Sr. Financial Sector Specialist Local capital markets in internationally integrated financial systems: How can capital markets best serve domestic investors and firms? Steen Byskov Sr. Financial Sector Specialist The World Bank November 14, 2011

International financial integration and the role of markets: Foreign, domestic, integrated, or a combination? Capital market integration and collaboration Rest of World Portfolio investment Bulgaria Banks Firms Capital market Firms FDI and trade finance Capital market Loans Banks Equity and loans

Central Europe (CE) has become deeply financially integrated Aggregate private and financial sector external funding sources, EU 10, 2010 Sources: IMF BOPS, Bank for International Settlements. It has been FDI intense, bank centric including direct cross border lending... …but only modestly through domestic capital markets

CE firms get much funding from abroad, but little from capital markets compared to other regions Sources: IFS, BOPS, WDI, BIS. Bank credit is rather important in EU10 Domestic capital markets are rather unimportant

Central European capital markets are still mostly small and illiquid Equity Market Capitalizations in Emerging Europe, 2010 Turnover Ratios in Emerging Europe, 2010 Sources: FESE for market capitalization, IMF for GDP. Source: World Development Indicators, the World Bank.

Estimated net funds raised on stock exchanges markets Firm’s raised money through the local stock market pre-crisis, but it stopped during the 2008-09 crisis Estimated net funds raised on stock exchanges markets Sources: WDI, Bloomberg Note: Net funds raised are estimated as the growth in market capitalization net of the price effect as measured by the main index on the stock exchange.

Share of funding from banks (vs. bonds) European trend towards decreasing bank funding since 2008 increases the need for markets Structural trend or tactical response? Trend may be accelerated by Immediate funding pressures and higher cost of capital for parent banks Shifting parent bank strategies Home country supervisory actions (Austrian example) EBA recapitalization requirements Basel III Share of funding from banks (vs. bonds) Median among a survey of 161 EMEA corporates Source: FitchRatings, “European Corporate Funding Disintermediation”, Oct. 19, 2011

Why have CE markets remained small, and what is the solution? The economic and financial structure in CEE countries do not support independent local markets Markets were set up to facilitate privatizations Small economies cannot independently support liquid capital markets Alternative funding from domestic and international banks developed quickly FDI companies are not likely to use local markets HOWEVER, pressures on banks will strengthen the demand for capital markets Solution Improve investors’ and firms’ access to capital markets through market integration and collaboration EU facilitates capital market integration In Western Europe, market infrastructure has integrated, but in CEE it remains national Policy choices are interconnected -> need for cross border coordination The next presentation outlines capital market development in EU and options for CEE