Innovative Experiences in Access to Finance: Market Friendly Roles for the Visible Hand?

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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

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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.

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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

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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

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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

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Conceptual Building Blocks (cont.)

• 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

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Role of the State Alternative Paradigms

• 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

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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

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Illustrative Experiences from Latin America

• 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)

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NAFIN Internet Based Receivables Finance The
Problem

• 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

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

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FIRA Working Capital Financing The Solution
Functioning of Working Capital Structured Scheme
Transfer of credit rights
100
OCEAN GARDEN
BANKS
100
Participation certificates
TRUST FUND
Loan for working capital 100
Supply Agreement
Payments
FIRA
SHRIMP FEED SUPPLIERS
Feed
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FIRA Working Capital Financing The Solution
(cont.)
Functioning of Working Capital Structured Scheme
in Case of Default
Global guarantee (up to 25 of total fund value)
OCEAN GARDEN
BANKS
Guarantees (49)
TRUST FUND
Second loss guarantee (46)
Default on supply agreement
Individual guarantee (9)
Individual guarantee (15)
FIRA
SHRIMP FEED SUPPLIERS
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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

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FIRA Inventory Financing The Solution
Functioning of Scheme
SUGAR MILL
Funded Participation Agreement
BANKS
80
CDs Repo
80
CARGILL
Inventories 100
CDs 100
Screening and Monitoring
WAREHOUSES
FIRA
Sugar Inventories
Margin Calls
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FIRA Inventory Financing The Solution (cont.)
Functioning of Scheme in Case of Default
BANKS
SUGAR MILL
Loss3.2
Default
Guarantee 76.8
CARGILL
Put option 64
Inventories (book value 100, market value ?)
FIRA
WAREHOUSES
Inventories (book value 100 market value ?)
Loss12.8
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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 (2nd tier), risk-sharer (for a price),
  coordinator, subsidy provider?
• How to ensure professionalism, transparency, and
  accountability in interventions, given complexity
  of schemes?

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Questions for Future Policy Research (cont.)

• 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?

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• END