Download Challenges posed by underdeveloped financial

Challenges posed by underdeveloped financial
markets and instruments
Kevin Davis
Professor of Finance, University of Melbourne
Research Director, Australian Centre for Financial
Studies (and Professor, Monash University)
University of Melbourne 1
Outline
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Finance and Growth – the relationship
Finance – channels of influence
Impediments to financial development
Policy Options
University of Melbourne 2
Financial Development and Economic Growth
• Research indicates
financial development
causes faster
economic growth
– Although economic
development also
stimulates financial
sector growth
University of Melbourne 3
Financial Sector Functions
Market
frictions
• Information costs
• Transactions
costs
Financial
markets and
Intermediaries
Financial
Functions
• Mobilise savings
•
• Allocate resources
•
• Exert corporate
control
• Facilitate risk
management
• Ease trading of
goods, services,
contracts
Channels to
growth
Growth
Capital
accumulation
Technological
innovation
Source: Adapted from Levine (1997)
University of Melbourne 4
Functions of the Financial Sector
• Mobilize and pool savings for investment
• Ease the exchange of goods and services
• Create liquidity – reconciling long term needs of
users with short term preferences of savers
• Facilitate risk management – across
participants and across time
• Create price signals and information to guide
decisions on capital allocation
• Monitoring / disciplining recipients of funds to
ensure efficient and proper use of funds
University of Melbourne 5
Long run consequences: Finance and Growth
500
450
400
350
300
250
200
150
100
50
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
GDP (2% growth)
GDP (5% growth)
Cons (2% growth)
Cons (5% growth)
• Improved finance sector can increase growth through
• productivity growth by better allocation of funds
• encourage savings and investment
•
(example shows effect of higher investment rate and productivity)
University of Melbourne 6
Impediments to Financial Development
• Look at impediments to overcoming
information and transactions (including
contracting) costs.
Market
frictions
• Information costs
• Transactions
costs
Financial
markets and
Intermediaries
Financial
Functions
• Mobilise savings
•
• Allocate resources
•
• Exert corporate
control
• Facilitate risk
management
• Ease trading of
goods, services,
contracts
Channels to
growth
Growth
Capital
accumulation
Technological
innovation
University of Melbourne 7
Impediments to Financial Development
• Legal Systems
– Property rights and certainty of contract
– Access to courts and redress
• Information, Education, Financial Inclusion
• Accounting / Auditing and information reliability
• Economic Stability
– Redistributive effect of unexpected inflation
• & contracting problems when high inflation
– Macroeconomic fluctuations and default risks
• Financial Institution Safety / Prudential Regulation
• Regulation and Vested Interests
University of Melbourne 8
Regulatory Impediments
• Example: interest rate
ceilings
– Imposed to “protect”
borrowers
– Consequences:
• less funds available
for borrowers
• Poorer borrowers
rationed out
• Social loss
Interest rate
Supply
Ceiling
Demand
Loans
Lost opportunities
University of Melbourne 9
Regulatory Impediments
• Example: Capital account
restrictions
– Consequences:
• less funds available
for borrowers
– At higher interest
rate
• Social loss from
foregone profitable
investments
Interest rate
Domestic
Supply
rd
“world”
Interest rate
rw
Domestic
Demand
Loans
Lost opportunities
University of Melbourne
10
Vested Interests
Marginal
Cost =
Monopoly
Supply
• Financial system evolution
Interest rate
shaped by influence of
existing vested interests
Average
rm
• Example: existing
Cost =
monopolies lose profits if rc
Competitive
Supply
competition allowed
– Lobby to influence
legislators and protect
Demand
position
– Social loss – in addition
Loans
Lost opportunities
to redistributive effects
University of Melbourne
11
Retirement Financing Challenges
or
As economies become wealthier, family sizes shrink
And mortality improvements mean larger share of aged
University of Melbourne
12
Retirement Financing Challenges
or
• Less reliance on family support for aged
• Need for retirement savings – but individuals generally don’t!
• Increased call on government safety nets / pensions
• when aged dependents / working age population falling
• Rationale for tax incentives/compulsion/defaults for long term
retirement income saving
• Higher saving generates a pool of investable funds
• Potentially available for longer term investments
University of Melbourne
13
The Importance of Financial Consumer Protection
• Economic development generates increasing household
involvement with the financial sector
• Financial development leads to increasing complexity of
financial products and services
• Financial literacy is generally low
• Opportunities for miss-selling, overcharging are significant,
particularly given individuals’ gullibility and greed
University of Melbourne
14
Gullibility and Greed
A fundamental challenge of
Financial Consumer Protection
- Protecting individuals from themselves
- As well as from others!
If it’s too
good to be
true it
probably
is!
Fools and
their money
are easily
parted
University of Melbourne
15
The Importance of Financial Consumer Protection
• Economic development generates increasing household
involvement with the financial sector
• Financial development leads to increasing complexity of
financial products and services
• Financial literacy is generally low
• Opportunities for miss-selling, overcharging are significant,
particularly given individuals’ gullibility and greed
• Some providers of financial products, services, and advice
may have questionable ethics, governance, incentives
• Financial failures, scams, consumer losses reduce
confidence and cause sub-optimal use of the financial
sector
University of Melbourne
16
G20 Financial Consumer Protection Principles
1
Legal, Regulatory & Supervisory Framework
2
Role of Oversight Bodies
3
Equitable, Fair Treatment of Consumers
4
Disclosure and Transparency
5
Financial Education and Awareness
6
Responsible Business Conduct of Providers and Agents
7
Protection of Consumer assets against Fraud and Misuse
8
Protection of Consumer Data and Privacy
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Complaints Handling and Redress
10
Competition
The World Bank Good Practices for Financial Consumer Protection
(2012) provides guidance on practices at a sectoral level
Source: OECD
University of Melbourne
17
FCP Policy Underpinnings
• The legal/regulatory framework is crucial
– When can redress be sought?
• Strict “terms and conditions” v
“reasonable expectations”
• Abusive practices definitions
• Duty of care
– How can redress be sought?
• Individual legal action
• Class actions (and litigation funders)
• Legislated dispute resolution schemes
• Government agency (enforcement) role
University of Melbourne
18
Financial Development Opportunities
• Technological advance is changing (reducing)
information and transaction costs
– Past financial development patterns may
be less relevant
– Threats to existing business models
• Electronic finance not without its problems
– Cyber-crime; potential instabilities
University of Melbourne
19
Financial Development Opportunities
• Some potential areas of focus
– Micro-finance: social networks and
incentives
– Electronic payments: SMEs and financial
inclusion
– Information sharing: credit bureaus
– Retirement savings programs
University of Melbourne
20
Conclusions and Cautions
• Government policies for financial development
– Need for good “financial infrastructure”
• Law, politics, stability, financial system
– One size does not fit all
• Need to take account of existing social and
economic structure / constraints
– Need to recognise individuals have behavioural
biases
– Promoting competition is important
• But market imperfections are substantial
– Financial stability is not guaranteed
• Sound regulation / supervision essential
University of Melbourne
21
Thank You
Questions?
University of Melbourne
22