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 Facilitating access to credit for small enterprises and the self-employed. One of the bestknown microcredit examples is ADIE in France, which supports businesses started by the unemployed who cannot access traditional financial institutions. It offers loans of up to EUR 6 000 at market interest rates, start-up grants funded by the government or by local authorities and non-interest bearing subordinated loans. These financial products are complemented with business support services.

 Making mainstream entrepreneurship support accessible and relevant to diverse client groups, using targeted marketing. An example is Finland’s state-owned risk financing company, Finnvera Plc, which offers targeted loans for women entrepreneurs. These loans are derived from mainstream products but are targeted and marketed exclusively to women.

 Using strong selection criteria to target support at those with the best projects, who are the most likely to succeed. One example is the Prince’s Trust Youth Business Scotland, which supports ‘‘un-bankable’’ young entrepreneurs. The scheme couples targeted business development services and microfinance that is awarded through competitive mechanisms.

 Accepting that many start-ups will fail, that this is not a policy failure, but that it will require the appropriate modification of policies. For example, the Start-up Credit for Partially Occupationally Disabled Persons in the Netherlands provides start-up loans for business creation to partially disabled people who can nevertheless participate in some capacity in the labour market. Given the greater difficulties this group faces in the labour market, and the social as well as economic objectives of the policy, the targeted survival and growth rates from these businesses should not necessarily be set as high as for mainstream entrepreneurship programmes and complementary support may be considered. The scheme was recently adjusted to include more coaching following evaluations of similar schemes in other countries that have highlighted the significant role that can coaching have in successful business start-up.

3.4 – The financial sector and its relation to Inclusive Growth Unequal rewards from the operations of the financial markets Access to finance is central to growth and job creation, but an increasingly complex financial sector puts small savers and investors at a disadvantage. Financial intermediation plays a central role in supporting growth by channelling savings to productive investment, facilitating risk pooling and reducing the cost of capital and investment. However, in their role as financial intermediaries, the financial sectors of OECD countries in particular have moved into trading ever more complex instruments, such as derivatives, on their own account in order to diversify and shift risk (Figure 3.5). Trade in derivatives and other complex financial instruments can be highly profitable, but it requires highly-skilled and highly paid professionals. Computer-based trading strategies have increased short-termism, channelling the rewards mainly to financial market participants (Box 3.10). This increased sophistication of financial markets and products makes individual financial decisions, for instance saving for retirement, more challenging, and more and more financial risks are being transferred onto individuals who are not necessarily well equipped to bear them. It is especially problematic, since pension and health care reforms are making pay-as-you-go public pensions and health support less generous, and defined-benefit private pensions less available.

Figure 3.5.

The growth of derivatives has outpaced traditional financial assets

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Source: OECD calculations based on data from Bank for International Settlements (BIS); Thomson-Reuters, Datastream; World Federation of Stock Exchanges.

The industry of managing household savings has boomed but the benefits of greater financial intermediation have increasingly benefitted the well-off. In many countries, pension systems are increasingly relying on a funded component where the ultimate pension benefits depend on the performance of stock markets. In the last decade pension funds, insurance companies and investment funds have doubled their assets under management from USD 36 trillion to almost USD 75 trillion47. A large portion of these assets is invested in publicly listed stocks. It is estimated that Europeans between the ages of 30-65 today allocate 35% of their savings to the stock market, mostly through funds and other intermediaries (McKinsey Global Institute, 2011). Despite an increased reliance on financial assets among broad segments of the population, an important driver of increased income inequality, as discussed in Chapter 1, is a skewed distribution of capital income. The benefits of greater financial intermediation appear to have gone disproportionately to higher-income households.

Box 3.10. Short-termism crowds out long-term investment in stock markets to the benefit of traders The equity market structure has significantly changed over the last decade. Trade practices have become more sophisticated, markets more fragmented and new instruments have been increasingly dominating the markets. Trading in equity increased much faster than the supply of new equity capital through initial and secondary public offerings in the stock exchanges. Particularly in the pre-crisis period, between 2004 and 2007, the increase in trade volume was three times the increase in new equity capital raised.

An important change in trading practices and investment strategies over the last decade is the dominance of algorithmic trading, which means that orders are executed by computer-based systems according to a predesigned set of rules and procedures. The current public discussion focuses primarily on one particular type of algorithmic trading, namely high-frequency trading (HFT), which represents the largest, and in many cases an increasing, share in trade volumes in some OECD markets. HFT is characterised by very short timeframes for transactions (e.g. milliseconds) and cancelation of orders shortly after the submission. Today, HFT accounts for more than 60% of the total trading volume in the US equity market. In Europe, it represents some 38% of total trade volume in 2010 with an upward trend.

It is important to note that HFT is more than a technological advancement allowing high-speed computer trading. From a corporate governance perspective, it can also be seen as an investment strategy with a very short-term focus. The goal is not to assess and trade on genuine information concerning the long-term performance of any individual company, but rather to benefit from short-term arbitrage opportunities that are often obtained by unique and fast access to trading information. Defenders of HFT claim that it makes markets more liquid and thus reduces the cost of transactions. Arguably, those cost savings accrue mainly to the HFT traders themselves.

Source: (Isaksson and. S. Çelik 2013). “Who Cares? Corporate Governance in Today’s Equity Markets”, OECD Corporate Governance Working Papers, No, 8, OECD Publishing, Paris.

Companies now finance themselves differently, and their profits are less equally shared. In the last decade, many companies abandoned the public stock markets as a way of raising finance, relying instead on internal funds or raising money on the bond markets via investment banks. There has also been an almost 60% drop in listed new companies in OECD economies (Figure 3.6). Indeed, in the United States the stock market now has only half the number of publicly traded companies that it had ten years ago. At the same time, the number of listed companies in Europe decreased by some 27%. The decision not to be publicly traded is obviously the choice of the individual company or entrepreneur. However, if rules, regulations or tax treatment provide a bias in terms of choice it is a public policy concern, since there are good reasons to believe that the way companies are financed and managed will affect the distribution in society of the wealth that companies create. When companies become increasingly privately held, the general public is excluded from sharing in their profits and wealth creation.

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Source: Thomson Reuters New Issues Database; World Bank World Development Indicators The build-up of debt in the run-up to the global crisis did not benefit poor households. Against a macroeconomic background of low interest rates and rising prosperity, OECD households took on more and more fixed-interest debt, especially mortgage debt. But the value of their assets – real estate and financial assets – was vulnerable to a downturn. The new international rules that regulate banks enabled them to borrow cheaply and invest more riskily. Ever more sophisticated instruments facilitated the creation of debt and were also used to encourage poorer households to take on more debt. This was most prominently the case with subprime mortgages that enabled them to become homeowners, but many were finally unable to service the mortgages. A combination of financial innovation in general, changes in the business models of banks, and the inability of many households to make financial decisions in an environment of increasingly complex financial services and products led to a build-up of debt and growing vulnerability for lower-income, less educated individuals and households.

Rethinking the financial sector

A resumption of credit growth in many OECD countries depends on comprehensive reform of policies and regulations. Comprehensive reform packages include initiatives to strengthen the capital base of banks and make their business models safe by reducing leverage and making risk-weighting of assets less complex and less open to regulatory arbitrage (Blundell-Wignall, Atkinson and Roulet, 2014a). There should also be resolution mechanisms in place for an orderly wind-down of weak banks (Schich and Kim, 2013). But to help prevent bank failures, business model reforms that separate high-risk activities of universal banks (particularly with respect to proprietary activities) should be a priority. Achieving consistency in such business model reforms, already in place or in preparation (US Volcker rule, UK Vickers and EU Liikanen proposals), will be important. Fragmentation of approaches should be avoided, because securities firms operate across national borders and will take advantage of regulatory loopholes.

The competitive structure of the banking sector should also be of policy makers’ concern. Empirical evidence indicates the positive role, based on relationship banking, played by smaller banks during the crisis, as they are better able to support households and firms when they go through rough times.

The structure of bank managers’ remuneration could be reformed to discourage them from adopting risk strategies that are not socially optimal. Bonuses could be paid in part in assets whose value is tied to that of the parent bank, and some part of large bonuses earned in good years could be made repayable in the case of bank failure. In addition, managers and directors could be obliged to sign affidavits stating that they had checked the risk management systems under their responsibility, and found them satisfactory, thus opening them to lawsuits if risk-taking is found to be excessive (Goodhart, 2013).

It is also desirable to reduce the traditional high reliance of SMEs on bank finance and broaden the range of non-bank financing instruments available to SMEs and entrepreneurs. This would enable them to continue to play their role in Inclusive Growth, innovation and employment. Revitalising securitisation by making it safer, simpler and more transparent is an important element in this effort, and perhaps needs some (initial) government and regulatory support. For mid-sized companies, bonds and private placements may also provide useful alternatives. For high-growth firms, equity finance, including venture capital, is important, and policy can also play a role in supporting seed finance and early stage finance. Many dynamic SMEs might also benefit from equity-type products, in particular “mezzanine finance”, a variable mix of equity-type and debt-type financing, normally senior only to common stock.

Crowd-funding is another avenue that opens financing possibilities for SMEs. Furthermore, the role of equity markets is important as they allow venture capital companies to be sold to the public in an initial public offering (IPO), and more generally can provide risk capital for mid-cap companies (conventionally companies with a market capitalization of between USD 2-10 billion.48 Corporate governance reform is fundamental to the well-functioning of a dynamic private sector and Inclusive Growth. The ability of equity markets to serve the real economy has weakened. This concerns both the primary markets, where growth companies should be able to raise risk capital to innovate, expand and create jobs, as well as the secondary markets where the shares of already listed companies are traded. A decade of far-reaching changes in investment practices, corporate ownership structures and the functioning of stock markets is challenging the conventional wisdom and the relevance of current corporate governance standards. Corporate governance policies should be adapted to better serve the needs of growth companies and those intermediaries who want to take a long-term perspective.

Reducing the conflicts of interest and the complexity in the investment chain from households to corporations will provide an opportunity for achieving Inclusive Growth where individual households can share in the wealth created by the corporate sector.

Institutional investors such as pension funds, insurers and sovereign wealth funds, represent a potentially major source of long-term financing for illiquid assets such as infrastructure. Over the last decade, these investors have been looking for new sources of long-term, inflation protected returns. Asset allocation trends observed in recent years show a gradual globalisation of portfolios with an increased interest in emerging markets and diversification into new asset classes. However, the role of institutional investors in long-term financing is constrained not only by the short-termism increasingly pervasive in capital markets but also by structural and policy barriers such as regulatory disincentives, lack of appropriate financing vehicles, limited investment and risk management expertise, transparency, viability issues and a lack of appropriate data and investment benchmarks for illiquid assets. The matching of longterm liabilities for pension and insurance companies requires sound long-term investments that are suitable for pension funds in terms of viability and duration. Infrastructure investment has the potential to develop financing vehicles that could be well suited to such aims. Developing the right policy frameworks and financial products is therefore a critical and integral part of financial reforms and policy making.

Focusing on individuals and financial consumers

Policies also need to address these problems at the level of individuals and consumers of financial services. Fostering financial education and consumer protection is essential to equipping the most vulnerable groups with the basic skills and competencies they need in order to efficiently use financial services available to them and make informed financial choices as well as to effectively protect these groups against the effects of unfair practices. With a view to consistently addressing these issues, two sets of Principles endorsed by G20 Leaders in 2011 and 2012 respectively were developed on Financial Consumer Protection by the OECD dedicated task force and on National Strategies for Financial Education by the OECD and its International Network on Financial Education (INFE). These Principles provide a fundamental framework and guidance to design and implement policies to develop consumers’ financial awareness and skills while at the same time ensuring that they are adequately informed and protected in their dealings with financial institutions.

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