Optimal Financial Sector Architecture: Issues for Discussion

1
Optimal Financial Sector Architecture Issues for
Discussion

• Armine Khachatryan
• Prepared for AIPRG Conference Monetary and
  Financial Sector Policies and Challenges.
• April 2006

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The power of the finances...

• Finance can not create opportunities. It only
  makes it easier to exploit them what it can do
  is identify the areas of opportunity to decline
  and achieve a better match by giving to sectors
  with a future while taking away from those with
  only a past. Finance can find and mold that clay
  of opportunity, but it cannot create the clay
  itself.
• Saving Capitalism from the Capitalists
• R.G. Rajan and L. Zingales

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Issues for discussion

• Should financial sector development be considered
  as a reflection of a broader economic and
  political developments?
• Should policymakers promote bank-based or
  market-based financial systems? Comprehensive or
  targeted reforms.
• Do the benefits from creation of all elements of
  financial system outweigh the costs born by the
  economy and the society as a whole?
• How to prioritize the reforms in the financial
  sector, the role of the donor society in meeting
  the needs of this vital process?

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The role and the impact of the real sector on
financial sector development

• Overall, it become a conventional wisdom that the
  success and the failure of the financial system
  is a reflection of the same processes in the
  real sector of the economy.
• It is even more important to consider the impact
  of the private/corporate sector on the
  effectiveness and overall health of the
  financial institutions, although often this area
  is undermined by many reformists in transition
  economies.
• Butis this the right angle for discussion?,
  many economists also prove that the financial
  sector development precedes rather than follows
  the economic growth.

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Bank-based, market-based is there a trade-off?

• With the evolution of the financial
  intermediation, informal finances become less
  important and the bank intermediation takes over.
  
• While in most of the countries the formal
  financial system is bank dominated, the role of
  the capital market tends to increase with the
  improvement of the economic functioning of
  entities and the development of the country as a
  whole.
• The need to design financial systems of
  transition economies gave new look to the debate
  of advantages and disadvantages of bank-based
  financial system versus market-based system.

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Bank-based , market-based is there a trade-off?

• Developed capital market creates strong
  preconditions for increase of competition in
  corporate and financial sectors it provides
  equal rules of information disclosure for all
  market participants, and ability to diversify
  risks and customize risk management
  devices(WER, 2002).
• At the same time, even in developing country with
  poor legal framework and contract enforcement
  mechanisms powerful bank may have strong impact
  on information disclosure of borrowers and can
  force them to pay their debts (Rajan, Zingales).

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Bank-based , market-based is there a trade-off?

• However, neither country-nor industry- or
  company-level studies reveal substantial
  empirical support for the impact of the financial
  structure on cross-country differences in
  economic growth, economic performance or the
  performance of a single company.
• The key explanation here is that banks and
  capital markets have different sets of
  requirements for information disclosure, contract
  enforcement, etc.(examples)

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Bank-based , market-based is there a trade-off?

• The question to answer What is ultimately
  important?
• Financial services view (Levine, 1997, 2002)
• Law and finance view (La Porta, Schliefer and
  others)

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Issue for discussion one

• In order to implement policies aimed to support
  financial sector development, it is necessary to
  create a legal and regulatory environment for
  demand driven evolution of the financial
  structures. Here, the key conditions are the
  various components of private property protection
  (examples).
• Conceptually this fits into both bank and market
  based systems, since none of them can function
  without strong property protection mechanisms and
  their enforcement.

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Other aspects affecting the financial sector
development

• Political systems and differences associated with
  the division of the power between state and
  private property holders,
• Competitiveness within the countrys economic
  units and the ability of country to compete in
  the international business community,
• Monetary and fiscal policies, debt strategy and
  institutional support
• Prudential regulation (self-imposing regulations)
• Securing the transactions (collateral laws)
• Market infrastructures

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Benefits and costs of financial sector reforms

• The transition started less than two decades ago,
  however in many instances policymakers expected
  immature markets and institutions to accomplish
  unattainable goals. This condition resulted in
  enormous vast of resources and energy.
• While the problems of financial sector
  development seem to be identical in emerging and
  transition economies, the transition economies
  are not analogous to traditional developing
  countries(BOFIT Discussion Papers, 9/2002).

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Issues for discussion II

• The role of the economies of scale in designing
  financial sector reforms. Full scale or targeted
  adjustment?
• Is it likely for small countries to develop full
  spectrum of financial market segments and
  institutions? If not, does access to foreign
  capital and global financial markets replace the
  domestic institutional development?
• Comprehensive or scattered reforms? (the role of
  governments ownership and commitment)
• Model of financial system regulation( integrated,
  risk based, etc.)

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Issues for discussion III

• Evolutionary versus revolutionary strategies,
• Costs of improper legal initiatives and
  unfinished reform agenda (example)
• The role of donor society, concepts, agreements,
  commitments and coordination.

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What is next?

• Defining a broad vision,
• Provision of theoretical and empirical support on
  a cross-country and cross-sectoral level,
• Analysis for Armenia policy choices and
  simulation of several development scenarios.

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What is next?

• The future belongs to those who believe in beauty
  of their dreams
• E. Roosevelt
• The future belongs to us..