Latin American Capital Markets

INSTITUTIONAL INVESTORS AND CAPITAL MARKET DEVELOPMENT 129tion, with high costs of local capital, small and medium enterprises may find it difficultto obtain financing and economic growth may be slowed (Gaa and others 2001).Table 5-2 also shows that the growth of institutional investors correlates positivelywith the level of market liquidity. Institutions create liquidity by channelingadditional savings into the markets and by actively trading in high volumes. Some institutionsmay create the liquidity necessary for the development of other types ofinvestors. For example, newly established pension funds may not engage in activetrading until they have accumulated sufficient financial assets (Vittas 1996), whereasmutual funds that rely on daily redemptions and the ability to mark their assets tomarket require a highly liquid market In this way, pension funds may pave the way formutual funds to enter the marketAlternatives to Commercial BanksInstitutions also contribute to market liquidity and provide other benefits by alleviating aneconomy's dependence on commercial banks as savings and financing vehicles. By providingalternatives to bank deposits, institutions may create a pool of long-term financialassets available for investment, particularly through funded pension programs (Vittas1996), and possibly increase savings as a whole (Greenough and King 1976). By channelingthese savings into capital markets, institutions contribute to market growth and liquidityand transform savings into productive investments and resulting economic growth.Institutional investors also provide alternatives to traditional bank financingthrough their participation in primary markets through private placements, initial publicofferings, venture capital investment, and secondary market participation. Capitalmarket financing, unlike bank financing, does not depend directly on interest rates;therefore, capital market financing may provide financing opportunities for riskier venturesand long-term projects for which bank financing may not be available (IDB1998). As a result of the shift toward market-based financing, competitive pressuresmay cause banks to increase their securities activities and offer sophisticated derivativesand over-the-counter products (Gaa and others 2001).Market StabilitySome institutional investors, particularly those with a long-term outlook, may encouragemarket stability. For example, pension funds, due to their nature as retirement assetsand the tax penalties for early withdrawals, are more likely to remain invested duringa crisis. In principle, mutual funds have the potential to aggravate stock marketCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub