The LTF Initiative applies a flexible definition of LTF that reflects the differing productive life of assets being financed, which may vary between 20 to 30 years in the infrastructure and housing sectors and 5 years or less for enterprises. Gaps in the provision of LTF arise because of the varied maturities available to those financing investments in these sectors. Long-term finance is defined as any financial instrument with maturity suitable to the financing of productive investment in the sector in question, and can take the form of bank loans, leasing, bonds and other forms of debt finance as well as public and private equity instruments. Maturity refers to the length of time between origination of a financial claim (loan, bond, or other financial instrument) and the final payment date, at which point the remaining principal and interest are due to be paid. Equity is to be regarded as an instrument without a finite maturity.
The one year cut-off maturity corresponds to the definition of fixed investment in national accounts. The Group of 20, by comparison, uses a maturity of five years more adapted to investment horizons in quoted financial markets (G-20 2013). Depending on the sectoral focus, the Scoreboard use one of these two definitions to characterize the extent of provision of long-term finance. Moreover, because there is no consensus on the precise definition of long-term finance, wherever possible, rather than use a specific definition of long-term finance, the Scoreboard provides granular data showing as many maturity buckets and comparisons as possible.
Why is access to long-term finance important for the development of African countries?
Extending the maturity structure of finance is often considered to be at the core of sustainable economic growth. Long-term finance contributes to faster growth, greater welfare, shared prosperity, and enduring stability in two important ways: by reducing rollover risks for borrowers, thereby increasing investment horizons, and reducing investment risk, and by increasing the availability of long-term financial instruments, thereby allowing investors – both institutional investors and households to address their saving and life-cycle challenges.
The term of the financing reflects risk-sharing between providers and users of finance. Long-term finance shifts risk to the providers because lenders bear the risks associated with interest rate fluctuations and possible default, and as result they may well require a premium as part of their compensation for the higher risk. On the other hand, short-term finance shifts risk to users, as it forces them to frequently roll over their financing.
In well-functioning markets, borrowers and lenders will enter short- or long-term contracts depending on their financing needs reflective of how they agree to share the risk involved at different maturities. In supporting investment in productive assets what matters is that borrowers have access to financial instruments that allow them to match the time horizons of their investment opportunities with the time horizons of their financing. At the same time, savers will need to be compensated for the extra risk they might take.
Where it exists in Africa, the bulk of long-term finance is provided by banks; use of equity, including private equity, is limited particularly for smaller firms. As financial systems develop, the maturity of external finance tends to lengthen. Banks’ share of lending that is long term tends to fall with a country’s income and the development of capital markets and institutional investors. Long-term finance for firms through issuances of equity, bonds, and syndicated loans has grown significantly over the past decades, but only very few large firms can efficiently access long-term finance through equity or bond markets. As demonstrated by countries such as Chile, the promotion of nonbank intermediaries (pension funds and mutual funds) in developing countries, does not always guarantee an increased demand for long-term assets.
What are the key challenges to better LTF in Africa?
Attempts to actively promote long-term finance have proved both challenging and controversial. The prevailing view is that financial markets in developing economies are imperfect, resulting in a considerable scarcity of long-term finance, thus impeding investment and growth. Indeed, a significant part of lending by multilateral development banks (including World Bank Group lending and guarantees) has aims at compensating for the perceived lack of long-term credit. At the same time, research shows that weak institutions, poor contract enforcement, and macroeconomic instability result in shorter maturities on financial instruments. Indeed, shorter maturities are to be expected when legal, regulatory and institutional capacity is weak and creditor rights are inadequately enforced.
From this perspective, the policy focus should be on fixing these fundamentals, not on directly boosting the term-structure of credit. Indeed, some argue that attempts to promote long-term credit in developing economies without addressing the fundamental institutional and policy problems have often turned out to be costly for development. For example, efforts to jump-start long-term credit through development financial institutions in the 1970s and 1980s led to substantial costs to taxpayers and in extreme cases to failures (World Bank 1989). In response, the World Bank reduced this type of long-term lending in the 1990s and the 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 – may hold promise for mobilizing financing for long-term projects, and allow governments to mitigate political and regulatory risks while mobilizing funding for private investment.