Long Term Finance
30 May 2018
How do we define long-term finance?
We define long-term finance as financial transactions above a certain maturity threshold, for example above one or five years. More generally, one can think of long-term finance as financial transactions that match real sector transactions that require long-term funding, such as housing, infrastructure, firm investment, or long-term savings needs. In terms of specific products, long-term finance comprises long-term loans for households and enterprises, bonds, but also equity claims and long-term insurance contracts. Typical long-term financial liabilities comprise long-term savings products, life insurance products and pension claims. Long-term finance can be intermediated by banks, insurance companies, mutual funds and pension funds or directly on capital markets.
Why do we care about long-term finance?
There is ample evidence that households, firms, governments and society/economy at large benefit from the availability of long-term finance.
- Take first firms; the availability of long-term finance allows firms to invest in R&D activities. Or to look at it from the other side, the lack of access to long-term finance results in a pro-cyclical behaviour of the share of long-term in total firm finance, with too much given during good times and not enough during bad times, ultimately resulting in higher aggregate volatility and lower growth for the economy. More generally, better access to long-term finance allows a better maturity matching of assets and liabilities and reduces the dependence of investment decisions from cash flow availability.
- Take next households. On the savings side, it allows consumption smoothing over the life cycle, including access to necessary credit products for the “sandwiched generation” (i.e. the generation with children in education and parents with need for care) and savings for retirement. On the funding side it allows large investment, prominently into housing, but also into human capital, independent of current income but as a function of future expected income streams.
-Take finally governments; access to long-term finance, especially local currency bond markets, allows governments to finance fiscal deficits without having to resort to financial repression (ultimately undermining the overall efficiency of the financial system) or foreign currency borrowing on international markets (ultimately exposing government and the economy to additional macro-risks). Liquid and efficient markets also allow for more effective monetary policy transmission.
When discussing long-term finance, people often refer to infrastructure finance.
According to UNECA estimates, the infrastructure financing gap exceeds USD 30bn per year in Africa, across all areas - electricity; ICT; roads; water and sewerage. Government and donor finance will not be enough to fill this gap and thus private resources have to be levered. Given high resource needs and long-time horizons between start of construction, its completion and revenue phase, however, appropriate funding structures are needed. As private-public partnerships in infrastructure gain in importance, corresponding financing structures are needed that match maturity and risk structures of assets with funding. This is one area where Africa can learn from other regions, such as some countries in Latin America that have successfully implemented PPP frameworks and combined public funding and guarantees with private funding, both locally and internationally.
Is the lack of long-term finance an issue specific to Africa?
No, it is a challenge across the world, both in developing and advanced economies. Just take the example of infrastructure again. Infrastructure needs are high in both developed and developing countries; while difficult to put an exact number on these needs, G30 estimates infrastructure needs of USD 7 trillion for nine major economies, accounting for 60 percent of global GDP, until 2020. And long-term finance is not easily available in most countries. For example, the capital market union initiative in the European Union is partly driven by the objective of having more long-term finance in the economy from diversified sources.
What is the state of long-term finance in Africa?
There are two ways to answer this question: one, we know that there is very little. Banks’ assets and liabilities are focused on the short end of the yield curve. The traditional providers of long-term financial resources (life insurance companies, pension funds, mutual funds) are very underdeveloped and where they exist they do not necessarily invest their long-term funding and liabilities into long-term assets. Having said this, and to provide a more correct response to the question, we simply do not know sufficiently to properly assess the state of long-term finance in Africa. We have little information on private equity and debt markets in the region and our information on public capital market is limited, except from the African Financial Markets Initiative – www.africanbondmarkets.org – AFMI, an initiative of the African Development Bank -AfDB). That is why we recently have started an additional initiative to collect more systematically information on long-term finance provision across the region to thus have a better information base for analysts and policymakers. This initiative has brought together AFDB, FSD Africa and the German Development Cooperation and has two components. First, we will construct a scoreboard to inform policy makers, the private sector and donors about the availability of long-term finance across Sub-Sahara Africa (SSA). The scoreboard will include an array of indicators of the depth and inclusiveness of long-term financial markets and the data can also be used to benchmark specific indicators according to structural country characteristics. Second, an in-country diagnostics to focus on specific transactions in infrastructure, housing and firm finance. This diagnostic aims at understanding the financing options available for such transactions and potential barriers. It is designed as bottom-up approach rather than a broad institutional assessment, thus starting from the long-term financing needs of a country and how to fulfil them.
Over the past decade, there has been a strong focus on financial inclusion – is there an overlap with the long-term finance agenda?
The financial inclusion agenda – increasing the share of population with access to basic formal financial services – and the long-term finance agenda have a clear overlap but are also complementary to each other. African financial systems offer their customers few long-term savings products (be they savings, insurance or pension products) and not only are mortgage finance systems very shallow, but the share of the population with access to mortgage products is miniscule. As you can see, there is a clear overlap between these two agendas. When talking about other aspects of the long-term agenda, on the other hand, it is complementary to the financial inclusion agenda. Investment in infrastructure, providing long-term finance for mid-sized and large as well as small companies is critical for African economies to grow.
Where do we go from here?
Over the past decade, African financial systems have made enormous progress in terms of financial inclusion, driven by innovation and new providers, but also by the availability of more data and research. I very much hope for a similar development in the area of long-term finance. There is a need for new players and new products and a partnership between private sector, government and donors. While there is not one silver bullet to solve the challenge of long-term finance in Africa, many opportunities await. Better data and better analysis can help.