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Financial Sector Reform Sergio Schmukler Rethinking Structural Reform Conference Federal Reserve Bank of Atlanta Inter-American Development Bank October.

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Presentation on theme: "Financial Sector Reform Sergio Schmukler Rethinking Structural Reform Conference Federal Reserve Bank of Atlanta Inter-American Development Bank October."— Presentation transcript:

1 Financial Sector Reform Sergio Schmukler Rethinking Structural Reform Conference Federal Reserve Bank of Atlanta Inter-American Development Bank October 2003 Discussion on Bekaert, Harvey and Lundblad Galindo and Micco

2 2 Discussion Outline 1. Reform agenda: logic and scope Broader than these papers Broader than financial sector reforms 2. Outcomes for Latin America: mixed or disappointing Extensive to other regions Not as predicted by these papers 3. If reforms did disappoint, why? Policy alternatives to these papers’ recommendations 4. Liberalization papers 5. Creditor rights paper

3 3 1. Reform Agenda: Logic Generate more and cheaper financing BANKS (fragile and inefficient) CAPITAL MARKETS FIRMS Increased competition Cheaper financing INVESTORS Higher returns Wider set of instruments More financing GOVERNMENT Supervision and regulation

4 4 Depository and clearing Trading platforms Pension funds Mutual funds Insurance companies 1. Reform Agenda: Logic Sweeping reforms throughout financial sector CAPITAL MARKETS SUPPLY Financial liberalization DEMAND Privatization Tax incentives Long-term financing and specialization Lower transaction costs Improve exchange infrastructure Foreign capital available Increase liquidity Supervisory agency Investor protection Mitigate information and agency problems More retail investment Promote stocks dissemination More discipline and efficiency

5 5 1. Reform Agenda: Actions Financial liberalization increasing since late-1980s Countries included are Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. The value 1 means repression, 2 partial liberalization, and 3 full liberalization. Figures correspond to end-of-month values. Source: Kaminsky and Schmukler 2002 Latin America: Indices of Financial Liberalization by Sector More liberalization Less liberalization

6 6 1. Reform Agenda: Actions Other reforms implemented in the early-1990s The figure shows the percentage of countries (from a group of 16 countries) that had implemented reforms before 1990, in , and in Countries included are Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, Guatemala, Honduras, Jamaica, Mexico, Panama, Paraguay, Peru, Uruguay, Venezuela. Sources: Bhattacharya and Daouk 2000, ICRG, and local data Percentage of Latin American Countries that Implemented Reforms

7 7 1. Reform Agenda: Actions Reforms occurred mostly after liberalization The table shows the percentage of coutries that had implemented reforms before partial and full liberalization. Countries included are Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. Sources: Bhattacharya and Daouk 2000, Kaminsky and Schmukler 2001, and ICRG Sequencing: Financial Liberalization and Institutional Reforms

8 8 2. But Results Not as Expected (Reforms are good according to these papers) Equity markets Visible growth (market cap), but not as in OECD Rising concentration and delisting Migration to international equity markets  Small relative to bond markets

9 9 2. But Results Not as Expected Bond markets Dominated by government paper Dollarization Short duration Currency and maturity mismatches Institutional investors Fast growth but tapped by governments

10 10 2. But Results Not as Expected Latin America Equity Market Growth Is Poor Stock Market Capitalization Percentage of GDP Countries included are Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. Asian countries: Hong Kong, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand. G-7countries: Canada, France, Germany, Italy, Japan, U.K., and U.S. Figures correspond to end-of-year values. Sources: IFC's Emerging Markets Database, World Federation of Exchanges (FIBV), and The World Bank

11 11 2. But Results Not as Expected Stock Exchanges Affected by Increasing De-listing Domestic Stock Exchanges: Number of Companies Source: IFC's Emerging Markets Database

12 12 2. But Results Not as Expected Large Companies Migrate to International Markets Latin American Companies: Value Traded Countries included are Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. Internationalized companies are defined as companies that cross-list or raise capital in international stock markets at some point in time. Figures correspond to end-of-year values. Sources: The Bank of New York, Euromoney, and IFC's Emerging Markets Database USD Millions

13 13 2. But Results Not as Expected Equities Traded Belong to a Handful of Large Firms Percentage Stock Market Concentration (end-2000) Source: IFC's Emerging Markets Database

14 14 2. But Results Not as Expected Public Bond Trading Outweighs Equity Trading Value Traded in Domestic Markets (2000) The figure shows the value traded through the domestic exchanges. However, in the case of Mexico, repo operations (conducted or not through the exchange) are also considered. Sources: Local data, The Handbook of World Stock, Derivative & Commodity Exchanges 2001, Federacion Iberoamericana de Bolsas de Valores (FIABV), and The World Bank Percentage of GDP

15 15 3. If Reforms Did Disappoint, Why? Wrong sequencing Financial integration went too fast Imperfections in international markets lead to vulnerabilities when domestic sector is not ready Thus, follow right sequencing But, are there sufficient incentives to reform institutions without the discipline from openness and crisis? Wait for the fruits of reforms and do more The dividends from reforms have long gestation period Thus, accelerate pace But, we all know what happens in the long run

16 16 3. If Reforms Did Disappoint, Why? Wrong expectations Recommendations based on cross-sectional evidence Reforms did not tackle well some basic issues for EMs Macro policy Systemic risk Domestic and external shocks, e.g. capital flows volatility Institutional factors – size, information asymmetries, moral hazard Globalization Thus, redesign reform to address the basic issues, and revise expectations But, many of these issues are intrinsic to emerging markets and solving them is a daunting task

17 17 4. Liberalization Papers Great papers! Important contributions Welfare implications relative to previous work Growth mean and volatility Solid work Almost painful to read, “overwhelming force” Incorporated most comments received in the past years, so difficult to discuss Particularly for the growth mean paper Volatility paper needs to address the same comments that spur paper already did

18 18 4. Liberalization Papers Potentially relevant issues to consider “One of the most fundamental national policy decisions of the past 25 years has been the liberalization of equity markets across the world.” Here, allowing foreigners to purchase domestic stocks But witness size of stock markets And witness effects of capital account liberalization Which samples/estimations make sense? Mix of developed and developing, including very poor countries Including countries with no change in liberalization Time series for emerging markets Fixed effects estimations Coefficient diminishes to 0.56 But why including countries with no variation in liberalization here?

19 19 4. Liberalization Papers Potentially relevant issues to consider (continued) More on econometrics Overlapping observations How are common factors treated besides SUR specification? How is endogeneity addressed, specially given that it comes up in the growth paper? Removing seems arbitrary Crises as outliers? Rationale? Why including 99 and 00? Perhaps, crises consequence of liberalization, as suggested Even with crises, other evidence points towards lower volatility

20 20 4. Liberalization Papers Caveats related to liberalization measures Wider set of financial liberalization measures Pace of liberalization Reversals Intensity of liberalization Capital account liberalization Might seem more important to many readers Treatment of capital account liberalization

21 21 4. Liberalization Papers Other specific points More on economic significance would be welcomed Results weakened with other controls For LAC countries, mean results insignificant Other regressors Other controls, like GDP per capita Level of inflation might matter Risk sharing Perhaps, could be another paper Ability versus actual risk sharing

22 22 5. Creditor Rights Paper Great paper! Important points of the paper Effectiveness of creditor rights, interacted with With rule of law With efficiency of the judiciary With small and medium firms Perhaps nicest results Three effects of creditor rights Credit/GDP Share of bank credit financing of small and medium firms Change in real credit (procyclicality)

23 23 5. Creditor Rights Paper Potentially relevant issues to consider More consistency across empirical analysis Creditors rights, rule of law, or broad institutions? No multivariate analysis, omitted variables Only done very partially for change in credit, when controlling both for creditor rights and rule of law Perhaps, control for GDP per capita, given that GNP and GDP growth not significant Interaction might result more from law and order explanatory power than from creditor rights Perhaps interact with GDP per capita and other variables Why is creditor rights insignificant by itself second part?

24 24 5. Creditor Rights Paper Potentially relevant issues to consider (continued) Why procyclicality? Risk can be reduced ex-ante, knowing state of institutions More explanation would be welcomed Policy recommendations Cross section evidence versus time series recommendation More reforms needed Foreign jurisdictions Systemic shocks and creditors right Repudiation of contracts Shocks to collateral In fact, acknowledged importance in institutional analysis

25 25 5. Creditor Rights Paper More on data and variables Macro variables not significant, except budget deficit WEBS survey Only for 1999 Share of investment financed with bank credit and legal protection What about other type of financing Other specific point Econometrics Procyclicality results weak using IVs Clustering standard errors


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