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Research Roundup (2008-2011): Finance & Private Sector Research

World Bank research on Finance and Private Sector Development focuses on understanding the role of the financial and private sectors in promoting economic development and reducing poverty, and identifying policies to improve their effectiveness. Finance research is organized around access to financial services and risk management and stability. Private sector research focuses on determinants of firm entry and performance to better understand the microeconomics of the growth process.PDF (374kb)


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 studies the channels through which access to finance can contribute to growth through promoting entrepreneurship, innovation, and the process of technology adoption.

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.


Have the rules of finance changed after the crisis?

The global financial crisis which started in 2008 challenged conventional thinking in areas of finance and private sector development, and continues to reveal key knowledge gaps. First, how do we ensure that financial systems are growth-promoting and inclusive, yet stable? What are the key tradeoffs? What roles do financial liberalization, regulation and supervision, and financial education play in this process? Second, are there optimal financial structures at different stages of the development process? What does this imply for the role of banking versus market development, banking structure, and size distribution? And finally, which policy interventions enhance the role of the financial and private sector in promoting development?[1]

Research on the causes of the crisis attributes a significant role to faulty microeconomic incentives.[2]  It has also investigated the implications of the crisis for macroeconomic and financial policies, emphasizing that the challenge of financial sector policies is to align private incentives with public interest without taxing or subsidizing private risk-taking. The analysis suggests that public ownership or regulation that is too aggressive would simply hamper financial development and growth. But clearly striking this balance is becoming increasingly complex in an ever more integrated and globalized financial system.[3,4]

Investigating the financial system trends in the boom period leading up to the global crisis shows that lower margins from traditional lines of business and the search for higher returns were only possible through high risk-taking, especially in high-income countries.[5]  Analyzing bank activity and funding strategies during this period also shows that overall, banking strategies that rely prominently on generating noninterest income or attracting nondeposit funding are very risky, consistent with the demise of the U.S. investment banking sector.  The recent financial crisis can also teach us lessons on bank capital regulation. During the crisis,[6] higher capital resulted in better stock performance, mostly for larger banks and less well-capitalized banks, suggesting that calls to strengthen capital requirements is broadly appropriate. The relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk-adjusted capital ratio, indicating how difficult it is to properly measure risk exposure for large and complex financial organizations. Finally, higher quality forms of capital, such as Tier 1 capital and tangible common equity are likely to provide more effective protection.[7]

Our research on re-examining the role of the state in the financial sector, particularly on regulation and supervision, ownership of financial institutions, competition policy and strengthening financial infrastructure is feeding into a new Bank publication, Global Financial Development Report, which is expected to position the Bank Group more prominently in policy discussions in the area of financial development.

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 special issue of the World Bank Economic Review documents barriers to access, and investigates the impact of access to finance on households and firms.[8] Theory and empirical evidence point to the critical role that improved access to finance has in promoting growth and reducing income inequality.[9]

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 Policy Research Report Finance for All? Policies and Pitfalls in Expanding Access, which was disseminated widely in 2008 in many of our client countries.[10]  One of the important messages of the report is on lack of data on financial inclusion. In 2010, the Bill and Melinda Gates Foundation gave a grant to the Development Research Group to construct a new public database on “Global Financial Inclusion Indicators,” to measure how the world’s poor, women, and other disadvantaged groups save, borrow and make payments. The goal of the project is to measure financial inclusion in a consistent manner over a broad range of countries and over time, and create a public dataset that can be used to motivate, formulate, and track global policy and progress to improve access to financial services, and hence contribute to the G-20 agenda on financial inclusion.

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 high rates of loan repayment, but 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 transaction 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.[11] Regulatory supervision is also an important issue affecting microfinance profitability and outreach.[12]

Do large and foreign banks serve small and medium businesses?  Conventional wisdom is skeptical.  But the data show that all types of banks are catering to SMEs and large, multiple-service banks have a comparative advantage in offering a wide range of products and services on a large scale, through the use of new technologies, business models, and risk management systems. Moreover, these patterns have not been derailed by the global financial crisis.[13,14

Role of financial literacy in raising demand for formal financial services in emerging markets. Financial literacy campaigns are increasingly heralded as the best way to increase demand for formal financial services in emerging markets. But do they work and for whom? One view argues that limited financial literacy stifles demand. A second view argues that demand is rationally low, because formal financial services are expensive and of relatively low value to the poor.

Original surveys and a field experiment in India and Indonesia show that financial literacy is a powerful predictor of demand for financial services. The relative importance of literacy and price was tested in a field experiment that offered randomly selected unbanked households financial literacy education crossed with a small incentive (US $3–$14) to open a bank savings account. The financial literacy program had no effect on the likelihood of opening a bank savings account in the full sample, but showed modest effects for uneducated and financially illiterate households. In contrast, small subsidy payments had a large effect on the likelihood of opening a savings account. These payments proved to be more than two times more cost-effective than the financial literacy training.[15]

Technology can help improve financial access: Biometric identification can increase loan repayment rates. In countries that lack a unique identification system, identity fraud—the use of someone else’s identity or a fictitious one—is a common means of gaining access to credit or other services. Lenders tell anecdotes of past borrowers purposefully defaulting and trying to obtain a fresh loan from the same or another institution. As a result, lenders have restricted the supply of credit. In a field experiment, randomly selected loan applicants had a fingerprint collected as part of the loan application. Such biometric technology can make the threat of future credit denial credible because it makes it easier for the bank to withhold new loans from past defaulters, and to reward responsible past borrowers with increased credit. The results show that fingerprinted borrowers have substantially higher repayment rates than other borrowers. This is particularly true among borrowers who have high default risk. The increase in repayment rates is due to both a reduction in adverse selection (fingerprinted high-risk borrowers took out smaller loans) and to lower moral hazard (fingerprinted borrowers diverted less of the loan from its intended purpose). A cost-benefit analysis of the pilot experiment suggests that the benefits from improved repayment greatly outweigh the costs of equipment and fingerprint collection.[16]

What is needed to promote firm growth and create jobs?

The recent financial crisis and the resulting high unemployment have sparked a renewed interest in government policies to create jobs and where job creation occurs.[17] In Mexico, business environment reforms as well expanding access to finance have created jobs by fostering entrepreneurship. Simplified business registration procedures led to an increase in the number of registered firms and raised employment by 2.8 percent.[18]  Research also shows that larger and broader reforms are better for stimulating new firm registrations. Countries that start out with high registration costs need larger reforms to induce a significant number of new registrations. These results suggest that small incremental reforms are not as effective as larger broader reforms in boosting the private sector.[19]  Opening banks for low-income individuals increased the number of informal businesses, which was also accompanied by a rise in employment, by 1.4 percent.[20

Recent labor market regulations on Chinese firms affected firm performance, labor wages, and job creation, leading to labor downsizing with negative short-term effects on productivity, but smaller productivity losses for smaller private firms compared to state-owned firms (though the reverse is true for wage losses), indicating a stronger profit incentive for private firms.[21]  Using new data—the World Bank Group Entrepreneurship Survey—and Enterprise Surveys research has also examined a broader set of policies and interventions that could promote entrepreneurial activity and create jobs.[22,23,24]

Microenterprises are an important source of employment in most developing countries. Yet few of the self-employed grow beyond subsistence level. A large share of employment in developing countries takes place in small and informal firms. The rapid expansion of microfinance is based on the belief that these firms have productive investment opportunities. Measuring the return to capital, however, is complicated by unobserved factors such as entrepreneurial ability and demand shocks. Researchers used a randomized experiment to measure the return to capital for microenterprises in Sri Lanka. They provided cash and equipment grants to randomly selected small firms and measured the consequent increase in profits from this extra capital. They find the average real return to be 4–5 percent per month, substantially higher than the market interest rate. Returns are highest for poor, high-ability owners.[25] The returns to capital from the grants vary dramatically by gender—large male-owned enterprises experienced higher capital returns then female-owned microenterprises.[26] One argument to explain this outcome is that female-owned enterprises are constrained by the sectors the owners operate in, and by household bargaining issues, suggesting job creation efforts also need to focus on the types of jobs created, not just whether there is a job.

Another constraint to the growth of small enterprises is often thought to be informality. Research in Bolivia shows large gains to small enterprises from formalizing, but only for those firms that are constrained by information or distance from registering their businesses. Sole proprietorships appear to not benefit from formalizing.[27]

Turning to productivity improvements in small and medium enterprises, research shows poor management skills can hamper firm productivity. Free management consulting was provided to a random sample of large Indian textile firms to measure the extent of poor management practices, and whether they can be changed. Another control sample was also monitored. Firms receiving consulting advice experienced large improvements in monitoring systems, quality control, and human resource practices. Average productivity rose by 11 percent through improved quality and efficiency and reduced inventory. And the adoption of decentralized decision making led to better information flows and enabled owners to delegate more day-to-day decisions to middle managers. Many of these practices were immediately profitable, so why had firms bypassed such low hanging fruit? The study finds that informational barriers were at play, and that constraints on firm entry and growth prevent badly managed firms from being driven from the market. Both types of constraints can be alleviated by policies that ensure better business education, a more vibrant local consulting industry, and the removal of barriers to multinational entry, which can potentially help reduce information barriers. Policies can also help reduce corruption and ease financing constraints, making it easier for better-managed firms to expand.[28]

All this research work is feeding into the 2013 World Development Report and the Knowledge Platform on Jobs, which focuses on job creation, taking a multi-sectoral approach.


Asli Demirgüç-Kunt, Senior Research Manager, Development Research Group, Development Economics Vice Presidency, World Bank (


  1. Demirgüç-Kunt, Asli, Douglas D. Evanoff and George G. Kaufman, ed. 2011. The International Financial Crisis: Have the Rules of Finance Changed? New Jersey: World Scientific Publishing Company.
  2. Caprio, Gerard, Asli Demirgüç-Kunt, and Edward Kane. 2010. “The 2007 Meltdown in Structured Securitization: Searching for Lessons, not Scapegoats.” World Bank Research Observer 25(1): 125–55.
  3. Demirgüç-Kunt, Asli, and Luis Servén. 2010. “Are All Sacred Cows Dead? Implications of the Financial Crisis for Macro and Financial Policies.” World Bank Research Observer 25(1): 91–124.
  4. de la Torre, Augusto, and Alain Ize. 2010. “Regulatory Reform: Integrating Paradigms.” International Finance 13(1): 109-139.
  5. Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2010. “Financial Institutions and Markets across Countries and over Time.” World Bank Economic Review 24(1): 77–92.
  6. Demirgüç-Kunt, Asli, and Harry Huizinga. 2010. “Bank Activity and Funding Strategies: The Impact on Risks and Returns.” Journal of Financial Economics 98(3): 626–50.
  7. Demirgüç-Kunt, Asli, Enrica Detragiache, and Ouarda Merrouche. 2010. “Bank Capital: Lessons from the Financial Crisis.” Policy Research Working Paper 5473, World Bank, Washington, DC.
  8. 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 include:
    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 María Soledad Martínez Pería. 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.
  9. Demirgüç-Kunt, Asli, and Ross Levine. 2009. “Finance and Inequality: Theory and Evidence.” Annual Review of Financial Economics 1: 287–318.
  10. World Bank. 2008. Finance for All? Policies and Pitfalls in Expanding Access. A World Bank Policy Research Report. Washington, DC: World Bank. Download Report | All PRRs 
  11. Cull, Robert J., Asli Demirgüç-Kunt, and Jonathan Morduch. 2009. “Microfinance Meets the Market.” Journal of Economic Perspectives 23(1): 167–92.
  12. Cull, Robert J., Asli Demirgüç-Kunt, and Jonathan Morduch. 2011. “Does Regulatory Supervision Curtail Microfinance Profitability and Outreach?” World Development 39(6): 949–65.
  13. de la Torre, Augusto, María Soledad Martínez Pería, and Sergio L. Schmukler. 2010. “Bank Involvement with SMEs: Beyond Relationship Lending.” Journal of Banking and Finance 34(9): 2280-93.
  14. Beck, Thorsten, Asli Demirgüç-Kunt, and María Soledad Martínez Pería. 2011. “Bank Financing for SMEs: Evidence across Countries and Bank-Ownership Types.” Journal of Financial Services Research 39(1): 35-54.
  15. Cole, Shawn, Thomas Sampson, and Bilal Zia. Forthcoming. “Money or Knowledge? What Drives Demand for Financial Services in Emerging Markets?” Journal of Finance.
  16. Giné, Xavier, Jessica Goldberg, and Dean Yang. Forthcoming. “Identification Strategy: A Field Experiment on Dynamic Incentives in Rural Credit Markets.” American Economic Review.  (Based on Policy Research Working Paper 5438, World Bank, Washington, DC.)
  17. Ayyagari, Meghana, Asli Demirgüç-Kunt, and Vojislav Maksimovic. 2011.  “Small vs. Young Firms across the World: Contribution to Employment, Job Creation, and Growth.” Policy Research Working Paper 5631. World Bank, Washington, DC.
  18. Bruhn, Miriam. 2011. “License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico.” Review of Economics and Statistics 93(1): 382–86.
  19. Klapper, Leora, and Inessa Love. 2010. “The Impact of Business Environment Reforms on New Firm Registrations.” Policy Research Working Paper 5493, World Bank, Washington, DC.
  20. Bruhn, Miriam, and Inessa Love. 2009. “The Economic Impact of Banking the Unbanked: Evidence from Mexico.” Policy Research Working Paper 4981, World Bank, Washington, DC.
  21. Dong, Xiao-Yuan, and L. Colin Xu. 2009. “Labor Restructuring in China’s Industrial Sector: Toward a Functioning Urban Labor Market.” Journal of Comparative Economics 37(2): 287–305.
  22. 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.
  23. Ayyagari, Meghana, Asli Demirgüç-Kunt, and Vojislav Maksimovic. Forthcoming. “Firm Innovation in Emerging Markets: The Role of Finance, Governance, and Competition.” Journal of Financial and Quantitative Analysis. (Based on Policy Research Working Paper 4157, World Bank, Washington, DC.)
  24. Djankov, Simeon.  2009. “The Regulation of Entry: A Survey.” World Bank Research Observer 24(2): 183-203.
    Djankov, Simeon, Tim Ganser, Caralee McLiesh, Rita Ramalho, and Andrei Shleifer. 2010. “The Effect of Corporate Taxes on Investment and Entrepreneurship.” American Economic Journal: Macroeconomics 2(3): 31-64.
  25. de Mel, Suresh, David McKenzie, and Christopher Woodruff. 2008. “Returns to Capital in Microenterprises: Evidence from a Field Experiment.” Quarterly Journal of Economics 123(4): 1329–72.
  26. de Mel, Suresh, David McKenzie, and Christopher Woodruff. Forthcoming. “Are Women More Credit Constrained? Experimental Evidence on Gender and Microenterprise Returns.” American Economic Journal: Applied Economics. (Based on Policy Research Working Paper 4746, World Bank, Washington, DC.)
  27. McKenzie, David, and Yaye Seynabou Sakho. Forthcoming. “Does It Pay Firms to Register for Taxes? The Impact of Formality on Firm Profitability.” Journal of Development Economics. (Based on Policy Research Working Paper 4449, World Bank, Washington, DC.)
  28. Bloom, Nicholas, Benn Eifert, Aprajit Mahajan, David McKenzie, and John Roberts. 2011. “Does Management Matter? Evidence from India.” Policy Research Working Paper 5573, World Bank, Washington, DC.

Last updated: 2012-02-29

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