Financial systems and development

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strides in recent years in establishing and invigo- requires all limited liability companies of a certain rating equity markets. Such markets now exist in size to make the same financial disclosures as pubmore than forty countries. Indeed, the market cap- licly listed firms. In the past, demand for securities italization of stock exchanges (that is, the total has been inhibited by the lack of investor confivalue of listed shares) is a greater proportion of dence. In the future, much of the demand is likely GNP in Jordan and Malaysia than in France and to come from institutional investors. Germany, and India's stock exchanges list more A primary reason for the underdeveloped state companies than the stock markets of any other of capital markets in many developing countries is country except the United States (see Table 7.1). In the absence of an appropriate legal, regulatory, many countries, however, equity markets remain and tax framework. In some countries new shares small. Only a few countries have active corporate have to be issued at par value, which makes them bond markets; they include Canada, India, Korea, unattractive to companies if the market value of and the United States. their shares has appreciated significantly. In other The supply of equities has been limited by the countries the tax-free status of time deposits or reluctance of owners of private companies to dilute government and public enterprise bonds lessens their ownership and control by issuing stock or to the appeal of private corporate instruments. Far comply with requirements to disclose information more important in developing countries, however, about their operations. The availability of less ex- is lax enforcement of corporate income taxes. This pensive debt finance has also discouraged equity makes it possible for closely held corporations to issues. Some countries-for example, Korea-have avoid taxes by showing very low accounting provided considerable tax incentives to encourage profits; publicly traded corporations cannot hide corporations to go public. In Jordan, any firm seek- their profits without hurting investor confidence. ing limited liability must offer a substantial per- A common problem in securities markets, especentage of its shares to the general public. Chile cially early in their development, is the danger of a speculative boom followed by a sharp decline. Such crises have affected markets in Brazil, Hong Kong, Korea, Mexico, the Philippines, Singapore, and Thailand. Large increases and declines in Figure 7.2 Stock indexes in selected developing prices also affect securities markets in high-income countries and the United States, 1987 and 1988 countries, but they can be much more pronounced in young markets. The Wall Street collapse of Oc- Index (December 1986 = 100) tober 1987 was far less abrupt than the collapse of 800 many smaller markets (see Figure 7.2). Countries with a relatively large business sector 700 and middle class should encourage the develop- 600 Portugal Turkey ment of securities markets. Fiscal policies that dis- ___- -- / -- criminate against equities should be changed. 500 ___ Governments also need to define the operational 400 i } \ X X ; ' 2 scope of underwriters, brokers, dealers, merchant ---------- _-- - -- ¢-t-- banks, and mutual funds and to encourage the es- 300 tablishment of credit rating agencies. Privatization 200 Mexico /----t---- i .. of state-owned enterprises can be another stimulus to securities markets. Privatization has been one of 100 ' the forces revitalizing Chile's equity market in re- 0 Philippines UnitedStates cent years. In France, 167 state enterprises and I 0 March September March September subsidiaries were divested from late 1986 through early 1988, and their shares were taken up by more December June December June December 1986 1987 1988 than 13 million individuals. As a result the capitalization of the Paris stock market increased by an amount equivalent to 6 percent of GDP. Note: For the developing countries, the stock index is the IFC Enouraging fori portf i s ns index of total returns in U.S. dollars; for the United States, it is Encouraging foreign portfolio investment is anthe Standard and Poor's 500. other way to raise demand for securities in devel- Sou(rce: IFC 1988 and 1989.wa oping countries. The increasing role of institutional investors means that foreign portfolio 110
investment might grow substantially. Prices in sev- Priorities for reform eral emerging markets have shown a low or negative correlation with price movements in the Building a financial system more responsive to the United States and Japan and thus offer foreign in- needs of lenders and borrowers will require subvestors an opportunity to reduce risk. During stantial improvements in the macroeconomic, le- 1975-87, equity markets in six developing coun- gal, and regulatory environments. Developing tries outperformed the market in the United countries also need to broaden the range and im- States, and two of them (Chile and Korea) outper- prove the efficiency of their financial institutions formed Japan. and markets. Much can be achieved by removing In capital-exporting countries, regulations on obstacles to the development of different instruforeign portfolio investment limit the extent to ments, by adopting a system of regulation by funcwhich contractual savings institutions can invest tion rather than by institution, and by strengthenabroad. In developing countries, concern over vol- ing the management capabilities of individual atile flows of money and increasing control by for- institutions. eigners has prompted a variety of restrictions and To operate efficiently, financial institutions and disincentives. Foreign portfolio investment is usu- markets have to be guided primarily by market ally passive, but the concerns of developing coun- forces rather than government directives. Competries can in any case be met by such means as the tition needs to be strengthened by encouraging the closed-end country fund, whose shares can be entry of new and innovative providers of finantraded but not redeemed. More than thirty devel- cial services, by phasing out interest rate controls oping country funds, most of them closed-end, and high levies on financial transactions, and by have been floated in emerging markets since 1980. stimulating the development of money and capital Since issue, the market value of twenty-five of them markets. has increased by 86 percent (as of August 1988). 111
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~~~~/ , -. \-E:-: - :: 0 0 - PUB768
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Oxford University Press NEW YORK OX
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countries' financial institutions i
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4 Financial sector issues in develo
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7.1 Shares of medium- and long-term
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* Fractional reserve banking. The p
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NTB Nontariff barrier * Growth rate
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and grew even faster in 1988 than i
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etter loan recovery procedures, mor
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l~ ~~~ ~ ~~~~~~~~~~~~~~~~~~~ ;:: ;
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The early years of the recovery wer
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Figure 1.4 Growth of export volume
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Figure 1.6 Saving and investment ra
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edly, in Argentina, Brazil, and Mex
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5~~~~ '~ ' S " ''t.*:'.: .:,0!3gft"
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Box 1.2 Debt concepts A variety of
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Table 1.1 Selected economic indicat
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Figure 1.8 Domestic and external li
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Box 1.3 Foreign equity investment E
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j Box 2.1 Life without money "Some
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other ways too. By imposing direct
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Box 2.2 Transaction costs and the s
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Box 2.3 Real interest rates and gro
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I Box 2.4 Swapping risk All economi
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Box 2.5 Deposit insurance Most high
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GOVERNMENT. As well as being regula
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and receivables, whereas developmen
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with the expansion of nonlocal trad
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over. Even so, bankers and industri
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Box 3.3 Financial swindles i Swindl
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Box 3.4 Financial underdevelopment
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Box 3.6 Universal banking One of th
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1960s. They speeded the internation
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4 Financial sector issues in develo
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Box 4.1 Directed credit in Turkey ,
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Box 4.2 Lending program for small e
Page 74 and 75: Box 4.4 The Botswana Development Co
Page 76 and 77: markets to finance their deficits,
Page 78 and 79: 0~~~~~ = == X .. _- -- = -_ _ _ __
Page 80 and 81: Figure 4.3 Financial savings and th
Page 82 and 83: Box 4.8 Financial indexation in Bra
Page 84 and 85: Financial systems in distress Not s
Page 86 and 87: t !< 4> - !: e z u- >as uei- i.e_.S
Page 88 and 89: tem. They have succeeded in stemmin
Page 90 and 91: governments gave too little thought
Page 92 and 93: Box 5.4 The U.S. savings and loan c
Page 94 and 95: or take a step in the other directi
Page 96 and 97: have been even larger. The cost of
Page 98 and 99: ~Foundations offinancial systems If
Page 100 and 101: (an issue closely related to the as
Page 102 and 103: several centuries. The spread of su
Page 104 and 105: Bankruptcy and reorganization monit
Page 106 and 107: Box 6.5 Elements of a bank supervis
Page 108 and 109: they attempted to discipline bank m
Page 110 and 111: Developing financial systems What s
Page 112 and 113: Figure 7.1 Shares of medium- and lo
Page 114 and 115: Box 7.3 The financial history of a
Page 116 and 117: Box 7.4 Housing finance The formal
Page 118 and 119: Box 7.5 Bank modernization: Indones
Page 120 and 121: DEVELOPMENT FINANCE INSTITUTIONS. T
Page 122 and 123: esources in government securities o
Page 126 and 127: Issues in informal finance Small-sc
Page 128 and 129: Box 8.2 Rotating savings and credit
Page 130 and 131: original amount to the renter by th
Page 132 and 133: cooperatives' managers because it a
Page 134 and 135: Box 8.4 The Badan Kredit Kecamatan:
Page 136 and 137: Toward more liberal and open financ
Page 138 and 139: a brief period firms faced rapid ch
Page 140 and 141: Box 9.2 Financial reform in Korea K
Page 142 and 143: In the next stage, financial reform
Page 144 and 145: industry, policy reforms and the re
Page 146 and 147: Conclusions of the Report challenge
Page 148 and 149: tion "Risks and costs of finance" d
Page 150 and 151: Montes-Negret, Fernando. "The Decli
Page 152 and 153: D.C.: International Monetary Fund a
Page 154 and 155: Harberger, Arnold C. 1985. "Lessons
Page 156 and 157: croenterprises: Programs or Markets
Page 158 and 159: Douglas Graham, and J. D. Von Pisch
Page 160 and 161: Table A.2 Population and GNP per ca
Page 162 and 163: Table A.5 GDP structure of producti
Page 164 and 165: Table A.8 Growth of export volume,
Page 166 and 167: Table A.10 Growth of long-term debt
Page 168 and 169: Table A.12 Composition of debt outs
Page 170 and 171: Contents Key 157 Introduction and m
Page 172 and 173: Introduction The World Development
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Throughout the World Development In
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Population _ 0-15 million The color
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Table 1. Basic indicators __ GNP pe
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Table 2. Growth of production______
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Table 3. Structure of production __
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Table 4. Agriculture and food Value
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Table 5. Commercial energy ~~Energy
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Table 6. Structure of manufacturing
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Table 7. Manufacturing earnings and
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Table 8. Growth of consumption and
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Table 9. Structure of demand Distri
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Table 10. Structure of consumption_
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Table 11. Central government expend
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Table 12. Central government curren
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Table 13. Money and interest rates
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Table 14. Growth of merchandise tra
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Table 15. Structure of merchandise
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Table 16. Structure of merchandise
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Table 17. OECD imports of manufactu
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Table 18. Balance of payments and r
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Table 19. Official development assi
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Table 20. Official development assi
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Table 21. Total external debt Long-
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Table 22. Flow of public and privat
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Table 23. Total external public and
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Table 24. External public debt and
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Table 25. Terms of external public
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Table 26. Population growth and pro
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Table 27. Demography and fertility
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Table 28. Health and nutrition popu
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Table 29. Education Percentage ofag
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Table 30. Income distribution and I
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Table 31. Urbanization Urban popula
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Table 32. Women in development_____
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Technical notes This twelfth editio
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Box A.1. Basic indicators for count
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Box A.2. Selected indicators for no
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from the Food and Agriculture Organ
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Exports of goods and nonfactor serv
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spectively. Since 1987 data are not
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The table reports the value of manu
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teed, and private nonguaranteed lon
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the Demographic and Health Surveys,
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also the one used within the global
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Bibliography Production and domesti
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Country classifications: World Deve
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I i
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