Domestic Capital Markets in Latin America and East Asia:

Emerging market economies – including Latin America and East Asia – have traditionally had bank-based financial systems, where capital markets have been small and poorly developed. In these settings, bond markets have tended to be shallow, heavily dominated by government debt, and with low turnover. Stock markets, likewise, have featured few issues and most have not been traded with any frequency. Thus, the banking sector, which is usually a combination of private commercial banks and government development banks, has provided the main source of finance for both public and private borrowers. Recent financial liberalization reforms have changed the way the banking sector operates by limiting government controls over interest rates and over the volume and recipients of credit, but they have not necessarily provided much stimulus for capital market development.

According to one strand of literature, these characteristics do not pose any particular problem since it is argued that bank-based systems provide a perfectly viable source of finance; indeed, the majority of the industrial countries have bank-based systems. The so-called Anglo-Saxon model, based on strong capital markets, is an anomaly even among industrial economies. Another line of thought suggests that it is important to have capital markets in addition to the banking system. Among the reasons put forward is that domestic capital markets will lower dependence on volatile foreign capital flows. Noteworthy is the fact that governments of many Asian countries have become proponents of the latter position in the aftermath of the Asian financial crisis of the late 1990s. While a few Latin American countries have long had fairly active capital markets, less emphasis has been put on developing them than in the Asian context.

This paper focuses on several issues with respect to capital markets in emerging market economies. The first section reviews the literature about their role and relative importance. The second provides data on financial market trends in Latin America and East Asia. The third analyzes the differences between the two regions and explores some implications. The final section concludes with some policy proposals for stimulating capital markets in emerging markets and asks to what extent the domestic markets really can be a substitute for foreign capital in the near future.

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