CAN MICROFINANCE REDUCE PORTFOLIO VOLATILITY?
Nicolas Kraussa and Ingo Walter
Microfinance is arguably one of the most effective techniques for poverty alleviation in developing countries. Although traditionally supported by nongovernmental organizations and socially-oriented investors, microfinance has increasingly demonstrated its value on a stand-alone basis, typically exhibiting low default rates combined with attractive returns, encouraging greater commercial involvement. This paper addresses a related issue – whether microfinance represents a distinct financial asset class, thereby forming the basis for access to global capital markets and performance-driven investors in their search for efficient portfolios. Our empirical tests generally show very low correlations between the performance of microfinance institutions and global and national market performance measures, suggesting that microfinance portfolios may constitute a distinct asset class that can have useful portfolio diversification value.
Keywords: microfinance, systemic risk, poverty alleviation. JEL Classification: G21, O16.
Paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=943786
DO FINANCIAL CONGLOMERATES
CREATE OR DESTROY
Markus M. Schmid and Ingo Walter
This paper attempts to ascertain whether or not functional diversification is value-enhancing or value-destroying in the financial services sector. Based on a U.S. dataset comprising approximately 4060 observations covering the period 1985-2004, we report a substantial and persistent conglomerate discount among financial intermediaries. Our results suggest that it is diversification that causes the discount, and not that troubled firms diversify into other more promising areas. We also investigate the geographic dimension of diversification as well as the interaction between geographic scope and functional diversification and find that the value-destruction associated with functional diversification is not apparent in geographic diversification. A further finding is that there is a significant premium for the very largest of our sample firms (with total assets above 100bn USD) indicating that there are "too big to fail" guarantees for very large financial conglomerates.
Keywords: Diversification; Focus; Organizational structure; Financial sector; Firm valuation. JEL Classification: G20, G32, G34.
Paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=929160.
REPUTATIONAL RISK AND CONFLICTS OF INTEREST IN BANKING AND FINANCE: THE EVIDENCE SO FAR
This paper attempts define reputational risk in financial intermediation and to identify the proximate sources of reputational risk facing financial services firms. It then considers the key drivers of reputational risk in the presence of transactions costs and imperfect information in financial markets, surveys empirical research in the literature on the impact of reputational losses imposed on financial intermediaries, and presents some new empirical findings. The paper then develops the link between reputational risk and exploitation of conflicts of interest in financial intermediation, arguably one of the most important threats to the reputational capital of financial firms. Finally, it considers some managerial requisites for dealing with both reputational risk and conflicts of interest.
Keywords: Operational Risk, Reputation, Conflicts of Interest. JEL Classification: G2, K2, L14.
Paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=952682.
THE ASSET MANAGEMENT INDUSTRY IN ASIA:
DYNAMICS OF GROWTH, STRUCTURE AND PERFORMANCE
Ingo Walter and Elif Sisli
We examine the industrial organization and institutional development of the asset management industry in Asian developing economies – specifically in China, Indonesia, Korea, Malaysia, Singapore, Philippines and Thailand. We focus on the size and growth of the buy-side of the respective financial markets, asset allocation, the regulatory environment, and the state of internationalization of the fund management industry in its key components – mutual funds, pension funds and asset management for high net worth individuals. We link these the evolution of professional asset management in these environments to the development of the respective capital markets and to the evolution of corporate governance. We find that the fund management industry occupies a very small niche in domestic financial systems that are dominated by banks. At the same time, we find that its growth has been very rapid in the early 2000s and we suggest that this is likely to persist as the demand for professional management of financial wealth in the region develops and as the pension fund sectors of the respective economies are liberalized to allow larger portions of assets to be invested in collective investment schemes. Keywords: Asset management, Asia financial systems, pension funds, mutual funds, private banking.
JEL Classification: G23, O16.
Paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=952568.
INNOVATION IN INTERNATIONAL LAW AND GLOBAL FINANCE: ESTIMATING THE FINANCIAL IMPACT OF THE CAPE TOWN CONVENTION
Anthony Saunders, Anand Srinivasan and Ingo Walter
This paper examines the financial impact of a transfer of legal sovereignty covering the rights to collateral to an international regime in the case of the Cape Town Convention and Protocol covering international mobile assets, specifically commercial aircraft and related equipment, which came into force in 2004. We estimate the impact on financing costs facing airlines based in signatory countries in terms of access to financial markets and interest differentials, debt rating migration and stock prices using rating-sensitivity analysis, OLS regressions and event studies. We find that the present value of the resulting financing cost reductions are very significant and are biased in favor of developing countries, the sources of much of the growth in demand for commercial aircraft going forward. The results suggest the power of changes in the legal framework of financial markets to influence the costs and pricing of global financial flows. Keywords: Law and finance; secured lending; aircraft finance; leasing; sovereign risk; asset securitization.
JEL: K11, K33, F34, G15, G28, G33.
Paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=894027
STRATEGIES IN FINANCIAL SERVICES,
THE SHAREHOLDERS AND THE SYSTEM IS BIGGER AND BROADER BETTER?
The financial services industry is “special” in a variety of ways, including the fiduciary nature of the business, its role at the center of the payments and capital allocation process with all its static and dynamic implications for economic performance, and the systemic nature of problems that can arise in the industry. So the structure, conduct and performance of the industry has unusually important public interest dimensions. One facet of the discussion has focused on size of financial firms, however measured, and the range of activities conducted by them. Is size positively related to total returns to shareholders? If so, does this involve gains in efficiency or transfers of wealth to shareholders from other constituencies, or maybe both? Does greater breadth generate sufficient information-cost and transaction-cost economies to be beneficial to shareholders and customers, or can it work against their interests in ways that may ultimately impede shareholder value as well? And is bigger and broader also safer? This paper starts with a simple strategic framework for thinking about these issues from the perspective of the management of financial firms. What should they be trying to do, and how does this relate to the issues of size and breadth? It then reviews the available evidence and reaches a set of tentative conclusions from what we know so far, both from a shareholder perspective and that of the financial system as a whole.
JEL Classification G20, L10
ARE EMERGING MARKET EQUITIES A SEPARATE ASSET CLASS?
Anthony Saunders and Ingo Walter
Historically, fund managers and investors have considered emerging market equities as a separate asset class in making their portfolio allocation decisions. For example, an asset manager might be instructed to divide an institutional investor’s portfolio into 20% emerging market and 80% developed market securities. Within these broad divisions, the asset manager would usually be given discretion to allocate his or her portfolio among individual country and/or industry securities based on their risk, return and correlation characteristics. In recent years a number of economic, legal, accounting and financial developments have eroded the sources of separation between what had been thought of as “emerging” and “developed” country financial markets. These liberalizations include capital market reforms that have reduced the constraints and limits on foreign investors (such as those imposed on the proportion of shares a foreign investor might hold in domestic firms’ equities), as well as the establishment of country funds.
Many of the initial liberalizations took place in the mid to late 1980s and have continued into the 1990s, even as emerging markets experienced considerable return volatility during this period. Part of this return volatility has been attributed to internal conditions (e.g., Mexico, Russia, Indonesia, etc.) while part has been attributed to the greater openness of emerging market economies to external shocks (so-called contagion-effects). Developed country markets have not been immune from either increased volatility or contagion emanating from emerging markets. For example, US and UK financial market volatilities were significantly impacted by both the Asian and Russian crises of 1997 and 1998. This paper examines quantitative and qualitative evidence underlying the view that emerging market equities no longer represent a separate asset class and, relatedly, that world capital markets are becoming increasingly integrated. We find that empirical evidence strongly supports the view that the world’s financial markets are becoming increasingly integrated and that the integration process encompasses emerging markets. As a result, the idea of rigidly separating emerging market and developed market pools of investable funds (along with adopting separate performance benchmarks) seems no longer appropriate.
THE ASSET MANAGEMENT INDUSTRY IN EUROPE:
The asset management industry represents one
of the most dynamic parts of the global financial services sector. Funds
under institutional management are massive and growing rapidly, particularly
as part of the resolution of pension pressures in various parts of the world.
The industry is not, however, well understood from the perspective if
industrial organization and international competition, which is the focus of
this paper. It begins with a schematic of asset management in a national and
global flow-of-funds context, identifying the types of asset-management
functions that are performed and how they are linked into the financial
system. It then assesses in some detail the three principal sectors of the
asset management industry -- mutual funds, pension funds, and private-client
assets, as well as foundations, endowments, central bank reserves and other
large financial pools requiring institutional asset management services.
Relevant comparisons are drawn between the United States, Europe, Japan and
selected emerging-market countries. This is followed by a discussion of the
competitive structure, conduct and performance of the asset management
industry, and its impact on global capital markets.
CONFLICTS OF INTEREST AND MARKET DISCIPLINE IN FINANCIAL SERVICES FIRMS
There has been substantial public and regulatory attention of late to apparent exploitation of conflicts of interest involving financial services firms based on financial market imperfections and asymmetric information. This paper proposes a workable taxonomy of conflicts of interest in financial services firms, and links it to the nature and scope of activities conducted by such firms, including possible compounding of interest-conflicts in multifunctional client relationships. It lays out the conditions that either encourage or constrain exploitation of conflicts of interest, focusing in particular on the role of information asymmetries and market discipline, including the shareholder-impact of litigation and regulatory initiatives. External regulation and market discipline are viewed as both complements and substitutes – market discipline can leverage the impact of external regulatory sanctions, while improving its granularity though detailed management initiatives applied under threat of market discipline. At the same time, market discipline may help obviate the need for some types of external control of conflict of interest exploitation JEL G21, G24, G28, L14. Keywords: Conflicts of interest. Financial regulation. Financial services. Banking.
FINANCIAL INTEGRATION ACROSS BORDERS AND SECTORS: IMPLICATIONS FOR REGULATORY STRUCTURES
This paper considers the generic processes and linkages that comprise financial intermediation--the basic "financial hydraulics" that ultimately drive efficiency and innovation in the financial system and its impact on real-sector resource allocation and economic growth. It goes on to document some of the structural changes that have occurred in both national and global financial systems, and suggests how the microeconomics of financial intermediation work. These can have an enormous impact on the industrial structure of the financial services industry and on individual firms. Sequentially, financial channels that exhibit greater static and dynamic efficiency have supplanted less efficient ones. Competitive distortions can retard this process, but they usually extract significant economic costs and at the same time divert financial flows into other venues, either domestically or elsewhere. We next examine the consequences of this process in terms of financial sector reconfiguration, both within and between the four major segments of the industry (commercial banking, securities and investment banking, insurance, and asset management) as well as within and between national financial systems. The paper then superimposes key regulatory overlays onto the basic economics and facts of reconfiguration in financial intermediation. This is a "special" industry, due both to the imbedded systemic risks and its fiduciary nature. Balancing financial efficiency against stability and fairness is not easy. The economics of financial intermediation are highly regulation-sensitive, so small changes in regulation can create important changes in markets. Regulators inevitably make some mistakes, and regulatory mandates are unusually contentious and vulnerable to entrenched economic interests. The final section of the paper considers the linkages between structural change in financial intermediation and supervisory and regulatory functions, including some comparisons between US and European legacies and prospects.