Latin American Capital Markets

102 VALERIANO F. GARCIA AND LUIS ALBERTO GIORGIOout. Apart from the lack of other requisites to allow capital market development, theexperience of Paraguay points to the moral hazard problem as a major constraint.Structural ConstraintsEmerging economies face significant challenges regarding the development of capitalmarkets. Some challenges are derived from inefficient institutional infrastructure thatmust be changed through legal reforms; others arise from the small size of the markets,the solution to which could require financial and commercial integration processes.In addition, during the 1990s, most Latin American and Caribbean countriesundertook structural reforms that downsized the scope of government as entrepreneurby means of privatization and, in some cases, restructuring the role of governmentin social security. In developed countries, such as the United Kingdom and Italy,this process contributed to the reinforcement of capital markets. This was not thecase in Latin America due to the lack of efficient institutional infrastructure, the smallsize of the market, and the weak impact of structural reforms.Lock of Efficient Institutional InfrastructureAccording to La Porta and others (1996), institutional variables explain the growth ofequity markets. The authors find that factors such as the rule of law, minority rights,and one share, one vote are relevant for stock market development. Institutionalfactors are highly correlated with stock market liquidity. Demirguc-Kunt and Levine(1996a) find that countries with transparent regulations and properly enforced legalrules tend to have large and more-liquid stock markets.The institutional infrastructureof capital markets has several equally essential pillars:• A strong legal framework characterized by short and reliable judicial processeswith full enforcement and by trust in civil and commercial litigation• Effective accounting standards, robust corporate governance, and welldesignedand enforced prudential regulations• Timely and reliable economic and business information that the marketprocesses and evaluates• Severe protection of the rights of minority shareholders.When some or all of the pillars do not exist or are poorly designed, the lackof efficient institutional infrastructure imposes significant constraints on the developmentof the markets. India may be a case in point on the importance of tradition andCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub