Financial systems and development

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Figure 4.3 Financial savings and the real deposit rate in Argentina and Thailand, 1970 to 1987 Argentina Thailand Percent Percent Percent Percent 45 2C 70 2', 40 A-,.erag re rl deposit 4 C - 35 ~race .rah sa e 1 0 / o\ Financial savings as a sare1 0 50 cr~~~~~~~~~~~~~~~~o GNP(lf scale) P 25 -U ' ' 20- ->0 15 t30 10 Fmancial savings as a share -60 \ 1 Average real deposir 5! CIo GNP (left scale) 20 -rate (right scale) IC C -80 10-1 1970 1973 1976 1979 1982 1985 1987 1970 1973 1976 1979 1982 1985 1987 Note: Financial savings are M2 (currency in circulation plus demand, time, and savings deposits at banks) and are five-quarter averages. Source: Gelb (background paper); IMF, International Financial Statistics; Easterly 1989; central bank bulletins; and World Bank data. riskier and more difficult to finance. It also makes the future purchasing power of financial contracts less certain. Even when interest rates are not regulated, uncertainty about future inflation makes it hard for lenders and borrowers to agree upon an appropriate fixed nominal interest rate. The lender risks inflation turning out higher than expected, the borrower risks inflation turning out lower than expected. The higher and more variable the inflation and the longer the time horizon, the greater the risks. In countries such as Argentina loans of more than thirty days became unusual. Several countries that have had chronic inflation, including Brazil, Chile, Colombia, and Israel, have authorized the use of indexed financial contracts. Indexation links the value of the financial contract to a price index. If indexation is complete, if the index accurately reflects prices, and if adjustment is immediate, indexation denominates the contract in terms of purchasing power rather than money. At high inflation rates, private sector borrowers often find it too risky to take on purchasing power obligations, because they fear their income will fail to keep pace. The public sector, in contrast, does not have this problem. It cannot go bankrupt in its domestic markets as long as it has the power to Table 4.2 Real loan interest rates for selected countries, 1980 to 1986 (percent) Country 1980 1981 1982 1983 1984 1985 1986 Argentina 5.1 31.2 -18.7 -22.9 -29.7 -6.3 3.9 Brazil -2.5 4.9 26.2 0.2 7.5 -0.1 -0.1 Chile 12.1 38.8 35.7 15.9 11.5 11.1 7.5 Colombia .. .. .. .. .. 14.1 11.8 Indonesia .. .. 10.9 9.9 16.4 17.4 13.1 Korea, Rep. of -12.3 5.1 6.6 7.9 7.4 6.6 8.6 Philippines .. 4.2 8.9 -5.4 -15.0 21.7 17.9 Thailand 1.4 5.9 16.0 13.3 19.2 15.2 15.1 Turkey -0.6 50.2 37.7 28.0 28.7 42.0 51.0 Note: Real interest rates were calculated from nominal rates according to the following formula: [(1 + r) /(1 + p) - 1] x 100, where r is the interest rate and p is the inflation rate. Source: Easterly 1989. 66
Box 4.7 The curb market In many developing countries, economic regulation age annual interest rate on curb loans was 24.0 percent (often in the form of interest rate controls) has led to in 1985, when the general bank loan rate was 10.0-11.5 the growth of an unregulated curb market, which can percent. be an important source of funds for both business and The curb market has been closely integrated with the households. In the Republic of Korea, it has been esti- formal market. According to one popular method of mated that the outstanding obligations in the curb mar- transaction, an informal lender makes a savings de- . ket in 1964 were roughly equal to 70 percent of the posit at a bank branch, which then extends a loan to a volume of loans outstanding from commercial banks. borrower designated by the depositor. The informal By 1972 the ratio had been reduced to about 30 percent, lender thereby earns the savings deposit rate plus largely as a result of interest rate reforms in the formal about 1 percent a month from the borrower, without sector in the mid-1960s. After the monetary authorities any risk of default. reduced interest rates in the late 1970s, there was a The curb market has been a significant part of the resurgence in the market. But the market has recently financial system in other countries as well. In Argendedined again. Business shifted from the curb market tina, for example, the reimposition of interest rate conto nonbank institutions that were allowed to offer sub- trols and financial repression after 1982 led to the rapid stantially higher returns. expansion of the curb market. According to one esti- According to one survey, about 26 percent of firms mate, informal credit from the curb market represented borrowed from the curb market, which supplied about nearly a quarter of the total granted by commercial 20 percent of their total borrowing. About 70 to 80 per- banks and finance companies in 1984. cent of credit from the curb market to small and Experience shows that the curb market becomes acmedium-size firms was extended without collateral. tive when the formal financial sector is heavily regu- -, But the curb market uses a sophisticated credit rating lated and interest rates are held below market levels. 0 system, and prime companies pay an interest rate sub- The curb market is effectively an unregulated bills stantially lower than less creditworthy ones. The aver- market. print money. Thus at high rates of inflation, most pressure on the central bank to provide accommoindexed contracts are issued or backed by the gov- dation. In Yugoslavia, for example, central bank ernment or by public entities. Indexing financial losses on the foreign currency deposit scheme instruments can be useful in inducing lenders and have added to inflationary pressures. borrowers to make longer-term commitments at some middle range of inflation, say 10 to 40 per- Exchange rate policies and financial development cent a year, but it is no substitute for controlling inflation. If unaccompanied by adequate stabiliza- During the 1970s many developing countries altion measures, indexation tends to make inflation lowed their exchange rates to appreciate in real worse (see Box 4.8). terms. This was made possible by relatively favora- As an alternative to indexing, some countries, ble terms of trade and by the availability of foreign including Turkey, Uruguay, and Yugoslavia, have loans to finance the resulting current account defiadopted foreign currency deposit schemes. In ef- cits. The real appreciation of the exchange rate fafect, these index deposits to the exchange rate. vored production of nontraded over traded goods Such schemes have increased the flow of savings and encouraged reliance on imported inputs. Fiinto the financial system. But they can also compli- nancial institutions accordingly allocated a larger cate monetary management. Since the domestic share of credit to firms in the nontraded goods value of the foreign exchange deposits rises auto- sector, as Figure 4.4 illustrates in the case of matically with currency devaluation, the monetary Colombia. aggregates tend to accommodate inflationary pres- Overvalued exchange rates and controlled intersures. To the extent that loans extended against est rates combined to stimulate capital outflows. foreign exchange deposits are denominated in do- These flows were illegal in countries with foreign mestic currency, the banks lose with each devalua- exchange controls, but such controls have rarely tion if the interest rate differential is insufficient to been effective. Although capital flight is hard to cover the change in currency values. This puts measure, the discrepancies between increases in 67
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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
Page 30 and 31: 5~~~~ '~ ' S " ''t.*:'.: .:,0!3gft"
Page 32 and 33: Box 1.2 Debt concepts A variety of
Page 34 and 35: Table 1.1 Selected economic indicat
Page 36 and 37: Figure 1.8 Domestic and external li
Page 38 and 39: Box 1.3 Foreign equity investment E
Page 40 and 41: j Box 2.1 Life without money "Some
Page 42 and 43: other ways too. By imposing direct
Page 44 and 45: Box 2.2 Transaction costs and the s
Page 46 and 47: Box 2.3 Real interest rates and gro
Page 48 and 49: I Box 2.4 Swapping risk All economi
Page 50 and 51: Box 2.5 Deposit insurance Most high
Page 52 and 53: GOVERNMENT. As well as being regula
Page 54 and 55: and receivables, whereas developmen
Page 56 and 57: with the expansion of nonlocal trad
Page 58 and 59: over. Even so, bankers and industri
Page 60 and 61: Box 3.3 Financial swindles i Swindl
Page 62 and 63: Box 3.4 Financial underdevelopment
Page 64 and 65: Box 3.6 Universal banking One of th
Page 66 and 67: 1960s. They speeded the internation
Page 68 and 69: 4 Financial sector issues in develo
Page 70 and 71: Box 4.1 Directed credit in Turkey ,
Page 72 and 73: 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 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 124 and 125: strides in recent years in establis
Page 126 and 127: Issues in informal finance Small-sc
Page 128 and 129: Box 8.2 Rotating savings and credit
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original amount to the renter by th
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cooperatives' managers because it a
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Box 8.4 The Badan Kredit Kecamatan:
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Toward more liberal and open financ
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a brief period firms faced rapid ch
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Box 9.2 Financial reform in Korea K
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In the next stage, financial reform
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industry, policy reforms and the re
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Conclusions of the Report challenge
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tion "Risks and costs of finance" d
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Montes-Negret, Fernando. "The Decli
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D.C.: International Monetary Fund a
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Harberger, Arnold C. 1985. "Lessons
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croenterprises: Programs or Markets
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Douglas Graham, and J. D. Von Pisch
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Table A.2 Population and GNP per ca
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Table A.5 GDP structure of producti
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Table A.8 Growth of export volume,
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Table A.10 Growth of long-term debt
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Table A.12 Composition of debt outs
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Contents Key 157 Introduction and m
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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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