Chapter 1

Conceptual Framework, Stylized Facts, and the Role of the Government


  • Long-term finance—defined here as any source of funding with maturity exceeding at least one year—can contribute to economic growth and shared prosperity in multiple ways. Longterm finance reduces firms’ exposure to rollover risks, enabling them to undertake longerterm fixed investments, contributing to economic growth and welfare. Access to long-term financial instruments allows households to smooth income over their life cycle—by investing in housing or education, for example—and to benefit from higher long-term returns on their savings.
  •  Firm and household data show limited use of long-term finance in developing countries, particularly among poorer households and smaller firms. As financial systems develop, the maturity of external finance lengthens. Banks are the main providers of long-term finance and the share of their lending that is long term increases with countries’ income. As countries’ income grows, economies have more developed capital markets and institutional investors that can support long-term finance.
  • The use of long-term finance reflects both the demand for and supply of contracts with longterm maturities and reveals the allocation of risk between users and providers. Greater use of long-term finance implies that lenders are exposed to greater risk relative to borrowers. Optimal risk sharing between borrowers and lenders may lead to different equilibrium levels of use of long-term finance for different borrowers and lenders, and in different countries and at different points in time.
  • Governments have a role to play in promoting long-term finance when it is undersupplied because of market failures and policy distortions. The government can promote long-term finance without introducing distortions by pursuing policies that foster macroeconomic stability, low inflation, and viable investment opportunities; promoting a contestable banking system with healthy entry and exit and supported with strong regulation and supervision; putting in place a legal and contractual environment that adequately protects the rights of creditors and borrowers; fostering financial infrastructures that limit information asymmetries; and promoting the development of capital markets and institutional investors. In contrast, efforts to promote long-term finance through directed credit, subsidies, and government-owned banks have not been successful in general because of political capture and poor corporate governance practices.

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