Grey matters

Read our article in the Cayman Financial Review Magazine, eversion 

Tigran Poghosyan 

Financial intermediation costs in low-income countries: The role of regulatory, institutional and macroeconomic factors, IMF Working Paper No. 12/140 available at

We analyse factors driving persistently higher financial intermediation costs in low-income countries (LICs) relative to emerging market (EMs) country comparators. Using the net interest margin as a proxy for financial intermediation costs at the bank level, we find that within LICs a substantial part of the variation in interest margins can be explained by bank-specific factors: margins tend to increase with higher riskiness of credit portfolio, lower bank capitalisation and smaller bank size. Overall, we find that concentrated market structures and lack of competition in LICs banking systems and institutional weaknesses constitute the key impediments preventing financial intermediation costs from declining.

Our results provide strong evidence that policies aimed at fostering banking competition and strengthening institutional frameworks can reduce intermediation costs in LICs.

CFR comment:  

The financial crisis has produced oodles of reform proposals that regulators and academics imagine solve problems; this paper provides some evidence about reforms that can actually address a real need. 

Asli Demirgüç-Kunt and Leora F Klapper 

Financial inclusion in Africa: An overview, World Bank Policy Research Working Paper No. 6088 available at 

This paper summarises financial inclusion across Africa. First, it provides a brief overview of the African financial sector landscape. Second, it uses the Global Financial Inclusion Indicators (Global Findex) database to characterise adults in Africa that use formal and informal financial services and identify the barriers to formal account ownership. Next, it uses World Bank Enterprise Survey data to examine how the use of financial services by small and medium enterprises in Africa compares with small and medium enterprises in other developing regions in terms of account ownership and availability of lines of credit.

The authors find that less than a quarter of adults in Africa have an account with a formal financial institution and that many adults in Africa use informal methods to save and borrow. Similarly, the majority of small and medium enterprises in Africa are unbanked and access to finance is a major obstacle. Compared with other developing economies, high-growth small and medium enterprises in Africa are less likely to use formal financing, which suggests formal financial systems are not serving the needs of enterprises with growth opportunities.

CFR comment:  

If your trading partners lack access to the financial system, trade is going to be much harder. This paper addresses a crucial lack in financial services in Africa that impedes trade.

Financial reform proposals are proliferating in the wake of the ongoing financial crisis and the Great Recession. These following papers give some insight in how to evaluate some of those, including restrictions on leverage and measures designed to promote transparency.

Elif C Arbatli and Julio Escolano 

Fiscal transparency, fiscal performance and credit ratings, IMF Working Paper No 12/156, available at 

This paper investigates the effect of fiscal transparency on market assessments of sovereign risk, as measured by credit ratings. It measures this effect through a direct channel (uncertainty reduction) and an indirect channel (better fiscal policies and outcomes), and it differentiates between advanced and developing economies. Fiscal transparency is measured by an index based on the IMF’s Reports on the Observance of Standards and Codes (ROSCs). We find that fiscal transparency has a positive and significant effect on ratings, but it works through different channels in advanced and developing economies.

In advanced economies the indirect effect of transparency through better fiscal outcomes is more significant whereas for developing economies the direct uncertainty-reducing effect is more relevant. Our results suggest that a one standard deviation improvement in fiscal transparency index is associated with a significant increase in credit ratings: by 0.7 and 1 notches in advanced and developing economies respectively.

CFR comment:  

If you are a government, you might wonder why be transparent? Isn’t transparency just a means of giving your opponents information with which to bash you? One possible answer is that transparency saves you money on interest costs. Seems a compelling result to us – we wish governments around the world would take it to heart. 

Hong Kong and Singapore are the paradigmatic trade-oriented jurisdictions and China takes center stage in discussions of trade. The following papers focus on those jurisdictions. 

Samar Maziad and Joong Shik Kang  

RMB internationalisation: Onshore/offshore links, IMF Working Paper No. 12/133 available at 

Among emerging market currencies, the RMB holds the most potential to become widely used internationally, due to China‘s large economic size, diversified trade structure and network, macroeconomic stability, and high growth rates – both current and expected. Yet, foreign access to RMB-denominated assets that could act as global stores of value remains limited due to extensive restrictions on capitals flows. At the same time, the rapid expansion of RMB trade settlement and issuance of RMB-denominated bonds by the Chinese government and corporates in Hong Kong, SAR have created some feedback channels across onshore (CNY) and offshore (CNH) RMB markets.

We employed a bivariate GARCH model to understand the inter-linkages between onshore and offshore markets and found that, while developments in the onshore spot market exert an influence on the offshore spot market, offshore forward rates have a predictive impact on onshore forward rates.

We also find evidence of volatility spillovers between two markets. Overtime, those spillover channels would be expected to grow as the offshore market further develops.

CFR comment:  

Even if you are not into the details of bivariate GARCH models (fascinating, take it from us), this is worth a read for its insights into the future of RMB markets. There is little doubt that RMB-denominated financial transactions and trade is going to grow and the academic literature is pointing to some interesting developments worth watching.

Norman P. Ho 

A tale of two cities: Business trust listings and capital markets in Singapore and Hong Kong, Journal of International Business and Law, Vol 11, 2012.

The modern, statutory business trust is an increasingly important business vehicle in both the United States and around the world; it remains, however, woefully understudied. In particular, hardly any comparative legal research on business trusts exists. This article seeks to fill such a void by providing a comparative analysis of business trusts and business trust listings in Singapore and Hong Kong, two of the world’s most important financial centres and the only two major jurisdictions in the world which have actively opened up their capital markets for business trust listings; this article is, to my knowledge, the first scholarly investigation of business trusts in Singapore and Hong Kong.

The article argues that the experience in Hong Kong and Singapore and hype there over business trusts shows that business trusts are gaining some popularity in foreign jurisdictions as important capital-raising vehicles, apart from traditional business trust forms in jurisdictions such as the United States, such as mutual funds and pension funds.

As seen through the Singaporean and Hong Kong experiences, when listed on public stock exchanges, business trusts arguably offer numerous advantages, namely: greater distributions to the beneficiaries, since distributions can be made out of cash flows rather than accounting profits, more funding opportunities through listing, increased investor liquidity and the asset owner’s ability continue to exercise control over the trust’s assets, to name a few. The control advantage is especially important, as Singapore and Hong Kong currently do not permit dual class stock structures – thus, business trusts offer management a suitable alternative to raise capital while maintaining control, and Singapore (and Hong Kong, which, as of June 2012, is still finalising its business trust listing regulatory regime) can serve as potential models for empowering business trusts as an alternate corporate form.

The article ends with a brief analytical comparison of business trusts and dual class stock structures and argues that the Singaporean and Hong Kong models can serve as points of reference for US business trust law reform.

CFR comment:  

Academic attention to business trusts is rare. This is a particularly interesting analysis of the growing use of business trusts in the two premier Asian financial market jurisdictions and suggests ways that these models can be adapted for use elsewhere.

Horace WH Yeung and Flora Xiao Huang 

 Law and Finance: What matters? Hong Kong as a test case, Asian Journal of Law and Economics, Vol 3, Issue 1, Article 1, 2012 available at 

This paper, using Hong Kong as a test case, challenges one conventional theory and confirms another one in law and finance study: (i) legal families in relation to stock market development; (ii) transplant effect of foreign laws. Economists, most notably La Porta and colleagues, allege that common law systems can offer superior investor protection and thereby facilitate the rise of financial markets. Undeniably, the legal system of Hong Kong, which was inherited from England, belongs to the common law family and is widely considered as one of Hong Kong’s advantages. Nonetheless, the high concentration of family ownership among Hong Kong companies implies that its system is not entirely Anglo-Saxon. Moreover, legal scholars, most notably Pistor and colleagues, claim that the import of laws from a developed system (legal transplantation) will have little impact unless there is such a demand in the first place.

Interestingly, for Hong Kong, the transformation of a small fishing village in the mid-nineteenth century to a financial service-oriented economy nowadays is an illustration of the existence of demand in corporate and financial laws. By absorbing the nutrients from English legal traditions, American style intense public enforcement and the flexibility of Chinese family businesses, Hong Kong has successfully established itself as one of the most crucial financial centres in the world.

CFR comment:  

As a confirmed sceptic of the La Porta legal families analysis (see Nuno Garoupa & Andrew P Morriss, The Fable of the Codes: The Efficiency of the Common Law, Legal Origins & Codification Movements, UNIVERSITY OF ILLINOIS LAW REVIEW (forthcoming 2012) available at, your editor particularly liked this paper’s focus on the details of Hong Kong’s legal system in contrast to the usual blanket assumption that all common law systems are the same. Even those not interested in academic debates over the legal origins hypothesis will find this an interesting assessment of what makes Hong Kong a success.

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Andrew P. Morriss

Andrew P. Morriss, Chairman, is the D. Paul Jones, Jr. & Charlene Angelich Jones – Compass Bank Endowed Chair of Law at the University of Alabama School of Law. He was formerly the H. Ross & Helen Workman Professor of Law and Business at the University of Illinois,Urbana-Champaign. He received his A.B. from Princeton University, his J.D. and M.Pub.Aff. from the University of Texas at Austin, and his Ph.D. (Economics) from the Massachusetts Institute of Technology. He is a Research Fellow of the N.Y.U. Center for Labor and Employment Law,and a Senior Fellow of the Institute for Energy Research, Washington,D.C., as well as a regular visiting faculty memberat the Universidad Francisco Marroquín,Guatemala. He is the author or coauthor of more than 50 scholarly articles, books, and bookchapters, including Regulation by Litigation (Yale Univ. Press 2008) (with Bruce Yandle and Andrew Dorchak), and is the editor of Offshore Financial Centers and Regulatory Competition (American Enterprise Institute Press 2010).

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