Latin American Capital Markets

4 KENROY DOWERS, FELIPE GOMEZ-ACEBO, AND PIETRO MASCIworld, there is a trend away from bank-dominated systems and toward mixed systems.Countries in the region require a shift away from bank dependence through thegrowth of a complementary capital market-based financial industry to increase accessto long-term financing and lower its cost.Capital markets help the financial sector achieve efficient allocation of resourcesand economic growth.These functions include clearing and settling payments,pooling funds to facilitate investment and achieve diversification, transferring economicresources over time, pooling and sharing risk, making price information available,and providing ways to deal with incentive problems when there is asymmetricinformation. Investors are usually reluctant to relinquish control of their savings forlong periods; however many high-return projects require a long-run commitment ofcapital. Capital markets solve this problem through risk pooling and instruments thatpermit diversification and maturity transformation, allowing savers to have liquid assetswhile firms have permanent use of the capital raised by issuing equities.Capital markets have additional functions, including providing more democraticaccess to capital, presenting financial support to innovators and entrepreneurs,and reducing the risk of contagion based on problems within one firm or industry thatcould spread to the overall economy. Equity and debt markets, in particular; serve toenhance corporate governance through increased monitoring of management performance,reduced agency cost, information dissemination, and increased efficiency ofinvestments and management decisions.The possibility of takeover increases the pressure,promoting management efficiency.Diversified financial systems result in more dynamic and efficient capital allocationprocesses. The efficient management of economic risk and uncertainty allowsfor long-term commitments to capital investments, leading to greater capital formationand accumulation.Thus, capital market development constitutes a form of publicgood, and government is required to step in to promote its development and act asa regulator to reduce information asymmetries and increase efficiency.In the past decade, many countries in Latin America and the Caribbean haveadopted policies aimed at creating or improving domestic capital markets to realizesome of these specific benefits. A precondition to the success of these policies is tobuild on a foundation of political, legal, and macroeconomic stability. Moreover, realizingthe benefits depends on the level of development, liquidity, depth, and completenessof the markets.The focus on development of the domestic capital market in emerging countriescan be divided into two stages or generations. 1 In the first generation, the focusCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub1The concept of first- and second-generation capital market reforms is used in this chapter to underscore differencesin the emphasis and focus of the types of policies, programs, and activities applied to create viable capital markets.