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Market Friendly Roles for the Visible Hand?. Public Banks in Latin America: Myths and Realities IADB Conference February 25 , 2005 Augusto de la Torre Sergio Schmukler. Structure of Presentation. Development policy, financial policy, development banks Interventionist state

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Market friendly roles for the visible hand

Market Friendly Roles for the Visible Hand?

Public Banks in Latin America:

Myths and Realities

IADB Conference

February 25, 2005

Augusto de la Torre

Sergio Schmukler

Structure of Presentation

  • Development policy, financial policy, development banks

    • Interventionist state

    • Laissez-faire state

    • Pro-market activist state

  • Development banks and pro-market activism

    • NAFIN – market for receivables-based finance

    • FIRA – structured finance

  • Questions for future research

1.a. Interventionist State

  • Development policy

    • Strategic or socially important sectors (SMEs, agriculture, low-income housing) are underdeveloped and will not take off by themselves

    • Protection (temporary) and investment by government is needed

  • Financial sector policy

    • Widespread market failures – markets will not finance take-off

    • Government should mobilize and allocate finance to these sectors

  • Public banks

    • A policy vehicle/instrument that is functional in this context

    • Although not necessary – selective allocation of credit also done via regulation of private banks

      • Administered interest rates, earmarked investments, quantitative ceilings

1.b. Laissez-Faire State

  • Development policy

    • Development is hampered by heavy-handed government intervention

    • Let markets breath and work (openness, privatization) and focus on strengthening “enabling” environment (rule of law, property rights)

  • Financial sector policy

    • State interventionism leads to financial repression

    • Liberalize financial markets and shift focus to prudential oversight

    • Improve contractual environment (creditor and minority shareholder rights, contract enforcement, accounting/disclosure, credit bureaus)

  • Public banks

    • They become de-contextualized

    • Privatize or liquidate public banks (at least move to 2nd tier)

    • Public banks in search of new identity

1.c. Pro-Market Activist State

  • Development policy

    • Links between reforms and development are elusive and studies of growth determinants give little policy guidance

    • Igniting growth and sustaining growth are different things

    • But problems (poverty, low growth, inequality) are pressing

    • Be heterodox, identify the binding constraint to mitigate second best

  • Financial sector policy

    • Degree of financial development disappointing despite reforms

      • Segmentation in access to finance particularly troublesome

    • The focus on “enabling” and “contractual” environment is insufficient

      • Deep implications of path dependent institutional change

    • Go back to basics, readjust expectations, and be creative

      • Explore market-friendly roles for the visible hand

1.c. Pro-Market Activism & Public Banks

  • New roles for existing public banks – “smart” interventions

    • Share risk (e.g., through partial guarantees)

    • Pool risk and group otherwise atomized borrowers

    • Facilitate achievement of economies of scale to lower costs

    • Encourage adoption of technological and financial innovation

    • Solve coordination failures, aligning incentives of stakeholders

  • Players

    • Non-financial private sector (e.g., large buyers, suppliers)

    • Private banks

    • Capital markets (domestic and international)

  • Type of activities

    • Selected interventions (focus is not on organization that intervenes)

    • Tailored to specific needs and institutional settings

2.a. Innovative Public Banking – NAFIN

The Problem

  • SMEs with limited or no access to working capital from banks

  • SMEs thus forced to grant credit (30-90 days) to their clients, many of which are big and reputable

  • 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

2.a. Innovative Public Banking – NAFIN

The Solution

  • Leapfrogging: creation of internet-based market for the discounting of accounts receivable (SME working capital)

    • Around 300,000 SMEs plus most large buyers and open to all banks

  • Most transactions are “reverse factoring” – SMEs discount their post-delivery receivables

    • Banks take risk exposure to reputable buyers, without recourse

    • Protocol to deal with defective deliveries w/o unwinding transaction

  • System ensures integrity and transparency

    • Authenticity of receivables, standardization, custody, legality of electronic contract, property rights transfer, settlement, etc.

  • Incipient market for discounting of pre-delivery orders

    • Banks take risk exposure to SME – agency problems bigger

    • System allows SMEs to build reputation (record of reliable delivery)

2.b. Innovative Public Banking – FIRA

  • Innovating beyond traditional 2nd tier lending

  • Examples:

    • Interest rate swaps with international markets – result in long-term, fixed-rate, local currency loans to small producers

    • Structured finance involving Cargill, sugar mills, small sugar producers, and banks – results in inventory financing

    • Structured finance involving shrimp exporting firm, feed suppliers, shrimp producers, and institutional investors – results in stable, affordable working capital financing

3. Questions for Research

  • Is there a clear value added to pro-market activist interventions by the public sector?

    • Will the private sector do it by itself? If not, why?

  • If there is a role for visible hand interventions, what is it?

    • Lender (1st or 2nd tier)? Risk sharer? Coordinator?

  • How to ensure professionalism, transparency, and accountability in interventions, given complexity of schemes?

  • How to minimize unintended consequences 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

3 questions for research
3. Questions for Research

  • Can idiosyncratic experiences lead to more general policy guidelines?

    • What are the key features that make these interventions work?

    • Can they be replicated to other sectors and other countries?

  • 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?