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Policy uncertainty, information asymmetries, and financial intermediation

  • Caprio, Gerard

Financial reform is often accompanied by other changes, including structural adjustment. Entrepreneurs'judgements about investing in a post-reform world are important but so are banks'considerations of the sunk costs of investments in both physical capital and information development. The accepted wisdom is that financial reform should not precede"real"sector adjustment, or banks will get into trouble by lending at disequilibrium prices. But postponing all financial reform until structural adjustment is complete is equally dangerous : unless the financial sector is prepared, investors will not have enough capital to invest, even given credible programs. The best candidates for reform - in both real and financial sectors - are countries with more diversified banking systems. These are more likely in well-diversified economies, with no recent history of severe financial repression. Countries that have had open capital markets will be better off since they do not have pent-up demand for such assets. Well capitalized banking systems will tend to fare better under reform, even though ample financial capital may not lead banks to lend aggressively in the face of greater uncertainty. Clear signals from reforming governments on where policies are headed will help both entrepreneurs and their financiers. Without these signals, banks will not be sure where to concentrate their investment in gathering information, and periods of loan retrenchment are likely to be prolonged.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 853.

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Date of creation: 29 Feb 1992
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Handle: RePEc:wbk:wbrwps:853
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  1. Gertler, M. & Rose, A., 1991. "Finance, growth, and public policy," Policy Research Working Paper Series 814, The World Bank.
  2. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
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  4. Lummer, Scott L. & McConnell, John J., 1989. "Further evidence on the bank lending process and the capital-market response to bank loan agreements," Journal of Financial Economics, Elsevier, vol. 25(1), pages 99-122, November.
  5. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
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  7. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. Dani Rodrik, 1989. "Policy Uncertainty and Private Investment in Developing Countries," NBER Working Papers 2999, National Bureau of Economic Research, Inc.
  9. Bruce C. Greenwald & Joseph E. Stiglitz, 1990. "Macroeconomic Models with Equity and Credit Rationing," NBER Chapters, in: Asymmetric Information, Corporate Finance, and Investment, pages 15-42 National Bureau of Economic Research, Inc.
  10. Lang, William W. & Nakamura, Leonard I., 1990. "The dynamics of credit markets in a model with learning," Journal of Monetary Economics, Elsevier, vol. 26(2), pages 305-318, October.
  11. Caprio, Gerard & Honohan, Patrick, 1990. "Monetary policy instruments for developing countries," Policy Research Working Paper Series 528, The World Bank.
  12. Faini, Riccardo & de Melo, Jaime, 1990. "Adjustment, investment, and the real exchange rate in developing countries," Policy Research Working Paper Series 473, The World Bank.
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