Current challenges in financial regulation

Financial intermediation and financial services industries have undergone many changes in the past two decades due to deregulation, globalization, and technological advances. The framework for regulating finance has seen many changes as well, with approaches adapting to new issues arising in specific groups of countries or globally. The objectives of this paper are twofold: to review current international thinking on what regulatory framework is needed to develop a financial sector that is stable, yet efficient, and provides proper access to households and firms; and to review the key experiences regarding international financial architecture initiatives, with a special focus on issues arising for developing countries. The paper outlines a number of areas of current debate: the special role of banks, competition policy, consumer protection, harmonization of rules-across products, within markets, and globally-and the adaptation and legitimacy of international standards to the circumstances facing developing countries. It concludes with some areas where more research would be useful.Banks&Banking Reform,Financial Intermediation,Non Bank Financial Institutions,Economic Theory&Research,ICT Policy and Strategies

Alternative forms of external finance : a survey

The main purpose of this paper is to survey the existing literature on alternative finance (AF) and indicate the major research gaps. In this way, the survey may help to identify the factors influencing the flow of AF; provide analytical, and empirically supported underpinnings for policy work; and assess the amounts likely to be available. The focus of this survey is on aspects of country risks related to AF and the dispute settlement of international claims, domestic incentive schemes to attract foreign financing, the intermediation role of multinational firms and banks, and the supply side of AF.The survey thus investigates the incentives for individuals and firms, and, where necessary, takes into account the aggregate implications. The paper provides some descriptive statistics of AF and makes a comparison with traditional finance (TF). It identifies the key characteristics in which AF differs from TF and briefly reviews the factors motivating capital flows. The paper identifies the extent to which TF and AF differ in the factors motivating capital flows and to what extent the implications of these differences have been explored in the literature to date.Financial Intermediation,International Terrorism&Counterterrorism,Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research

Banking reform in transition countries

In reforming the financial sector in transition economies, one important debate is whether governments should try to reform existing state-owned banks (the rehabilitation approach) or whether a new private banking system should be allowed to emerge (a new entry approach). Or should there be a mix of the two approaches, in which the state bank activities are restricted while a parallel private banking system develops? The authors'cross-country comparison of banks'institutional development in 25 transitional economies suggests that progress can be faster under the new entry approach, especiallyrelative to initial conditions. Progress under the rehabilitation approach appears to be inhibited by poor incentives. In most countries, even those with a good banking infrastructure and a large segment of good banks, a two track process has evolved, with differences between weak and strong banks. Weak banks have moved little beyond central planning. Regression estimates suggest that slow progress of weak banks is associated with: cover concentration, government preferential treatment, and limited new banks entry. The causality direction is often unclear. Policies and structural conditions can affect bank quality. The role of banks will remain limited in many transition economies due to weak legal infrastructures, much uncertainty and inside information, and problems associated with highly leveraged financial intermediaries - including fraud, political interference, and implicit guarantees. In the short run, self-finance and intermediation among enterprises and through nonbank financial institutions may prevail.Financial Intermediation,Banks&Banking Reform,Payment Systems&Infrastructure,Financial Crisis Management&Restructuring,Municipal Financial Management,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Municipal Financial Management,Settlement of Investment Disputes

Access to financial services: a review of the issues and public policy objectives

This paper reviews the evidence on the importance of finance for economic well-being, provides data on the degree of use of basic financial services by households and firms across a sample of countries, assesses the desirability of more universal access, and overviews the macroeconomic, legal, and regulatory obstacles to access using general evidence and case studies. Although access to finance can be very beneficial, the data show that universal use is far from prevalent in many countries, especially developing countries. At the same time, universal access has generally not been a public policy objective and is surely not easily achievable in most countries. Countries can, however, undertake many actions to facilitate access to financial services, including through strengthening their institutional infrastructures, liberalizing and opening up their markets and facilitating greater competition, and encouraging innovative use of know-how and technology. Government attempts and interventions to directly broaden the provision of access to finance, however, are fraught with risks and costs, among others, the risk of missing the targeted groups. The author concludes with possible global actions aimed at improving data on access and use, and areas for further analysis to help identify the constraints to broadening access.Banks&Banking Reform,Governance Indicators,Financial Intermediation,Poverty Assessment,Health Economics&Finance

The optimal currency composition of external debt

The increased volatility of exchange rates, interest rates and goods prices has focused fresh attention on the importance for developing countries of reducing their risks in these markets. Although, these countries generally cannotuse such conventional hedging instruments as currency and commodity futures, they can use the currency composition of their external debt to hedge against exchange rates and commodity prices. In this line, this paper uses findings from the literature on optimal portfolio theory to discuss the optimal currency composition of external debt. The analysis considers a small open economy facing a perfect world capital market and a large number of perfect commodity markets. The paper derives the optimal currency composition of the country's aggregate assets and external liabilities and describes the necessary estimations and computations, including how to take into account the currency composition of existing external liabilities.Economic Theory&Research,Environmental Economics&Policies,Fiscal&Monetary Policy,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Financial Intermediation

Equity portfolio investment in developing countries : a literature survey

The author surveys the literature on equity portfolio investment to develop a research agenda that could help developing countries interested in attracting equity portfolio flows. He finds that a broad literature exists on equity portfolio flows, but that most empirical tests have focused on industrial countries. Although some of the analytical papers may be applicable to developing countries, the author identifies areas of empirical research of specific interest to developing countries: identifying barriers that prevent a free flow of (equity portfolio) capitalbetween industrial and developing countries; quantifying the opportunity costs of these barriers in higher risk-adjusted cost of capital and lower flow of capital; analyzing the optimal amount of portfolio investment and the degree to which investors in industrial countries are currently (under-) invested in developing countries; and analyzing the efficiency of the various stock markets in developing countries, as inefficient stock markets could be a barrier to foreign flows. This research could help policymakers in developing countries make decisions about liberalizing capital accounts, reforming financial markets, and coping with the potential volatility of equity portfolio flows.Economic Theory&Research,International Terrorism&Counterterrorism,Banks&Banking Reform,Financial Intermediation,Markets and Market Access

Corporate governance and equity prices : evidence from the Czech and Slovak Republics

The 1992 Czechoslavakia mass privatization program involving about 1,500 eneterprises and implemented through a voucher scheme with competitive bidding was a bold step in changing the ownership and governance of a large part of the economy. It represents a clear test case of one approach, and other countries may benefit from its lessons. At the time, much skepticisism was voiced about mass privatization: it would lead to diffuse ownership, and no effective corporate governance would result. But innovative forces led to the emergence of investment funds that collected much of the individuals'voucher points, leading to a much more concentrated ownership structure. It has been expected that this concentrated ownership would lead to improved corporate governance. But the jury is still out. So far, only limited and largely anecdotal evidence is available on the impact investment funds have on the way firms are being managed. Too little time has passed and too many shocks have occurred (for example, the split of the Czech and Slovak Republics) to expect to find discernible changes in corporate governance on measures of actual firm performance. An alternative approach is to investigate whether firms that ended up with more concentratedownership -- and possibly improved governance -- sell for higher prices, either in the last voucher round or in the secondary market since then. In a forward-looking financial market, one can expect prices to incorporate the effects of better ownership on future firm performance and associated dividends to shareholders. Put differently, one would expect that two firms with different shareholding structures, but otherwise identical, would trade at different prices -- with the firm with a more concentrated ownership, and presumably better corporate governance, trading at a higher price. On a cross-sectional basis, ownership structure may thus be significant in explaining (relative) share prices. The author explores this line of reasoning. Controlling for a number of firm and sector-specific variables: he finds: 1) Majority ownership by a domestic or foreign investor has a positive influence on firm prices. 2) Firms with many small owners have lower prices. 3) Ownership by many small scale investors makes it easier for any single investor to establish effective control, but such control does not necessarily translate into higher prices. The author also provides two possible explanations of why higher prices appear to be associated only with majority ownership by a single investor: he finds: 1) The corporate legal framework and the difficulty in collecting proxy votes in the Czech and Slovak Republics may prevent a small investor from making the necessary changes in the way firms are managed, thus keeping prices low; and 2) Commercial banks are both managers of invesment funds and creditors of individual firms. Funds managers may face conflicts of interest and not be interested in increasing the value of equity alone but also the value of credits. This could explain why prices are relatively lower for those firms in which investment funds have effective control.Economic Theory&Research,Payment Systems&Infrastructure,International Terrorism&Counterterrorism,Environmental Economics&Policies,Labor Policies,International Terrorism&Counterterrorism,Payment Systems&Infrastructure,Environmental Economics&Policies,Financial Intermediation,Economic Theory&Research

Competitive implications of cross-border banking

This paper reviews the recent literature on cross-border banking, with a focus on policy implications. Cross-border banking has increased sharply in recent decades, particularly in the form of entry, and has affected the development of financial systems, access to financial services, and stability. Reviewing the empirical literature, the author finds much, although not uniform, evidence that cross-border banking supports the development of an efficient and stable financial system that offers a wide access to quality financial services at low cost. But as better financial systems have more cross-border banking, the relationship between cross-border banking and competitiveness has to be carefully judged. While developing countries have some special conditions, provided a minimum degree of oversight is in place, they experience effects similar to industrial countries. There are some questions, though, on the effects of cross-border banking on lending based on softer information and on stability. Relevant experiences from capital markets show that the degree of cross-border financial activities can affect local market sustainability and there can be path dependency when opening up to cross-border competition. Reviewing the fast changing landscape of financial services provision, the author argues that cross-border banking highlights the increased importance of competition policy in financial services provision. This competition policy cannot be traditional, institutional based, but will need to resemble that used in other network industries. Furthermore, with globalization accelerating, competition policy will need to be global, supported by greater cross-border institutional collaboration and using the General Agreement on Trade in Services (GATS) process and the disciplines of the World Trade Organization. GATS can be of special value to developing countries as it provides a binding, pro-competition framework that has proven more difficult to establish otherwise.Banks&Banking Reform,Economic Theory&Research,Financial Intermediation,Knowledge Economy,Education for the Knowledge Economy

Conditionality and debt relief

Six years into the debt crisis, questions about the relevance of policy measures to alleviate the crisis still abound. Conditionality by international financial institutions and rescheduling by commercial creditors have been dismissed in favor of debt reduction as strategies for restoring the creditworthiness of heavily indebted countries. This paper argues that the combination of conditionality and new private money - if properly interpreted and correctly implemented - should not be dismissed too lightly. The paper contends that liquidity (the availability of current resources) in the debtor country is probably as important an incentive for a country to invest and adjust as having a small enough debt stock outstanding. Debt reduction alone, is not as efficient as simultaneously providing liquidity and debt reduction if liquidity were available. The combination of new money and conditionality will work if the debt stock is small enough and enough new money is available.Environmental Economics&Policies,Economic Theory&Research,Strategic Debt Management,Financial Intermediation,Housing Finance

The internationalization of financial services in Asia

The internationalization of financial services -- eliminating discrimination between the treatment of foreign and domestic providers of financial services and removing barriers to the cross-border provision of financial services -- is of global interest, especially in Asia. Most of Asia limits the entry of foreign financial firms much more than otherwise comparable countries do. Empirical evidence for Asia and elsewhere suggests that this slows down institutional development and that, as a result, it costs more to provide financial services. Asian countries could benefit from accelerating the opening of the financial services sector, in conjunction with the further liberalization of capital accounts and domestic deregulation of financial markets. Apart from other benefits, internationalization helps build more robust, efficient financial systems by introducing international practices and standards; by improving the quality, efficiency, and breadth of financial services; and by allowing more stable sources of funds. The ongoing WTO (World Trade Organization) negotiation of financial services under GATS (General Agreement on Trade in Services) gives countries the opportunity to commit to opening their financial sectors. Safeguards can be built into the process, and the liberalization can be phased in gradually.Banks&Banking Reform,Decentralization,Fiscal&Monetary Policy,Payment Systems&Infrastructure,Economic Theory&Research,Banks&Banking Reform,Financial Economics,National Governance,Economic Theory&Research,Health Economics&Finance