Chapter 4

Bank and Nonbank Financial Institutions as Providers of Long-Term Finance

KEY MESSAGES

• There are significant and informative differences in the maturity holdings across different types of financial intermediaries and across countries. Overall, the evidence suggests that extending maturities through financial institutions in developing countries is more difficult than is usually thought.
• First, despite their advantage due to relationship lending, banks in developing countries do not seem to have compensated for the potential information asymmetries and other market failures prevalent in these countries. Their loans have significantly shorter maturities than those in high-income countries. Even in weak institutional settings, however, establishing a well-regulated, contestable, and private banking system with stable and long-term sources of funding is associated with the provision of longer-term maturity debt.
• Second, the development of large and sophisticated nonbank intermediaries does not guarantee an increased demand for long-term assets. Evidence from Chile shows that domestic mutual and pension funds tend to invest short term, especially when compared with insurance companies. Short-term strategies seem to arise from market and regulatory mechanisms that monitor managers on a short-term basis and give some of them incentives to invest shorter term.
• third, international evidence on mutual funds suggests that foreign investors hold more longterm domestic debt than domestic investors. Thus, it might be difficult to extend the maturity structure toward the long term by relying only on domestic mutual funds.
• Fourth, although sovereign wealth funds (SWFs) have grown rapidly, their overall investments remain concentrated in liquid-asset classes in high-income countries, while thin capital markets, as well as political and economic risks, still limit the role of SWFs as providers of long-term finance in developing countries.
• Fifth, private equity (PE) investments are an increasingly important source of entrepreneurial finance in developing countries. However, PE investments are relatively small and are heavily dependent on the institutional quality and depth of capital markets in the country of investment. This limits their viability as a source of long-term finance in many economies.

RELATED LINKS

• Acharya, Sushant, and Alvaro Pedraza. 2015. “Asset Price Effects of Peer Benchmarking: Evidence from a Natural Experiment.” Staff Report 727, Federal Reserve Bank of New York, New York.
• Divakaran, Shanthi, Patrick McGinnis, and Masood Shariff. 2014. “Private Equity and Venture Capital in SMEs in Developing Countries: The Role for Technical Assistance.” Policy Research Working Paper 6827, World Bank, Washington, DC.
• Gelb, Alan, Silvana Tordo, Havard Halland, Noora Arfaa, and Gregory Smith. 2014. “Sovereign Wealth Funds and Long-Term Development Finance: Risk and Opportunities.” Policy Research Working Paper 6776, World Bank, Washington, DC.
• Opazo, Luis, Claudio Raddatz, and Sergio Schmukler. 2015. “Institutional Investors and Long-Term Investment: Evidence from Chile.” Word Bank Economic Review 29 (2).
• Pedraza, Alvaro. Forthcoming. “Strategic Interactions and Portfolio Choice in Money Management: Theory and Evidence.” Journal of Money Credit and Banking.
• Randle, Tony, and Heinz Rudolph. 2014. “Pension Risk and Risk-Based Supervision in Defined Contribution Pension Funds.” Policy Research Working Paper 6813, World Bank, Washington, DC.
• Heinz Rudolph. 2014. “The Role of Savings in the Provision of Retirement Income.” In The Inverting Pyramid: Pensions Systems Facing Demographic Challenges in Europe and Central Asia, edited by A. Schwarz and O. Arias, 115–56. Washington, DC: World Bank.
• Stewart, Fiona. 2014. “The Use of Outcome-Based Benchmarks: Proving Incentives for Long-Term Investment by Pension Funds.” Policy Research Working Paper 6885, World Bank, Washington, DC.