Themes | Highlights | Team | Notes | Current Research Program | 2008 PublicationsThe Finance and Private Sector Development group focuses on understanding the role of the financial and private sectors in promoting economic development. Research on finance is organized around two dimensions-access to financial services and risk management and stability. Research on private sector development focuses on determinants of firm entry and performance to better understand the microeconomics of the growth process.
The research on access to finance-which is important in promoting growth and alleviating poverty-includes documenting and benchmarking access to financial services by small firms and poor households, and identifying underserved groups and analyzing barriers to building more inclusive financial systems.
Evaluative research is studying the channels through which access to finance can contribute to growth through promoting entrepreneurship, innovation, and the process of technology adoption. The goal is to evaluate the impact of firms' financing constraints and households' inability to access financial services on economic growth and poverty alleviation, and to identify different ways of improving this access, ranging from microfinance innovations to improving how mainstream financial institutions and systems function.
The research on risk management-which is important for ensuring the sustained effectiveness of financial systems and financial stability over the long run-investigates the impact of supervision strategies, as well as the impact of compliance with Basel Core Principles on bank stability, the interaction of bank insolvency resolution and deposit insurance policies, and the impact of financial globalization on bank efficiency and access to financial services. New work includes understanding the causes and implications of the recent financial crisis.
Research on the private sector focuses on firm dynamics-changes in the composition of the private sector and entry and exit over time-and performance, and how this affects firm productivity and growth. Special areas of focus include research on the determinants and consequences of informality, innovation, and governance as well as the impact of the business environment and its reforms. Future work will study features of the business environment and firm characteristics that may help enterprises better cope with and overcome the crisis.
The financial meltdown: root causes versus scapegoats
The intensity of recent turbulence in financial markets has surprised nearly everyone. But the search for scapegoats in policy circles has been diverting attention from the root causes of the crisis, which are closely associated with the underlying breakdown of incentives. These incentive conflicts explain how securitization went wrong, why credit ratings proved so inaccurate, and why it is superficial to blame the crisis on mark-to-market accounting, an unexpected loss of liquidity, or trends in globalization and deregulation in financial markets.
The research suggests some disturbing implications of the crisis for Basel II and its implementation. It is argued that the principal source of financial instability lies in contradictory political and bureaucratic incentives that undermine the effectiveness of financial regulation and supervision in every country in the world. Reforms should aim to improve incentives through increasing transparency and accountability in government and industry alike.1
Financial services remain out of reach for many in developing countries
Data show that more than half of people in developing countries face financial exclusion due to high barriers in accessing financial services. A recent issue of the World Bank Economic Review brings together papers documenting barriers to access, and investigating the impact of access to finance on households and firms.2 Theory and empirical evidence point to the critical role that improved access to finance has in promoting growth and reducing income inequality.
Papers in the symposium developed first estimates of financial outreach across countries, assembled evidence on the impact of finance on firm performance, and presented initial results on techniques and products to reach out to micro-borrowers and savers, including insurance. These papers were some of the background research for the recent Policy Research Report Finance for All? Policies and Pitfalls in Expanding Access, which was disseminated widely in 2008 in many of our client countries.
Deposit insurance is not always a good idea
Recent financial turmoil has pushed the issue of explicit deposit insurance systems back to the center of debates on regulatory policy in both developing and industrialized countries. Explicit deposit insurance is widely held to be a crucial element of modern financial safety nets, and outside experts frequently recommend it to countries undergoing reform. Predictably, explicit deposit insurance systems have proliferated in the developing world. A new book challenges the wisdom of encouraging countries to adopt deposit insurance in the absence of a strong institutional environment to balance the benefits of preventing crises and the costs of controlling bank and customer risk-taking.
The evidence and analysis confirm that deposit insurance is strong medicine. While it can be a useful part of a country's overall system of bank regulation and financial markets, research stresses the importance of establishing three preliminary steps before adopting explicit deposit insurance: promptly identifying and eliminating individual bank insolvencies, fostering informative accounting standards, and establishing reliable procedures for contract enforcement. Research also underlines the importance of building in a capacity and incentives for deposit insurance managers so that they can adapt dynamically to financial changes.3
A good regulatory environment can promote entrepreneurial activity
New data from the 2008 World Bank Group Entrepreneurship Survey indicates a strong and statistically significant relationship between entrepreneurship and a better business environment.4 Data on the number of total and newly registered corporations over an 8-year period (2000-2007) for 100 countries was collected from a worldwide registrar of companies. Data was also collected on the functioning and structure of business registries. After controlling for economic development (GDP per capita), higher entrepreneurial activity is significantly associated with cheaper, more efficient business registration procedures and better governance indicators.
Although the degree of progress in the modernization of business registries varies greatly, most countries are actively moving away from a paper-based business registry to a one-stop, automated, web-enabled registry capable of delivering products and services online. Our tests show that business registry modernization (often a component of broader private sector reforms) has a positive impact not only on the ease of creating a business, but also on new business registration. Overall, the data show that a quick, efficient and cost-effective business registration process is critical to fostering formal sector entrepreneurship.
Microfinance meets the market, but with high transaction costs
Microfinance institutions have proved the possibility of providing reliable banking services to poor customers. Their second aim is to do so in a commercially viable way. Research analyzed the tensions and opportunities of microfinance as it embraces the market, drawing on a dataset that includes 346 of the world's leading microfinance institutions and covers nearly 18 million active borrowers.
The data show remarkable successes in maintaining high rates of loan repayment, but the data also suggest that profit-maximizing investors would have limited interest in most of the institutions focusing on the poorest customers and women. Those institutions, as a group, charge their customers the highest fees in the sample but also face particularly high transactions costs, in part due to small transactions sizes. Innovations to overcome well-known information problems in financial markets were a triumph, but further innovation is needed to overcome the challenges of high costs.5
1. Caprio, Gerard, Asli Demirgüç-Kunt, and Edward Kane. 2008. "The 2007 Meltdown in Structured Securitization: Searching for Lessons not Scapegoats." Paper prepared for the joint IMF-WB Conference on Risk Analysis and Management, October 2-3. Conference Web Site.
2. Beck, Thorsten, and Asli Demirgüç-Kunt, ed. 2008. "Special Issue: Access to Finance." World Bank Economic Review 22(3, October).
Selected articles from this issue:
Ayyagari, Meghana, Asli Demirgüç-Kunt, and Vojislav Maksimovic. 2008. "How Important Are Financing Constraints? The Role of Finance in the Business Environment." World Bank Economic Review 22(3): 483-516.
Beck, Thorsten, and Asli Demirgüç-Kunt. 2008. "Access to Finance: An Unfinished Agenda." World Bank Economic Review 22(3): 383-96.
Beck, Thorsten, Asli Demirgüç-Kunt, and Maria Soledad Martinez Peria. 2008. "Banking Services for Everyone? Barriers to Bank Access and Use around the World." World Bank Economic Review 22(3): 397-430.
McKenzie, David, and Christopher Woodruff. 2008. "Experimental Evidence on Returns to Capital and Access to Finance in Mexico." World Bank Economic Review 22(3): 457-82.
Gine, Xavier, Robert Townsend, and James Vickery. 2008 "Patterns of Rainfall Insurance Participation in Rural India." World Bank Economic Review 22(3): 539-66.
3. Demirgüç-Kunt, Asli, Edward J. Kane, and Luc Laeven. 2008. Deposit Insurance around the World: Issues of Design and Implementation. MIT Press. Download chapter 1| Order the book
4. Klapper, Leora, Raphael Amit, and Mauro F. Guillén. Forthcoming. "Entrepreneurship and Firm Formation across Countries." In International Differences in Entrepreneurship, ed. Joshua Lerner and Antoinette Schoar. Cambridge, Mass.: National Bureau of Economic Research.
Download Chapter | Web Site | Database | Research Brief
5. Cull, Robert, Asli Demirgüç-Kunt, and Jonathan Morduch. Forthcoming. "Microfinance Meets the Market." Journal of Economic Perspectives.
Cull, Robert, Asli Demirgüç-Kunt, and Jonathan Morduch. 2008. "Microfinance Meets the Market." World Bank Research Digest 2(4, Summer): 6.