Capital Markets allow businesses to raise long-term funds by providing a market for securities, both through debt and equity. Capital Markets offer a whole range of sometimes complicated products which allow businesses and banks not just to raise capital but also to ‘hedge’ (protect) against risks.
IFC is involved in the provision of three main products in Capital Markets. Firstly, IFC aids the securitization of future capital flows (for example credit risk exposure and food security), secondly it is developing capital release products, thirdly by providing Diversified Payment mechanisms, and finally through Capital Release products.
Food security and pricing is an increasing concern the globe. Aside from the risks associated with natural disasters and droughts (which can be mitigated through insurance - link) concerns about price fluctuations between purchasing seeds and equipment and harvesting and selling a product can have a huge affect on a farmers or businesses decision on what and how much to plant – leading to food insecurity.
There is a now surging a demand for products which enable you to control the price risk in food production. Whilst the products do exist in emerging markets, often the upfront costs to businesses are prohibitively high, preventing their widespread use. IFC is helping to bridge that gap.
By working through financial intermediaries, IFC seeks to make available a price risk management product to Banks which then allows them to take on credit exposure of businesses and farmers. For example, this would allow a producer in Brazil, or a wheat producer in Africa to know what future price they can sell at. They can then buy a ‘price hedge’ to ensure the future value of the sugar they produce covers the costs of any loans they may need to produce it. Over the longer term this should bring about greater food price stability and indirectly more production. Such products also encourage lending to the agricultural sector for investment, as the borrower has greater certainty of a fixed return.
‘Capital release’ products aim to increase lending by banks in emerging markets to small and medium size businesses. Such lending is currently limited by unreasonably high risk weightings on SME assets and increasingly high capital requirements by regulators. The capital charges on SME lending that arise from this state of affairs have created strong disincentives/limit the ability for banks to grow their SME credit business.
IFC is therefore developing ‘capital release’ products which allow banks to obtain targeted risk protection for predetermined amounts of unexpected losses for specific SME loan portfolios. In this nascent market for ‘capital release’ transactions, risk mitigation is arranged by a small number of specialized, structured credit firms and placed by them with non-bank investors. Such transactions lower banks’ capital costs of lending to SMEs, and therefore free up capacity for them to do new SME credit business.
For the moment, most transactions of this nature have involved SME credit exposures in developed – and not emerging – markets. IFC aims aim to broaden application of the capital release product to emerging SME loan portfolios, thereby increasing the amount of capital and therefore credit that can be made available by banks to emerging market SMEs. Working almost like a catalyst, a capital release fund could free up capital worth up to ten times as much as the fund itself, serving as an engine of growth to SMEs and jobs.