Can International Capital Standards Strengthen Banks in Emerging Markets

Comments on:“Innovative Experiences in Access toFinance: Market Friendly Roles for theVisible Hand?”Comments on:“Innovative Experiences in Access toFinance: Market Friendly Roles for theVisible Hand?”

Liliana Rojas-Suárez

Center For Global Development

World Bank, March 2007

A very Timely PaperA very Timely Paper

Good times allow for innovative proposals sinceattention (and resources) can be devoted to long-runissues (rather than the need to deal with crisesresolution)

Recent consolidation of democracy in a number ofdeveloping countries has resulted in an increaseddemand by large segments of the population—traditionally excluded from the benefits ofmodernization– for access to such benefits, includingaccess to financial services

The Paper’s Two Main ContributionsThe Paper’s Two Main Contributions

Systematic classification and well-balanced

assessment of the alternative approaches taken bygovernments to improve financial access:

–“Interventionist view” : 1950s and 1960s

–“Laissez-faire view” : 1990s

–“Pro-market activist view” : new century

 Technical discussion of recent market-friendlyinitiatives promoted by Latin Americangovernments. These discussions can guide andinspire policymakers from other developingcountries

When can an Intervention be TrulyConsidered Market-Friendly?When can an Intervention be TrulyConsidered Market-Friendly?

When it satisfies the four conditions stated inthe paper:

1. Governments need to be selective in theirinterventions: always working with the markets,never against them.

2.Interventions need to be relatively small

3.Interventions need to be temporary

4. Mechanisms should be in place to prevent politicalcapture of the interventions

Does FIRA CLO Transaction to Provide Financeto shrimp producers satisfy the conditions forMarket-Friendly Interventions?Does FIRA CLO Transaction to Provide Financeto shrimp producers satisfy the conditions forMarket-Friendly Interventions?

Condition 1 is satisfied as FIRA “works with the market”since the structured finance arranged by FIRA solves aprincipal-agent problem by creating the right incentives forOcean Garden to effectively screening and monitoringshrimp producers

Condition 2 is satisfied since FIRA provides the “marginalguarantee” and charges a fee as an arranger and the providerof a guarantee

Satisfaction of Condition 3 remains to be proven

Although it is likely that Condition 4 is satisfied, the paperdoes not provide sufficient information in this area.

An Example of Another Market-Friendly Initiative(that Remains to be Implemented): Putting PensionFunds to Work (for Increased Financial Access)An Example of Another Market-Friendly Initiative(that Remains to be Implemented): Putting PensionFunds to Work (for Increased Financial Access)

The Facts:

It is estimated that, by 2015, in many countries in Latin America, the

accumulation of assets by pension funds will reach over 30% of

GDP (the current average ratio of deposits to GDP in the region)

The Facts:

But, regulatory restrictions combined with shallow capital markets have resulted in

pension funds’ portfolios tilted towards public sector debt (with the exception of Chile

and Peru)

In some cases, like Mexico and Uruguay, government bonds reach over 80 percent of

pension funds’ assets

The Recommendations:

–Pension funds need to be allowed to hold more diversifiedportfolios. However, concerns from local policymakers areunderstandable. For example, allowing free investment inforeign assets in countries that have not reached macrostability might exacerbate capital outflows

–If macro stability is achieved, pension funds should beallowed to invest in instruments which in some cases maynot be publicly offered or traded in exchanges, providedthat adequate disclosure and operational transparency allowfor appropriate external auditing. (see = www.claaf.org)

The reality of corporate structure in Latin America is quite differentfrom that in industrial countries. Firms in Latin America are mostlysmall, privately-held, family-owned. Thus, issuing securities issubject to higher fixed costs (relative to bank loans).

The Recommendations:

–To cater the investment needs of Latin America in a waycompatible with the pension funds’ return and safety goalsdemanded by citizens, the development of the followingasset classes is recommended (which exists only in somecountries to a very limited extent):

–Securitized bonds based on the pooling of receivablessuch as farm crops, livestock breeding, future flows ofuniversity tuitions, etc.

–Infrastructure finance bonds, with long-term durationand local currency denomination (attractive for pensionfunds). Ex: Chile.

–Collateralized Loan Obligations (CLOs), whicheffectively transform risky loans (say, to SMEs) into acombination of investment grade assets well suited forpension funds and high risk assets suited for otherinvestors.

The Recommendations:

To create markets for CLOs with tranchessuitable for pension fund investment,government guarantees might be initiallynecessary. It is therefore essential that thefour conditions for “market-friendly”interventions be considered in the designphase.