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Contractual Savings and Financial Markets. Alberto R. Musalem, Gregorio Impavido and Thierry Tressel Financial Sector Development Department Financial Sector Vice Presidency The World Bank. Definition and Importance of Contractual Savings. Funded pensions plans: accumulation period

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contractual savings and financial markets

Contractual Savings and Financial Markets

Alberto R. Musalem, Gregorio Impavido and Thierry Tressel

Financial Sector Development Department

Financial Sector Vice Presidency

The World Bank

definition and importance of contractual savings
Definition and Importance of Contractual Savings
  • Funded pensions plans: accumulation period
  • Annuities: pensions pay out
  • Life insurance
  • Funded unemployment benefits, gratuity, end of service indemnity
  • Other contingencies - down payment for a house, education, weddings, funerals
  • Supply long term savings
financial market effects
Financial Market Effects
  • Increase demand for shares and bonds, market capitalization and volume traded: increase depth and liquidity
  • Increase demand for long term bonds
  • Increase supply of long term loans
  • Improve regulations and transparency
  • Foster financial innovation, competition and efficiency
  • Improve corporate governance
causality
Causality
  • In countries with developed capital markets, direction of causality between contractual savings and either market capitalization or value traded is not clear.
  • In countries with underdeveloped capital markets, either contractual savings causes market capitalization and value traded, or causality runs both ways.
  • In developing countries, pension funds cause market capitalization while life and non-life insurance cause value traded.
  • In Malaysia and Singapore there is no causality in either way between institutions and mkt capitalization or value traded.
market capitalization
MarketCapitalization
  • Estimator: Error Components 2 Stage Least Square (EC2SLS), N=281, 26 unbalanced panels (21 OECD and 5 non-OECD countries, 1975-97)
  • Positive impact: contractual savings, non-life ins., value traded, real return on stocks
  • Negative Impact: real return on money, real interest rate, book reserves, stock price index volatility
  • Step dummy: developing countries with positive coefficient
  • Endogenous variables: asset returns
  • Exogenous variables: all other
  • Diagnostics: various specification tests passed
value traded
Value Traded
  • Estimator: EC2SLS, N=233, 26 unbalanced panels (21 OECD and 5 non-OECD countries, 1975-97)
  • Positive impact: contractual savings share portfolio, non-life insurance share portfolio, real return on money
  • Negative impact: real interest rate
  • Step dummy: developing countries with positive coefficient
  • Diagnostics: various specification tests passed
national saving effects
National Saving Effects
  • Mandatory plan and credit constraints increase household saving but watch welfare effects
  • Non-captive funding for public sector promotes its saving
  • Significant shift to funding promotes saving
  • Transition cost financed by cutting the non-pension public sector deficit increases Government saving
  • System coverage and retirement ages are increased
  • Uncertain effect from voluntary plan (tax incentive)
contractual savings and growth
Contractual Savings and Growth
  • Potential increase in saving
  • Decline in the cost of capital: equity and debt
  • Flatten the term structure of interest rates
  • Reduce the country risk premium
  • Promote efficiency gains
  • Virtuous cycle: higher growth increases saving thus furthering growth
social and financial risk mitigation effects
Social and Financial Risk Mitigation Effects
  • Beneficiaries improve management of longevity, death and other risks
  • Reduce debtors refinancing risks, including governments, by lengthening the maturity of debts
  • Reduce pressure on banks to engage in excessive term transformation risks
  • Reduce enterprise vulnerability to interest rate and demand shocks due to improved financial structure (higher equity/debt ratio)
  • Reduce capital markets volatility
slide16

Long-term to total debt ratio of listed companiesand contractual savings assets, 1997 (% GDP)

slide17

Leverage (TDTE) vs Contractual Savings: Conditional Correlation - Market-based Financial Structure

Residual = -1.16 * (CS Fin. Assets, % Sec. Market) (t-stat = -2.47) Pooled reg., 82 obs.

slide18

Leverage (TDTE) vs Contractual Savings: Conditional Correlation - Bank-based Financial StructureResidual = 4.0 * (CS Fin. Assets, % Sec. Market) (t-stat = 2.37) Pooled regression, 74 obs.

slide19

Debt Maturity vs Contractual Savings: Conditional Correlation - Market-based Financial StructureResidual = -0.09 * (CS Fin. Assets, % Sec Mkt) (t-stat = -3.84) Pooled regression, 82 obs.

slide20

Debt Maturity vs Contractual Savings: Conditional Correlation - Bank-based Financial StructureResidual = 0.28 * (CS Fin. Assets, % Sec Mkt) (t-stat = 5.28) Pooled Regression, 74 obs.

development of contractual savings institution
Development of Contractual Savings Institution
  • Reform pension systems to increase funding
    • Mandatory: privately or publicly managed
    • Voluntary
    • Regulation and supervision of pension funds: allow banks and life insurance companies to market pension plans
    • Tax treatment
  • Developing life insurance
    • Regulation and supervision: allow banks to market insurance
    • Tax treatment
slide24

Pension funds portfolio composition

Source: OECD Yearbook of institutional investors and WB database

slide25

Pension funds portfolio composition (Common Law)

Source: OECD Yearbook of institutional investors and WB database

slide26

Pension funds portfolio composition (non-Common Law)

Source: OECD Yearbook of institutional investors and WB database

slide27

Pension funds portfolio composition (MYS and SGP)

Malaysia: EPF

Singapore: CPF /1

Notes: 1/ 100% of assets are invested in non-tradable govt. securities. Money is channeled through the Consolidated Fund to investment holding companies of the Singapore Government. No public disclosure of their operations is required or made.

Source: WB database

slide28

Share of long-term bonds in bonds portfolio

Source: OECD Yearbook of institutional investors and WB database

slide29

Share of foreign bills and bonds in bills and bonds portfolio

Source: OECD Yearbook of institutional investors and WB database

slide30

Share of foreign stocks in stocks portfolio

Source: OECD Yearbook of institutional investors and WB database