Policies to broaden access

Since expanding access remains an important challenge even in developed economies, it is not enough to say that the market will provide. Market failures relating to information gaps, the need for coordination on collective action and concentration of power mean that governments across the world have an important role to play in building inclusive financial systems.

However, not all government action is equally effective and some policies—such as overly relaxed credit policies—can even be counterproductive. Hence it is important for governments to have realistic goals.

Deep institutional reform ensuring, above all, security of property rights against expropriation by the state is an underlying, albeit often long-term, prerequisite for well-functioning financial systems. Can we prioritize institutional reforms to broaden access in the short to medium term?  Recent evidence suggests that:

• In low income countries, establishing credit registries to improve the information infrastructure matters more than improving creditor rights. 
• In relatively underdeveloped institutional settings, reforms that enable an individual lender to recover on debt contracts (for example, those related to collateral) are more important in boosting bank lending than reforms related to resolving conflicts between multiple claimants, such as bankruptcy codes.
• Introducing specific legislation to underpin modern financial technology, from leasing and factoring, to electronic-finance and mobile-finance—will also produce results in the short- to medium-term.

Encouraging openness and competition – including private ownership and foreign entry -is also an essential part of broadening access, as it encourages incumbent institutions to seek out profitable ways of providing services to the previously excluded segments of the population. It also increases the speed with which access-improving new technologies are adopted.

Providing the private sector with the right incentives is important, as competition can also result in reckless or improper expansion if not accompanied by proper regulatory and supervisory framework. As the increasingly complex international regulations—such as  Basel II—are imposed on banks to help minimize the risk of costly bank failures, it is important to ensure that these arrangements do not inadvertently penalize small borrowers by failing to make full allowance for the potential for a portfolio of SME loans to achieve risk-pooling. 

Research suggests that while banks making small loans have to set aside larger provisions against the higher expected loan losses from small loans – and therefore they need to charge higher rates of interest to cover these provisions – they should need relatively less capital to cover the upper tail of the distribution, i.e. to support the risk that losses will exceed their expected value (to cover what are sometimes known as “unexpected” loan losses).

The scope for direct government interventions in improving access is more limited than often believed. While there is a large body of evidence that suggests interventions through government-owned subsidiaries to provide credit have generally not been successful, the experience has been more mixed for non-lending services.

Further, a handful of government financial institutions have moved away from credit, and evolved into providers of more complex financial services, entering into public-private partnerships to help overcome coordination failures, first-mover disincentives, and obstacles to risk sharing and distribution.  Ultimately, these successful initiatives could have been undertaken by private capital, but the state has had a useful role in jump-starting these services. 

Direct intervention through taxes and subsidies can be effective in certain circumstances, but experience suggests that they are more likely to have large unintended consequences, more so in finance than in other sectors.  For example, with direct and directed lending programs discredited in recent years, partial credit guarantees have been the direct intervention mechanism of choice for SME credit activists.  However, these are often poorly structured, embody hidden subsidies, and benefit mainly those who do not need the subsidy.  In the absence of thorough economic evaluations of most schemes, their net effect in cost-benefit terms thus remains unclear.