplementary pension plan. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 FINANCIAL INSTITUTIONS AS PROVIDERS OF LONG-TERM FINANCE 145 17. For example, Denmark’s labor market international evidence on the portfolio chan- supplementary plan is managed by a single nel of contagion, see Broner, Gelos, and Rein- independent institution and provides a par- hart (2006). tial guarantee model, whereby 80 percent of 19. See, for example, Raddatz and Schmukler members’ contributions are converted into (2012) for international mutual funds; Bern- a defined benefit promise. The remaining stein, Lerner, and Schoar (2013) for SWFs; 20 percent is invested in a nonguaranteed Jotikasthira, Lundblad, and Ramadorai (2012) investment portfolio. for global investment managers in emerging 18. Manconi, Massa, and Yasuda (2012) present markets; and Kaminsky, Lyons, and Schmuk- U.S. evidence of the transmission mechanism ler (2004), Hau and Rey (2008), and Raddatz, between securitized bonds and corporate Schmukler, and Williams (2014) for interna- bonds in the 2008–09 financial crisis. For tional equity funds, among many others. Statistical Appendixes This section consists of two appendixes. to the 2015/2016 Global Financial Develop- ment Report. Appendix A presents basic country-by- country data on financial system charac- These appendixes present only a small part of teristics around the world. It also presents the Global Financial Development Database averages of the same indicators for peer (GFDD), available at http://www.worldbank groups of countries, together with summary .org/financialdevelopment. Global Finan- maps. It is an update on information from cial Development Report 2015/2016 is also the 2014 Global Financial Development accompanied by The Little Data Book on Report. Financial Development 2015/2016, which is a pocket edition of the GFDD. It presents Appendix B provides additional country-by- country-by-country and also regional fig- country information on key aspects of long- ures of a larger set of variables than what is term fi nance around the world. It is specific shown here. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 147 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 149 APPENDIX A BASIC DATA ON FINANCIAL SYSTEM CHARACTERISTICS, 2011–13 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Afghanistan 7.9 9.0 7.4 Albania 38.5 28.3 5.9 29.2 Algeria 14.0 33.3 6.3 22.0 Andorra 14.3 Angola 20.7 39.2 12.7 15.9 Antigua and Barbuda 73.4 7.1 Argentina 14.9 33.1 2.6 3.4 11.8 29.1 4.3 27.4 Armenia 36.0 17.5 7.3 15.9 3.8 0.6 Aruba 59.7 7.6 23.5 Australia 121.5 98.1 3.1 11.3 165.5 53.2 83.7 15.4 Austria 116.7 97.1 13.7 70.3 37.0 61.1 24.9 Azerbaijan 18.9 14.9 8.2 9.6 Bahamas, The 81.0 2.7 16.5 Bahrain 66.6 64.5 5.2 15.2 64.0 1.6 8.2 Bangladesh 45.2 39.6 2.3 8.3 13.0 97.5 Barbados 6.1 16.9 103.2 0.4 Belarus 29.8 58.6 1.8 7.6 Belgium 92.1 96.3 37.6 106.6 41.5 18.4 Belize 56.7 7.6 14.4 Benin 23.3 10.5 15.6 Bermuda 14.2 Bhutan 44.3 8.7 37.1 Bolivia 35.8 28.0 9.4 9.0 15.8 0.4 Bosnia and Herzegovina 52.2 56.2 4.1 14.6 10.5 Botswana 28.0 30.3 6.8 13.1 29.0 3.2 7.5 Brazil 61.7 55.9 15.8 6.5 88.1 47.8 67.5 22.7 Brunei Darussalam 32.4 5.2 8.3 Bulgaria 52.8 6.8 15.7 14.1 4.8 15.1 Burkina Faso 20.0 13.4 9.5 Burundi 16.4 7.2 18.3 Cambodia 33.3 3.7 10.5 Cameroon 12.9 14.8 14.1 Canada 95.8 2.5 12.0 144.2 68.9 67.2 14.7 Cabo Verde 62.5 6.3 27.6 (appendix continued next page) 150 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 (continued) Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Cayman Islands 12.2 Central African Republic 11.8 3.7 14.7 Chad 7.9 9.0 12.5 Chile 69.0 42.2 4.0 16.4 159.6 55.1 17.7 15.6 China 124.4 63.8 3.0 21.2 93.0 74.7 141.3 19.7 Colombia 35.0 30.4 7.0 13.2 63.5 20.4 12.2 16.7 Comoros 20.3 21.7 8.8 Congo, Dem. Rep. 7.9 3.7 15.4 12.6 Congo, Rep. 8.7 9.0 3.3 Costa Rica 46.3 50.4 12.3 22.7 3.9 2.4 Côte d’Ivoire 17.8 14.5 26.1 2.1 Croatia 69.6 88.4 7.8 23.5 40.6 3.5 13.2 Cuba 11.3 Curacao 12.8 Cyprus 163.5 85.2 8.9 18.5 14.3 11.0 Czech Republic 80.7 4.4 37.6 32.6 31.2 19.6 Denmark 98.1 8.5 196.1 64.8 18.9 Djibouti 29.2 12.3 9.1 13.0 Dominica 56.2 5.9 8.1 Dominican Republic 21.8 38.2 7.7 29.4 Ecuador 25.0 36.7 2.3 6.9 2.1 8.8 Egypt, Arab Rep. 28.3 9.7 4.4 35.4 29.1 51.9 38.2 27.6 El Salvador 39.1 13.8 23.0 25.2 1.0 Equatorial Guinea 8.5 19.4 Estonia 79.5 96.8 5.0 7.4 9.9 11.6 18.6 Ethiopia 16.3 Fiji 66.0 4.1 12.3 1.4 Finland 97.4 98.1 2.6 71.6 105.2 23.3 France 114.3 97.0 9.3 121.4 75.9 23.9 Gabon 9.7 18.9 10.4 Gambia, The 15.5 15.4 5.6 Georgia 33.0 33.0 3.8 9.6 6.6 0.4 Germany 100.5 98.1 33.5 63.7 54.2 110.4 21.9 Ghana 13.7 29.4 12.4 8.4 3.1 9.3 Greece 124.7 77.9 2.3 48.9 31.1 51.1 28.5 Grenada 81.6 7.0 12.3 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 151 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 (continued) Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Guatemala 26.4 22.3 8.2 17.2 Guinea 7.9 3.7 5.7 Guinea-Bissau 11.6 5.0 Guyana 31.0 12.4 18.9 15.8 Haiti 15.1 22.0 9.3 21.5 Honduras 48.3 20.5 9.4 32.4 Hong Kong SAR, China 163.5 88.7 5.0 18.4 196.1 63.7 135.4 20.5 Hungary 72.7 3.2 18.0 32.9 7.8 77.6 24.0 Iceland 97.0 2.3 82.2 22.0 India 47.9 35.2 34.1 74.6 70.0 63.4 17.8 Indonesia 28.4 19.6 5.6 19.0 46.6 56.2 35.7 19.7 Iran, Islamic Rep. 12.1 73.7 19.5 21.1 Iraq 7.9 10.6 25.2 Ireland 163.5 93.9 32.8 152.3 11.7 19.3 20.7 Israel 87.2 90.5 3.4 24.8 103.3 47.0 56.4 17.7 Italy 123.4 71.0 15.5 55.7 141.3 27.4 Jamaica 26.9 71.0 14.6 26.3 47.5 3.1 8.9 Japan 106.9 96.4 1.8 35.5 139.8 71.9 104.5 20.3 Jordan 69.6 25.5 4.8 37.6 101.7 29.7 18.2 8.4 Kazakhstan 34.9 42.1 7.5 28.3 19.0 3.1 24.5 Kenya 30.2 42.3 8.7 10.5 28.2 8.0 10.8 Korea, Rep. 98.0 93.0 1.8 4.6 154.9 63.6 140.8 19.3 Kosovo 32.7 44.3 Kuwait 56.8 86.8 3.0 16.6 73.5 27.4 9.2 Kyrgyz Republic 3.8 11.6 22.8 3.8 6.2 Lao PDR 26.8 6.1 19.5 Latvia 89.7 5.6 5.7 4.8 3.0 17.1 Lebanon 84.6 37.0 1.8 37.6 29.3 7.8 9.7 Lesotho 16.1 18.5 7.4 15.4 Liberia 15.3 18.8 10.1 2.3 Libya 14.1 3.5 37.6 Lithuania 73.8 2.3 11.5 5.1 15.6 Luxembourg 162.9 94.6 31.6 156.5 7.8 0.4 Macao SAR, China 52.8 5.2 36.7 Macedonia, FYR 46.2 73.7 3.3 12.8 6.7 6.1 14.1 Madagascar 10.9 5.5 15.8 13.2 (appendix continued next page) 152 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 (continued) Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Malawi 13.5 16.5 15.8 11.0 22.6 2.5 Malaysia 111.7 66.2 1.9 14.7 196.1 63.3 28.6 9.4 Maldives 46.2 6.7 6.4 Mali 20.0 8.2 16.9 Malta 123.1 95.3 2.3 40.1 7.8 1.4 Mauritania 26.0 17.5 10.1 26.3 Mauritius 93.9 80.1 2.0 15.0 65.4 41.8 5.5 7.8 Mexico 19.4 27.4 3.5 15.5 54.0 39.9 26.1 15.8 Micronesia, Fed. Sts. 14.0 26.5 Moldova 34.1 18.1 5.9 5.9 Mongolia 46.5 77.7 6.5 23.9 14.1 4.1 23.8 Montenegro 57.0 50.4 7.3 86.3 1.4 17.1 Morocco 70.0 39.1 21.0 65.1 29.6 10.8 11.4 Mozambique 23.9 39.9 6.0 2.4 Myanmar 5.0 3.1 Namibia 45.4 4.4 5.3 9.4 1.6 19.5 Nepal 51.8 25.3 6.8 26.3 1.6 Netherlands 163.5 98.1 5.1 145.8 86.1 19.2 New Zealand 98.1 1.8 15.9 48.0 53.8 28.1 8.9 Nicaragua 24.2 14.2 11.2 2.4 Niger 13.1 3.7 18.9 Nigeria 12.1 29.7 9.2 2.4 10.9 10.2 14.0 Norway 18.8 85.9 24.4 77.2 22.5 Oman 39.4 73.6 3.1 12.5 28.7 60.2 14.8 9.8 Pakistan 16.7 10.3 5.5 11.4 17.8 32.3 14.2 Panama 74.4 24.9 4.6 23.3 29.3 1.3 7.5 Papua New Guinea 25.1 10.0 15.5 89.7 0.5 Paraguay 38.1 21.7 13.9 12.2 3.8 4.3 Peru 26.2 20.5 15.8 16.6 61.7 36.2 5.2 23.1 Philippines 31.5 26.6 3.3 19.1 75.0 59.7 19.3 17.7 Poland 70.2 14.0 34.4 46.0 49.4 20.7 Portugal 163.5 81.2 7.1 98.1 42.4 19.9 Qatar 36.2 65.9 3.7 26.8 74.7 24.3 16.0 11.7 Romania 37.2 44.6 5.9 12.3 14.7 9.8 21.1 Russian Federation 44.3 48.2 3.8 3.1 56.6 38.0 98.6 23.4 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 153 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 (continued) Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Rwanda 32.8 11.1 Samoa 38.9 7.5 21.4 San Marino 7.0 São Tomé and Príncipe 35.0 13.9 Saudi Arabia 34.8 46.4 21.4 54.9 43.5 95.1 15.9 Senegal 28.3 5.8 37.6 Serbia 49.7 62.2 8.1 9.8 21.1 3.3 16.1 Seychelles 20.8 9.0 9.7 Sierra Leone 7.9 15.3 11.0 4.7 Singapore 109.5 98.1 5.2 19.2 145.9 73.7 64.7 14.3 Slovak Republic 49.3 79.6 14.7 9.9 4.5 17.3 Slovenia 85.6 97.1 4.1 24.1 16.8 5.1 16.5 Solomon Islands 17.7 10.7 Somalia 31.0 South Africa 67.5 53.6 3.3 19.4 172.7 74.8 56.1 15.8 Spain 163.5 93.3 19.0 133.9 58.1 116.8 27.5 Sri Lanka 28.1 68.5 3.3 16.3 30.2 58.0 19.4 15.5 St. Kitts and Nevis 65.1 4.8 20.6 85.4 0.8 St. Lucia 108.1 6.4 4.2 St. Vincent and the Grenadines 53.0 6.5 Sudan 10.2 6.9 22.8 Suriname 23.4 5.1 33.8 Swaziland 23.4 28.6 6.3 15.5 Sweden 98.1 32.2 152.8 83.4 22.0 Switzerland 161.9 2.7 37.6 181.0 32.4 72.4 16.1 Syrian Arab Republic 23.3 16.0 Tajikistan 12.5 3.7 14.5 8.2 Tanzania 16.0 17.3 6.7 10.7 5.8 2.1 7.8 Thailand 108.8 72.7 4.3 8.0 131.1 56.2 85.0 18.8 Timor-Leste 11.1 11.0 Togo 27.8 10.2 3.9 Tonga 31.6 7.2 Trinidad and Tobago 30.5 75.9 6.2 10.9 59.7 1.0 Tunisia 68.4 32.2 3.8 21.1 14.3 10.8 Turkey 50.3 57.6 4.2 33.8 53.9 141.3 23.7 (appendix continued next page) 154 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE A.1 Economies and Their Financial System Characteristics, Averages, 2011–13 (continued) Financial institutions Financial markets Stock market capitalization Market + outstanding capitalization Private credit Account Bank domestic excluding top Stock by deposit at a formal lending- private debt 10 companies market money banks financial deposit securities to to total market turnover Stock to GDP institution spread Bank GDP capitalization ratio price Economy (%) (%, age 15+) (%) Z-score (%) (%) (%) volatility Turkmenistan 3.7 2.5 Uganda 15.6 20.5 10.1 19.4 27.6 0.4 Ukraine 54.5 41.3 6.5 12.0 17.9 8.9 28.5 United Arab Emirates 61.2 59.7 21.3 22.4 24.3 27.4 10.6 United Kingdom 161.7 97.2 23.1 130.8 67.0 94.7 17.1 United States 49.4 88.0 28.9 196.1 73.2 135.4 17.8 Uruguay 22.9 23.5 6.6 2.8 3.8 1.4 Uzbekistan 22.5 5.5 Vanuatu 66.9 4.2 10.9 Venezuela, RB 19.3 44.1 2.1 8.5 3.8 0.8 20.0 Vietnam 93.7 21.4 3.1 29.7 15.8 43.2 21.3 West Bank and Gaza 19.4 17.9 8.5 Yemen, Rep. 7.9 3.7 5.6 25.9 Zambia 21.4 6.7 13.3 14.2 4.3 Zimbabwe 39.7 2.6 ˇ ihák and others 2013. Source: Data from and calculations based on the Global Financial Development Database. For more information, see C Note: Empty cells indicate lack of data. NOTES market turnover ratio (%)” where averages for 2010–12 are reported. Table layout: The layout of the table follows the 4x2 matrix of financial system character- Averaging: Each observation is an arithmetic istics introduced in the 2013 Global Financial average of the corresponding variable over Development Report, with four variables 2011–13. When a variable is not reported or approximating depth, access, efficiency, and is not available for a part of this period, the stability of financial institutions and financial average is calculated for the period for which markets, respectively. observations are available. Additional data: Table A.1 presents a small Visualization: To illustrate where a country’s fraction of observations in the Global Finan- observation is in relation to the global distri- cial Development Database accompanying bution of the variable, the table includes four this report. For additional variables, his- bars on the left of each observation. The four- torical data, and detailed metadata, see the bar scale is based on the location of the coun- full data set at http://www.worldbank.org try or economy in the statistical distribution /financialdevelopment. of the variable in the Global Financial Devel- opment Database: values below the 25th per- Period covered: The table shows averages centile show only one full bar, values equal to for 2011–13, except for “Stock market or greater than the 25th and less than the 50th capitalization + outstanding domestic pri- percentile show two full bars, values equal vate debt securities to GDP (%)” and “Stock to or greater than the 50th and less than the GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 155 75th percentile show three full bars, and val- Bank lending–deposit spread (%) is lending ues greater than the 75th percentile show four rate minus deposit interest rate. Lending rate full bars. The bars are calculated using “win- is the rate charged by banks on loans to the sorized” and “rescaled” variables, as described private sector and deposit interest rate is the in the 2013 Global Financial Development rate paid by commercial or similar banks for Report. To prepare for this, the 95th and 5th demand, time, or savings deposits. The lend- percentiles for each variable for the entire ing and deposit interest rates are from IFS pooled country-year data set are calculated, lines 60P and 60L, respectively. and the top and bottom 5 percent of observa- tions are truncated. Specifically, all observa- Bank Z-score is calculated as [ROA + (equity / tions from the 5th percentile to the minimum assets)] / (standard deviation of ROA). To are replaced by the value corresponding to the approximate the probability that a country’s 5th percentile, and all observations from the banking system defaults, the indicator com- 95th percentile to the maximum are replaced pares the system’s buffers (returns and capi- by the value corresponding to the 95th per- talization) with the system’s riskiness (vola- centile. To convert all the variables to a 0–100 tility of returns). Return of Assets (ROA), scale, each score is rescaled by the maximum equity, and assets are country-level aggregate and the minimum for each indicator. The figures (calculated from underlying bank-by- rescaled indicator can be interpreted as the bank unconsolidated data from Bankscope). percent distance between the worst (0) and the best (100) financial development outcome, Stock market capitalization + outstanding defined by the 5th and 95th percentiles of the domestic private debt securities to GDP (%) original distribution (for further information measures the market capitalization plus the see the 2013 Global Financial Development amount of outstanding domestic private debt Report). The four bars on the left of the coun- securities as a percentage of GDP. Market try name show the unweighted arithmetic capitalization (also known as market value) average of the “winsorized” and rescaled vari- is the share price times the number of shares ables (dimensions) for each country. This aver- outstanding. Listed domestic companies are age is reported only for those countries where the domestically incorporated companies data for the relevant periods are available for listed on the country’s stock exchanges at at least four variables (dimensions). the end of the year. Listed companies do not include investment companies, mutual funds, Private credit by deposit money banks to or other collective investment vehicles. Data GDP (%) measures the domestic private credit are from Standard & Poor’s Global Stock to the real sector by deposit money banks as Markets Factbook and supplemental Stan- a percentage of local currency gross domes- dard & Poor’s data, and are compiled and tic product (GDP). Data on domestic private reported by the World Development Indi- credit to the real sector by deposit money cators. The amount of outstanding domes- banks are from the International Financial tic private debt securities is from table 16A Statistics (IFS), line 22D, published by the (domestic debt amount) of the Securities Sta- International Monetary Fund (IMF). Local tistics by the Bank for International Settle- currency GDP is also from IFS. ments. The amount includes all issuers except governments. Account at a formal financial institution (%, age 15+) measures the percentage of adults Market capitalization excluding top 10 com- with an account (self or together with some- panies to total market capitalization (%) mea- one else) at a bank, credit union, another sures the ratio of market capitalization out- financial institution (e.g., cooperative, micro- side of the top 10 largest companies to total finance institution), or the post office (if appli- market capitalization. The World Federation cable), including adults who report having of Exchanges (WFE) provides data on the a debit card. The data are from the Global exchange level. This variable is aggregated up Financial Inclusion (Global Findex) Database to the country level by taking a simple average (Demirgüç-Kunt and Klapper 2012). over exchanges. 156 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 Stock market turnover ratio (%) is the total REFERENCES value of shares traded during the period divided by the average market capitalization ˇ ihak, Martin, Aslı Demirgüç-Kunt, Erik C for the period. Average market capitaliza- Feyen, and Ross Levine. 2013. “Financial tion is calculated as the average of the end- Development in 205 Economies, 1960 to of-period values for the current period and 2010.” Journal of Financial Perspectives 1 the previous period. Data are from Standard (2): 17–36. (Earlier version issued as Pol- & Poor’s Global Stock Markets Factbook icy Research Working Paper 6175, World and supplemental Standard & Poor’s data, Bank, Washington, DC). and are compiled and reported by the World Demirgüç-Kunt, Aslı, and Leora Klapper. Development Indicators. 2012. “Measuring Financial Inclusion: The Global Findex.” Policy Research Stock price volatility is the 360-day standard Working Paper 6025, World Bank, Wash- deviation of the return on the national stock ington, DC. market index. The data are from Bloomberg. World Bank. 2014. Global Financial Devel- To visualize a country in the distribution, the opment Report 2014: Financial Inclu- ranking of price volatility is reversed to show sion. Washington, DC: World Bank. higher stability as more bars. doi:10.1596/978-0-8213-9985-9. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 157 MAP A.1 DEPTH—FINANCIAL INSTITUTIONS To approximate financial institutions’ depth, this (IFS), line 22D, published by the International Mon- map uses domestic private credit to the real sector etary Fund (IMF). Local currency GDP is also from by deposit money banks as a percentage of local cur- IFS. The four shades of blue in the map are based rency gross domestic product (GDP). Data on domes- on the average value of the variable in 2011–13: the tic private credit to the real sector by deposit money darker the blue, the higher the quartile of the statisti- banks are from the International Financial Statistics cal distribution of the variable. Quartiles 4 3 Quartiles 2 4 3 1 2 No data 1 No data TABLE A.1.1 Depth—Financial Institutions Private credit by deposit money banks to Number of Standard Weighted GDP (%) countries Average Median deviation Minimum Maximum averagea World 160 51.2 36.1 41.2 7.9 163.5 83.7 By developed/developing economies Developed economies 41 96.1 97 46 8.5 163.5 91.9 Developing economies 119 35.8 28.3 25.1 7.9 124.4 69.3 By income level High income 41 96.1 97 46 8.5 163.5 91.9 Upper-middle income 46 48.2 45.8 29.8 9.7 124.4 79 Lower-middle income 46 33.3 31.2 18.6 7.9 93.7 36.1 Low income 27 18.6 15.5 11 7.9 51.8 27.7 By region High income: OECD 24 114.5 110.6 37.3 49.3 163.5 93.3 High income: non-OECD 17 70 59.7 45.2 8.5 163.5 68.1 East Asia and Pacific 15 55.7 38.9 37.3 11.1 124.4 112.3 Europe and Central Asia 17 38.9 37.2 12.2 12.5 57 44.4 Latin America and the Caribbean 28 41.9 35.4 23.5 14.9 108.1 40.6 Middle East and North Africa 11 36.9 28.3 29.8 7.9 84.6 23.7 South Asia 8 36 44.7 16.4 7.9 51.8 43.9 Sub-Saharan Africa 40 22.2 16.2 17.6 7.9 93.9 29.9 Source: Global Financial Development Database, 2011–13 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by current GDP. 158 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 MAP A.2 ACCESS—FINANCIAL INSTITUTIONS To approximate access to fi nancial institutions, this Inclusion (Global Findex) Database. The four shades map uses the percentage of adults (age 15+) who of blue in the map are based on the value of the vari- reported having an account at a formal financial insti- able in 2011: the darker the blue, the higher the quar- tution. The data are taken from the Global Financial tile of the statistical distribution of the variable. Quartiles 4 3 Quartiles 2 4 3 1 2 No data 1 No data TABLE A.1.2 Access—Financial Institutions Account at a formal fi nancial institution Number of Standard Weighted (%, age 15+) countries Average Median deviation Minimum Maximum averagea World 147 45.7 38.2 31.6 3.7 98.1 48.1 By developed/developing economies Developed economies 40 86.9 93.2 13 46.4 98.1 89 Developing economies 107 30.3 25.5 20.8 3.7 89.7 40.1 By income level High income 40 86.9 93.2 13 46.4 98.1 89 Upper-middle income 40 46.3 44.4 19.9 3.7 89.7 56.6 Lower-middle income 38 24 21.4 15.3 3.7 77.7 28.1 Low income 29 16.6 13.4 12.7 3.7 42.3 22.4 By region High income: OECD 28 91 96.1 9.3 70.2 98.1 90.5 High income: non-OECD 12 77.4 80.6 15.8 46.4 98.1 65.4 East Asia and Pacific 9 42 26.8 27.7 3.7 77.7 54 Europe and Central Asia 23 40.9 44.3 23.9 3.7 89.7 44.4 Latin America and the Caribbean 20 32 27.7 14.7 13.8 71 38.8 Middle East and North Africa 12 26.6 24.4 18.8 3.7 73.7 32.1 South Asia 6 31.3 30.3 22.1 9 68.5 32.7 Sub-Saharan Africa 37 21 17.5 16.3 3.7 80.1 23.2 Source: Global Financial Development Database, 2011 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by total adult population in 2011. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 159 MAP A.3 EFFICIENCY—FINANCIAL INSTITUTIONS To approximate efficiency of fi nancial institutions, The lending and deposit rates are from IFS, lines 60P this map uses the spread (difference) between lending and 60L, respectively. The four shades of blue in the rate and deposit interest rate. Lending rate is the rate map are based on the average value of the variable in charged by banks on loans to the private sector, and 2011–13: the darker the blue, the higher the quartile deposit interest rate is the rate paid by commercial or of the statistical distribution of the variable. similar banks for demand, time, or savings deposits. Quartiles 4 Quartiles 3 4 2 3 1 2 1 No data No data TABLE A.1.3 Efficiency—Financial Institutions Number of Standard Weighted Bank lending-deposit spread (%) countries Average Median deviation Minimum Maximum averagea World 118 6.8 6.2 3.7 1.8 15.8 5.7 By developed/developing economies Developed economies 24 4.2 4.1 1.7 1.8 7.8 4.1 Developing economies 94 7.5 6.7 3.8 1.8 15.8 6.4 By income level High income 24 4.2 4.1 1.7 1.8 7.8 4.1 Upper-middle income 41 6.2 5.9 3.6 1.8 15.8 5.6 Lower-middle income 37 7.7 7.3 3 3.1 14 7 Low income 16 10.4 10.1 4.2 2.3 15.8 9.2 By region High income: OECD 11 3.1 3.1 1.2 1.8 5 3 High income: non-OECD 13 5.1 5.2 1.6 2.7 7.8 5 East Asia and Pacific 16 6.3 5.3 3.5 1.9 14 4.4 Europe and Central Asia 16 6.4 5.9 3.2 1.8 14.5 5.5 Latin America and the Caribbean 26 8.3 7.4 3.9 2.1 15.8 8.3 Middle East & North Africa 7 5.1 4.8 2.3 1.8 9.1 4.1 South Asia 5 5.3 5.5 2.6 2.3 8.7 5.3 Sub-Saharan Africa 24 9.2 8.9 4 2 15.8 7.6 Source: Global Financial Development Database, 2011–13 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by total banking assets. 160 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 MAP A.4 STABILITY—FINANCIAL INSTITUTIONS To approximate stability of financial institutions, indicator compares the banking system’s buffers this map uses the Z-score for commercial banks. The (returns and capital) with its riskiness (volatility of indicator is estimated as follows: [ROA + (equity / returns). The four shades of blue in the map are based assets)] / (standard deviation of ROA). Return on on the average value of the variable in 2011–13: the assets (ROA), equity, and assets are country-level darker the blue, the higher the quartile of the statisti- aggregate figures (calculated from underlying bank- cal distribution of the variable. by-bank unconsolidated data from Bankscope). The Quartiles 4 3 Quartiles 4 2 3 1 2 1 No data No data TABLE A.1.4 Stability—Financial Institutions Number of Standard Weighted Bank Z-score countries Average Median deviation Minimum Maximum averagea World 180 15.4 14.3 9.5 2.3 37.6 17 By developed/developing economies Developed economies 55 17.5 15.9 10.1 2.3 37.6 17.6 Developing economies 125 14.6 13.1 9.2 2.3 37.6 16.3 By income level High income 55 17.5 15.9 10.1 2.3 37.6 17.6 Upper-middle income 48 13.5 11.8 9.7 2.3 37.6 15.1 Lower-middle income 46 18.2 16.1 9.2 2.4 37.6 20.7 Low income 31 10.7 10.5 5.9 2.3 22.8 9.8 By region High income: OECD 32 18.2 15.7 11.8 2.3 37.6 18.5 High income: non-OECD 23 16.5 16.5 7.3 2.3 36.7 15.9 East Asia and Pacific 14 16.4 17.2 7.9 3.1 29.7 17.7 Europe and Central Asia 22 10.2 8.9 6.6 2.3 29.2 11 Latin America and the Caribbean 27 15.1 14.4 9.2 2.3 33.8 14.6 Middle East and North Africa 12 24.4 23.6 11 3.8 37.6 28.1 South Asia 8 16 9.9 12.6 6.4 37.1 16.9 Sub-Saharan Africa 42 12.8 12.9 7.4 2.3 37.6 14.3 Source: Global Financial Development Database, 2011–13 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by total banking assets. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 161 MAP A.5 DEPTH—FINANCIAL MARKETS To approximate depth of financial markets, this map Stock Markets Factbook and supplemental S&P uses market capitalization plus the amount of out- data, and are compiled and reported by the World standing domestic private debt securities as a per- Development Indicators. The amount of outstand- centage of GDP. Market capitalization (also known ing domestic private debt securities is from table 16A as market value) is the share price times the number (domestic debt amount) of the Securities Statistics by of shares outstanding. Listed domestic companies are the Bank for International Settlements. The amount the domestically incorporated companies listed on includes all issuers except governments. The four the country’s stock exchanges at the end of the year. shades of blue in the map are based on the average Listed companies do not include investment compa- value of the variable in 2010–12: the darker the blue, nies, mutual funds, or other collective investment the higher the quartile of the statistical distribution vehicles. Data are from Standard & Poor’s Global of the variable. Quartiles Quartiles 4 4 3 3 2 2 1 1 No data No data TABLE A.1.5 Depth—Financial Markets Stock market capitalization + outstanding Number of Standard Weighted domestic private debt securities to GDP (%) countries Average Median deviation Minimum Maximum averagea World 107 61.5 40.6 55 3.8 196.1 119.1 By developed/developing economies Developed economies 45 92.4 82.2 55.5 9.9 196.1 141.6 Developing economies 62 39.1 23.9 42.7 3.8 196.1 71.4 By income level High income 45 92.4 82.2 55.5 9.9 196.1 141.6 Upper-middle income 33 50.9 29.3 52.1 3.8 196.1 77.4 Lower-middle income 22 28.1 16.8 25.4 3.8 89.7 50.9 Low income 7 18.2 22.6 10.5 3.8 28.2 17 By region High income: OECD 32 101.1 100.7 55.5 9.9 196.1 144.4 High income: non-OECD 13 70.9 59.7 51.3 18.5 196.1 80.2 East Asia and Pacific 9 74.9 75 61.5 12.3 196.1 91.7 Europe and Central Asia 14 22.1 14.4 23.5 3.8 86.3 43 Latin America and the Caribbean 16 37.2 20.5 42 3.8 159.6 64.4 Middle East and North Africa 6 44.3 29.2 32.7 19.5 101.7 29.7 South Asia 5 32.4 26.3 24.6 13 74.6 64.4 Sub-Saharan Africa 12 35 24.3 46.2 5.8 172.7 74.3 Source: Global Financial Development Database, 2010–12 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by current GDP. 162 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 MAP A.6 ACCESS—FINANCIAL MARKETS To approximate access to financial markets, this map aggregated up to the country level by taking a simple uses the ratio of market capitalization excluding the average over exchanges. The four shades of blue in top 10 largest companies to total market capitaliza- the map are based on the average value of the vari- tion. The World Federation of Exchanges (WFE) able in 2011–13: the darker the blue, the higher the provides data on the exchange level. This variable is quartile of the statistical distribution of the variable. Quartiles 4 3 Quartiles 2 4 3 1 2 No data 1 No data TABLE A.1.6 Access—Financial Markets Market capitalization excluding top 10 companies Number of Standard Weighted to total market capitalization (%) countries Average Median deviation Minimum Maximum averagea World 48 44.6 47.4 20.2 7.8 74.8 51 By developed/developing economies Developed economies 27 42.1 46 22.5 7.8 73.7 50.5 Developing economies 21 47.9 51.9 16.7 19 74.8 51.8 By income level High income 27 42.1 46 22.5 7.8 73.7 50.5 Upper-middle income 15 45.3 41.8 17.6 19 74.8 50.9 Lower-middle income 6 54.2 57.1 13.5 29.6 70 54.5 Low income 0 By region High income: OECD 19 43.5 47 22.1 7.8 73.2 47.7 High income: non-OECD 8 39 33.9 24.8 7.8 73.7 55.4 East Asia and Pacific 5 62 59.7 7.7 56.2 74.7 61.8 Europe and Central Asia 3 37 38 17.5 19 53.9 38.7 Latin America and the Caribbean 6 38.1 38 12.5 20.4 55.1 42.1 Middle East and North Africa 3 37.1 29.7 12.8 29.6 51.9 32.6 South Asia 2 64 64 8.5 58 70 66.1 Sub-Saharan Africa 2 58.3 58.3 23.3 41.8 74.8 64 Source: Global Financial Development Database, 2011–13 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by stock market capitalization. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX A 163 MAP A.7 EFFICIENCY—FINANCIAL MARKETS To approximate efficiency of fi nancial markets, this Factbook and supplemental S&P data, and are com- map uses the total value of shares traded during the piled and reported by the World Development Indi- period divided by the average market capitalization cators. The four shades of blue in the map are based for the period. Average market capitalization is cal- on the average value of the variable in 2010–12: the culated as the average of the end-of-period values darker the blue, the higher the quartile of the statisti- for the current period and the previous period. Data cal distribution of the variable. are from Standard & Poor’s Global Stock Markets Quartiles Quartiles 4 4 3 3 2 2 1 1 No data No data TABLE A.1.7 Efficiency—Financial Markets Number of Standard Weighted Stock market turnover ratio (%) countries Average Median deviation Minimum Maximum averagea World 106 34.8 14.6 41.4 0.4 141.3 53.2 By developed/developing economies Developed economies 45 54.7 51.1 44 0.4 141.3 69.5 Developing economies 61 20.1 5.2 32.6 0.4 141.3 29.8 By income level High income 45 54.7 51.1 44 0.4 141.3 69.5 Upper-middle income 33 24.3 5.5 38.9 0.8 141.3 35.5 Lower-middle income 21 14.5 4.3 17.9 0.4 63.4 19.7 Low income 7 16.9 2.5 35.6 0.4 97.5 13 By region High income: OECD 32 64.5 66 41.5 0.4 141.3 71.4 High income: non-OECD 13 30.8 14.8 42.2 0.4 135.4 66.2 East Asia and Pacific 9 39.9 28.6 46.4 0.5 141.3 43.9 Europe and Central Asia 14 20.9 4.9 42.9 0.4 141.3 34.9 Latin America and the Caribbean 15 10 3.1 17.5 0.4 67.5 17.7 Middle East and North Africa 6 18.4 16.2 10.8 7.8 38.2 17.4 South Asia 5 42.9 32.3 38 1.6 97.5 43.9 Sub-Saharan Africa 12 8.2 3.1 15.3 0.4 56.1 24.7 Source: Global Financial Development Database, 2010–12 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by stock market capitalization. 164 APPENDIX A GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 MAP A.8 STABILITY—FINANCIAL MARKETS To approximate stability of fi nancial markets, this distribution, the ranking of stock market index vola- map uses the 360-day standard deviation of the tility during 2011–13 is reversed to show higher sta- return on the national stock market index. Data bility as darker colors. are from Bloomberg. To visualize a country in the Quartiles 4 3 Quartiles 2 4 3 1 2 No data 1 No data TABLE A.1.8 Stability—Financial Markets Number of Standard Weighted Stock price volatility countries Average Median deviation Minimum Maximum averagea World 85 17.1 17.3 5.7 7.5 28.5 19.1 By developed/developing economies Developed economies 38 18.3 18.8 5.2 8.2 28.5 19.4 Developing economies 47 16.2 15.8 6 7.5 28.5 18.2 By income level High income 38 18.3 18.8 5.2 8.2 28.5 19.4 Upper-middle income 31 15.9 15.8 5.8 7.5 27.4 18.2 Lower-middle income 14 17.8 17.7 6.2 8.5 28.5 18.6 Low income 2 9.3 9.3 2.2 7.8 10.8 10.7 By region High income: OECD 29 20.1 19.6 4.2 8.9 28.5 19.6 High income: non-OECD 9 12.6 11.7 3.9 8.2 20.5 19 East Asia and Pacific 8 18.8 19.6 4.2 9.4 23.8 17.7 Europe and Central Asia 12 18.9 17.1 5.2 10.5 28.5 23.3 Latin America and the Caribbean 10 16.6 16.2 6.8 7.5 27.4 19.2 Middle East and North Africa 6 12.7 10.2 7.4 8.4 27.6 14.2 South Asia 3 15.8 15.5 1.8 14.2 17.8 17.1 Sub-Saharan Africa 8 11.6 10.1 4.4 7.5 19.5 15.2 Source: Global Financial Development Database, 2011–13 data. Note: OECD = Organisation for Economic Co-operation and Development. a. Weighted average by total value of stocks traded. GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX B 165 APPENDIX B KEY ASPECTS OF LONG-TERM FINANCE TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Afghanistan 8.9 8.2 0.7 0.00 Albania 16.2 58.5 58.9 2.2 2.1 2.0 Algeria 15.2 6.0 2.1 0.1 Andorra 7.0 Angola 7.0 38.1 41.0 3.6 17.7 0.1 Antigua and Barbuda 33.5 0 94.6 Argentina 18.1 34.6 35.1 0.4 1.4 0.6 4.6 2.5 Armenia 49.6 1.0 3.8 1.6 Aruba 55.0 Australia 37.2 2.2 8.6 34.7 Austria 25.3 1.3 9.4 86.0 78.3 Azerbaijan 24.0 0.3 5.3 1.4 10.0 1.3 78.4 Bahamas, The 13.9 2.8 23.1 62.4 91.1 Bahrain 4.0 12.8 2.0 7.0 6.6 Bangladesh 18.4 2.4 1.8 0.1 Barbados 13.6 4.7 4.6 59.1 90.3 Belarus 26.1 9.6 2.4 0.04 3.0 1.8 Belgium 33.3 3.0 9.1 56.9 66.8 Belize 23.2 14.9 Benin 2.3 0.4 7.0 0.1 18.5 Bermuda 22.5 8.3 Bhutan 44.3 0 Bolivia 24.5 67.1 50.3 4.0 5.8 0.8 Bosnia and Herzegovina 41.6 3.5 3.3 2.1 58.1 Botswana 28.2 59.8 62.4 1.4 2.3 0.1 1.5 0.2 Brazil 34.1 1.3 1.5 1.9 7.5 11.1 40.8 Brunei Darussalam 0.1 Bulgaria 27.6 38.9 32.7 1.9 1.8 1.0 5.0 5.2 69.7 Burkina Faso 18.0 0.4 11.6 0 9.8 Burundi 15.5 43.5 29.0 0.5 10.6 3.6 Cambodia 6.1 1.7 5.0 1.5 (appendix continued next page) 166 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 (continued) Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Cameroon 16.5 1.5 15.2 0.04 36.8 Canada 28.5 3.7 12.1 34.3 72.5 Cabo Verde 37.8 0 Central African Republic 13.0 0.7 6.5 0 28.1 Chad 4.8 7.4 10.0 0.00 25.6 Chile 33.8 29.4 54.9 3.5 4.1 3.2 16.1 9.1 64.6 China 7.7 5.0 3.6 4.1 4.7 0.7 Colombia 23.8 23.2 22.6 2.6 6.2 2.2 11.0 6.1 Comoros 0.7 12.1 0 Congo, Dem. Rep. 2.6 22.0 63.3 0.4 7.2 1.3 Congo, Rep. 5.2 6.0 15.5 0.3 7.8 2.2 50.6 Costa Rica 21.0 62.0 39.8 3.2 2.5 1.0 30.0 2.4 Côte d’Ivoire 3.7 15.6 17.8 6.5 19.8 Croatia 42.1 4.3 2.8 2.9 6.6 15.4 78.9 Cuba 0.4 Cyprus 23.4 2.4 7.3 26.8 77.5 Czech Republic 19.2 8.1 1.2 1.3 8.7 15.8 70.3 Denmark 47.2 1.3 9.6 41.0 Djibouti 5.1 6.9 0 Dominica 25.8 0.8 93.2 Dominican Republic 25.8 1.6 7.1 0.9 7.0 5.3 Ecuador 24.2 23.1 27.2 2.0 4.8 0.5 Egypt, Arab Rep. 6.0 1.8 4.9 0.3 4.9 0.8 El Salvador 23.1 71.8 56.4 1.6 3.3 1.3 10.0 9.3 Equatorial Guinea 0 Eritrea 2.4 0 Estonia 26.3 16.2 5.9 0.6 5.4 4.0 92.2 Ethiopia 13.0 0 Faeroe Islands 38.5 Fiji 38.5 4.1 Finland 29.7 2.6 6.6 63.5 86.6 France 26.7 3.5 7.2 63.4 80.9 Gabon 3.6 36.0 19.0 0.5 9.3 1.8 25.6 Gambia, The 10.0 3.9 6.5 0.02 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX B 167 TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 (continued) Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Georgia 37.1 0.6 1.2 4.7 8.4 8.9 76.1 Germany 31.9 20.8 2.7 6.8 52.3 84.5 Ghana 10.2 11.6 31.6 2.5 7.8 6.6 Greece 19.4 6.2 1.4 2.4 5.8 14.5 62.9 Grenada 31.7 0.4 92.8 Guatemala 24.1 60.8 68.8 1.5 4.0 0.8 9.7 0.8 Guinea 0.5 10.0 102.0 0.5 10.8 0 20.3 Guinea-Bissau 0.8 26.9 0 26.4 Guyana 0.1 Haiti 2.4 28.6 0 Honduras 15.1 57.1 28.4 1.5 4.3 1.6 Hong Kong SAR, China 11.2 4.6 7.5 11.7 Hungary 37.8 12.6 1.6 0.2 7.0 44.3 70.4 Iceland 1.6 7.0 50.8 India 28.8 2.3 5.5 1.3 8.2 1.7 63.7 Indonesia 9.0 0.7 10.7 0.9 8.3 5.5 Iran, Islamic Rep. 15.1 0.7 4.0 0.01 Iraq 2.5 14.8 12.9 0.7 Ireland 28.9 32.4 3.3 8.9 244.7 67.7 Isle of Man 33.0 Israel 15.3 9.8 0.7 8.2 8.6 Italy 10.2 1.8 12.9 45.5 62.6 Jamaica 22.9 3.2 3.1 12.6 7.8 2.4 Japan 16.0 1.6 6.9 7.0 Jordan 15.1 2.7 5.6 0.8 3.5 1.4 Kazakhstan 23.9 4.5 3.1 1.9 18.9 4.7 Kenya 15.6 0.9 8.5 1.0 10.7 0.7 Kiribati 0 Korea, Rep. 28.1 20.2 3.8 5.9 10.9 Kosovo 14.8 1.6 1.4 0 Kuwait 21.6 19.1 0.1 5.0 0.4 Kyrgyz Republic 35.3 0.4 1.1 0.03 2.0 1.9 Lao PDR 13.2 1.2 8.1 0.5 Latvia 33.1 8.1 3.8 0.03 3.3 12.4 77.9 (appendix continued next page) 168 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 (continued) Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Lebanon 42.6 5.9 16.6 0.9 5.0 4.1 Lesotho 29.9 1.0 11.3 0 Liberia 9.5 4.5 4.6 3.6 15.4 128.0 Libya 0 Liechtenstein 5.5 7.6 2.4 Lithuania 46.7 5.6 2.0 0.6 5.1 25.7 77.6 Luxembourg 34.1 9.6 9.4 994.5 61.5 Macao SAR, China 3.8 7.5 0.3 Macedonia, FYR 34.0 3.9 5.2 2.0 65.7 Madagascar 8.1 9.3 30.6 0.8 5.4 0.00 Malawi 16.3 5.3 9.0 0.04 Malaysia 36.0 12.7 5.5 5.5 7.6 17.6 96.4 Maldives 0 Mali 15.0 24.6 24.0 0.6 8.1 0.03 16.9 Malta 18.4 5.6 77.4 Mauritania 7.3 20.8 106.3 5.3 16.5 0.01 Mauritius 30.8 43.2 22.9 4.5 3.2 6.4 Mexico 17.3 18.0 40.8 2.7 8.6 3.0 10.8 12.1 71.7 Micronesia, Fed. Sts. 5.8 0 Moldova 32.6 0.6 4.8 0.5 Monaco 0.03 Mongolia 21.8 3.0 7.0 0.2 5.0 13.9 Montenegro 65.2 4.5 8.5 4.9 Morocco 13.3 4.8 3.7 2.1 Mozambique 4.9 7.7 20.9 0.9 8.3 0.3 Namibia 15.7 62.7 86.7 5.5 Nepal 16.3 5.1 12.5 0 Netherlands 40.1 3.6 11.4 177.8 68.5 New Zealand 35.3 1.3 5.9 17.6 Nicaragua 17.2 34.2 218.9 0.4 1.8 1.6 Niger 8.8 1.5 5.8 0.01 30.1 Nigeria 1.4 0.6 4.7 0.1 5.0 0.8 Norway 4.2 9.8 37.2 Oman 14.5 0.4 5.0 0.1 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX B 169 TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 (continued) Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Pakistan 9.1 1.8 3.0 0.01 3.6 0.3 Panama 6.4 50.2 41.6 11.5 13.3 1.6 15.6 23.0 Papua New Guinea 2.0 Paraguay 23.3 18.4 18.9 1.3 9.1 1.2 10.0 1.2 Peru 40.1 19.6 32.2 1.1 5.5 2.1 10.1 8.7 Philippines 15.0 3.6 20.7 1.8 9.4 8.7 Poland 30.0 2.7 0.5 0.4 6.7 19.6 69.7 Portugal 15.3 23.2 3.3 5.7 43.7 73.4 Qatar 18.5 1.1 12.7 3.8 Romania 34.1 3.7 0.8 0 2.0 7.2 62.9 Russian Federation 9.1 1.4 0.8 2.8 8.5 2.0 72.7 Rwanda 18.0 23.6 82.2 1.9 10.1 1.6 Samoa 41.7 0 São Tomé and Príncipe 0.05 Saudi Arabia 12.3 10.0 1.1 11.5 0.1 46.2 Senegal 15.0 20.8 48.3 0.1 2.6 3.0 34.3 Serbia 37.8 1.4 2.6 1.5 7.0 8.2 56.9 Seychelles 4.1 Sierra Leone 8.9 5.6 12.8 0.4 10.6 1.8 Singapore 18.9 5.7 2.9 5.2 16.6 72.0 Slovak Republic 25.8 7.5 1.3 3.7 16.1 23.4 62.1 Slovenia 37.6 10.3 1.1 6.6 37.1 71.5 Solomon Islands 0.01 South Africa 25.8 31.6 39.0 4.3 6.0 1.6 6.8 11.4 Spain 23.7 31.6 2.4 8.2 47.8 81.5 Sri Lanka 37.1 3.6 2.2 0.5 5.0 8.6 St. Kitts and Nevis 38.1 15.4 93.1 St. Lucia 22.7 1.4 94.0 St. Vincent and the Grenadines 34.6 2.5 96.0 Sudan 6.2 22.9 0 Suriname 33.0 0.05 Swaziland 12.0 57.3 25.8 6.0 15.2 0.3 Sweden 53.5 3.2 5.5 61.6 24.2 Switzerland 3.5 7.7 10.0 (appendix continued next page) 170 APPENDIX B GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 TABLE B.1 Economies and Their Maturity Structure of Finance, 2013 (continued) Firms Households Providers Proportion Issuance Average Bank loans to of fixed volume of maturity nonfinancial investment Average Average corporate of issued Nonresident firms with financed by duration duration Adults bonds by corporate holding of maturity at banks, equity, of the last of the last with loans Adults with private bonds by long-term origination or stock bank loan by bank loan by for home loans for nonfinancial private debt equal to or sales small firms large firms purchase school fees firms to GDP nonfinancial securities to above 1 year Economy (%) (months) (months) (%) (%) (%) firms (years) GDP (%) (%) Syrian Arab Republic 5.3 3.6 0.05 Tajikistan 29.6 0.4 4.1 1.1 Tanzania 8.0 19.4 26.9 4.4 11.6 1.0 Thailand 62.7 5.1 11.2 3.8 6.6 5.0 Timor-Leste 0.8 0 Togo 14.9 2.1 11.4 0.04 27.1 Tonga 36.5 0 Trinidad and Tobago 21.3 1.5 3.3 4.4 10.0 6.7 Tunisia 2.4 4.3 4.0 67.5 Turkey 42.0 1.4 3.1 0.4 7.3 11.6 Turkmenistan 0.7 0.6 Tuvalu 0 Uganda 13.2 14.6 41.0 1.0 11.5 0.7 Ukraine 31.0 1.0 1.3 1.6 5.5 7.5 48.1 United Arab Emirates 17.9 20.2 1.7 10.8 6.8 United Kingdom 31.0 4.2 12.9 55.8 70.0 United States 31.2 4.6 11.1 29.3 3.7 Uruguay 15.8 32.0 33.8 1.9 1.3 0.2 6.1 17.5 Uzbekistan 8.0 0 0.5 0.02 2.7 0 Vanuatu 37.7 0 Venezuela, RB 0.5 3.6 1.0 13.0 5.8 Vietnam 15.8 3.0 10.1 0.1 4.5 1.3 West Bank and Gaza 6.2 5.3 19.8 0.00 Yemen, Rep. 2.5 1.0 1.5 0 4.4 Zambia 6.2 22.7 27.5 1.2 2.8 2.4 Zimbabwe 9.0 0.8 9.9 0.4 GLOBAL FINANCIAL DEVELOPMENT REPORT 2015/2016 APPENDIX B 171 NOTES report having an outstanding loan to pay for school fees. The data are from Global Findex Additional data: The above table presents (Demirgüç-Kunt and Klapper 2012). information from various databases, includ- ing the World Bank Global Financial Inclu- Issuance volume of corporate bonds by pri- sion (Global Findex) Database, World Bank vate nonfinancial firms to GDP (%): Ratio Enterprise Surveys, World Bank Global Syn- of newly issued corporate bonds by nonpub- dicated Loans and Bonds Database (FinDebt), lic sector in industries other than finance, IMF Coordinated Portfolio Investment Survey holding companies, and insurance to gross (CPIS), as well as from central banks of indi- domestic product (GDP). The data are from vidual member countries. More information the World Bank FinDebt Database with can be found at underlying information from DCM Analyt- Global Findex: http://www.worldbank.org ics, Dealogic. /globalfindex Enterprise Surveys: http://www.enterprise Average maturity of issued corporate bonds surveys.org/ by private nonfinancial firms (years): Vol- IMF CPIS: http://cpis.imf.org/Default.aspx ume weighted average of corporate bond maturity for all issuances by the nonpublic Period covered: The table shows 2013 or sector in industries other than finance, hold- the most recent data for individuals, formal ing companies, and insurance. The data are firms, and providers. from the World Bank FinDebt Database with underlying information from DCM Analyt- Proportion of fixed investment financed by ics, Dealogic. banks, equity, or stock sales (%): Estimated proportion of total purchases of fi xed assets Nonresident holding of long-term debt secu- financed from bank loans, owners’ contribu- rities to GDP (%): Bonds, debentures, and tion, or issuance of new equity shares. The notes with original terms to maturity of data are from Enterprise Surveys, World Bank. more than one year, held by nonresidents. The data are based on the IMF Coordinated Average duration of the last bank loan by Portfolio Investment Survey, table 16.2.A, small firms (months): Original term to matu- on long-term debt securities. Strictly positive rity of the most recent outstanding loan or amounts smaller than 0.005 percent of GDP line of credit, averaged over small firms (with are reported as 0.00. Countries covered in employee size less than 20). The data are the database but with no issuances in 2013 from Enterprise Surveys, World Bank. are reported as 0. Average duration of the last bank loan by Bank loans to nonfinancial firms with matu- large firms (months): Original term to matu- rity at origination equal to or above 1 year rity of the most recent outstanding loan or (%): Percentage of bank loans to nonfi nan- line of credit, averaged over large firms (with cial firms with original maturity equal to employee size equal to or above 100). The data or above one year. The data are available are from Enterprise Surveys, World Bank. from national central banks and supervisory Adults with loans for home purchase (%): authorities. Percentage of adult respondents (age 15+) who report having an outstanding loan to REFERENCE purchase their home or apartment. The data are from Global Findex (Demirgüç-Kunt and Demirgüç-Kunt, Aslı, and Leora Klapper. 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