Learning Outcome Financial Systems and Policies Major Functions of Financial Policy in a Developing Country By the end of this chapter you should be abe to: * Discuss the major functions of financial policy in a developing country Discuss how the role offi a developed country ancial policy differs in a developing and but that apply to and take account of the specific features and role of individual nancial policies ‘sectors, must tailor those policies to achieve the objectives of Acaqiring information and or the “emergence of financial markesand Financial systems therefore human development Many factors influence the incentives to invest and, therefore, the level and structure of intended investments. However, some, or 4 substantial share, of those intentions may remain unrealized, potentially viable, This has obvious implications for growth, In developing countries, financial policy should. ‘and while ensuring that their presence an nd/or operations do not render the system ff and crisis-prone in the long run, becas nancial markets are not ike those for ‘loan oran insurance contract isnot a» |——— (of all types and sizes). Similarly, the system must ensure availability of information which is central to the effective functioning of finat of information needs to be available to which groups of society? Ove attracting foreign capital flows, have liberalized policies gs the last two to three decades, many developing countries, intent on presence and activities of foreign financial firms in their domestic financial sectors. One likely consequence that has received considerable attenti¢ an increase in financial fragility an the likelihood of currency and financial The implementation of financial policies canbe ne ES {GB Definition and formulation ofthe main objectives and specification of potential and immediate tasks that must be addressed to achieve goal 18 Wewiscation of key areas of financial resources, and development of be devised and implemented. Such iil”140 tthe 0 isp Mt would be wrong to assume that a stabilization policy automatically replaces @ situation in moderate financial policy in order solely to balance the economic the country, as there are major differences between these two concepts. ‘FOPERAABIA 2 policy of economic growth may be ‘when, typically, a country has already exceeded the volume of prod ropriate at a time duction ential, while a stabilization policy and production is approaching its full po ‘would not be helpful in such a situation and might even restrict growth of production capacity 1 py TT a! mi equal to | percent of GDP typically reduces GDF by about @iSipereenty within two years and raises. the \ decline in the real value of the domestic currency, plays an dation ‘perecntagespoin. However This is partly Beeaiie? central banks usually provide substantially more stimulus follow spending-based contraction than following a tax-based contract “Monetary stimulus sp as the value-added tax, VATLeaming Outcome Financial temeison ——— Financial Systems and Policies cial Intermediation By the end of this chapter you should be able to Define the concept of financial intermediation .ctors hampering financial intermediation and discuss Discuss the its impact on the operation of a finan ss A financial intermediary isa financial institution ——— The classi ‘ofa financial intermediary is ‘a bank that ‘Often the agents doing the saving in the economy are not the same as those doing the investing (for example, households save, but firms invest). BANKS If tive, people do (the real interest rate is ne not trust banks, et.) As such, nel funds from people who have extra money financial intermediaries ch (savers) 10 those who do not have enough money to carry out a desired activity (borrowers). The! is the share of financial assets of financial Financial intermediaries also Financial intermediaries pA ajor functions” Converting short-term liabilities to long-term numbers of lenders and borrowers, and reconcile their conflict ds) Conversion of risky investments into relatively risk-free ones (e.g ssets (banks deal with lending to multiple borrowers to spread the risk), Matching small deposits with large loans and large deposits with small loans, 1142 MURA atproteticdt the conflicting needs of lenders and borrowers are reconeiled, preventing market failure | 2WURRGVEHSION! Intermediaries help spread and decrea ‘SE UBonoMeS OF SEAR! Using financial interme of lending and borrowing ‘AUERORGHAIES GF SeOPE! Intermediaries concentrate on the demands of the Tenders and borrowers and are able to enhance their products and diaries reduces the costs services (ase same inputs to produce diffrent outputs) Financial intermediaries a eT This mittens arses primarily By abouitiloan projects financial intermediaries snus ita orang. Acorn. HEE the ev! the severity of the Great Depression was due in part to the loss of intermediary, services suffered when the banking system collapsed in 1930-337Financial Systems and Policies Chapter Financial Disintermediation, Deepening, Repression and Shallow Finance Learming Outcome By the end ofthis chapter you should beable Discuss the concept of financial disintermediation ‘Define the concept of shallow finance Define the concept of financial repression ‘= Define the concept of financial deepening, Financial deepening 7 : he term also ret tothe nd Itcan also play an Financial deepening and inereased financial intermediation have their G86 ‘wher economies develop and become more complex, but they are not virtues” mtemselves In al economies, the value of financial ‘omits ability to ease transactions, and his pig that there are and that Autonomously evolved financial systems may not be the most appropt ) since they can reflect the imperfections and inequities of the economic base from whieh they emerge. In practice, there are a numberof e688 why autonomously evolved and unregulated financial sectors can be inappropriate from a developmental point of view. For @xatpl informal financial structures in backward and predominantly elect the unequal distribution of assets and economic power an deredit markets, operate in ways tha nding inimical 10 productive investment. Similarly, autonomously evolved finaneial structures the inter-tinking of land, labor choices influenced by considerations that put at risk the savings of uninformed depositors. Aeeording to DiazsAlejandro(1986:13-14), 3 Financial Dasatrnedinion, Depeing, Represion and Shallow Fiance .144 ‘TOR Chive aia nani shallow GEORG here naxion had wiped out the rel value of deb, o an excessively financially deep economy where creditors owned avery large share of real wealth, a clear case of Yoo much debt and too litle equity’ which were hardy arms length, were responsible forthe high use of debt by private firms within the private sector, extreme indebtedness was found among those that controlled banks houses, the largest private company mutual funds, broker pension funds and the two largest private commercial banks. Many b ster or more oftheir resources to affiliates ‘Such concentration of credit in related enterprises not only results in exclusion of other potential borrowers, but also in lending driven by criteria other than exposure that can lead to default economic or even social returns and in 0 [Reference: UNDESA - Financial Policies’ Notes - 2007 by C.P. Chandrasekhar] ‘Finaneial-Disintermediation’ Disintermesiation is the Amoval OF intennediaies om a process? ‘emergence of disintermediation is the Financial disintermediation #6808? eb ramesramee This situation exists when depositors withdraw: their savings from financial institutions and invest the money diectiyin the market placé This is done usually because they ean obtain a 7 A shallow financial depth (FD) hat the Itisa hat Under shallow finance, the however, capping the nominal interest rate will (especially if there is inflation, which reduces the are cameled though intermediaries, the post sous are aterallosaend ‘would go elsewhere. Financial repression can be particularly effective at liquidating debt Sots an Baking Regulatos| Reference BooFinacial Dsintrston, Deen. Repression nd Shallow Finan The term *finanal FepResSion? was first f The term is see However, the same techniques were also Ce reer particularly after World War lana vvhen such direct goverment intervention i markets fell out of favor. Financial repression may consist ofthe following REFINERS for control over interest rates, such as on (Bh otc nt goverment de and deposits {29 Coverment ownership or eorrl of domes banks and Manca institutions while placing barriers to entry before other institutions seeking to enter the market Creation or maintenance of a captive domestic market for government debt achieved by requiring domestic banks to hold government debt via reserve requirements, or by prohibiting or by removing any incentives of alternative options that institutions might otherwise prefer. {AP Government restrictions on the transfer of assets abroad through the imposition of eapital controls. STEELS once ro ee rate evn i = ise oe "ghee one iguidates) or Thus, financial repression is most eins doseoF inflation and it can be considered a form of taxations Showed that finanial repression and areter than 3% for five countries. For Pakistan, Sri Lanka, and Zimbabwe) i tcreveni! In the case of MER, 40% of tax reveies (India, Mexico,