A shortage of long-term financing since the 2008 crisis is choking the investment-backed growth of companies in developing countries and hampering the ability of credit-worthy families to borrow for education and housing needs and escape poverty, a new World Bank report has warned.
At the global level, this shortage of long-term financing also means that despite appeals by the Group of Twenty (G-20) and other key international groups, developing countries are struggling to mobilize the billions of dollars in financing they need to build badly-needed infrastructure in order to grow their national and regional economies.
According to the new report: ‘Global Financial Development Report 2015-2016: Long-term Financing,’ extending the maturity structure of finance is considered to be at the core of sustainable financial development.
Securing long-term financing, defined as investment funding that matures in a year or more, depends on the same fundamentals essential to tackling the current volatility in global capital markets: Policy makers need to focus on institutional reforms, such as promoting macroeconomic stability, establishing a regulated and legally enforceable banking and investment system that protects creditors and borrowers, and setting a framework for capital markets and institutional investors.
World Bank Group President Jim Yong Kim says, “It would be a challenge to achieve high and sustainable rates of economic growth if countries fail to invest in schools, roads, power generation, electricity distribution, railways and other modes of transport, and communications. Private sector construction of plants and investment in machinery and equipment are also important. Without long-term financing, households face great hurdles to raising income over their lives -for example by investing in housing or education-and may not benefit from higher long-term returns on their savings.”
While commercial banks remain the primary source of financing for firms and households around the world, capital markets have grown rapidly, especially in emerging market economies like China and India. Firms in developing countries saw a 15-fold increase in the amounts raised in equity, bond, and syndicated loan markets between 1991 and 2013. Although the majority of this finance originated in high-income countries, there are notable exceptions: more than 70 percent of India’s total syndicated loan market originates domestically.
“Long-term finance facilitates investment in infrastructure, durable goods, and people’s education and skills, and, as such, is the bedrock of sustained growth. Finance, however, needs good institutions and effective contract enforcement,” said Kaushik Basu, World Bank Senior Vice President and Chief Economist. “Fortunately, a lot is happening to give us hope. Equity and bond markets, for instance, have grown from less than half the financial system in the 1980s to 53 percent in China and 65% in India, in 2005-10. A new distribution system for government securities using mobile phones has broadened the financial access of retail investors in Kenya. By bringing a wealth of information and analysis to the table, this year’s report greatly enhances our understanding of this critical sector.”
Long term housing finance is arguably the most important ingredient towards home ownership, yet the disparity across countries is stark: an average of 21 percent of individuals in high-income countries have an outstanding home loan, compared to a mere 2.4 percent in lower-middle and low-income countries. India is a typical case, with only 2.3 percent of individuals having a home loan.
Firms in developing countries also face substantial disparities. Loan durations to firms in low-income countries average 23.3 months, less than half of the average for firms in high-income countries at 58.7 months. Firms’ loans in Sierra Leone and Liberia have particularly low durations, with averages of 8 and 4.4 months respectively.
“The temptation to seek quick fixes is strong, but only a wholesale effort to reform the institutions that underpin the financial system will solve this problem,” said World Bank Director of Research Asli Demirguc-Kunt. “This report lays out a path that countries can follow to make available the kind of long-term finance that will support sustainable, equitable growth.”
The report highlights examples, as well as innovative approaches, that some countries have taken to win access to long-term financing:
* Too little credit information makes it difficult for lenders to assess risk reliably and pushes them towards shorter lending maturities. Bulgaria and Nicaragua sharply increased average loan maturities after private credit bureaus were established.
* Limited protection of investor rights leads lenders to prefer short-term contracts to discipline borrowers by threat of termination. India introduced debt recovery tribunals to speed up debt recovery cases, and as a result, firms made significant movements away from short-term debt toward longer-term instruments.
* Weak corporate governance leads to a weak contractual environment. A study of over 7,000 firms in 22 countries found that firms with strong corporate governance tended to use less short-term debt.
* Insufficient financial knowledge often means that people opt for expensive short-term debt. Effective financial education would allow households to make better decisions, along with consumer protection and financial disclosure rules.
* Development of local bond, equity markets and institutional investors may improve the availability of long-term financing and also serve as a “spare tire” when the banking system is adversely hit by shocks.
* In South Africa, pensions have helped ensure that families are able to invest more in their children by sending them to school longer and reducing their hours worked.
While explaining the scope for long-term finance, the report also cautions that long-term finance is not optimal or even necessary in all circumstances. Firms match the maturity structure of their assets with liabilities, and typically seek shorter-maturity debt to finance payroll and inventory, while seeking longer-maturity debt for fixed assets, says the report. In the United States, for example, the overextension of credit to non-creditworthy borrowers proved to be a key contributing factor to the subprime mortgage crisis.
Source: World Bank
