1. Innovative Experiences in Access to Finance: Market Friendly Roles for the Visible Hand? Augusto de la Torre and Sergio Schmukler World Bank UN International Forum on the Eradication of Poverty New York, November 15-16, 2006

2. 2 Based on De la Torre, A., J.C. Gozzi, and S. Schmukler, 2006. Innovative Experiences in Access to Finance: Market Friendly Roles for the Visible Hand? World Bank, Latin America and Caribbean Regional Study.

3. 3 Contents Motivation and objective of study Conceptual building blocks Role of the state – alternative paradigms Market friendly roles for the visible hand? Illustrative experiences NAFIN – Internet-based market for receivables finance FIRA – Working capital structured financing scheme FIRA – Inventory Finance Questions for future policy research

4. 4 Motivation and Objective of Study Rising interest in access as key to financial development Observed levels of access to financial services in developing countries is strikingly low, even the middle income Access-related stories are predominant in the theorizing on channels through with financial development leads to growth Finance fuels creative destruction by leveling the opportunity playing field (Rajan and Zingales 2003) Some evidence that broader access might reduce poverty, although channel not identified Buirgess and Pande (2005) Investigate scope for, and nature of, market-friendly government interventions to broaden sustainable access

5. 5 Conceptual Building Blocks Narrow definition of problem of access ( lack of access) A project that would be internally financed if own resources were available does not get external finance Wedge between the expected internal rate of return of the project and the rate of return required by external investors Drivers of the wedge Principal-agent problems Adverse selection Moral hazard Transaction costs

6. 6 Role of contractual institutions Weak contractual institutions agency problems are mitigated through personalized relationships and fixed collateral Access limited to a circumscribed network of participants Weak institutions affect differently different credit markets Strong contractual institutions enable arms-length financing Contracts are impersonal and rely on transparency and enforcement of general rules by a third party (generally courts) Path dependence Self-reinforcing arrangements due to increasing returns Transplantation of isolated legal or regulatory change from one institutional milieu to another can backfire Role of technological and financial innovation Microfinace thriving even where contractual institutions are weak Conceptual Building Blocks (cont.)

7. 7 Virtual consensus that some type of government intervention is crucial to foster financial development… …but views vary on specific nature of intervention Three typological views: Interventionist – widespread market failures require government direct involvement in mobilizing and allocating financial resources Laissez-faire – focus only on improving the enabling environment and let the market do its magic Pro-market activism – in addition to long-term institution building, direct government actions are required in the transition to promote and complete financial market development Role of the State – Alternative Paradigms

8. 8 Market Friendly Roles for the Visible Hand? An evolving list of interventions to Solve coordination failures, overcome first mover disadvantages, align incentives of multiple stakeholders Promote achievement of economies of scale to lower costs Encourage adoption of technological and financial innovation Pool risk and group otherwise atomized borrowers Share risk (e.g., through partial credit guarantees) Smart subsidies Selective interventions focused on solving specific market failures by crowding in the private sector Tailored to specific needs and institutional settings

9. 9 Public provision of market infrastructure BANSEFI (Mexico) NAFINs Reverse Factoring Program (Mexico) Correspondent Banking (Brazil) Structured finance FIRAs working capital and inventory financing schemes (Mexico) Partial credit guarantee programs FOGAPE (Chile) Transaction cost subsidies FIRAs SIEBAN program (Mexico) Microfinance BancoEstado (Chile) Illustrative Experiences from Latin America

10. 10 Mexican SMEs had limited or no access to working capital financing from banks SMEs required to grant trade credit (30-90 days) to their buying clients, many of which are big and reputable firms Receivables not perceived as good collateral Lack of reliable registry system for receivables Ample room for double-pledging or forging of receivables No effective way to bridge part of the problem by taking advantage of creditworthiness of issuers of receivables NAFIN – Internet Based Receivables Finance The Problem

11. 11 LARGE BUYERS Functioning of NAFINs Reverse Factoring System SUPPLIERS (SMEs) BANKS Delivery of purchased goods Online posting of negotiable document (representing accounts payable) NAFIN website Online interest rate quote Payment of full amount of negotiable document Selection of desired lender Payment of amount of negotiable document less interest rate NAFIN – Internet Based Receivables Finance The Solution

12. 12 FIRA Working Capital Financing The Problem Strong reduction in bank lending to the primary sector after the 1994-95 crisis Shrimp producers with limited or no access to working capital finance from banks Lack of collateral Costly and difficult to screen and monitor small producers Price uncertainty Supplier credit was the only credit source available to producers Unfavorable conditions Only covered about 50 percent of their costs

13. 13 OCEAN GARDEN Functioning of Working Capital Structured Scheme $100 SHRIMP PRODUCERS BANKS FIRA Supply Agreement Loan for working capital $100 Transfer of credit rights $100 TRUST FUND SHRIMP FEED SUPPLIERS Participation certificates Payments Feed FIRA Working Capital Financing The Solution

14. 14 OCEAN GARDEN Functioning of Working Capital Structured Scheme in Case of Default Guarantees (49%) SHRIMP PRODUCERS BANKS FIRA Individual guarantee (9%) Default on supply agreement Global guarantee (up to 25% of total fund value) TRUST FUND SHRIMP FEED SUPPLIERS Individual guarantee (15%) Second loss guarantee (46%) FIRA Working Capital Financing The Solution (cont.)

15. 15 FIRA Inventory Financing The Problem Banks not willing to lend to sugar mills Sugar inventories not perceived as a good collateral Movable collateral, difficult to secure Lack of a warehousing market to guarantee value and quality of inventories Difficulties in repossession and liquidation in case of default Price volatility Strong seasonal fluctuations in sugar cane prices Lack of integrated global markets

16. 16 FIRA Inventory Financing The Solution $80 CDs $100 Inventories $100 SUGAR MILL BANKS CARGILL $80 Screening and Monitoring Margin Calls WAREHOUSES Functioning of Scheme FIRA Funded Participation Agreement CDs Repo Sugar Inventories

17. 17 FIRA Inventory Financing The Solution (cont.) SUGAR MILL CARGILL WAREHOUSES Functioning of Scheme in Case of Default Guarantee $76.8 BANKS FIRA Inventories (book value $100; market value ?) Put option $64 Inventories (book value $100, market value ?) Default Loss:$3.2 Loss:$12.8

18. 18 Questions for Future Policy Research How to isolate specific value added of pro-market activists policies? Why does the private sector not do it by itself? What conditions determine most appropriate role for market friendly visibly hand? Lender (2 nd tier), risk-sharer (for a price), coordinator, subsidy provider? How to ensure professionalism, transparency, and accountability in interventions, given complexity of schemes?

19. 19 How to minimize unintended harm of second-best? Governments may be distracted away from the first-best solutions Given path dependence, second best solutions may lead to traps that are difficult to exit To what extent can we separate the organization (e.g., development bank) from the instrument? Even if experiences are replicable, should government create organizational capacities where they do not exist? Questions for Future Policy Research (cont.)

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