Long-term financing
Definition
Long-term financing can be defined as any financial instrument with a term of more than one year (such as bank loans, bonds, leasing and other forms of debt financing) and public and private equity instruments. Term refers to the length of time between the origination of a financial claim (loan, bond or other financial instrument) and the final payment date, at which time the remaining principal and interest must be paid. Equities, which have no final repayment date for any principal amount, can be viewed as an instrument with an infinite term. The cut-off period of one year corresponds to the definition of fixed asset investments in the national accounts. By comparison, the Group of 20 uses a five-year term that is better aligned with the investment horizons on the financial markets (G-20 2013). Depending on the availability and focus of the data, the report uses one of these two definitions to characterize the extent of long-term financing. Because where possible there is no consensus on the precise definition of long-term financing, the report provides detailed data showing as many maturities and comparisons as possible, rather than using a specific definition of long-term financing.
The importance of long-term financing
Extending the maturity structure of the financial sector is often considered the core of sustainable financial development. Long-term finance contributes to faster growth, greater prosperity, shared prosperity and sustainable stability in two important ways: by reducing borrower rollover risk, thereby extending investment horizons and improving performance, and through the availability of financial instruments to increase in the long term. which offers households and businesses the opportunity to solve their life cycle challenges (Demirgüç-Kunt and Maksimovic 1998, 1999; Caprio and Demirgüç-Kunt 1998; de la Torre, Ize and Schmukler, 2012).
The duration of financing reflects the risk-sharing contract between providers and users of financing.With long-term financing, the risk shifts to the providers, because they have to bear the fluctuations in the probability of default and other changing conditions on the financial markets, such as interest rate risk. Providers often charge a premium as part of compensation for the higher risk that this form of financing entails. On the other hand, short-term financing shifts risk to users because it forces them to continuously pass on financing.
It is not clear what amount of long-term financing is optimal for the economy as a whole.In well-functioning markets, borrowers and lenders will enter into short- or long-term contracts, depending on their financing needs and how they agree to share risks at different maturities. What is important for the economic efficiency of the financing arrangements is that borrowers have access to financial instruments that allow them to align the time horizon of their investment opportunities with the time horizon of their financing, depending on economic risks and volatility in the economy (where long term (term financing can provide a partial insurance mechanism). At the same time, savers had to be compensated for the extra risk they had to take.
Where this exists, most of the long-term financing is provided by banks; the use of equity capital, including private equity, is limited for companies of all sizes. As financial systems evolve, so does the maturity of external financing.The share of banks in long-term loans increases with a country's income and the development of banks, capital markets and institutional investors. Long-term financing for companies through the issuance of shares, bonds and syndicated loans has also grown significantly in recent decades, but very few large companies have access to long-term financing through the stock or bond markets. The promotion of non-bank intermediaries (pension funds and investment funds) in developing countries such as Chile has not always guaranteed increased demand for long-term assets (Opazo, Raddatz and Schmukler, 2015; Stewart, 2014).
Political challenge
Efforts to actively promote long-term financing have proven both challenging and controversial.The prevailing view is that financial markets in developing economies are imperfect, resulting in significant scarcity of long-term financing, which hinders investment and growth. In fact, a significant portion of multilateral development bank lending (including World Bank Group loans and guarantees) is intended to compensate for the perceived lack of long-term credit. At the same time, research shows that weak institutions, poor contract enforcement and macroeconomic instability naturally lead to shorter maturities of financial instruments. In fact, these shorter maturities are an optimal response to dysfunctional institutions and property rights systems, as well as instability.
From this perspective, the policy focus should be on identifying these fundamentals, rather than directly expanding the structure of credit time. Some even argue that attempts to promote long-term credit in developing economies without addressing the underlying institutional and policy problems have often proven costly to development. For example, efforts to promote long-term credit through development finance institutions in the 1970s and 1980s resulted in significant costs to taxpayers and, in extreme cases, failures (Siraj 1983; World Bank 1989). In response, the World Bank reduced these types of long-term loans in the 1990s and 2000s. On the other hand, well-designed private-public risk-sharing arrangements – such as public-private partnerships for large infrastructure projects or credit guarantee schemes – can offer the promise of mobilizing finance for long-term projects and enablinggovernments to reduce political and regulatory risks and mobilize finance for private investment.
Recommended reading:
G-20 (group of 20). 2013. “Long-Term Investment Finance for Growth and Development: Umbrella Paper.” Found on:https://g20.org/wpcontent/uploads/2014/12/Long_Term_Financing_for_Growth_and_Development_February_2013_FINAL.pdf
Caprio, Gerard and Asli Demirgüç-Kunt. 1998. “The Role of Long-Term Finance: Theory and Evidence.” World Bank Research Observer 13(2):171–89.
Demirgüç-Kunt, Asli and Vojislav Maksimovic. 1998. “Law, Finance, and Business Growth.” Journal of Finance 53 (6): 2107–37.
Demirgüç-Kunt, Asli and Vojislav Maksimovic. 1999. “Institutions, Financial Markets, and the Maturity of Corporate Debt.” Journal of Financial Economics 54 (3): 295–336.
de la Torre, Augusto, Alain Ize and Sergio L. Schmukler. 2012. “Financial Development in Latin America and the Caribbean: The Way Forward.” Policy Research Working Paper 2380, World Bank, Washington, DC.
Opazo, Luis, Claudio Raddatz and Sergio Schmukler. 2015. “Institutional Investors and Long-Term Investments: Evidence from Chile.” World Bank Economic Journal 29 (2).
Siraj, Khalid. 1983. “Report of the Task Force on Portfolio Problems of Development Finance Companies.” The World Bank, Washington, DC
Stewart, Fiona. 2014. “The Use of Performance-Based Benchmarks: Demonstrating Incentives for Long-Term Investment by Pension Funds.” Policy Research Working Paper 6885, World Bank, Washington, DC.
World Bank. 1989. Report of the Task Force on Financial Sector Operations. Financial Sector Development Department. The World Bank, Washington, DC.
