by M. Ayhan Kose Research Department International Monetary Fund Discussion of Financial Development in Emerging Economies: Stylized Facts and the Road Ahead by Tatiana Didier and Sergio L. Schmukler by M. Ayhan Kose Research Department International Monetary Fund

Disclaimer! The views presented here are those of the authors and do NOT necessarily reflect the views of the IMF or IMF policy.

Summary Views A welcome contribution A massive effort to document facts A carefully executed project Important policy implications Few comments about possible additional exercises and new directions…

Comments 1. What is the “optimal” level of financial development? 2. What is the “relevant benchmark” for financial development? 3. What factors explain cross-country differences? 4. What are the policy implications?

1 . What is the “optimal” level of financial development? “Despite these developments, many emerging countries still lag behind the progress witnessed by advanced nations and convergence is still largely failing to happen.” (Abstract) Limited theoretical and empirical knowledge on: - the optimal level of financial development - the necessity of the convergence of financial systems

Is “too much finance” always good? LONG-RUN: Positive relationship between (intermediate levels of) financial development and growth (Levine, 2004) SHORT-RUN: Financial sector can be a source of macro volatility (Kindleberger, 1978; Reinhart and Rogoff, 2009) “Has financial development made the world riskier?” Yes. (Rajan, 2005) Can “too much finance” have a negative impact on growth? Yes… Threshold: Credit/GDP=110 percent (Arkand, Berkes and Panizza, 2011)

Credit Boom and Financial Development: Twins? Rapid credit growth (a credit boom) is often associated with an increase in the level of financial development Credit growth during the boom can have - spillover effects on financial development over the long-run - an amplifying impact over the short-run (deeper recessions…)

Credit Booms and Financial Development

Credit Booms: Not Always Happy Endings

Unconditional Probability of Recession: Lower… ( fraction of time in recession)

But Recession More Likely w/ a Credit Crunch (fraction of time in recession given a disruption)

Recessions More Costly w/ Credit Crunches (cumulative losses, in percent)

2. What is the “relevant benchmark” for financial development? Emerging markets are compared with advanced countries Can we think of some statistical benchmarks for different indicators of financial development? FinStats 2011: A Ready-to-Use Tool to Benchmark Financial Sectors across Countries and Over Time (Al-Hussainy, et.al., 2011, World Bank)

Constructing Benchmarks Require Lots of Data 40 indicators of fin development; 120 countries; 2000-2009 How to determine the benchmarks? Run quintile regressions of financial development indicators on a set of explanatory variables (gives regional and income level benchmarks) Factors of economic development (GDP per capita); population factors (population size, density); demographic factors (age dependency ratios); country factors (oil exporters, financial centers); global cycle

Korea: Financial Sector Development - 1 (Real Credit / GDP , in percent)

Korea: Financial Sector Development - 2 (Stock Market Capitalization / GDP, in percent)

3. What factors explain cross-country differences? Extensive evidence of substantial differences in financial development across countries and over time Useful to consider the possible factors explaining these differences: policy driven; institutional dimensions; structural elements; supply and/or demand driven; and global factors (capital inflows) Regressions involving the temporal changes in the indicators of financial development on some potential determinants

4. What are the policy implications? “… emerging economies will need to catch up, grow their financial systems, and take more risk, in their process to become more similar to developed nations.” (Conclusion) A well-functioning financial sector: encourages idiosyncratic risk without elevating systemic risk Emerging markets need to have deep, but effectively regulated, financial systems

Potential Factors: Not Macro Anymore? Stronger growth prospects with sound macro policies Institutional environment Regulation and supervision, legal system, and governance State role in financial sector (ownership) Also helpful thinking about policy implications….

Policy Challenges Abound Emerging markets need to deepen their financial markets But, at the same time, make progress in advancing the quality of institutional structures, regulation and supervision of financial sector, and aligning macro and prudential policies How much have they been able to do that over the past two decades? Would be good to document changes in policies/institutions as well

Summary Views A welcome contribution A massive effort to document facts A carefully executed project Important policy implications Few comments about possible additional exercises and new directions…

Questions & Comments M. Ayhan Kose akose@imf.org