Ideally, financial institutions foster growth by efficiently mobilizing and channeling resources to where they will be most productive. If the system is working well, financial institutions identify and finance the best projects, support innovation, provide instruments to manage risks, nurture small businesses and rapid-growth firms, and reach a broad cross-section of businesses, driving higher productivity and financial inclusion.
If the financial system is not up to par, companies across the economy are hard-hit, especially smaller businesses. That’s the case in Latin America and the Caribbean, where interest rates tend to be higher and long-term funding scarcer than in some other regions.
The Inter-American Development Bank has calculated that overall financial development in Latin America and the Caribbean is lower than in emerging markets in Asia and far lower than in OECD countries (Organization for Economic Co-operation and Development). For example, banks in emerging Asian markets and in OECD countries extend more than twice the amount of domestic credit to the private sector as banks in Latin America and the Caribbean, as measured by percentage of GDP. And net interest margins for banks are higher in this region—in some cases, four times higher—than in the OECD countries.
Capital markets in Latin America and the Caribbean are also smaller, forcing larger firms to rely excessively on bank loans. The region’s relatively low supply of non-bank financial institutions—such as insurance, leasing and factoring companies—further limits financing options for companies.
Some of this is due to regional market distortions. Small economies, high rates of informality, macroeconomic uncertainty, weak institutional environments, low savings rates—these are just a few of the factors that work against financial institutions and create less-than-optimal conditions. The consequences include:
- scarcity of long-term and local-currency funding
- bias toward consumer loans instead of business or housing loans
- focus on larger companies at the expense of smaller ones
- costly finance
- shallow and illiquid capital markets
- few or nonexistent risk management instruments
- high collateral and capitalization requirements
A technology gap further hampers access to finance in the region. Many lenders have failed to develop expertise and invest in new digital technologies that could help them reduce their operating costs, introduce new services and reach underserved segments of the market.
Reduced access to finance stymies overall economic growth. And it has a particularly negative impact on many areas of the economy critical to development, such as micro, small and medium-sized enterprises, trade, environmental initiatives, affordable housing, and health and educational services.
At IDB Invest, we are working in partnership with financial intermediaries around the region to close some of the gaps in these areas.