Volume 42 | Number 3 Summer 2007
Banking Law Reform and Users-Consumers in Developing Economies: Creating an Accessible and Equitable Consumer Base from the “Excluded”
V. Concluding Observations: The Need for a Suitable Legal-Institutional Infrastructure and Policy Reorientation
The world of the IFIs and Regional Financial Institutions (RFIs) has historically been a world of economists, a large portion of whom are macroeconomists, while law and lawyers traditionally have played a very minimal role. But, during the 1990s, the IFIs/RFIs came to learn and appreciate the importance of the legal-institutional infrastructure of a country in supporting the domestic financial system by: 1) establishing the requisite institutional and administrative capacities; 2) developing the desired supporting linkages between the public and private sectors; 3) putting in place clear rights, responsibilities, and liabilities of parties in a transaction; 4) maintaining the appropriate incentives and adequate information that espouse market forces; and 5) providing adequate and fair means to enforce legal obligations and claims effectively.
This author recognizes that for over a decade, institutions such as the World Bank and the IMF have expended considerable efforts on “deepening” financial sector legal-institutional infrastructure reform in developing countries (e.g., as to the legal aspects focusing on the importance of property and contract rights and remedies, secured transactions, corporate governance, and corporate and bank insolvency;145 and as to the institutional aspects focusing on modern administrative, enforcement, and judicial bodies146). Such legal-institutional and infrastructural reforms are indeed a prerequisite to a sound foundation for building a viable financial sector. However, these reforms fail to consider what a country wishes its financial system to embrace, the base of participants to include, or what policies, institutions, and additional legal infrastructure to implement in order to achieve these developmental objectives.
For the legal system to achieve these objectives, key legislation needs to be put into place, i.e., at a minimum, modern contract, corporate, bankruptcy, private property, and commercial laws, as well as modern banking and investment securities laws (and even, most probably, a basic asset securitization law). These latter legal provisions specifically governing financial activities need to be rule-based and transparent while preserving a required degree of flexibility necessary to adapt to innovations and changing market conditions. The financial legislation/regulations should promulgate disclosure of information so as to enable market forces to discipline the activities of financial institutions and “market players.” Clarity of entry and exit standards of financial institutions reduces uncertainty within the financial markets. A well-defined exit policy is especially imperative since this is the time when the market is likely to act rashly and to cause self-fulfilling bank runs.147
In addition, administrative and judicial procedures need to be sufficiently clear and to be backed up with quality enforcement entailed to them. The problem for many emerging economies is the lack of any effective administration and enforcement. Thus, ensuring that enforcement is carried out extends the appropriate incentives for market participants to act normatively. Two specific priorities are seen as improving the enforcement of financial contracts: 1) Effective means to take possession of collateral exist; and 2) Revision and updating of legal codes are carried out to reflect new market realities.
The lack of legal remedies in the case of non-compliance can paralyze the market and discourage foreigners from investing in emerging markets. The uncertainty surrounding the outcome of legal procedures and processes also inhibits the robustness of financial markets.148
Other key components for building modern international financial best practices/standards might include the twelve key standards set out by the Financial Stability Forum.149 All these reform components serve to strengthen and deepen the stability base of the preexisting financial sector, which is only representative of the top of the socioeconomic pyramid. However, they are not designed to broaden the financial sector base.
As mentioned above, the G7/8 views the “robustness” of a financial system is an essential characteristic of a stable system. To promote this, the G10 Working Group has identified three crucial actions that should be taken by each country according to their specific situation:
[1)] Creation of an institutional setting and financial infrastructure necessary for a sound credit culture and effective market functioning[;] . . .
[2)] Promotion of the functioning of markets so that owners, directors, investors and other actual and potential stakeholders exercise adequate discipline over financial institutions[; and] . . . [3)] Creation of regulatory and supervisory arrangements that complement and support the operation of market discipline.150
This would entail improving the infrastructural aspects of the financial system, namely, the legal and judicial framework, accounting and disclosure standards, and market structure. When viewed in this way, financial legal sector reform becomes a deep, complex, and long-term matrix of reform efforts, presenting truly awesome challenges for, and demands on, the IFI resources and personnel at a time when they are being pressured to react to ongoing, immediate financial crises.151 Yet, the deepness of this reform process is not directed toward broadening the reform base to be more inclusive as to access or as to serving true developmental objectives.
What is rightly asserted by Claessens and Perotti now seems self-evident for those who have been involved with financial sector reform: the relationships between inequality and finance seem to be becoming clearer at the beginning of the twenty-first century. Important research conducted so far has suggested that to reduce inequality, financial systems need to be broadened, not just deepened. “Financial reform will only reduce inequality . . . if it improves access to growth opportunities for more individuals. Reforms thus need to broaden, not just deepen financial systems.”152 Certainly, in logically and pragmatically following through on Sen’s paradigm of “choice (freedom) and development,” choice presupposes meaningful and effective “access.”153 Access, in turn, presupposes the existence of suitable supporting governmental policies and financial sector infrastructure, which presumes the presence of appropriate, supporting policies, institutions, legal infrastructure, and legal instruments.
However, the need to broaden is not simply about creating greater access to the financial system for the currently disenfranchised population, but should also address broadening the financial system itself so that it is not structurally geared only to the elite economic, business, and social elements of a developing country’s society. The financial system should also be systemically structured in terms of suitable development policy to provide appropriate institutions, laws, and instruments for accommodating the poor, low-income, and other excluded elements of the country’s population. For instance, it becomes critical to identify the particular sectors of a society that need priority development (e.g., agriculture, small business, housing, social safety net components, etc.), to assess the extent the existing financial sector and institutions might be better utilized in furthering such developmental objectives, and to determine what new institutions, laws, regulations, and instruments might be required. To achieve all this in a coherent, sequenced, and long-term sustainable manner is indeed an enormous challenge for any country and for the supporting IFIs/RFIs. But, without having a financial system that is relevant to a country’s developmental stage and objectives, and designed to bring in and to serve the excluded in meaningful ways, a country’s financial system cannot effectively contribute to optimum, meaningful, and sustainable socioeconomic development. Nor can such a system provide a broad, stable platform for achieving stability with robust and sustained growth in the financial sector.
As indicated in the first paragraph of this Article, this author originally had intended to address in detail the types of protection banking and financial sector users-consumers in developing countries might require, until it became apparent that the more fundamental need was the creation of a suitable user-consumer base, which is currently lacking in developing countries. Should there also be consumer protection in the financial sector of developing economies? Certainly, the answer must be yes. In creating greater access to the financial sector, consumer protection should be achieved in an equitable manner, and part of this equity needs to be the assurance that both new users-consumers and those not yet included are fairly treated and protected from predatory, overreaching, and abusive practices (formal and informal). The provision of such protection should not be viewed as an afterthought or as a subsequent level of reform, but should be an integral and contemporaneous part of the access-equity financial sector reform agenda.
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Footnotes
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