Latin American Capital Markets

DEVELOPING BOND MARKETS: A COMPREHENSIVE VIEW 315surance, brokerages, and mutual funds.The government, as the developer of the market,is the only one in position to offset the stated resistance by setting rules to encouragedisintermediation from bank deposits to capital market instruments and promotingcompetition among participants. One way to do this is by presenting a largeenough business perspective to the new players and strong moral suasion, which onlypublic sector authorities can exercise. In Latin American countries, the banking industrydominates the financial system, and that is especially difficult to change in smalleconomies. In Costa Rica, for example, one or two banks dominate the system, and amore competitive environment would be difficult to establish due to the lack of economiesof scale and the political resistance to reforming public sector banks.Mutual funds represent a significant source of demand for short- and midtermsegments of government securities markets. The fact that these funds are createdfor special investment purposes explains why they do not necessarily have diversifiedportfolios. In order to develop the mutual fund industry, it is important toincrease competition, removing barriers to entry to the financial sector and allowinginternational institutions to enter domestic markets. In addition, a sound regulatoryframework must be built to develop mutual funds, which should include investor protection,market integrity, high standards of disclosure of information, and a clear separationbetween managers and depository institutions. It is imperative to avoid anyregulatory arbitrage, especially between the regulatory frameworks for banks and mutualfunds. Mutual funds constitute an excellent means for reaching out to retail investors.However mutual funds require the network of commercial banks to distributetheir products, which may lead to conflicts of interest between both marketparticipants that government has to address by creating a more competitive environment.Brazil constitutes a showcase, where the mutual fund industry has experimentedwith a major increase in the savings channeled by these institutions. Thisgrowth can be partially explained by the tax benefit that the funds receive with respectto the tax applied to financial transactions; that is, investments made by mutualfunds do not pay the transaction tax.Therefore, economic agents, including other institutionalinvestors (banks, pension funds, and insurance companies), directed an importantpart of their investments through mutual funds. Now that the industry hasreached a certain level of development, an interesting problem has arisen from thetax distortion; that is, the concentration of the investor base has affected the liquidityof the market as fewer participants are managing a greater part of the resources.Pension funds and insurance companies provide a strong demand for fixedincomesecurities. Institutional investors benefit capital market development by introducingfinancial innovation, transparency, corporate governance, competition, efficientCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub