Main Messages

  • Use of long-term finance—frequently defined as all financing for a time frame exceeding one year—is more limited in developing countries, particularly among smaller firms and poorer individuals. This is true even after controlling for firm characteristics such as asset and industry composition and profitability and individual attributes such as wealth and education. In developing countries, only 66 percent of small firms and 78 percent of medium-size firms report having any long-term liabilities, compared with 80 percent and 92 percent in high-income countries, respectively. Firms in high-income countries report financing almost 40 percent of their fixed assets externally, whereas this figure is barely 20 percent in low-income countries. Similar differences exist for individuals’ use of term finance. For example, the average share of individuals with an outstanding loan to purchase a home is 21 percent in high-income countries, yet barely 2.5 percent in lower-middle- and low-income countries. Other products such as education loans are not widespread in the developing world and, when they are available, are used by wealthier individuals.
  • Where it exists, the bulk of long-term finance is provided by banks; use of equity, including private equity, is limited for firms of all sizes. As financial systems develop, the maturity of external finance also lengthens. Banks’ share of lending that is long term also increases with a country’s income and the development of banking, capital markets, and institutional investors. Long-term finance for firms through issuances of equity, bonds, and syndicated loans has also grown significantly over the past decades, but only very few large firms access long-term finance through equity or bond markets. The promotion of nonbank intermediaries (pension funds and mutual funds) in developing countries such as Chile has not always guaranteed an increased demand for long-term assets.
  • The global financial crisis of 2008 has also led to a reduction in leverage and use of long-term debt for developing-country firms. Small and medium enterprises in lower-middle- and low-income countries were particularly adversely affected, seeing a reduction in both their leverage and use of longterm debt. Large firms in developing countries that are able to access financial markets were affected as well, because they rely on international markets to a greater extent than their high-income counterparts. Such firms were also more vulnerable to the large drop in syndicated lending during the crisis.
  • Market failures and policy distortions have a disproportionate effect on long-term finance, suggesting an important role for policies that address these failures and distortions. Long-term finance is not always optimal—its use in an economy reflects the risk sharing between users and providers of finance. Shorter maturities shift risk from providers to users because these instruments force users to roll over financing frequently. Also, because firms and individuals tend to match the maturity structure of their assets and liabilities, not every firm or household needs to use long-term financing instruments. Hence, use of long-term finance across countries may vary naturally depending on the asset being financed and on how borrowers and lenders agree to share the risks involved between each other. However, limited use of long-term finance is generally also a symptom of market failures and policy distortions since longterm financing instruments are disproportionately affected by these failures and distortions.
  • Sustainably extending the maturity structure of finance is a key policy challenge since long-term finance can be an important contributor to economic growth and shared prosperity. If long-term finance is not available for deserving firms, they become exposed to rollover risks and may become reluctant to undertake longer-term fixed investments, with adverse effects on economic growth and welfare. Without long-term financial instruments, households cannot smooth income over their life cycle—for example, by investing in housing or education—and may not benefit from higher longterm returns on their savings. Empirical evidence also suggests use of long-term finance by firms and households is associated with better firm performance and improved household welfare. There is little evidence however, that direct efforts to promote long-term finance by governments and development banks—for example, through directed credit to firms or subsidies for housing—have had sustainable positive effects. These policies have generally not been successful because the underlying institutional problems and market failures that underpin the low use of long-term finance remain and because political capture and poor corporate governance practices undermine the success of direct interventions by governments. Similarly, extending maturity structures by promoting development of institutional investors or by building stock or bond markets has proven difficult unless there is a commitment to address fundamental institutional problems.
  • There is no magic bullet to promote long-term finance; governments need to focus on fundamental institutional reforms. These include pursuing policies that promote macroeconomic stability, low inflation, and viable investment opportunities; promoting a contestable banking system with healthy entry and exit 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 laying the necessary institutional and incentive frameworks to facilitate long-term development of capital markets and institutional investors. Most of these policies will promote financial development more generally but will disproportionately increase long-term finance, which is more affected by distortions.
  • Institution building is a long-term process; hence in the short to medium term, market-friendly innovations that overcome market failures and institutional weaknesses and that support financial literacy and consumer protection may help extend maturity. Asset-based lending instruments such as leasing may even help small and nontransparent firms gain access to longer-term finance. For larger firms able to access markets, evidence suggests that foreign investors hold more long-term domestic debt than domestic investors; hence policies that promote foreign investment are also likely to extend the maturity structure of finance, although this will also make firms more vulnerable to external shocks. For households, supporting financial literacy, consumer protection, and disclosure rules to improve information and its use, and providing investment default options to reduce behavioral biases can help increase individuals’ understanding of long-term finance instruments.
  • Well-designed private-public risk-sharing arrangements may also hold promise for mobilizing financing for long-term projects. Through public-private partnerships for large infrastructure projects, governments can mitigate political and regulatory risks and mobilize private investment. Sovereign wealth funds are state-owned investment funds that are seen as a promising source of longer-term finance, given their long investment horizon and mandate to diversify economic risks and manage intergenerational savings, but they are not entirely immune to some of the problems of political capture and poor governance that plagued national development banks. Multinational development banks can promote long-term finance by offering knowledge and policy advice to help shape policy agendas for institutional reform that are essential for promoting long-term finance, as well as by structuring infrastructure or other long-term financing projects that allow private lenders and institutional investors to participate in this financing while reducing project and credit risk.