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Wef fs redefining_emergingmarketopportunity_report_2012

  1. 1. Insight ReportRedefining the EmergingMarket OpportunityDriving Growth throughFinancial Services InnovationPrepared in collaboration with The Boston Consulting Group
  2. 2. Insight ReportRedefining the EmergingMarket OpportunityDriving Growth throughFinancial Services InnovationPrepared in collaboration with The Boston Consulting Group
  3. 3. The information in this report, or upon which this report World Economic Forum USA Inc.is based, has been obtained from sources the authors 3 East 54th Streetbelieve to be reliable and accurate. However, it has 18th Floornot been independently verified and no representation New York, NY 10022or warranty, expressed or implied, is made as to the Tel.: +1 212 703 2300accuracy or completeness of any information contained Fax: +1 212 703 2399in this report obtained from third parties. Readers E-mail: forumusa@weforum.orgare cautioned not to place undue reliance on these www.weforum.org/usastatements. The World Economic Forum, the WorldEconomic Forum USA, and its project advisers, The World Economic ForumBoston Consulting Group, undertake no obligation to 91-93 route de la Capitepublicly revise or update any statements, whether as a CH-1223 Cologny/Genevaresult of new information, future events or otherwise, and Tel.: +41 (0)22 869 1212they shall in no event be liable for any loss or damage Fax: +41 (0)22 786 2744arising in connection with the use of the information in this E-mail: contact@weforum.orgreport. www.weforum.orgThe views expressed in this publication have been based Copyright © 2012on workshops, interviews and research, and do not by the World Economic Forum USA Inc.necessarily reflect those of the World Economic Forum. All rights reserved No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by any information storage and retrieval system. ISBN-10: 92-95044-58-4 ISBN-13: 978-92-95044-58-6 A catalogue record for this book is available from the British Library. A catalogue record for this book is available from the Library of Congress.
  4. 4. Contents Case Study 4: Rationalizing the Branch-Banking.........................75Contributors v Model to Deliver ‘No Frill’ Services Case Study 5: Savings-Linked Conditional Cash.........................79Preface vii Transfer Programs Case Study 6: Using Legacy Payment Data................................83Executive Summary ix and Infrastructure to Expand into Consumer Loans Case Study 7: Developing the Broader Ecosystem......................87Part 1: Financial Services Opportunities 1 for Technology-Enabled Channelsin Emerging Markets Case Study 8: Instant Disbursement of........................................91 Vehicle-Based FinancingChapter 1: Unleashing Growth Opportunities 3 Case Study 9: Adopting a Franchise Model to.............................95in Emerging Markets Expand Low-Income Financial ServicesAppendix A: Supporting Figures....................................................13 Case Study 10: Using Equity to Finance SMEs in..........................99 Credit-Constrained MarketsChapter 2: The Opportunity in Consumer 17 Case Study 11: Federalizing Product Development.....................103Financial Services to Tailor Loan Products to SMEsStage 1: Exploiting Existing Infrastructure and Capabilities............22 Case Study 12: Adapting POS Networks..................................... 107Stage 2: Enhancing Mass-Market Distribution Channels...............27 to Deliver SME LoansStage 3: Delivering a Balanced Portfolio of Services.....................29 Case Study 13: Using a Pawnshop-Bank Partnership................. 111 to Improve Propositions for CustomersChapter 3: The Opportunity in SME Financing 31 and ProvidersStage 1: Developing Key Institutional Competencies.....................34 Case Study 14: Using an Electronic Platform to Provide............. 115Stage 2: Transforming Economics through Partnerships...............40 Supply-Chain Financing for SMEsStage 3: Setting the Stage for Future Growth................................43 Case Study 15: Finance SME Suppliers through......................... 119 National Reverse Factoring InfrastructureChapter 4: The Opportunity in Corporate Bonds 47 Case Study 16: Developing the Venture Capital........................... 123Stage 1: Laying the Foundation......................................................52 Industry through Co-InvestmentStage 2: Building Scale for Corporate Bond Markets.....................54 with Foreign InvestorsStage 3: Enhancing Liquidity and Deepening Markets...................55 Case Study 17: Forging Central Bank Partnerships to................. 127 Build the Market for a Region’s BondsPart 2: Case Studies 59 Case Study 18: Building a Bond Investor Base through.............. 131 Pension Fund and Insurance ReformList of Case Studies 61 Case Study 19: Building Liquidity in Government........................135 Bonds to Pave the Way for CorporateCase Study 1: Community Partnership Models...........................63 Issuances for Efficient Product Delivery Case Study 20: Overcoming Institutional Voids to.......................139Case Study 2: Bundling Products to Encourage..........................67 Issue Corporate Debt Experienced-Based LearningCase Study 3: Delivering Consumer Loans to..............................71 Low-Income Consumers through Acknowledgments 143 Utility Company Infrastructure Redefining the Emerging Market Opportunity | iii
  5. 5. ContributorsPROJECT TEAM EXPERT COMMITTEEErnest Saudjana Thorsten BeckProject Manager, Redefining the Emerging Market Professor, Tilburg UniversityOpportunity project, World Economic Forum USA Erik Berglof(on secondment from The Boston Consulting Group) Chief Economist, European Bank for ReconstructionJames Bilodeau and DevelopmentSpecial Advisor, Financial Services Mario BlejerWorld Economic Forum USA Vice-Chairman, Banco HipotecarioRanu Dayal Walid ChammahSenior Partner and Managing Director, Chairman and Chief Executive Officer, Morgan Stanley InternationalThe Boston Consulting Group Janamitra DevanTodd Glass Vice-President, Financial and Private Sector Development,Project Associate, Emerging Markets Finance, International Finance CorporationWorld Economic Forum USA Ismail Douiri Co-Chief Executive Officer, Attijariwafa Bank Chris Furness Managing Director, Standard Chartered Kamesh Goyal Head of Group Planning and Controlling, Allianz SE Frank Hatheway Chief Economist, The NASDAQ Stock Market, USA Fawzi Kyriakos-Saad Chief Executive Officer, Europe, Middle East and Africa (EMEA) and Member of the Executive Board, Credit Suisse Nkosana Moyo Founder and Executive Chair, Mandela Institute for Development Studies Rajat M. Nag Managing Director General, Asian Development Bank Mthuli Ncube Chief Economist and Vice-President, African Development Bank Steven Puig Vice-President, Private Sector and Non-Sovereign Guaranteed Operations, Inter-American Development Bank Mark Richards Partner, Actis Sergio Schmukler Lead Economist, World Bank Barry Stowe Chief Executive, Prudential Corporation Asia, Prudential Fernando Alvarez Toca Chief Executive Officer, Banco Compartamos Levent Veziroglu Executive Vice President, Dogus Holding Redefining the Emerging Market Opportunity | v
  6. 6. PrefaceKEVIN STEINBERG, Chief Operating Officer, World Economic Forum USA, andGIANCARLO BRUNO, Senior Director and Head, Financial Services Industries, World Economic Forum USAThe World Economic Forum is proud to release this tap into the aforementioned opportunities in advanceReport, Redefining the Emerging Market Opportunity: of capacity building. Many of these models have theDriving Growth Through Financial Services Innovation. potential to be transferrable across borders. The ReportThe project was initiated to explore innovative models is accompanied by nearly three dozen real-world casefrom financial institutions that accelerate development of studies and cases-in-point. These illustrate strategiesopportunities in emerging markets. and initiatives that have transformed unmet emerging- Over the past few years, emerging markets have market need and demand into opportunity and progress,played a major role in driving global economic growth. as well as challenges encountered along the way. CaseEven faster growth can be observed in the financial studies include new models in distribution models,services space, contributing to high shareholder return product development, and risk assessment, as well asby emerging market institutions. approaches to overcoming institutional barriers. Despite this strong growth, penetration of financial The Report itself is the result of a year-longservices remains low in many developing countries. The collaboration between the World Economic Forum,World Economic Forum’s Financial Development Report The Boston Consulting Group, and leading industry2011 highlighted the fact that many emerging economies practitioners, policymakers, and academics participatinghave undeveloped areas within their financial systems. in interviews and workshops around the globe.Developing these opportunities will be critical to realizing Throughout this process, intellectual stewardship andeconomic growth and prosperity for people in these guidance was provided by an actively engaged Expertregions. Committee. This Report highlights two broad conclusions: We trust that this publication can help overcome asymmetries in knowledge and experience across • The most powerful and compelling opportunities for financial services firms to promote growth and different regions and organizations, and help realize stability in emerging markets lie in three specific the untapped opportunities within the financial services areas: consumer financial services, small and space in emerging markets. Moreover, we hope that this medium enterprise (SME) financing, and corporate Report can provide relevant input and catalyze dialogue bond markets. among the private sector, governments, investors, and other stakeholders in implementing innovative models in • ”Leapfrog” innovation in these three areas, rather various emerging economies. than simple capacity building, will be the key to success in driving broad economic growth. At the On behalf of the World Economic Forum, we wish to same time, capitalizing on these opportunities will thank all who have contributed their time and expertise provide institutions and their investors an avenue for to this Report, particularly the Expert Committee, the long-term growth and shareholder return. interview and workshop participants, Project Manager Ernest Saudjana, Senior Advisor James Bilodeau, The Report showcases a shortlist of proven, Project Associate Todd Glass, and our project advisorinnovative approaches that financial institutions from from The Boston Consulting Group, Ranu Dayal.around the world have successfully implemented to Redefining the Emerging Market Opportunity | vii
  7. 7. Executive SummaryThe rising importance of developing economies has led emerging-market economic expansion contributedto an increased role for financial institutions in emerging US$8 trillion, or roughly 60 percent of global GDPcountries. The result is a historic opening for financial growth, during that half-decade. Many emerging marketsservices firms to provide new financial services to have also achieved unprecedented financial stabilityupwardly mobile low-income populations as well as to and economic resilience. The growth of developingregional companies evolving to world-class competitors. economies has been accompanied by an even faster For financial providers committed to understanding evolution of financial services.and unlocking the potential, there is unparalleledopportunity to build long-term growth and superior SUPERIOR SHAREHOLDER VALUEshareholder value. At the same time, providers can Financial institutions active in emerging marketshelp empower small and medium sized enterprises and have benefited from tremendous growth in marketlow-income people by providing financial access and a capitalizationpotential path out of poverty. Financial institutions in different parts of the world have seen very different outcomes for their market valueThree key opportunities: consumer financial in recent years. In high-income countries belongingservices, SME financing, and corporate bonds to the Organization for Economic Co-operation andThe purpose of this Report is to provide a guide to those Development (OECD), the market value of financialopportunities as well as a framework for action. Among institutions sustained a US$1.5 trillion decline from 2006the Report’s key conclusions: to 2011. At the same time, in non-OECD high-income countries, it grew by US$243 billion, and in emerging • First, the most significant opportunities for financial markets, values soared by US$572 billion. A five-year services firms in emerging markets lie in three total shareholder return (TSR) analysis of financial business activities: consumer financial services, institutions globally shows that the majority of top small- and medium-sized enterprise (SME) financing, and corporate bonds. institutions in emerging markets performed above the median level, while most of the large financial institutions • Second, innovation of financial products and in developed markets ranked in the bottom half. Of services—through lower barriers to entry, increased the 30 leading emerging-market banks, 75 percent productivity, and transformed economics of service performed in the TSR ranking’s first quartile—but none of delivery—is the main driver of success in emerging top 30 developed-market banks did. markets. Capacity-building of traditional services is not sufficient. The rise of financial institutions in emerging markets This Report is accompanied by nearly three dozen has reshaped international competitioncase studies and short “cases-in-point” highlighting Emerging-market banks in the top 200 tripled in numbersuccessful, real-world innovations. These profiles from 22 to 66 between 2005 and 2011 and now accountdocument strategies and initiatives that have transformed for one-third of leading global institutions. The rise ofunmet emerging-market needs and demands into emerging-market competitors is even more strikingopportunity and economic progress, as well as the within the top 100 institutions, where the number grewchallenges encountered along the way. (Case studies are from nine to 33 in the same period. In the middle of thegathered in Part 2; cases-in-point appear in boxes within 2000s, the emerging-market financial institutions risingthe report.) to the top ranks came mostly from China. More recently, institutions from Brazil, Chile, Indonesia, Thailand,Strong economic growth in emerging markets Malaysia, Turkey, India, and South Africa have made theirunderpins the new opportunity for providers way up the rankings, as well. The GDP growth of emerging nations stronglyoutpaced that of high-income countries from 2006 to2010. Developing economies grew at an annual rate ofroughly 15 percent, compared with growth averaging just3 percent for the developed world. In absolute terms, Redefining the Emerging Market Opportunity | ix
  8. 8. Executive SummaryCompetition will grow, requiring financial providers Successful providers focus first on filling a specificto create new business models in order to adapt mass-market needMany emerging-market institutions have advanced by Financial institutions usually find it difficult to createadopting highly innovative approaches in their own profitable services for low-income consumers whenmarkets. They have overcome infrastructure limitations they use legacy business models created to serve moreand addressed local needs through creative distribution affluent clients. Simply adjusting traditional businessmodels, risk practices, and partnerships. Some models—that is, relying on capacity-building initiatives—institutions, for example, can disburse financing to small is not enough. Innovating new channels, products, andbusiness customers within 10 minutes through electronic processes is necessary. Successful providers usuallychannels and without documentation or guarantor started by meeting an express and specific mass-marketrequirements. need and only then introduced additional products.Countries and financial institutions must steer clear A three-stage framework for developing consumerof potential macro- and micro-level risks financial servicesCountries need to ensure that they can respond to Our research suggests that consumer markets inglobal shocks, as macroeconomic conditions are closely emerging countries can best be developed in threelinked to the health of financial systems. Countries that stages of activity:have little fiscal and monetary flexibility must manage the Stage 1: Exploiting existing infrastructure andrisk of future macroeconomic challenges. capabilities. Institutions explore partnership models On a micro level, for financial providers, there is a to expand their reach to mass-market customers withrisk of reduced returns, as the high interest margins in minimal capital expenditure.emerging markets are expected to go down as marketsmature and competition intensifies. Financial providers Stage 2: Enhancing mass-market distributioncan overcome top-line compression by improving channels. Providers develop cost-effective models toefficiency, lowering costs, and diversifying income build and expand channels.streams. Institutions need to expand beyond credit Stage 3: Delivering a balanced portfolio ofrevenues. services. Governments establish an environment andCONSUMER FINANCIAL SERVICES: ENABLING infrastructure enabling providers to deliver a full set ofGROWTH AND REDUCING POVERTY services more efficiently in the long term.While emerging countries are growing faster thanmature ones, consumer financial services have not Case study highlights: Consumer financial servicescaught up Case studies accompanying this Report documentSavings accounts, insurance, loans, payments, and successful innovations in developing consumer financialsimilar offerings—where they do exist—penetrate services, including:unevenly and often reach only higher-income • Sales and distribution partnerships betweenpopulations. As a result, the enormous potential of financial providers and non-financial organizationsmass-market consumers to drive economic growth including utility providers, retailers, supermarketin emerging countries has barely been tapped. In the chains, and community organizations.portfolio of the poor, three key services are greatly in • New models for low-cost, paperless retail branches,demand but often inadequately provided: managing technology-enabled delivery channels, andmoney on a daily basis, building long-term savings, franchised distribution of mass-market services.and borrowing for various needs. Providing insuranceproducts will also be a significant opportunity. • Use of legacy consumer payment records in risk assessment and credit benchmarking.Providers will benefit by embracing financial SME FINANCING: BATTLING THE CREDIT PARADOXinclusion for lower-income populations Emerging markets face a credit paradox that hindersFor providers of consumer financial services, the most small- and medium-size businesses (SMEs), as wellsignificant “white space” opportunities for emerging- as their banks. Only one-third of SMEs, on average,market growth lie in mass-market services and products. have access to credit and loans, even though three- Financial inclusion of the poor will also benefit quarters of them maintain bank savings and checkingemerging countries. Consumer financial services can accounts. Banks, for their part, lack sufficient accessreduce poverty, improve health care, and increase the to shared data—such as tax records, credit history,consumer’s ability to afford needed goods on a more and legal status—to risk lending to many SMEs. As aequitable basis. The infrastructure for these services also result, many businesses lack much-needed cash tosupports and improves the society’s broader efficiency grow, while financial institutions miss the opportunityin raising capital, making payment transactions, and to tap into the huge pool of potential SME borrowers.distributing wealth. Emerging economies suffer because they dependx | Redefining the Emerging Market Opportunity
  9. 9. Executive Summaryheavily on smaller companies for economic growth and respect to products, services, risk management, andjob creation. SME client segmentation. Stage 2: Transform business models andSMEs play a major role in economic development offerings through national-scale partnerships andSMEs account for a significant share of employment collaborations with formal and informal organizations.and GDP around the world, especially when taking into Create shared infrastructure—such as repositories ofaccount the informal sector. SMEs provide an average SME data—and employ financial channels to deliverof 67 percent of the formal employment in developed government loans and subsidies.countries and around 45 percent in developingcountries. They also contribute a sizable share to formal Stage 3: Set the stage for future growth byGDP, 49 percent on average in high-income countries improving the business and financial managementand 29 percent on average in low-income countries, capabilities of SMEs themselves and thus theirrespectively. While that share may seem modest, the creditworthiness and attractiveness for investors outsideinformal sector—most of which comprises SMEs— the banking system.accounts for up to 48 percent of the total labor forceand 37 percent of GDP. The corresponding proportions Case study highlights: SME financingfor developed countries are just 25 percent of the labor Case studies accompanying this Report documentforce and 16 percent of GDP. successful innovations in SME finance development, including:Innovation can overcome SME financing challenges • Client micro-segmentation and customizationA number of innovative institutions are working actively strategies based on SMEs’ detailed financial needs,and creatively to topple the barriers to SME financing along with new models for rationalizing SMEin emerging markets. We have conducted a global services, such as “remote” relationship managers.review of these efforts and present in this Report asummary of those that have been the most successful • Using transaction information and psychometric testing to develop credit risk-assessment tools andand scalable. These models can be adopted or adapted benchmarks.by financial providers seeking to broaden their rangeof SME financing opportunities. There is little doubt • Adapting POS electronic networks to approve andamong global financial institutions that SMEs are a key deliver SME loans.source of profits now and that they will continue to be • Developing specialized financing sources, includingso in the future. In a 2008 survey of 91 banks in 45 venture capital and equity financing.countries, more than 80 percent of the banks describedthe SME market as a large and attractive one. More than CORPORATE BONDS: PROVIDING STABILITY AND70 percent said profitability was the top driver of their REDUCING RELIANCE ON TRADITIONAL CREDITinvolvement. Corporate bond markets provide many advantages, in the nations where they thriveThe private sector needs alternative mechanisms to Economies, companies, and investors all receive clearhelp new SMEs develop their capabilities and measurable benefits when corporations competeTraditional banks are often not the right institutions for transparently to raise funds by selling debt. Domesticserving start-up companies. Financial institutions, due corporate bond markets help diversify economies,to their risk-management approach, typically prefer to reduce systemic risk, and mitigate exposure to currencyfinance companies with clear cash flow that are already swings. As economies evolve, local companies growoperational. Additionally, formal financial providers larger, too, and develop more complex funding needs,often have scant knowledge of quickly evolving high- such as handling larger investments and managingtechnology industries and their SME business models, liquidity, interest-rate, and foreign currency risks. Bankand are inclined to reject loans for those entrepreneurs. credit alone cannot meet these requirements.As a result, emerging economies are deprived ofthe innovation, energy, and competitive capabilities Corporate bonds provide a valuable alternative tothat start-ups and other SMEs bring to developed bank financingeconomies. Venture capital, private equity, and similar The macroeconomic and financial dislocations thatstart-up financing operations are crucial to support followed the crises in emerging markets in the latenew SMEs trying to expand into the next stage of 1990s highlighted the importance of developing localdevelopment. bond markets as an alternative source of debt financing. Bond markets can strengthen corporate and bankThe three stages of action to improve SME financing restructuring and thus accelerate the resolution of aOur research suggests that financing for SMEs in crisis. Well-functioning local corporate bond marketsemerging countries can best be developed in three also provide institutional investors with an instrument thatdistinct stages of activity: satisfies their demand for fixed-income assets, especially of long maturities that match their long-term liabilities, Stage 1: Develop and improve primary while providing higher yields than government bonds. Forinstitutional competencies and business models with Redefining the Emerging Market Opportunity | xi
  10. 10. Executive Summarythe same reasons, corporate bonds can also strengthen • Creating central bank partnerships to promotethe balance sheets of pension funds and life insurance development of regional bond markets.companies. • Building a bond investor base through pension fund and insurance reform.Two pillars support corporate bond markets:economic size and level of development As this Report demonstrates, emerging economiesThe ability of a country to develop a corporate bond cannot rely solely on capacity building to acceleratemarket is largely determined by two factors: the size financial development. Traditional models often areof its economy and its level of economic development. unsuitable for seizing new opportunities. In manyA sizable and strong economy is required to sustain a countries, the best path for accelerating financial gainsliquid sovereign bond market, a prerequisite to creating will be “leapfrog” innovation that crosses borders,a corporate bond market. A government bond market platforms, and concepts at a single bound. This kind ofserves as a crucial stepping stone to corporate issuance bold change, and the policies that support it, are crucialin several ways. For one, government bonds provide to ensure that emerging markets are able to realize theirvaluable price and yield benchmarks for corporate economic potential and improve the lives of their citizens.debt. Big economies also directly promote the viabilityof corporate bond markets, as their scope allows morecompanies to grow large and flourish.There are considerable barriers to corporate bonddevelopment in emerging economiesDeveloping a corporate debt market is a complex taskrequiring a systematic approach. Initiatives to improveliquidity are required in order to attract a wide range ofinvestors. Several key conditions need to be achieved,including sustained investor demand and bond issuancesupply, strong business and legal environments, and afast and efficient issuance process.The sequential path of development for corporatebond marketsDeveloping a corporate bond market requires asequential approach. Based on our research for thisreport, we have divided the development process intothree distinct phases. Stage 1: Laying the foundation. The marketis very small and unsophisticated. Bond issues andinvestors are few and the sovereign bond market isunderdeveloped. Transactions occur sporadically andusually by private placement. Stage 2: Building scale for corporate bondmarkets. The primary market is sound, with a fairlystable macro-political environment and several high-quality issuers. Stage 3: Enhancing liquidity and deepeningmarkets. An active secondary market is growing. Duringthis phase, primary issuance remains active.Case study highlights: Corporate bond marketsCase studies accompanying this Report documentsuccessful real-world innovations in corporate bondmarket development, including: • Developing multi-stakeholder engagement to support issuance and private placement of bonds in the least developed markets. • Creating investor syndicates to lower issuance costs for large, repeat issuers.xii | Redefining the Emerging Market Opportunity
  11. 11. Part 1Financial ServicesOpportunitiesin Emerging Markets
  12. 12. CHAPTER 1 As wealthier nations emerge from the financial turmoil and economic retrenchment of recent years, they are relying on the developing world to serve as the engineUnleashing Growth of global growth. Emerging economies, despite the turbulence, have managed stronger and more sustainedOpportunities in economic expansion than developed ones. These economies have been bolstered by a record of improvedEmerging Markets financial and fiscal stability. The growing importance of developing economies has led to an increased role for financial institutions in those regions of the world. Both trends are likely to continue. The result is a historic opening to provide new financial services to low-income populations rapidly transitioning to middle-income status, as well as to regional companies evolving to world-class competitors. For financial providers equipped to understand and unlock the potential, there is an unparalleled set of opportunities to build long-term growth and superior shareholder value. The purpose of this Report is to provide a guide to those opportunities as well as a framework for assessing them and taking action. Research has been based on expert interviews and discussions among Forum stakeholders, including global and emerging-market financial institutions, regulators, multilateral organizations, and academics. On that basis, the Report highlights two key themes: • First, the most significant immediate opportunities for financial services firms in emerging markets lie in three specific realms of activity: consumer financial services, financing for small- and medium- size enterprises (SMEs), and corporate bonds. It is there that new financial services will have the largest impact in driving broad economic growth while creating new sources of future value for their own institutions and their shareholders. • Second, the main driver of accelerated success by financial organizations in emerging markets is product and service innovation. Innovation is critical to accelerate progress and expand the market for financial services, through lower barriers to entry, increased productivity, and transformed economics of service delivery. In some cases, as discussed below, innovation must be preceded or accompanied by coordinated, multi-party capacity- building initiatives to lay the groundwork for success. There are many ways for institutions to innovate, and each must find its own. This report highlights a shortlist of proven, creative approaches, accompanied by nearly three dozen real-world case studies and cases-in-point. These are intended to illustrate strategies and initiatives that have transformed unmet emerging-market needs and demands into opportunity and economic progress, as well as challenges encountered along the way. STRONG AND PERSISTENT ECONOMIC GROWTH CREATES A FINANCIAL SERVICES OPPORTUNITY The economic expansion of developing economies has been accompanied by an even faster evolution of financial services in those regions of the world. The key to maximizing that opportunity going forward lies Redefining the Emerging Market Opportunity | 3
  13. 13. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 1: Growth of financial services assets Figure 1a: Banking asset growth Figure 1b: Insurance premium real growth rate 120 20 +9% 100 15 Banking assets (US$ trillions) Real growth rates (percent) 80 10 60 5 40 0 n  Low and Lower middle income EMs –5   Emerging markets 20 n  Upper middle income EMs   Industrialised countries n  High income countries 0 –10 2006 2010 1990 1994 1998 2002 2006 2010Sources: Economic Intelligence Unit, Financial Indicator database (consulted March 14, 2012); Swiss Re, 2011.in understanding the complexities—and occasional The developing world’s economic expansion hascontradictions—of that remarkable expansion. precipitated an even faster growth of financial services. The GDP growth of emerging nations has strongly Emerging countries contributed nearly 40 percent of theoutpaced that of high-income countries from 2006 to global growth of banking assets in absolute terms from2010 (see Figure A1 in appendix). Developing economies 2006 to 2010 (see Figure 1a). This translates to an annualgrew at an annual rate of roughly 15 percent, compared growth rate of more than 20 percent for banking assetswith growth averaging just 3 percent for the developed in emerging markets themselves, compared with a rateworld. In absolute terms, emerging-market economic of just 6 percent in high-income countries. The growth ofexpansion contributed US$8 trillion, or roughly 60 banking assets in emerging markets has outpaced GDPpercent of global GDP growth, during that half-decade. growth there, because of the low initial level of financial In addition to their faster expansion, many emerging development and penetration in many of those markets.markets also demonstrated unprecedented financial The insurance industry also has expanded robustlystability and economic resilience during the two-year in emerging countries since the early 1990s. The growthperiod of turmoil beginning in 2008. While developed of premium income was triple the rate in developednations’ aggregate GDP fell from US$44 trillion in 2008 countries (see Figure 1b), expanding by nearly 10to US$41 trillion in 2009, emerging market output percent annually in real terms over the last two decadesremained constant at US$13 trillion. while growth in high-income markets averaged just That economic performance and financial stability 2-3 percent. In 2010, the contrast was even morehave continued, prompting numerous sovereign credit pronounced: emerging market premiums grew 11rating upgrades of emerging economies since mid- percent, while those in developed countries inched2010. At the same time, recurring financial turmoil has forward an average 1.4 percent.triggered downgrades in the Euro zone. Over the two-year period ending in February 2012, five emerging High growth + high returns = superiorcountries—Brazil, Bulgaria, Colombia, Indonesia, and the shareholder valuePhilippines—received sovereign credit rating upgrades The high-growth, high-return nature of emergingfrom Moody’s Investors Service. The January 2012 markets makes it a valuable area for financial institutionsupgrade for Indonesia returned Southeast Asia’s largest globally to target in order to generate shareholdereconomy to investment grade for the first time since the return. Institutions need to place significant attention onAsian financial crisis 14 years earlier. A sixth developing emerging markets to drive growth, improve profitability,country, Turkey, had its local-currency debt rating raised and generate long-term value.to investment grade by Standard & Poor’s in September The last five years have created tremendous value2011. for financial institutions active and successful in emerging4 | Redefining the Emerging Market Opportunity
  14. 14. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 2: Total shareholder return of global financial institutions, 5-year TSR (2006–2011) 1 Top 30 banks by market First capitalization from emerging quartile markets 150 Top 30 banks by market capitalization from high Second income countries quartile TSR ranking 300 Third quartile 450 Fourth quartile 600 –80 –60 –40 –20 0 20 40 60 Average annual total shareholder return (percent)Sources: Thomson Reuters Datastream (consulted April 2, 2012); BCG analysis.Notes: TSR derived from calendar year data in local currency; Rank (n=582); Median average annual TSR: First quartile, 14.1%, second quartile, 1.6%, third quartile, –8.3%, fourth quartile, –22.7%.markets, where those institutions’ growth in market spread—the difference between return on equity andcapitalization has been concentrated. In high-income cost of equity. Although emerging markets are known tocountries belonging to the Organisation for Economic have higher cost of equity, their significantly higher returnCo-operation and Development (OECD), the market on equity offsets this impact.value of financial institutions sustained a US$1.5 trillion The spread generated by emerging marketdecline from 2006 to 2011. At the same time, in non- institutions is significantly higher than that in developedOECD high-income countries it grew by US$243 billion, markets. More than half of leading developed-marketand in emerging markets, values soared by US$572 institutions operate at a negative overall return spread.billion. By contrast, the majority of such institutions in emerging A five-year total shareholder return (TSR) analysis of markets are operating on positive territory, manyfinancial institutions globally shows a striking contrast in exceeding 5 percent. The higher return spread resultsperformance between institutions in emerging markets in much higher valuation multiples for institutions inand those in developed markets. While the majority of emerging markets.top institutions in emerging markets performed abovethe median level, most of the large financial institutions in Developing markets will continue driving globaldeveloped markets ranked in the bottom half (Figure 2). growth while remaining resilientOf the 30 leading emerging-market banks, 75 percent Developing markets are expected to continue their roleperformed in the TSR ranking’s first quartile—but none of as the engines of global economic growth. In the fivetop 30 developed-market banks did. years through 2015, the International Monetary Fund It is important to understand what drives (IMF) forecasts that emerging-market GDP will grow atshareholder return over the long term. Growth is, by far, around 10 percent annually, compared to 5 percent inthe most important driver of long- term TSR for top- high-income countries (Figure A2). This is equivalent toperforming financial institutions (Figure 3). Changes in roughly 55 percent of global GDP growth in absolutevaluation multiples can also drive value creation in the terms.short to medium term, but the impact is diminished over Financial institutions will need to build capacity andthe longer term. This means institutions must be able to expand their offerings to continue to realize this growthdrive continuous, sustained growth even under uncertain potential, especially since financial services penetrationmacroeconomic conditions. and development remain low in many emerging markets Examples from the banking sector highlight despite recent growth. There is still significant room forthe stark contrast in the valuation of institutions in healthy growth of banking assets, as penetration is stilldeveloped versus emerging markets (Figure 4). This very low (Figure 5a). Seventy-six percent of emergingvaluation premium closely correlates to the overall return markets have a banking asset-to-GDP ratio of less than Redefining the Emerging Market Opportunity | 5
  15. 15. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 3: Sources of value creation for top-quartile global FS performers, 2001-2011 40 n  Change in free cash flow n  Change in multiple (P/E) 30 n  Change in margin (EBITDA) n  Revenue growth Value creation (TSR %) 20 10 0 –10 3 years TSR 5 years TSR 10 years TSRNote: TSR derived from calendar year data in local currency. Sample size are financial institutions from S&P 1200 and top 200 financial institutions by market capitalization as of December 2011.Figure 4: Profitability and valuation of banks 5 Emerging market banks Developed market banks 4 Price-to-Book Value 3 2 1 –15 –12 –9 –6 –3 0 3 6 9 12 15 Return on Equity (ROE)–Cost of Equity (COE) (percent)Sources: Bloomberg (consulted on March 14, 2012); BCG analysis.Note: Data are as of December 2011.6 | Redefining the Emerging Market Opportunity
  16. 16. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 5: Banking penetration and asset growth projection Figure 5a: Banking asset penetration Figure 5b: Banking asset growth estimate 2010 banking penetration(banking assets / GDP) 8 150 Lower middle income 120 6 Upper middle income Banking assets (US$ trillions) High income 90 4 60 2 n  Low and lower middle income EMs 30 n  Upper middle income EMs n  High income countries 0 0 0 25,000 50,000 75,000 100,000 2010 2015 GDP per capita (US dollars)Sources: Economic Intelligence Unit, Financial Indicator database (consulted March 14, 2012); IMF, World Economic Outlook Database, September 2011.Notes: 76% of EMs have penetration under 1.0; 67% of DEs have penetration under, while 67 percent of developed markets have a ratio While this slowdown was largely the result of policyabove 2.0. tightening to cool overheating economies and curb The Economic Intelligence Unit projects that banking inflation, it also reflects weaker exports and reducedassets in emerging markets will continue to grow more capital inflows. Emerging markets as a group still havethan 20 percent annually, compared to 3 percent in high- a high degree of monetary and fiscal firepower at theirincome countries (Figure 5b). This implies that emerging disposal, compared to most high-income countries,markets will contribute to 68 percent of global banking which have little or no room to cut interest rates orasset growth from 2010 to 2015 in absolute terms. increase public borrowing. However, this aggregate The insurance industry has similar potential for picture masks dramatic differences. Some governmentsexpansion. With the exception of South Africa, India, and have much more scope to loosen policy than others.Malaysia, many emerging markets still have relatively The Economist used several key monetary and fiscalundeveloped life insurance business (Figure 6a). indicators to assess 27 emerging economies’ ability toEighty-six percent of emerging markets have premium ease monetary and fiscal policy. The average of thesepenetration less than 2 percent. Similarly, for non-life monetary and fiscal measures is the overall “wiggle-insurance, there is still room to accelerate insurance room index.” China, Indonesia, and Saudi Arabia haveadoption in many emerging markets, as 82 percent of the greatest capacity to use monetary and fiscal policiesemerging markets still have premium penetration of less to support growth and respond to external shocksthan 2 percent (Figure 6b). (Figure 7). Chile, Peru, and Russia are also in a solid position. On the other hand, Egypt, India, and PolandDeveloping countries’ room to maneuver varies have the least room for stimulus. Argentina, Brazil,widely Hungary, Turkey, Pakistan, and Vietnam are also in theDespite some signs of slowing growth due to the recent “red zone.”global economic turmoil, emerging economies willcontinue to have a stronger macroeconomic outlook. The shift in global competition underscores the needHowever, attractiveness will vary significantly across for financial innovationcountries. Over the last five years, there has been a significant shift An assessment by The Economist magazine in in the competitive dynamics of global finance, influencedJanuary 2012 suggests that the downturn in the euro by the rise of global-scale institutions in the emergingzone and the uneven recovery in the United States have markets. The number of emerging-market banks inalready taken their toll on the emerging world. Setting the top 200 tripled from 22 to 66 between 2005 andChina’s economy to one side, the average growth rate in 2011, and now accounts for one-third of leading globalother developing countries is estimated to have slumped institutions (Figure 8). The rise of emerging-marketto an annual rate of less than 3 percent in the fourth competitors is even more striking within the top 100quarter of 2011, from 6.5 percent in the first quarter. Redefining the Emerging Market Opportunity | 7
  17. 17. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 6: Monetary and fiscal policy wiggle room Egypt India Poland Brazil Vietnam Pakistan Turkey Argentina Hungary South Africa Taian Venezuela Czech Republic Mexico Colombia Malaysia Thailand Philippines Hong Kong Peru Russia n  Least flexible (“red zone”) Singapore n  Neutral South Korea n  Most flexible (“green zone”) Chile China Indonesia Saudi Arabia 0 20 40 60 80 100 Room to ease fiscal and monetary policy (minimum flexibility=100)Sources: The Economist, 2012.Figure 7: Number of emerging market banks in top 200 by market capitalization 80 Market Capitalization Rank 70 n  1–50 n  51–100 n  101–150 60 n  151–200 Number of banks 50 40 30 20 10 0 2005 2006 2007 2008 2009 2010 2011Source: Thomson Reuters Datastream (consulted April 2, 2012).Note: Emerging market banks in top 200 tripled their numbers in six years.8 | Redefining the Emerging Market Opportunity
  18. 18. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 8: Appearance of financial development indicators Increasing GDP per capita Foreign Domestic Public debt public public debt debt services Banking Bank Bank Bank Bank deposits wholesale private claims funding credit on FIs Foreign Domestic market Capital Stock market private private debt debt Institutional investor Pension Non-life Life Mutual funds insurance insurance fundsSource: World Bank, 2012.institutions, where the number grew from nine to 33 To win and gain market share, institutions willwithin the same period. need to innovate constantly and identify “white space” In the middle of the 2000s, the emerging-market opportunities to exploit.financial institutions rising into the top ranks of global-market capitalization ranking came mostly from China. Financial institutions must steer clear of potentialMore recently, institutions from Brazil, Chile, Indonesia, macro- and micro-level risksThailand, Malaysia, Turkey, India, and South Africa have Countries need to ensure that they can respond tomade their way up the rank. global shocks, as macroeconomic conditions link closely Despite the attractive opportunities presented by to the health of the financial system. Countries that areemerging markets, competition will get more intense. in the “red zone” in terms of fiscal and monetary wiggleInstitutions will need to continue looking for creative room must manage the risk of future macroeconomicbusiness models to tap a wider range of opportunities. challenges. While government institutions such as theAs later chapters of this report will show, many Reserve Bank of India have sensibly not yet reducedemerging-market institutions have advanced by adopting interest rates in the face of a weakening economy, somehighly innovative approaches in their own markets. They others have ignored the red zone described earlier.can get around infrastructure shortcomings and address Brazil’s central bank has reduced interest rates fourthe local needs and practices of emerging-market times since last August, and it has signaled that morecustomers. They have done this through innovative cuts lie ahead. Such easing will support growth this year,distribution models, risk practices, and partnerships. but at the risk of reigniting inflation in 2013.Some institutions, for example, can effectively disburse On a micro level, there is potential for reducedfinancing to small business customers within 10 minutes returns as markets mature and competition intensifies.through electronic channels and without documentation As mentioned previously, return spread is a key driveror guarantor requirements. In developed markets, such of valuation for financial institutions. The high interesttransactions normally take days and require mailing in margins in emerging markets are expected to go downdocuments. as the market matures and competition intensifies. Redefining the Emerging Market Opportunity | 9
  19. 19. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsAs market penetration increases, net interest margin A World Bank study suggests, on a macro level, that(NIM) tends to go down (Figure A3). However, margin corporate bonds emerge late in the development path.compression will not happen overnight. There is still In typical financial development, government borrowingsignificant room for development before NIM reduction emerges before basic banking services, which emergewill take place, as penetration in many emerging markets before capital markets, as the financial system developsis still low. and income levels rise (Figure 9). Institutional investors Financial providers can also overcome top-line appear at various stages of the process, reflecting policycompression by improving their efficiency to lower costs factors as well as links with other components of theand by diversifying income streams into fee revenues. development process. Pension funds typically emergeIn the early stages of financial development, interest early, before insurance and mutual funds.income dominates a financial institution’s income stream.However, as markets mature and financial activities Consumer financial services: Enabling growth bybecome more diverse, the institution can tap into reducing poverty, unleashing consumptionopportunities from non-interest income, from transaction For emerging markets, increased consumption, includingbusiness and investment banking activities. by lower-income consumers, will be critical in driving Institutions, especially credit providers, will need to economic expansion. As previously discussed, theresecure sufficient capital to continue their growth. While will be significant shifts in global spending over themany emerging markets generate high earnings that can next decade. There is a major opportunity to driverecapitalize them for future growth, external influences, consumption, especially in the lower-income segment, tosuch as pressure for high dividend payouts, can impact produce both economic and social benefits.this ability. In some emerging markets, the banking Obtaining access to financial services and adoptingspace is still dominated by state-owned institutions, disciplined savings habits are both prerequisites forwhich often face government pressure to pay high lower-income consumers to afford more goods anddividends to increase state revenue. Governments must services, including emergency expenses such asbalance fiscal revenue needs with the longer-term impact medicine and home repair. Expanding financial access ison banks’ ability to provide capital to support enterprises also a path for low-income people to escape poverty.and consumers. While there is significant demand for financial Institutions need to be able to expand beyond services, poor communities continue to be underservedcredit revenues. Credit growth should be accompanied by formal institutions. In the portfolio of the poor,by deposit growth in order to ensure sustainable and three key services are greatly in demand but oftenprofitable business. Institutions need to build capability inadequately provided: managing money on a dailyto gather deposits, including unlocking potential from basis, building long-term savings, and borrowing for“under-the-mattress” savings. The compounded effect of various needs.interest-margin reduction, as previously mentioned, will Providing insurance products will also be arequire financial institutions to diversify their sources of significant opportunity, as low-income consumers arerevenue to include fee income. the most susceptible to adverse events. Building a Finally, business environments must be open savings culture is also a requirement for supporting otherto innovation in order for their efforts to succeed. parts of financial system. For example, a savings cultureGovernments and agencies can do their part by is a prerequisite for establishing pension funds andmonitoring policies and adjusting or rejecting those that insurance, which, in turn are required for creating deepcreate market distortions, hampering innovations and capital markets.efficiencies. Policies driven by political decisions, such as Unlocking under-the-mattress savings can benefitinterest rate ceilings, dampen progress in unlocking new the larger financial system by helping governments andopportunities. global organizations deliver benefits and assistance to low-income people. Conversely, as the report will laterProviders should focus on three critical areas of highlight, government-to-person (G2P) payment alsoopportunity: consumer financial services, SME plays an important role in driving financial inclusion.financing, and corporate bonds Lowering the costs of such programs can makeThere are many financial services opportunities in them more effective. In a pilot program in Mexico, aemerging markets. Three of them are particularly critical new payment method for conditional cash transfersto supporting economic growth: consumer financial decreased transaction costs and opportunity costs forservices, financing for SMEs, and corporate bonds. beneficiaries from 30.1 pesos to 0.5 pesos, and from While the first two opportunities are relevant for 16.9 pesos to 2.2 pesos, respectively. This is equivalentmost emerging markets, developing a large and deep to a transaction cost reduction of more than 90 percentcorporate bond market should be the focus of emerging in delivering aid to low-income people.economies at the middle income level and at a moreadvanced stage of financial development. However, SME financing: Battling the credit paradoxas discussed in later chapters, there are opportunities Emerging markets face a credit paradox that hindersto support select corporate bond issuance in less small- and medium-size businesses, as well as theirdeveloped economies. banks: only one-third of SMEs, on average, have access to credit and loans, even though three-quarters of them10 | Redefining the Emerging Market Opportunity
  20. 20. Chapter 1: Unleashing Growth Opportunities in Emerging MarketsFigure 9: Credit demand and constraints across African enterprises 100 n  Received loan n  No credit demand 80 n  Credit constrained 60 Percent 40 20 0 Small enterprise Medium enterprise Large enterpriseSources: IFC, 2010; http://www.enterprisesurveys.org/Data/ExploreTopics/finance.Note: Calculations are based on surveys from Kenya, Madagascar, Senegal and Uganda. Small enterprises have <=25 employees, medium have 26-100, and large have > 100.maintain bank savings and checking accounts. Banks, of formal SMEs in emerging markets do not have accessfor their part, lack sufficient access to shared data—such to formal institutional loans or overdrafts, despite a needas tax records, credit history, and legal status—to risk for these services.lending to many SMEs. As a result, many businesses The finance gap is far larger when considering microlack much-needed cash to grow, while financial and informal enterprises. By that measure, 65-72 percentinstitutions miss the opportunity to tap the huge pool of of all SMEs in emerging markets lack access to credit.potential SME borrowers. The proportional size of the finance gap varies widely SMEs play a major role in economic development across regions and is particularly daunting in Asia andin both emerging and developed economies. SMEs Africa, especially in low-income countries. A World Bankaccount for a significant share of employment and GDP investment climate assessment survey indicates thataround the world, especially when taking into account small enterprises in Africa have much greater difficultythe informal sector. SMEs employ an average of 67 in obtaining credit access than large enterprises. Onlypercent of the formal employment in developed countries 20 percent of small enterprises in Africa get access toand around 45 percent in developing countries (Figure credit, while 41 percent are credit constrained (FigureA4a). They also contribute a sizable share to formal A5).GDP, 49 percent on average in high-income countriesand 29 percent on average in low-income countries, Corporate bonds: A foundation for long-term growthrespectively. The macroeconomic and financial dislocations that While the proportion in developing countries seems followed the crises in emerging markets in the latemodest, the informal sector—most of which comprises 1990s highlighted the importance of developing localSMEs—accounts for up to 48 percent of the total labor bond markets as an alternative source of debt financing.force and 37 percent of GDP in these countries. The Bond markets can strengthen corporate and bankcorresponding proportions for developed countries are restructuring and thus accelerate the resolution of amuch lower, at 25 percent of the total labor force and 16 crisis. At the same time, local bond issues facilitate thepercent of the GDP (Figure A4b). reduction of currency and maturity mismatches on their In addition, SMEs typically contribute more to job balance sheets and thus reduce the vulnerability of thecreation than do large firms, especially in the case of corporate sector.start-up companies. Moreover, a vibrant SME segment Well-functioning local corporate bond markets alsocan help economic development through other provide institutional investors with an instrument thatchannels, such as innovation and competition. Access satisfies their demand for fixed-income assets, especiallyto finance remains a key constraint to SME development of long maturities that match their long-term liabilities,in emerging economies. The International Finance while providing higher yields than government bonds. ForCorporation (IFC) recently estimated that 45-55 percent the same reasons, corporate bonds can also strengthen Redefining the Emerging Market Opportunity | 11